Economics Vocab and Equations

Describe the difference between micro and macro economics (macro is the one we are currently learning)

Microeconomics is the study of individual households and firms while Macroeconomics is the study of economy-wide phenomenon such as economic growth, inflation, unemployment, short-term fluctuations or business cycles.

The biggest difference is that in microeconomics we’re zooming into a single market it’s hard to explain market-wide phenomenons like unemployment, inflation, interest rate and so on. Microeconomics is still helpful for creating things like public policies, such as limitations on the cigarette market.

What does the “long-run” refer to in economics?

It usually refers to a period of decades and include issues such as growth and inflation

What does “short-term” refer to in economics?

It usually reflects the time period between 6 months to 2 years and includes things such as economic fluctuations.

Describe what successful policy making requires:

i. knowledge about how the economy works

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ii. models of the economy (we look at the economy in smaller sectors since it’s so huge)

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iii. Data of the economy (no data=no model)

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iiii. Ability to measure fundamental macroeconomic quantities (such as measuring price)

Income is a measure of

what you produce or what is produced

GDP is

the market value of all DOMESTICALLY produced FINAL goods and services over a given period of time

GDP measures income or wealth?

INCOME; it measures the flow of NEWLY produced goods and services

How do we get GDP per capita? (Equation)

GDP divided by the population = GDP/capita

This helps us put into perspective large amounts of money

Why should we care about GDP? No one cares about the numbers right?

Wrong; yes the numbers itself may not seem very appealing, but actually countries with higher GDP tend to have higher populations, lower infant mortality rates, and more! So by looking at the GDP per country, we can decide which country we will be better off in and perhaps “happier” or more satisfied

In the equation to solve for GDP per capita we include population. What could perhaps understate or overstate the results of this equation?

Population is ambiguous and general. When we think about it, who are we including in the population? Do we take into account citizens abroad, undocumented citizens, retired people??

List the components of GDP:

1. Consumption (C)
2. Investment (I)
3. Government Purchases (G)
4. Net-Export (NX or E)

\*Perhaps remember it as CIGE or CINX?

Components of GDP: describe Consumption (C)

consumption is the expenditure on goods/services (including durable goods like fridges or washing machines) by households or private individuals

Components of GDP: describe Investment (I)

Investment does NOT refer to stocks or bonds in this case. We are talking about expenditure by households and firms on new physical capital: machinery, tools, infrastructure and structures INCLUDING new houses

Components of GDP: describe Government Purchases (G)

expenditure by state / local / federal government

This EXCLUDES: transfer payments such as social security, medicare, unemployment benefit etc.

Components of GDP: describe Net Export (NX or E)

exports-imports in the dollar value

(T/F) Consumption includes rented and bought houses

FALSE: consumption only includes rent but excludes purchases of new houses. This is because rental value can be implied but bought homes would be understated by GDP

Is a car an investment or consumer good?

Consumer good

Is a bought house a consumer or investment good?

Investment

Do used goods contribute to GDP?

NO; they don’t because it already existed and had a value. Only new goods are contributing to the GDP

What is the National Income Accounting Identity? (its an equation)

Y = C + I + G + NX

Y = C + I + G + NX; what does Y indicate?

Y=GDP

Y = C + I + G + NX; what does C + I + G + NX indicate?

Demand

Intermediate Good

Materials that are sold to others so they can make it into a final good (ex: paper sold to Hallmark so it can become a card and be sold as a FINAL good)

Final Good

The final good of all bought materials (Ex: a card)

Does GDP include intermediate goods?

NO

List tangible goods

Food, clothings, cars

List intangible goods

haircuts, housecleaning, doctor visits

If a Canadian citizen works in the US does that count towards GDP?

Yes

Do transfer payments from government purchases (like social security) count toward GDP?

No cuz its not directly contributing to the economy

How do you calculate net exports?

Net exports = foreign purchases of domestically produced goods (exports) minus (-) the domestic purchases of foreign goods (imports)

Nominal GDP

the production of goods and services valued at current prices (does not require a base year to calculate)

Real GDP

What would be the value of the goods and services produced this year if valued using the prices that prevailed in some specific year in the past?

