ECON 2105 Midterm ch 4-6 Ward

GDP (Gross Domestic Product)

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

• most common way of measuring how productive a country is and therefore how wealthy it is.

Market values

the prices at which items are traded in markets (Price1 x Q1) + (P2 x Q2) = total market value

Final Good

an item that is bought by its final user during a specified time period

• Only the value of final goods count toward GDP.

Intermediate good

an item that is produced by one firm, bought by another firm, and used as a component of a final good or service

Produced within a country

(domestic) - goods produced within the US count toward GDP of US or goods produced within Mexico count toward GDP of Mexico

Produced in a given time period

to measure GDP we need to pick a time period and measure goods produced only during that period - either Quarter - year (quarterly GDP) or a year (annual GDP)

Expenditures

payments that go through goods markets toward firms.

There are 4 types: consumption expenditure, investment, government expenditure, and net exports. (shown in red)

consumption expenditure

payments from households to firms

• largest component of GDP

• denoted as C

Investment

payments from firms to firms

example: UPS buys a new delivery van

• denoted as I

Depreciation

is the decrease in the value of a firm’s capital that results from wear and tear and obsolescence.

• due to depreciation, there are 2 different ways to measure investment (net and gross investment)

Gross investment

is the total amount spent on both new capital and replacement capital

Net investment

is the increase in the value of capital.

Gross investment - Depreciation = Net investment

Government Expenditure

Payments from governments to firms

• include purchases that gov makes (roads, tanks, buildings)

! does not include taxes

• denoted as G

Net exports

Payments from the rest of the world to US firms

• net exports = X (exports) - M (imports)

Exports

are the things we sell to the rest of the world.

• denoted as X

Imports

are the things we buy from the rest of the world

• denoted as M

Export MORE than we import

net exports are positive

• payments flowing into the US overall

Export LESS than we import

Net exports are negative

• payments are flowing out of the US overall

income

Payment flows from firms through factor markets to households

• most income is wages

• denoted as Y

Two ways to measure the value of everything produced

1. Add up all the payments for the final goods “Expenditure approach”

2. Add up all the income that households get from producing those goods “Income approach”

Aggregate expenditure =

C + I + G + X – M ( consumption expenditure + investment + government expenditure + exports - imports)

Aggregate Income =

Y (income)

GDP =

Y = C + I + G + X - M ( Aggregate income = Aggregate expenditure)

meaning - GDP = Aggregate expenditure = Aggregate Income or vice versa

Nominal GDP

is the value of final goods and services produced in a given year when valued at the prices of THAT year

Real GDP

is the value of final goods and services produced in a given year when valued at the prices of a reference BASE year

• tracks the changes in total production of an entire country over time

Real GDP per person =

Real GDP / population

Potential GDP

The highest level of GDP that is sustainable in the long run, given the factors of production that are available.

• the maximum level of real GDP that can be produced while avoiding shortages of​ labor, capital,​ land, and entrepreneurial ability that would bring rising inflation

Fluctuations follow a common pattern called

the business cycle

The Business Cycle pattern

1. Expansion: Real GDP increases

2. Peak: Real GDP hits a temporary high point!

3. Recession: Real GDP decreases

4. Trough: Real GDP reaches a temporary low point

• Then we start over again with expansion.

• Expansions are usually bigger and longer than recessions, so real GDP grows over time.

remember! expansion > peak > recession > trough

Business cycle’s timing is

not predictable

Household production

Productive activities that are never traded on the market

• not counted in GDP

• Result: GDP underestimates total production  

Underground economic activity

Goods and services that are paid for but that aren’t observed by the government 

Leisure

Activities that people do for fun, rather than to produce something 

• Does not count toward real GDP  

• A country where people vacation a lot will probably have LOWER GDP 

Environmental Quality

clean air, clean water, etc is valuable but does not factor into real GDP.  

expenditure approach to measuring GDP

The expenditure approach to measuring GDP sums together consumption​ expenditure, investment, government expenditure on goods and​ services, and net​ exports

The largest component in expenditure approach

consumption expenditure

income approach

we sum together compensation of​ employees, other factor​ incomes, indirect taxes less​ subsidies, and depreciation

hyperinflation

an inflation rate of 50 percent a month or higher that grinds the economy to a halt and causes a society to collapse 

• inflation ≥ 50 percent a month

Consumer Price Index (CPI) 

An index that measures the average of prices paid by urban consumers for a fixed basket of consumer goods and services 

• The CPI is designed to compare current prices to average prices from a specified date in the past.

CPI =

Cost of CPI basket at current prices   × 100 

Cost of CPI basket at base period prices  

CPI inflation rate

measures the percentage change in the price level of a basket of consumer goods and services over time, reflecting the cost of living and inflation trends

CPI inflation rate =

CPI this year – CPI last year  × 100 

CPI last year 

core inflation rate

the rate increase in the Personal Consumption Expenditures Price Index (PCEPI) excluding food and fuel.

• serves as a crucial operational guide for the Federal Reserve in assessing inflation trends

real wage rate =

nominal wage x 100

price level

unemployment rate =

Number of people unemployed × 100

Number of people in the labor force

labor force =

[Number of people employed] + [Number of people unemployed]

employment to population ratio =

Number of people employed × 100

Working age population

labor force participation rate =

Labor force × 100

Working age population

discouraged worker

A marginally attached worker who has stopped looking for a job because of repeated failure to find one

frictional unemployment

The portion of unemployment that comes from normal labor turnover

• finding a first job

• Switching jobs

• Someone retires and someone else takes their place

Structural unemployment

the portion of unemployment that’s due to changes in the skills needed to perform jobs or changes in the locations of jobs.

