ECON heavy emphasis

Exam Preparation Notes

Chapters 4, 10, 11, 15, 20 & 21: Calculation Focus

• Expect a heavy emphasis on calculating concepts from these chapters.

Chapters 1, 3, 9: Moderate Emphasis

• Expect 2-5 questions from each of these chapters.

Chapters 2, 13, 17, 18, & 22: Low Emphasis

• Don't spend much time reviewing these chapters (0-2 questions each).

Chapter 1: Key Concepts

• Scarcity: Human wants exceed available resources.
  • Leads to higher prices, shortages, and competition.
• Trade-offs: Achieving one objective negatively impacts another.
• Marginal Analysis: Comparing additional benefits to additional costs.
• Opportunity Costs: Loss of potential gain from alternatives when one is chosen.
• How Trade Enhances Outcomes: Facilitates economic growth, improves efficiency, increases consumer choice, and promotes competition.

General Notes

• More than 5 questions on chapters with heavy emphasis.
• 0-2 questions each on chapters with low emphasis.
• Lots of questions about Aggregate Demand (AD) and Aggregate Supply (AS) models.
  • Understand how the system reacts to shifts in AD and AS in the short and long run.
  • Tutorial from Chapter 21: Review the four scenarios highlighted.
• Pay attention to graph axes and table headers.
• Understand the differences between concepts and their societal, individual, and business impacts. Can you measure any of them?
• How productivity and standard of living are connected: Higher productivity leads to increased output, which can enhance the standard of living.
• Impact of "printing more money" on prices: Can lead to inflation, causing prices to rise.
• Relationship between prices, unemployment, and output in the short run: Lower prices can lead to higher output and lower unemployment, while higher prices can have the opposite effect.

Chapter 2: Positive vs. Normative Statements

• Positive Statements: Factual; describes the world as it is.
• Normative Statements: Opinion; describes how the world should be.

Circular Flow Model

• Definition: Shows how households and firms interact in goods/services and labor markets.
• Two Markets: Goods/services and factors of production (resources).
• Actors: Households and firms
• Households buy goods and services, firms buy the factors of production from households.
  Firms sell goods and services, households supply factors of production.

Production Possibility Frontier (PPF)

• Definition: Maximum output combinations of two goods with available resources.
• Curve Representation: The law of diminishing returns.
• Slope: Opportunity cost.
• Understand: What is possible, EFFICIENT, inefficient, and not possible.
• Bowed Curve: Increasing opportunity cost along the curve.

Chapter 3: Gains from Trade

• When Two Countries Gain: Specialize based on comparative advantage.
  • Comparative Advantage: Ability to produce a good at a lower opportunity cost.
  • Absolute Advantage: Ability to produce more of a good with the same resources.
• Country Exports: Goods/services with a comparative advantage.
• Country Imports: Goods/services produced more efficiently elsewhere.

Chapter 4: Supply and Demand

• Law of Supply and Demand: Price adjusts to balance quantity supplied and demanded.
• Quantity Demanded vs. Change in Demand:
  • Change in quantity demanded is due to price changes (movement along the demand curve).
  • Change in demand is a shift of the entire curve.
• Demand Shifters: Consumer preferences, income, prices of related goods.
• Supply Shifters: Production costs, technology, number of sellers.

Chapter 10: Comparative Advantage

• Comparative vs. Absolute Advantage
• Opportunity Cost Calculation: Consider total production and hours per unit (efficiency).
• Shifts in Supply and Demand: Know your shifters
• Recognize a scenario and connect it to changes in market price and quantity
• Impact on Market Equilibrium: Price and quantity changes.
• Combined Shifts: What happens when both supply and demand shift?
• Identify Causes: Based on price and quantity changes using graphs and word problems.

