ECO 222 Exam 1

Scarcity

The limited nature of society’s resources

Economics

The study of how society manages its scarce resources

Opportunity cost of an item

Whatever must be given up to obtain it

Circular Flow Diagram

Illustrates the movement of goods and services between households and firms, as well as the flow of income and expenditure

GDP Approach

GDP = C (consumption) + I (investment) + G (government spending) + NX (net exports = exports - imports)

C (consumption)

Spending by households on goods and services, except new housing

I (investment)

Includes business spending on physical capital (machinery, buildings)

G (government purchases)

Spending on goods and services by local, state, and federal governments

NX (net exports)

The value of a nation’s exports minus the value of its importsR

Nominal GDP

The production of goods and services valued at current prices

– Not corrected for inflation

Real GDP

The production of goods and services valued at constant prices

(base year)

– Is corrected for inflation

GDP Inflation Rate

Measures the change in real GDP from one period to another

GDP Deflator Formula

GDP Deflator = (Nominal GDP/Real GDP) x 100

GDP Inflation Rate Formula

GDP Inflation Rate = (GDP Deflator Year 2 - GDP Deflator Year 1/GDP Deflator Year 1) x 100

Consumer Price Index (CPI)

Measures the overall level of prices faced by a typical consumer (cost of goods and services bought by a typical consumer)

CPI Formula

CPI = (Price of basket in current year / price of basket in base year) x 100

Inflation Rate

Measures the percentage increase in the CPI from one period to another

Problems with CPI

Over time, some prices rise faster than others

– Consumers substitute toward goods that become relatively

cheaper, mitigating the effects of price increases.

– The CPI misses this substitution because it uses a fixed

basket of goods.

– Thus, the CPI overstates increases in the cost of living

Indexation

The automatic correction by law or contract of a dollar amount for the effects of inflation

Productivity Y/L

The efficiency with which goods and services are produced, often measured as output per worker or per hour worked

Productivity Formula

Productivity = Output/Input (hours worked)La

Labor

The human effort, both physical and intellectual, used in the production of goods and services

Physical Capital K

Tangible assets like machinery, buildings, and infrastructure that are used in production

Human Capital H

The knowledge, skills, and education that workers acquire, which can increase productivity

Natural Resources N

The raw materials provided by nature that are used in the production of goods and services

Technical Knowledge A

Society’s understanding of the best ways to produce goods and services

Production Function

Y = A x F (L, K, H, N)

Economic Growth

Refers to the increase in a country’s output (real GDP) over time

What does higher productivity lead to?

Higher real GDP per capita, improving living standards