Macro test two

Business Cycle

The cyclical fluctuations in economic variables, particularly real

GDP, that an economy experiences over a short period of time.

Real GDP standard gauge of ?

the business cycle

four main parts to a business cycle

expansion, peak, contraction (recession), and trough

A period of time in which real GDP is growing is an

expansion

When an expansion ends, we call that?

peak

A period of time in which real GDP is shrinking is called

contraction

a contraction that

lasts for two quarters.

recession

When a contraction ends, we call

that

trough

The standard indicator of a recession

two consecutive

quarters of falling real GDP.

Potential workers include everyone in the general

population with three exceptions:

Children under 16 years of age

2 People on active duty in the military

3 People who are institutionalized with restricted

personal mobility

people who

are jobless, have actively looked for a job in the last four

weeks, and are available for work are

unemployed

Labor Force Participation Rate

Labor force participation rate = Labor force / Potential workers × 100

Unemployment Rate

Unemployment rate = Unemployed / Labor force × 100

Employment Rate

Employment rate = Employed / Labor force × 10

he official unemployment rate is

u-3

U-4

total unemployed plus discouraged workers, as a

percent of the civilian labor force plus discouraged

workers

total unemployed, plus all persons marginally

attached to the labor force, plus total employed part

time for economic reasons, as a percent of the civilian

labor force plus all persons marginally attached to the

labor force

u-6

Discouraged Worker

A person who is eligible for employment and is able to work,

but is currently unemployed and has not attempted to find

employment in the last four weeks. Discouraged workers have

usually given up on searching for a job because they found no

suitable employment options and/or were met with lack of

success when applying.

U-4 Unemployment Rate formula

U-4 unemployment rate = Unemployed + Discouraged workers / Labor force + Discouraged workers

Frictional unemployment

results from transitions of

workers and employers or from workers and employers

having inconsistent or incomplete information about

available jobs

Structural unemployment

a persistent mismatch

between available jobs and workers based on skills, wages,

or locations.

Cyclical unemployment

is the deviation from the

natural rate of unemployment following fluctuations in the

business cycle.

Frictional and structural unemployment are always present

in

a healthy economy

natural rate of unemployment

is the

unemployment rate when there is no cyclical

unemployment. The natural rate of unemployment is the

lowest unemployment rate an economy can sustain over

the long run.

Inflation Rate

The percentage change in the price level over some time

period, typically one year.

Inflation Rate

If Pt is the economy’s price level in year t and Pt−1 is the

price level from the previous year, then the inflation rate

πt in year t is:

Negative inflation is called

deflation

price index

is a weighted average of the prices of a given

“market basket” of goods and services over time.

Hyperinflation

Very high and usually accelerating rates of inflation, which

rapidly erodes the real value of a money and causes the

population to minimize their holdings of that money

inflation tax.

inflation serves as a way for government to pay its

debts without raising regular taxes. For this reason, we

refer to this practice as the inflation tax

Shoe-leather costs

are the resources that are wasted

when people change their behavior to hold less money.

These are so-named because people wear out their shoes

by running back and forth to the bank and stores.

Menu costs

are the costs businesses incur by having to

change prices. These get their name because restaurants

have to reprint their menus more often.

Stagflation

occurs when unemployment

and inflation are both high or rising at the same time.

Sticky prices

occur

when prices do not quickly adjust to changing market

circumstances.

short run Phillips curve

downward sloping,

showing the short run tradeoff between inflation and

unemployment

long run Phillips curve

vertical over the natural

rate of unemployment, showing no tradeoff between

inflation and unemployment.

international trade

the trade of goods and services

across national boundaries.

Protectionism

the use of policies such as tariffs,

quotas, or other regulations to shield domestic industries,

firms, or workers from foreign competition.

tariff

is a tax on imports.

Price elasticity of demand/supply

is a measure of how

sensitive quantities bought/sold are to changes in the

price

quota

a legal limit on the amount of a good that can

be imported from particular countries or in general.

Because quotas limit the quantity of trade, they tend to

result in higher prices for consumers.