Chapter 11: GDP

• Nominal GDP: Value of goods/services using current prices.
• Real GDP: Adjusted for inflation.
  • Definition: The market value of the output of all final goods and services produced within a country in a given year. Measures the size of a nation’s overall economy.
  • Formula: $Real GDP = \frac{nominal GDP}{\frac{price index}{100}}$
  • Equation: GDP = Consumption + Investment + Government + Trade Balance.
  • Expenditure Approach: GDP(E) = C+I+G+(X-M)
• Percentage Change in GDP: $(\frac{GDP<em>{new} - GDP</em>{old}}{GDP_{old}})*100$
• Components of GDP: Subcomponents of Consumption, Investment, Government Spending, and Net Exports.
• Summing All Prices and Quantities
• Inflation

Shortcomings of GDP Calculation

• Exclusion of non-market transactions, income inequality, failure to account rate of growth is sustainable or not, costs composed on human health

Consumer Price Index (CPI)

• Definition: Measures the typical consumer’s cost of living.
• Connection to Inflation: It is a measure of inflation.
• Related Terms: Core inflation, deflation, disinflation, GDP deflator, median PCE inflation, substitution bias, and producer price index.
• CPI Calculation: $CPI = \frac{cost \ of \ basket \ in \ current \ year}{cost \ of \ basket \ in \ base \ year} * 100$
• Using Previous Years CPIs $Inflation rate = \frac{CPI \ this \ year - CPI \ last \ year}{CPI \ last \ year} * 100$
• Inflation Rate: Change in the price level.
• Base Year: Reference point in economic analysis (typically set to 100).
• CPI focuses on the consumer perspective while the GDP Deflator looks at the broader economy's production level.

GDP Subcomponents

• Summing all prices and quantities

CPI Shortcomings

• May not accurately reflect spending patterns of different consumer groups.

Real vs. Nominal Interest Rates

• Real Interest Rate: Lending interest rate adjusted for inflation (GDP deflator).
• Nominal Interest Rate: Stated interest rate without inflation adjustments.
  • Shows the true return on an investment after accounting for how much money is worth in the future
• Inflation’s Wealth Transfer: Purchasing power shifts from lenders to borrowers.

Chapter 15: Unemployment

• Definition: An individual is unemployed and looking for work/can’t find work
• Unemployment Rate: Percentage of adults in the labor force seeking jobs but without them.
  • Calculation: $unemployment \ rate = \frac{unemployed \ people}{total \ labor \ force} * 100$
• Labor Force: Employed plus unemployed.
• Discouraged Worker: Stopped looking due to lack of suitable positions.
• U1: Unemployed 15 weeks or longer.
• U3: Unemployed and looking for work.
• U6: Total unemployed, plus discouraged workers, plus all marginally attached workers (part time)
• Natural Rate of Unemployment: Lowest sustainable level in a stable, growing economy.
• Cyclical Unemployment: Rises and falls with the business cycle.
• Structural Unemployment: More job seekers than jobs available.
• Frictional Unemployment: Exists due to people moving between jobs.
• Bureau of Labor Statistics (BLS): Who measures the unemployment rate

Calculating Past or Present Prices

Shortcomings

• Excludes discouraged workers, does not distinguish between full-time and part-time work, mis reports of work status in the BLS survey

Structural Unemployment - reasons why it exists

Technological advancements, industry shifts, globalization, lack of education or training, geographic limitations, and government policies

Chapter 22: Phillips Curve

• Definition: Inverse relationship between inflation and unemployment.
• Importance: Illustrates the trade-off for policymakers.
• Impact: Affects businesses, workers, governments, and economists.

Business Cycle

• Definition: Natural ups and downs in economic activity over time.
• Four Stages: Expansion, peak, contraction, and trough.
  • Expansion: Output rises, unemployment falls, inflation increases.
  • Peak: Output maximum, unemployment low, inflation high.
  • Contraction: Output decreases, unemployment rises, inflation falls.
  • Trough: Output lowest, unemployment highest, inflation low.
• Firm’s Desire for Consistent Inventories drive some of these outcomes
• Output and unemployment are generally consistent, inflation less predictable.
• No expectations as to how long any phase of the Business Cycle should/will last.
• Determination of the broader issues/downsides of trying to cure one of the two items the Phillips Curve depicts