Basically shows us how the economy’s overall production of goods and services changes over time

If total spending rises from one year to the next, at least one of two things must be true:

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the economy is producing a (smaller/larger )output of goods and services, or goods and services are being sold at (lower/higher) prices.

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the economy is producing a (larger) output of goods and services, or goods and services are being sold at (higher) prices.

Do we use real GDP or nominal GDP when trying to calculate the measure of the amount produced?

Real GDP; and it ONLY reflects changes in the quantity produced, it measures the economy’s production of goods and services

Is real GDP or nominal GDP better at gauging economic well being?

Real GDP since it calculates production and how people’s needs and desires are being satisfied

Real GDP reflects quantities produced, what should we do if we want to see just the prices of goods and services?

GDP Deflator

(T/F) The GDP Deflator for the base year always equals 100

True, because nominal GDP and Real GDP are the same (equal)

What are causes of recessions?

low income, rising unemployment, falling profits, increased bankruptcies

CPI Consumer Price Index

measure of the overall cost of the goods and services bought by a typical consumer

When the CPI rises, the typical family has to spend (more/less) money to maintain the same standard of living.

When the CPI rises, the typical family has to spend (more) money to maintain the same standard of living.

Core CPI

a measure of the overall cost of consumer goods and services excluding food and energy

Producer Price Index (PPI)

a measure of the cost of a basket of goods and services bought by firms

What are the three problems with CPI?

Substitution Bias, the introduction of new goods, unmeasured quality change

Substitution bias

Not all prices change proportionately, meaning some prices rise more than others. If a bag of Lays increased significantly people may substitute a different brand of chips if they’re prices or lower or perhaps even falling. Since the basket is fixed with CPI it will not take into account in substitution.

The introduction of new goods

pretty self explanatory but it’s a problem that occurs with calculating CPI accurately; the more variety the more the dollar value goes up. But since the basket of goods is fixed the CPI will not be able to take into account new goods and the reflection of variety.

Unmeasured quality change

Let’s the quality of a good you’ve been buying suddenly decreases. The fixed basket of goods can’t detect the loss in value of the good.

What is the difference between CPI and GDP Deflator?

1. The GDP deflator reflects the prices of all goods and services produced *domestically* while the CPI reflects the prices of all goods and services bought by *consumers*

Think of it like this: The D in GDP is for DOMESTIC and the C in CPI is for CONSUMER


2. The CPI compares the price of a FIXED BASKET of goods and services while GDP deflator compares the price of CURRENTLY PRODUCED goods and services. Which means the group of goods and services used to compute GDP deflator actually change over time since its not fixed like CPI

Nominal interest rate

the interest rate that measures the change in dollar amounts

tells us how fast the number of dollars in your back account rise over time

Real interest rate

the interest rate corrected for inflation

tells us how fast the purchasing power of your bank account rises over time

During inflation nominal interest rates are (exceeding/below) real interest rate

exceeding

During delation what happens to nominal interest and real interest?

During deflation the real interest rate exceeds the nominal interest rate

Physical capital per worker

the stock of equipment and structures used to produce goods and services

Ex: woodworkers with saws, lathes and drill presses. The more efficient and high quality if equipment the more each worker can produce

Human capital

the knowledge and skills that workers acquire through education, training, and experience

Ex: skills accumulated during early childhood programs, grade school, high school, college and on the job training for adults in the labor force

Natural resources

inputs into production that are provided by nature, such as land, rivers and mineral deposits

Technological knowledge

the understanding of the best ways to produce goods and services

It can be in forms of common knowledge like the assembly-line

Proprietary only by the company that discovers it. Coca cola only knows it’s secret recipe for making soft drinks

What are the two forms of natural resources?

Renewable and nonrenewable resources

Ex: a forest is renewable

Oil is non-renewable since it takes millions of years for nature to create

Most economists are blank 1 that natural resources will eventually limit economic growth. As evidence, they note that the prices of most natural resources, adjusted for overall inflation, have tended to blank 2 over time.

not concerned; fall

Diminishing Returns

the property whereby the benefit from an extra unit of an input declines as the quantity of the input increases

In other words:

when workers already have a large quantity of capital to use in producing goods and services, giving them an additional unit of capital increases their productivity only slightly.