• usually lasts longer than frictional unemployment

cyclical unemployment

The changes in unemployment due to fluctuations in the business cycle

• During an expansion, cyclical unemployment shrinks.

• During a recession, cyclical unemployment grows.

out put gap

difference between real GDP and potential GDP

price level

average level of prices for all goods

inflation

a persistently rising price level

deflation

A persistently falling price level

What do unexpected inflation and deflation do?

• redistribute wealth

• lower real gdp and employment

• divert resources away from production

unexpected inflation >

borrower wins

unexpected deflation >

lender wins

majority of US income is?

wages

working age population

the total population but the people under 16 or living in an an “institution” (hospital, jail, nursing facility, etc.)

labor force

people who can work and are either working or trying to find work

unemployed

those who are in the labor force but do not have a job

growth rate in xx =

Value of XX in current year − Value of XX in previous year x 100

Value of XX in previous year

growth rate in real GDP =

Real GDP in current year − Real GDP in previous year × 100

Real GDP in previous year

Real GDP tells us

how productive the entire country is

Real GDP per person tells us

how high the average standard of living is

growth rate of real GDP per person =

Growth rate of real GDP – Growth rate of population

Economic growth

The expansion of production possibilities

Rule of 70

A rule that states that the number of years it takes for the level of any variable to double is approximately 70 divided by the annual percentage growth rate of the variable.

• If a variable grows at X% each year, it will take about 70/X years for the variable to double.

Aggregate Production Function

• X-axis: Quantity of labor (hours per year)

• Y-axis: Real GDP

• “If people in this economy work a total of X hours this year, what will be the resulting value Y of real GDP?”

• More labor hours → More real GDP

Aggregate Labor Market

• Just a graph of the supply and demand for labor.

• X-axis: Quantity of labor (hours per year) in total for the country

• Y-axis: Price of one hour of labor (“real wage rate”)

when we are at full employment, then

real GDP = potential GDP

two key forces that can make potential GDP grow

1. growth of supply of labor

2. growth of labor productivity

quantity of labor

total number of hours worked in the economy

quantity of labor changes if any of these changes:

1. Average hours per worker

2. Employment-to-population ratio

3. Working-age population

to illustrate an INCREASE in the supply of labor,

we go to the aggregate labor market graph, and shift the labor supply curve to the right

labor productivity =

Real GDP / total labor hours

if a country wants to have labor productivity growth, it needs 4 preconditions

1. firms

2. markets

3. property rights

4. money

once a country has preconditions to grow labor productivity, the pace of growth depends on THREE variables

1. Physical capital growth (more machines and tools)

2. Human capital growth (more knowledge and expertise)

3. Technological advances (better ideas and new ways of doing things)

which of the three variables has made the greatest contribution to labor productivity growth?

Technological change

classical growth theory

a theory of economic growth based on the view that the growth of real GDP per person is temporary and that when it rises above subsistence level, a population explosion eventually brings it back to subsistence level

• Thomas Malthus created it so it is also called Malthusian Theory

neoclassical growth theory

a theory of economic growth that proposed that real gdp per person grows because technological change induces an amount of saving and investment that makes capital per hour of labor grow

new growth theory

a theory of economic growth based on the idea that real GDP per person grows because of the choices that people make in the pursuit of profit and that growth will persist indefinitely.

growth rate

is the annual percentage change of a variable - the change in the level expressed as a percentage of the initial level

Growth rate of population

Population in current year − Population in previous year × 100

Population in previous year

Why does GDP equal aggregate income and also equal aggregate​ expenditure?

GDP equals aggregate income and also equals aggregate expenditure because​ _______.

firms pay out as incomes​ (aggregate income) everything they receive from the sale of their output​ (aggregate expenditure)

An intermediate good is​ _______.

An example of an intermediate good is​ _______.

an item that is produced by one​ firm, bought by another​ firm, and used as a component of a final good or​ service

wheat sold to a baker to make bread

A final good is​ _______.

An example of a final good is​ _______.

an item that is bought by its final user during a specified time​ period

• bread sold to a consumer

The firm that printed your textbook bought the paper from XYZ Paper Mills.

Was this purchase of paper part of​ GDP? If​ not, how does the value of the paper get counted in​ GDP?

This purchase of paper​ _______ part of GDP because the paper is​ _______ good.

is​ not; an intermediate

The value of the paper is counted in GDP as​ _______.

part of the value of the textbook

Question content area

Part 1

Classify each of the following items as a final good or service or an intermediate good or service and identify which is a component of consumption​ expenditure, investment, or government expenditure on goods and​ services:

  

Item 1. Cheese bought by Domino's

Item 2. The purchase of a new security system for Congress

Item 3. The ringtone you bought today

Item 4. A new apartment building

Item 1 is​ _______ and item 2 is​ _______.

an intermediate good​;

a final good which is government expenditure

Classify each of the following items as a final good or service or an intermediate good or service and identify which is a component of consumption​ expenditure, investment, or government expenditure on goods and​ services:

  

Item 1. Cheese bought by Domino's

Item 2. The purchase of a new security system for Congress

Item 3. The ringtone you bought today

Item 4. A new apartment building

Item 3 is​ _______ and item 4 is​ _______.

a final good that is consumption expenditure​;

a final good that is investment