Midterm #1 Exam

Gross Domestic Product (GDP)

Market value of all final goods and services produced within a country in a given time period

Final Good

A good or service purchased by its final user, not used as input for further production.

Intermediate Good

A product used to produce a final good or service; excluded from GDP to avoid double-counting.

Nominal GDP

GDP measured at current-year prices, reflecting both price and quantity changes.

Real GDP

GDP measured in base year prices to remove the effects of inflation

Base year

the reference year whose prices are used to calculate real GDP

GDP Deflator

 (Nominal GDP / Real GDP) x 100 - measures overall price changes for all final goods and services in GDP

Gross Investment

Total spending on new capital plus replacement of depreciated capital

Net Investment

Gross investment minus depreciation

Depreciation

Loss of value of capital due to wear, tear, or obsolescence

Exchange Rate

Price of one country’s currency expressed in terms of another’s

Purchasing Power Parity (PPP)

Adjustment of GDP figures to account for cost of living differences across countries.

GDP Per Capita

Real GDP divided by population; approximate measure of average living standard

Gross National Product (GNP)

Market value of goods and services produced by a nation’s residents, regardless of location

Net National Product (NNP)

GNP minus depreciation

Aggregate Demand

Total Demand for all goods and services in an economy

Aggregate Supply

Total supply of goods and services that firms plan to sell at each price level.

Fiscal Policy

Government spending and taxation decisions to influence the economy.

Monetary Policy

Central bank actions affecting money supply and interest rates

Business Cycle

Fluctuations in economic activity: expansion, peak, recession, trough

Recession

significant decline in national output (real GDP) lasting at least a few months.

Depression

Severe and prolonged economic downturn

Trade Balance

Exports minus imports (X - M)

Trade Surplus

Exports exceed imports

Trade Deficit

Imports Exceed exports

Factor Incomes

wages, profit, rent, and interest paid for the use of production factors

Indirect Taxes

Taxes such as sales or excise taxes added to market prices

Subsidies

Government payments to businesses that offset costs or support production

GDP = _____ + _______ + ________ + (______ - _______)

Consumption + Investment + Government + (exports - imports)

The process of converting nominal GDP into real GDP uses a _______ year and a _______.

Base, price index

The GDP deflator equals (_______/ ________) x 100

Nomial GDP / Real GDP

a significant decline in GDP is called a _________, while a deeper and longer one is ________

Recession, depression

GDP per capita is calculated by dividing ______ by _______.

Real GDP; population

_________ policy refers to changes in government spending and taxation while _______ policy refers to central-bank actions.

Fiscal; monetary

Net investment equals gross investment minus __________

depreciation

PPP adjustments account for differences in ________ levels across countries.

price or cost-of-living

Price level

the average level of prices and the value of money

inflation

a persistently rising price level

deflation

a persistently falling price level

Why are inflation and deflation problems?

unpredictable inflation or deflation is a problem because it

1) redistributes income

2) redistributes wealth

3) lowers real GDP and employment

4) diverts resources from production

Why is a high inflation rate a problem?

it diverts resources from productive activities to inflation forecasting

Hyperinflation

an inflation rate so rapid that workers are paid twice a day because money loses its value so quickly

market basket

a list of specific goods and services in fixed quantities.

• items typically purchased by individuals

• keeping the quantities of each item constant ensures that changes only reflect price changes

price index

measure showing how much the cost of a market basket has changed relative to the cost in a base time period or location.

• base year index equalized to 100

Consumer price index (CPI)

a measure that tracks changes in the cost of a basket of goods and services purchased by a typical US household.

• most commonly used index tool for tracking changes in the cost of living in the US

• the CPI is tracked by the Bureau of Labor Statistics (BLS)

How do you measure Consumer Price Index (CPI)?

CPI = (cost of base - year basket in desired year prices / cost of base - year basket in base year prices) x 100

What are the two challenges in measuring price changes?

1. Deciding which goods should go into the market basket

2. The basket of goods remains fixed even if consumers substitute between similar goods.

Many economic variables give an incomplete picture when expressed in __________, as their _________ may be different over time.

nominal terns, real value

Price indices transform ______ into ________

nominal values, real values

headline inflation

measures price changes for the entire market basket

core inflation

measures price changes with food and energy costs removed

• energy and food prices fluctuate often, which could over or understate the real change in overall prices.

producer price index (PPI)

measures the prices of goods and services purchased by firms

GDP deflator

measures the prices of goods and services produced in the country.

the CPI or another price index can be used to _______ nominal values into real values

deflate

Which is the equation to convert nominal value into real value?

Real Value(year Y) = Nominal Value(year x) x (CPI year y/ CPI year x)

Indexing

a practice of automatically increasing payments in proportion to the cost of living.

• these payments are often referred to as “cost of living adjustments”

Adjusting for inflation: minimun wage

• the nominal minimum wage has steadily increased since the 1940s

• the real value has fluctuated as congress has adjusted the nominal value to try to keep up with inflation

Why does PPP almost never hold?

