GDP, Inflation, Unemployment, and Production Growth Vocab

Microeconomics

the study of how individual households and firms make decisions and how they interact with one another in markets

Macroeconomics

the study of the economy as a whole (goal being to explain the changes that affect many households, firms, and markets simultaneously)

Circular

flow diagram

Firm

an organization that produces goods and services for sale (remember, though, that a firm also is a buyer of the factors of production

Household

a person or a group of people who share income (remember that households are buyers in the product markets and sellers in the factor markets)

Factors of Production

the inputs used to produce goods and services (also known as resources…they include land, labor, capital and entrepreneurship)

Labor (L)

the effort that workers put forth towards the production of a good or service (one of the factors of production)

Wages

compensation to households in exchange for their labor (wages, salaries, fringe benefits, social security contributions, health plans, retirement plans)

Physical capital (K)

machinery, tools, equipment, and buildings (plants or facilities) that humans use to produce goods and services (one of the factors of production…in most instances, physical capital will just be referred to as capital)

Interest

payments to households in exchange for their financial capital resources (interest earned on a savings account, money market account, etc)

Land

any natural resource used to produce goods and services

Rent

income of property owners (payments households receive for the use of land that they own)

Entrepreneurship

the special collection of skills possessed by an entrepreneur

Profits

income earned by households in exchange for their entrepreneurship (profits can be earned by households who directly own and operate a business (proprietor’s income) or they can be earned by households who indirectly own businesses (a household owns shares of stock in a corporation and the corporation has earned profits that it either shares with stockholders or reinvests)

Leakage (from the circular flow of spending and income)

a diversion of funds from spending and earning activities (examples include savings, taxes, and BUYING IMPORTS)

Factor markets (resource markets)

markets in which firms buy the resources they need to produce goods and services

Markets for goods and services (product markets)

markets in which households buy final goods and services from firms

Gross domestic product

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

Expenditure approach (to national income accounting)

calculating GDP as the sum of total spending on final goods and services produced (C + G + I + NX)

Factor income approach (to national income accounting)

calculating GDP as the sum of total factor income earned by households operating in a particular country (rent + wages + interest + profits)

Value added approach (to national income accounting)

calculating GDP by finding the difference between the value of final sales and the value of the inputs purchased from other businesses (count up all the parts)

Intermediate good or service

goods and services bought by one firm from another firm that are inputs for production of final goods and services (intermediate goods are excluded from GDP calculations…we don’t count the parts and the whole, we just count the whole…otherwise we would be double counting…for example, if a new car is produced and sold for $20,000 to a household, we only count the car’s sale price ($20,000)..we don’t add the value of the tires, the windows, the bumpers, the back

Final good or service

goods and services sold to the final, or end, user

Double counting

the mistake of including the value of intermediate stages of production in gross domestic product (GDP) on top of the value of the final good

Domestically produced

production happens within a country’s borders (with GDP we care only about WHERE THE GOOD IS PRODUCED…if a good is produced within the US borders, it counts towards US GDP, regardless of whether or not the producer is an American )

Consumption (consumer spending or C)

spending by households on goods and services, with the exception of purchases of new housing (construction of new housing goes in Investment spending

Disposable income

the total income households have left after paying taxes and receiving government transfers (consumers use disposable income to consume…whatever disposable income they don’t use for consumption goes into their savings)

Financial asset

a paper claim that entitles the buyer to future income from the seller. Loans, stocks, bonds, and bank deposits are types of financial assets. (purchases of financial assets (stocks, for example) are NOT counted towards GDP…no good or service is being purchased so the transaction doesn’t count towards GDP)

Investment (investment spending or I)

spending on capital equipment, inventories, and structures, including household purchases of NEW housing (newly constructed homes are the one household purchase that goes in the investment spending category as opposed to consumption)

Inventories

stocks of goods and raw materials held to satisfy future sales (goods that are produced but not yet sold…additions to inventories ARE ADDED TO GDP…with GDP we are measuring production…so we don’t care if a good is not yet consumed…if it is produced in 2016, it is counted towards 2016 GDP, even if it doesn’t sell until 2017…additions to inventory are counted as INVESTMENT spending)

Inventory investment

the value of the change in total inventories held in the economy during a given period. Unlike other types of investment spending, inventory investment can be negative if inventories fall (inventory investment counts towards GDP…it adds to it if it is positive and takes away from it if it is negative…INVENTORIES BUILDING UP CAN BE A SIGN OF A RECESSION ON THE HORIZON…if a lot of goods are being produced but not sold, that will result in fewer new orders (meaning falling future production)…when new orders drop, unemployment rises and a recession may occur)