When productivity stunts due to diminishing returns

In the long run, the higher saving rate leads to a higher level of productivity and income but not to higher growth in these variables.

Ctach-up effect

the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich

Foreign Direct Investment

A capital investment that is owned and operated by a foreign entity

ex: Ford Motor Company might build a car factory in Mexico

Foreign Portfolio Investment

All investment financed with foreign money but operated by domestic residents (like buying foreign stocks)

Gross National Product (GNP)

the income earned by residents of the country both at home and abroad

What do economists advise governments in less developed economies to do?

Encourage investment from abroad; meaning removing restrictions that governments have imposed on foreign ownership of domestic capital (World Bank)

What is the opportunity cost with education (human capital)?

Students forgo joining the labor force in order to continue education for higher wages. Some students drop out and join the labor force forgoing the possibility of a higher wage through continuing education

Externality

the effect of one person’s actions on the well being of a bystander

Why is education considered a positive externality?

Education can enter society’s pool of knowledge and other people can pick up from it

What is brain drain?

emigration of many of the most highly educated workers to rich countries, where these workers can enjoy a higher standard of living.

If human capital does have positive externalities, then this brain drain makes those people left behind even poorer.

What’s the dilemma surrounding the policy makers with brain drain?

What if the people from poor countries who emigrate to the US for better education stay and don’t return to their country? The nation remains even more poor

What did Robert Fogel say about health?

improved health from better nutrition has been a significant factor in long-run economic growth

malnourished people can’t do manual labor it’s all correlated to productivity

The more a nation develops economically people eat more and the population gets taller

In essence; height it correlated to productivity, taller workers tend to earn more

Property rights

the ability of people to exercise authority over the resources they own

Ex: A mining company isn’t gonna mine iron ore if it’s gonna get stolen this makes courts and the criminal justice system vital

Inward-oriented policies

aim to increase productivity and living standards within the country by avoiding interaction with the rest of the world.

What do most economists think about inward oriented policies

they would be better off pursuing outward oriented policies including international trade. It’s an issue because without trade they’d need to produce everything despite a tight economy and no equipment

Is knowledge a public good?

Yes since it ends up in society’s pool

How can the government encourage research?

patent system:

When a person or firm creates an innovative product, such as a new drug, the inventor can apply for a patent. If the product is deemed truly original, the government awards the patent, which gives the inventor the exclusive right to make the product for a specified number of years. Makes it a public good to a private good

Financial Markets

financial institutions through which savers can directly provide funds to borrowers

Bond

a certificate of indebtness

Like an IOU

the date of maturity

the time at which the loan will be repaid

principal in bonds

promise of interest and eventual repayment of the amount borrowed

What is a bond that never matures called?

perpetuity - it pays interest but principal is never paid

Credit risk (bonds)

the probability that the borrower will fail to pay some of the interest or principal

What is failure to pay a bond called?

default

junk bonds

pay very high interest rates but are by financially shaky corporations

Tax treatment

the way tax laws treat the interest earned on the bond

some of the interest earned by bonds needs to be paid in income taxes

Municipal bonds

when state and local governments issue bonds

What is the benefit to municipal bonds over others?

Since its issued by the government there is no income tax involved. However it does mean it offers a lower interest rate because of this

Inflation protection

promising to pay interest and principal in a specific number of dollars (dodges future purchasing power)

stock

a claim of partial ownership in a firm

equity finance

the sale of stick to raise money

debt finance

sale of bonds

Which is riskier bonds or stocks?

Stocks since bonds have promised principal

stock index

average of a group of stock prices (Dow Jones)

Financial Intermediaries

financial institutions through which savers can indirectly provide funds to borrowers

Ex: banks, mutual funds,

medium of exchange

an item that people can easily use to engage in transactions

mutual fund

an institution that sells shares to the public and uses the proceeds to buy a selection or portfolio, of various types of stocks, bonds or both.

index funds

buy all stocks in a given stock index

accounting

various numbers are defined and added up

closed economy

one that does not interact with other economies

doesn’t engage in international trades

open economies

interact with other economies around the world

What’s the equation for a closed economy?

Y=C+I+G (NX is missing because there are no net exports)