• transaction costs

• non-tradables

• trade restrictions

Purchasing power indexes (PPIs)

Help describe differences in prices across locations.

How do you develop a purchasing power index?

1. Find a market basket of goods and services to compare across countries

2. Measure the price of the goods in each country

3. Calculate the cost of purchasing the basket in each country

4. Build an index showing how much the basket costs in each country relative to some base

PPP adjustment

recalculates economic statistics to account for differences in price levels across countries

PPP adjustment equation to compare GDP across countries:

Nominal dollars country A x 1/ (1-price level adjustment country A)

employed

currently working for pay

unemployed

out of work and actively looking for a job

out of the labor force

those who are not working and not looking for work, whether they want employment or not

labor force

the number of employed plus the unemployed

unemployment rate

the percentage of adults who are in the labor force and thus seeking jobs, but do not have jobs

Calculate unemployment rate

unemployment rate = (unemployed people / total labor force) x 100

What is the most costly unemployment?

long term unemployment that results from job loss

hidden unemployment

people who are mislabeled in the categorization of employed, unemployed, or out of the labor force

• this can also include part time or temporary workers looking for full time, underemployed, and discouraged workers

underemployed

individuals who are employed in a job that is below their skills

discouraged workers 

those who have stopped looking for employment due to the lack of suitable positions available 

Labor force participation rate

the percentage of adults in an economy who are either employed or who are unemployed and looking for a job

How do you calculate the labor force participation rate?

total labor force / total adult population x 100

employment to population ratio

the percentage of the working age population who have jobs.

employment to population ratio =

(employment / total adult population) x 100

What causes changes in unemployment over the short run?

cyclical unemployment

cyclical unemployment

unemployment closely tied to the business cycle, like higher unemployment during a recession

Why might wages be sticky downward?

implicit contract, efficiency wage theory, and adverse selection of wage cuts argument, insider-outsider model, and relative wage coordination argument

implicit contract

an unwritten agreement in the labor market that the employer will try to keep wages from falling when the economy is weak or the business is having trouble, and the employee will not expect huge salary increases when the economy or the business is strong

efficiency wage theory

the theory that the productivity of workers, either individually or as a group, will increase if the employer pays them more

adverse selection of wage cuts argument

if employers reduce wages for all workers, the best will leave

insider outsider model

those already working for the firm are insiders who know the procedures; the other workers are outsiders who are recent or prospective hires.

Relative wage coordination argument

across the board wage cuts are hard for an economy to implement, and workers fight against them.

Rising wage and low unemployment: Where is the unemployment in supply and demand?

a) in a labor market where wage are able to rise, an increase in the demand for labor from D0 to D1 leads to an increase in equilibrium quantity of labor hired from Q0 to Q1 and a rise in the equilibrium wage from W0 to W1. 

b) in a labor market where wages do not decline, a fall in the demand for labor from D0 to D1 leads to a decline in the quantity of labor demanded at the original wage (W0) from Q0 to Q2. These workers will want to work at the prevailing wage W0, but will not be able to find jobs

Natural rate of unemployment

the unemployment rate that would exist in a growing and healthy economy from the combination of economic, social, and political factors that exist at a given time.

frictional unemployment

unemployment that occurs as workers move between jobs

structural unemployment

unemployment that occurs because individuals lack skills valued by employers

productivity shifts and the natural rate of unemployment

• the rate of productivity increase has been zero for a time, so employers and workers have come to accept the equilibrium wage level (W)

• then productivity increases unexpectedly, shifting demand for labor from D0 to D1

• at the wage (W), this means that the quantity demanded of labor exceeds the quantity supplied, and with job offers plentiful, the unemployment rate will be low.

Public policy and the natural rate of unemployment

on the demand side of the labor market some public policies can affect the willingness of firms to hire:

• government rules

• social institutions

• presence of unions 

Economic growth

measures how real GDP per capita grows over time

What explains differences in living standards across countries?

Differences in historical growth rates of real GDP per capita

What is the formula for future GDP given a growth rate?

GDP1 x (1 + growth rate)^n = GDP2

What does the Rule of 70 tell us?

the number of years for a variable to double = 70 / annual growth rate

Why is sustained growth powerful?

Even small annual increases compound into huge gains in living standards over time.

What is the Malthusian cycle?

Rising income —> Higher fertility —> Population growth —> lower income per capita (return to subsistence)

How did societies escape the Malthusian cycle?

through technological progress (Industrial Revolution) and demographic transition (lower fertility)

What was the Industrial Revolution?

Widespread use of power-driven machinery and major social/economic changes starting in the early 1800s

What period marks modern economic growth?

from about 1870 onward — sustained increases in living standards due to rapid innovation

What is sustained growth?

positive and steady growth maintained over long periods (50-200 years)

What is catch up growth?

When poorer nations grow faster by adopting rich nation’s technology