Chapter 12: Productivity

• Calculation: Productivity = $\frac{output(gdp)}{input}$
• Determinants: Human capital, technological change, economies of scale.
• Importance: Increased production, profit, wages, economic growth, standard of living.
• Real GDP per capita: Economic output per person, adjusted for inflation.
• Calculation: Real GDP per capita = $\frac{Real \ GDP}{population}$

Calculating % change in GDP per capita

Chapter 16: Money

• Functions: Medium of exchange, store of value, unit of account, standard of deferred payment.
  • Standard of Deferred Payment - Money must also be acceptable to make purchases today that will be paid in the future
• Types: Commodity and Fiat.
  • Examples: Commodity vs Fiat
• Liquidity: M1 Money.
• Federal Reserve System: Central banking system of the United States.
  • Jerome Powell is in charge of the Federal Reserve System
• Purpose: Maintain stable financial system and economy.
• Three Tools: Open market operations, the discount rate, and reserve requirements.
• How Banks Create Money: Accepting deposits and making loans.
• Fractional Reserves: Banks hold a fraction of deposits as reserves and lend the rest.
• Reserves: Actual, required, and excess.

Chapter 17: The Federal Reserve System

How are the value of money and the price level related?

• As the price level increases (inflation), the value of money decreases, and vice versa.

Money Growth and Inflation

• Equation of Exchange: States that the total value of all transactions in an economy is equal to the total money supply multiplied by the velocity of money
  Equation of Exchange, Long-Run*: MV=PY
• Velocity: The rate at which money changes hand
• Impact of Money Supply Changes: Influencing interest rates, inflation, and overall economic activity.

Chapter 18: Net Exports (NX)

• Definition: Difference between a country's total exports and total imports.
• Calculation: Total Value of Exports - Total Value of Imports.
• Alterations: Domestic and foreign incomes, relative price levels, exchange rates, trade policies, preferences & technology.
• Relationship between NX and NCO: They equal each other

Savings, Investment, and NX Relationship

• S = I + NX
  *In a closed economy, national savings always equals investment.
  *In an open economy: NX = S -I

Chapters 20 & 21: Aggregate Demand and Supply

*What are on the axes (AD and AS)?

Aggregate Demand (AD)

• Definition: Total spending on domestic goods and services.
• Graph: Downward sloping.

Aggregate Supply (AS)

• Definition: Total quantity of output firms produce.
• Potential GDP: Maximum quantity with full employment of existing resources.
  *What are its components? What does it look like on a graph?
• What is likely to occur in the short-run v. what is likely to occur in the long-run?

Shifts in AD

• Caused by changes in its components (consumption, investment, government spending, and net exports).
  What are the results on P and Y?

Shifts in AS

• Caused by changes in production costs or potential output.
  What are the results on P and Y?

Self Correction

• How does the economy "Self-Correct" on its own?
• Who can utilize policy tools to help stabilize the economy?
  *What can congress utilize to solve an economic fluctuation? The Fed? What components of GDP are each policy option expected to impact?

Effectiveness of Fiscal Policy

• What can reduce the effectiveness of Fiscal Policy
• Time lags, political considerations, crowding out, lack of coordination.
  In the short run, fiscal policy primarily influences aggregate demand, impacting output and employment through government spending and taxation changes. In the long run, fiscal policy can affect the economy's potential for growth and overall level of output by influencing factors like savings, investment, and productivity

Changes in the money supply in the long-run

Primarily affect the overall price level

• Shortcomings of Stabilization Policies: Potential destabilization, long lags, difficulty predicting responses.

Changes in spending and GDP

• How are changes in spending connected to changes in GDP?
• What role does the MPC play?
• Can you walk through the 4 common macroeconomics scenarios?

Chapter 9: International Trade

• Comparative Advantage: Apply to what a nation should export and import - A nation should export goods in which it has a comparative advantage and import goods in which it has a comparative disadvantage
• Domestic vs. World Price: A country with a comparative advantage has a lower domestic price.
• Consumer and Producer Surplus: Analysis with exports and imports.

Tariffs

• Tariffs on prices of imported goods
• CS & PS from a tariff

Arguments for Trade Restrictions

Bonus:

• Paying attention in class to important economic data, influential people, rules of thumb, and key historical events?