Government purchases (government spending or G)

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

Transfer payments

a government payment to an individual or a family (with no good or service provided in return…transfer payments are NOT counted towards GDP because no good or service is produced)

Closed economy

a model that assumes there is no foreign sector (no exports or imports)

Exports

goods and services SOLD TO other countries

Imports

goods and services BOUGHT FROM other countries

Net exports (NX or XN)

spending on domestically produced goods by foreigners (exports) minus spending on foreign goods by domestic residents (imports)

Aggregation

the process of summing the microeconomic activity of households and firms intro a macro measure of economic activity

Secondhand sales

final goods and services that are resold (excluded from GDP because of NO NEW production)

Nonmarket transactions

household work or do

Underground/shadow economy

the unreported or illegal activity, bartering, or informal exchange of cash for goods and services that will not be reported in official tabulations of gross domestic product

Aggregate spending (GDP)

the sum of all spending from four sectors of the economy

Aggregate income

the sum of all income by suppliers of resources in the economy

Income

Expenditure Identity

Real GDP (rGDP or GDPR)

the value of the production of goods and services when adjusted for inflation (…also the production of goods and services valued at constant prices)

Actual GDP

the actual value of goods and services when adjusted for inflation (actual GDP can differ from potential GDP…we can be underperforming currently (actual GDP is less than potential) or overheating currently (actual GDP is beyond potential)

Potential GDP (Natural rate of output)

the value of goods and services that would be produced if the economy was at full

Nominal GDP (nGDP or GDPN)

the value of the production of goods and services unadjusted for inflation (…also the production of goods and services valued at current year prices)

Inflation

a situation in which the economy’s overall price level is rising

Inflation rate

the percentage change in some measure of the price level from one period to the next ( (Δ in price index) / start value) x 100)…((price index year2 – price index year 1) / price index year 1) x 100

GDP deflator

a measure of the price level calculated as the ratio of nGDP to rGDP times 100 ((nGDP/rGDP) x 100)

Base year

the year that serves as a reference point for constructing a price index and comparing real values over time

Price index

a measure of overall price level (a measure of the cost of purchasing a given market basket in a given year, where that cost is normalized so that it is equal to 100 in the selected base year)

Market basket

a collection of goods and services used to represent what is consumed in the economy

Aggregate price level

a measure of the overall level of prices in the economy

Consumer price index (CPI)

measures the cost of the market basket of a typical urban American family

Producer price index (PPI)

measures the changes in prices of goods purchased by producers

GDP per capita

GDP divided by the size of the population

Gross national product (GNP)

the total income earned by a nation’s permanent residents (we care about where your permanent residency is not where the production occurs)

Real GDP (rGDP or GDPR)

the value of the production of goods and services when adjusted for inflation (…also the production of goods and services valued at constant prices…if calculating rGDP for 2013 and the base year is 2010, then you multiple 2013 output levels x 2010 prices)

Nominal GDP (nGDP or GDPN)

the value of the production of goods and services unadjusted for inflation (…also the production of goods and services valued at current year prices…to calculate 2012 nGDP we take output levels for 2012 x 2012 prices)

Inflation

a situation in which the economy’s overall price level is rising (inflation is not one single good/service increasing in price but rather an economy wide phenomenon…it doesn’t mean that every good/service is more expensive but rather in general, prices are rising)

Inflation rate

the percentage change in some measure of the price level from one period to the next ( (Δ in price index) / start value) x 100)…((price index year2 – price index year 1) / price index year 1) x 100

GDP deflator

a measure of the price level calculated as the ratio of nGDP to rGDP times 100 ((nGDP/rGDP) x 100) (GDP deflator is used to convert nominal GDP to real GDP…formula to do this is (nGDP/GDP deflator) x 100)

Base year

the year that serves as a reference point for constructing a price index and comparing real values over time

Price index

a measure of overall price level (a measure of the cost of purchasing a given market basket in a given year, where that cost is normalized so that it is equal to 100 in the selected base year)

Menu costs

the cost for firms to change their prices (it may be necessary to reprint menus, update price lists or re

Shoe leather costs

the costs of engaging in more financial transactions in an attempt to avoid the inflation penalty (the loss of purchasing power that comes when inflation reduces the value of money). Since money loses value during inflation, people seek to reduce their holding of it. Instead, they hold mutual fund shares, equities, or bonds that offer higher rates of return than money (which offers 0 return). But to carry out these transactions, they usually need money. Additionally, as they engage in these financial transactions, they waste time and energy.

