AP Macro Unit 2

The Circular Flow Diagram

The Circular Flow Diagram

• firms produce goods and services

• households provide labor

• CED: GDP as a total flow of income and expenditure can be represented by the circular flow diagram

• total household expenditures = total household income = total revenue for firms

households

provide labor to firms through the factor market in exchange for wages

firms

provide goods & services through the product market in exchange for revenue in the form of consumer spending

transfer payments

payments that the govt. makes to individuals without expecting a good or service in return (examples: social security, scholarships, grants)

economic system

a mechanism that decides what to make, how to make it, and who gets it

Which of the following best describes the difference between microeconomics and macroeconomics?

microeconomics is about individuals, households, and firms

macroeconomics is about economies as a whole

financial markets

stocks

factor services from households

outputs from firms

factor markets

product markets

GDP

• Gross Domestic Product: total market value of all final goods and services produced within a country in one year

• the purpose of GDP is to get a total count of production within an economy

nominal GDP

• CED Def: a measure of output, measured in current prices

• an increase/decrease in price will cause an increase/decrease in nominal GDP

real GDP

• CED Def: a measure of what’s produced, measured in constant prices (aggregate (total) output for both)

• Removes the affect of changes in overall price level due to the use of constant prices

• an inflation-adjusted measure that reflects the value of all goods and services produced by an economy in a given year

quarters

measure GDP every 3 months

trough

expansion

peak

trend

recession

• 2 consecutive quarters

• a period of decline in total output, income, and employment

income

what you produce of value

inflation

an increase in the overall level of prices

uncertainty

impacts companies by forcing them to make projections

expectations

• future expectations affect current behavior

• unmet expectations (shocks) create shifts in the economy

shocks

unexpected results:

• can be good or bad

• can effect demand or supply

flexible & inflexible (“sticky”) pricing

• prices may not change as neatly as our supply and demand graph indicates

• companies are often reluctant

GDP Expenditure Approach Formula

GDP = C + I(subscript g) + G + X(subscript n)

• C: Consumption

• Ig: Gross Private Investment

• G: Government Spending

• Xn: Net Exports

Nominal GDP Formula

Real * GDP Deflator (or Price Index) * 100

Real GDP Formula

(Nominal/GDP Deflator) * 100

GDP Deflator Formula

(Nominal/Real) * 100

Nominal GDP Formula (from a TABLE):

Sum of Current Price * Current Quantity

Real GDP Formula (from a TABLE):

Sum of Current Quantity * Base Price (“using year 1 as the base year” so multiply quantity from year 2 and base price from year 1)

durable goods

products that have expected lives of three years or more

Consumption

Gross Private Investment

Government Spending

Net Exports

nondurable goods

products with less than 3 years of expected life

(Khan Academy): In Fitlandia, a $100M skyscraper is constructed over 2 years. In the first year, $60M was spent, and in the second year, $40M was spent. How will the construction of these skyscrapers impact Fitlandia’s GDP in year 1 and 2?

Answer: Increases by $60M in year 1 and $40M in year 2

Explanation: The $100M is the total budget for the skyscraper, which was split between the two years. In the first year, $60M was used, so that $60M goes towards the GDP of year 1, since even though the skyscraper isn’t finished, it is still a “final good” in the sense that money was spent on it, which factors into the GDP. This same scenario is shown in year 2 also.

total market value

• the value of all production within an economy

final goods

products you can pull right off of store shelves (ex: bottle of ketchup)

intermediate goods

the goods used to make final goods (ex: tomatoes, sugar used to make the ketchup)

production

• MUST happen in the COUNTRY to count towards that country’s GDP (even if it’s a foreign brand)

What is not Included in GDP?

• Used / Second-hand products

• Purely Financial Transactions (ex: transfer payments, stocks and bonds)

• Services provided for no money (ex: stay at home parent)

• Inputs / Intermediate goods and services

• Foreign produced goods and services

business cycle

Short-run fluctuations in GDP but a long-run increase in GDP over time

unemployment rate

focuses on those in the labor force actively seeking work, indicating economic health

unemployment rate formula

unemployed/labor force * 100

3 types of unemployment

• structurally unemployed

• cyclically unemployed

• frictionally unemployed

structurally unemployed

cyclically unemployed

frictionally unemployed

underemployed

• Someone is underemployed if they are working part-time when they want full-time work or have jobs they are overqualified for.

• Not counting underemployed workers means that the official rate of unemployment makes the employment situation seem better than it is

discouraged workers

(Khan Academy): Burgin works part-time serving bubble tea at a Karaoke club while he tries to find a full-time job as a lumberjack. What term can be used to describe Burgin’s employment situation?

underemployed

labor force participation rate

reflects the proportion of the total working-age population involved in the workforce

unemployment rate vs. labor force participation rate

The unemployment rate measures the percentage of individuals in the labor force who are unemployed, while the labor force participation rate measures the percentage of the working-age population that is in the labor force.