In general, economists support the limited use of

protectionism

Some of the standard arguments for protectionism are

National security

Dumping

Infant industries

Currency manipulation

Dumping

occurs when firms sell goods in foreign markets

below cost or domestic prices in order to gain market

share

Dumping is considered

predatory behavior. In theory, by

charging very low prices for goods, a foreign company can

run domestic competitors out of business to increase their

monopoly power

his would lead to the usual problems of monopoly:

reduced quantity, higher prices, less consumer choice, and

deadweight loss

exchange rate

The rate at which one money exchanges for another in the

open market is called an exchange rate.

there are three basic types of exchange rates

Fixed

Floating

Managed

fixed exchange rate

occurs when one country changes

at a constant rate for another currency until the

government changes the exchange rate.

floating exchange rate system

the supply

and demand for a currency determines its value.

The relative values of two different currencies determine

the rate at which they will exchange for one another in a

floating exchange rate system.

managed exchange rate system

a sort of hybrid of

the two other systems.

While exchange rates can adjust with a managed system

(i.e. they aren’t fixed), a country’s government limits the

values that exchange rates may take or influences them in

a particular direction.

currency manipulation

hat is, a country may adjust its exchange rate by

supplying more or less currency to currency exchange

markets. When this is done in a predatory way, it may be

called currency manipulation.

current account

the sum of that nation’s

net exports, net factor payments from abroad, and net

transfers from abroad

Net exports

payments from abroad for exports -

payments to foreigners for imports.

Net factor payments

factor payments from abroad -

factor payments to foreigners.

Net transfers from abroad

transfers from abroad -

transfers to foreigners

capital account

the increase in domestic assets

held by foreigners - increase in foreign assets held

domestically.

balance of payments

is the sum of all the

financial transactions that take place between its residents

and the residents of foreign nations.

In other words, the balance of payments is equal to the

sum of the current and capital accounts. It’s said to

“balance” because:

Current Account Value + Capital Account Value = 0

Business cycle theory

seeks to explain the causes and

effects of the short run cyclical fluctuations in real GDP

(i.e. the business cycle).

Keynes argues

short run fluctuations in the

economy will depend on the economy’s spending, i.e.

aggregate expenditure. This model led to the oft-repeated

idea that spending drives the economy.

The aggregate expenditure or economy’s demand Z is

thus

Z = C + I + G + X − M

economy is closed

That is, there are no exports and no

imports:

Xn = X = M = 0

Therefore, Xn drops out of the demand for our economy’s

goods and services and we’re left with:

Z = C + I + G

C depends primarily on

the disposable income YD of consumers. That is,

consumption is an increasing function of disposable

income:

C = C (YD )

consumption is a linear

function of two parameters

c0 and c1.

c0 is the amount consumers would spend in a year if their

disposable income were 0

c1 is the percentage of an additional dollar of disposable

income that gets spent on consumption goods. This is

known as the marginal propensity to consume (MPC ).

marginal propensity to consume (MPC ).

c1 is the percentage of an additional dollar of disposable

income that gets spent on consumption goods

consumption function as:

C = c0 + c1YD

define disposable income

YD ≡ Y − T ,

where Y is national income or output and T is net taxes.

Net taxes are simply the taxes collected by government

less any government transfers paid to consumers.

replace YD in equation 2 to obtain

C = c0 + c1(Y − T )

This suggests that income has a positive effect on

consumption spending, whereas taxes have a negative

effect.

exogenous

we will assume

that investment spending is given or fixed. Another term

for a variable that is to be taken as given from outside a

model is exogenous. Thus, I is exogenous in this model.

The final component of demand Z in our closed economy

is government purchases G .

Government spending generally depends on the state of

the economy, foreign affairs, and the political makeup of

governments. Though we primarily think of the federal

government’s contribution to G , this category also

includes state and local government spending.

For simplicity, we will assume G is also given or

exogenous

overall demand Z :

Z = co + c1(YD ) + I + G

equilibrium when

demand equals output, i.e

where Z = Y

If Z < Y

inventories rise and firms lay off workers and

cut production. If Z > Y , inventories fall and firms hire

workers and increase production.

in equilibrium, we have that:

Y = c0 + c1(Y − T ) + I + G

To find equilibrium output,

we need to solve for Y

o start, we can distribute the c1 in 5 to obtain:

Y = c0 + c1Y − c1T + I + G

Moving c1Y to the left, we have:

Y − c1Y = c0 + I + G − c1T