Unit

of

Market basket

a collection of goods and services used to represent what is consumed in the economy

Aggregate price level

a measure of the overall level of prices in the economy

Consumer price index (CPI)

measures the cost of the market basket of a typical urban American family

Producer price index (PPI)

measures the changes in prices of goods purchased by producers

Interest rate

the amount charged, expressed as a percentage of principal, by a lender to a borrower for the use of assets (need to use context clues to determine whether “interest rate” refers to the “nominal interest rate” or “real interest rate”)

Principal

the amount borrowed or the amount still owed on a loan (separate from interest)

Nominal interest rate

the interest rate before taking inflation into account (the dollar value that is earned by a lender or the dollar value that is paid by a borrower…every loan contract is written in nominal terms)

Real interest rate

the interest rate after taking inflation into account (nominal interest rate – actual rate of inflation…the transfer of purchasing power from the borrower to the lender…a real interest rate could be negative if the nominal interest rate ends up being less than inflation…this could happen in the real world because loan contracts are written based on what you expect to happen to prices…sometimes, though, expectations don’t meet reality)

Nominal income

today’s income measured in today’s dollars, unadjusted by inflation

Real income

income measured in base year dollars. Income after taking into account the effects of inflation on purchasing power. The amounts of goods and services that money income will buy. (change in real income is change in nominal income – actual rate of inflation)

Nominal wages

wages measured in terms of money and not by the ability to buy goods and services (wages unadjusted for inflation…a nominal wage is the dollar value of the wage…I get paid $50,000)

Real wages

wages measured in terms of the amount of goods and services that can be bought. Wages adjusted for the effects on purchasing power of inflation. (change in real wages is change in nominal wages – actual rate of inflation…if your nominal wage increases by less than the actual rate of inflation, your real wage goes down

Indexation

the automatic correction by law or contract of a dollar amount for the effects of inflation (many government programs are “indexed” to inflation…for example, social security checks increase or remain unchanged from one year to the next based on changes in the CPI (the consumer price index)…if the consumer price index increases by 2%, then maintaining a standard of living will require 2% more dollars… if the CPI increases by 2%, law will dictate that social security checks will increase by 2%)

Inflationary expectations

rate of inflation that workers, businesses, and investors think will prevail in the future, and that they therefore factor into their decision

Actual inflation

the rate at which overall prices actually rose (can differ from expected inflation)

Deflation

a decrease in the general price level of rises (when the inflation rate falls below 0%)

Disinflation

a slow

Microeconomics

the study of how individual households and firms make decisions and how they interact with one another in markets

Macroeconomics

the study of the economy as a whole (goal being to explain the changes that affect many households, firms, and markets simultaneously)

Employed

a person is employed if he or she has worked for pay at least one hour in the last week

Unemployed

a person is unemployed if he or she is currently not working but is actively seeking work

Out of the labor force

a person is classified as out of the labor force if he or she has chosen to not seek employment

Discouraged workers

citizens who have been without work for so long that they become tired of looking for work and drop out of the labor force (because these citizens are not counted in the ranks of the unemployed , the reported unemployment rate is understated)

Frictional unemployment

a type of unemployment that occurs when someone new enters the labor market or switches jobs (this is a relatively harmless form of unemployment and it is not expected to last long…it is the time people are spending in the job search process…it is the time spent between jobs…the implication is there is a job waiting for the person, but they have not yet come across it and secured it)

Seasonal unemployment

a type of unemployment that is periodic, is predictable, and follows the calendar (workers and employers alike anticipate these changes in employment and plan accordingly, thus the damage is minimal )

Structural unemployment

a type of unemployment that is the result of fundamental, underlying changes in the economy such that some job skills are no longer in demand (structural unemployment also results from permanent mismatches in the number of job seekers and the number of jobs available…sustained mismatches can arise from minimum wage laws, strong labor unions, efficiency wages, etc)

Cyclical unemployment

a type of unemployment that rises and falls with the business cycle (this form of unemployment is felt economy

Full employment

exists when the economy is experiencing no cyclical unemployment (when the economy is at the natural rate of unemployment)

Natural rate of unemployment

the unemployment rate associated with full employment, somewhere between 4 and 5% in the U.S. (the natural rate of unemployment is the sum of frictional and structural unemployment)

Business cycle

the periodic rise and fall in economic activity around its long

Expansion

a period where rGDP is rising (as output rises, unemployment should fall, as people are employed to make goods and services)