Macroeconomics 200 Midterm Study Notes

Introduction to Economics

Macroeconomics vs. Microeconomics
- Macroeconomics: The study of the overall economy, including topics such as inflation, unemployment, and economic growth.
- Microeconomics: The study of individual units within the economy, such as households, firms, and industries.
Positive vs. Normative Questions
- Positive Questions: Questions that can be answered with facts or data, describing "what is" (e.g., "The demand for smartphones decreased after the introduction of a new government tax."). These statements are objective and testable.
- Normative Questions: Questions that involve value judgments and opinions, describing "what ought to be" (e.g., "Taxes on luxury goods should be increased to promote income equality."). These statements are subjective and not directly testable with facts alone.
Trade-offs
- The concept that to get something, you must give up something else. All decisions involve trade-offs due to scarcity.
- Example (from study time): Choosing to study more for Economics means giving up study time for History, and vice versa. Maximizing one subject's score necessitates a lower score in the other, assuming limited total study hours.
Opportunity Cost
- The value of the next best alternative that must be forgone as a result of making a particular choice.
- It is the most important concept in economics, as it highlights the true cost of any decision.
- Examples:
  - Reselling a ticket: The opportunity cost of reselling a homecoming game ticket for twice its price might be the experience of attending the game.
  - Student study time: If a student moves from a grade of 60 to a grade of 88 in Economics, the opportunity cost is the reduction in their History score to achieve that gain (e.g., if moving from 4 hours Econ/6 hours History to 6 hours Econ/4 hours History, the opportunity cost is going from 88 History to 76 History, a loss of 12 points).
  - Choosing a dessert: If a restaurant patron chooses apple pie, and their next best choice would have been chocolate brownie cake, then the opportunity cost of choosing the pie is the enjoyment of the chocolate brownie cake.

Production Possibilities Frontiers (PPFs)

Definition: A graphical model that illustrates the combinations of outputs that an economy can produce if all of its resources are used efficiently given current technology.
Opportunity Cost on the PPF Slope
- The slope of the PPF represents the opportunity cost of producing one good in terms of the other.
- Moving along the PPF demonstrates the trade-offs an economy faces when reallocating resources from the production of one good to another.
Determining Production Bundle Feasibility and Efficiency
- Points on the PPF: Possible and efficient. All resources are fully employed and utilized to their maximum potential.
- Points inside the PPF: Possible but inefficient. Resources are either unemployed or underutilized (e.g., a recession hitting and companies laying off workers, leading to production inside the PPF).
- Points outside the PPF: Currently unattainable. Production levels are beyond the economy's current capacity given its resources and technology.
Types of PPFs
- Linear PPF: Occurs when the opportunity cost of producing one good in terms of the other is constant. This implies that resources are equally adaptable to the production of either good.
- Bowed-Out PPF: Occurs when the law of increasing opportunity cost holds. This means that as more of one good is produced, the opportunity cost of producing an additional unit of that good increases. This is generally the case because resources are specialized and not perfectly adaptable for producing different goods. For example, some resources are better suited for producing dumbbells, while others are better for sandals.
Shifts in the PPF
- Increases in Resources: An increase in the quantity or quality of available resources (e.g., more labor, capital, or natural resources) will cause the entire PPF to shift outward, representing greater productive capacity for all goods.
- Improvements in Technology: Technological advancements in the production of a specific good will shift the PPF outward primarily along the axis of the good that has experienced the technological improvement. If technology improves across all sectors, the entire PPF will shift outwards. For example, if scientists invent a new GMO form of wheat requiring less water, the PPF for wheat and fighter jets would shift outward along the wheat axis. A technological advance introduces new techniques or methods so that firms can produce more with less.
- Unattainable points: A point that is currently unattainable can become attainable if there is an increase in resources or an improvement in technology, shifting the PPF outward.

Gross Domestic Product (GDP)

Purpose: GDP is the primary measure used to gauge the overall economic activity and size of an economy.
Definition and Calculation:
- GDP measures the market value of all final goods and services produced domestically within a given year.
- Market Value: Calculated as ext{Price} imes ext{Quantity}.
Key Inclusion Criteria:
- Only Final Goods and Services: Only goods and services sold to the final user are counted to avoid double-counting. Intermediate goods (used in the production of other goods) are not counted separately. For example, when John buys new tires for his car, it counts toward GDP because the tires are final goods. When Ford Motor Co. buys tires for new cars, it does not count toward GDP because they are intermediate goods.
- Only Domestic Production: Goods and services produced within the geographical borders of a country, regardless of the nationality of the producer.
- Only Produced in a Given Year: Counts only new production within the specified time period. The sale of used goods (e.g., a 1969 Ford Mustang sold between two friends) does not count towards current GDP.
Measurement Approaches:
- GDP can be theoretically measured using three equivalent approaches: Production (sum of value added), Income (sum of factor payments), or Expenditures (sum of spending).
- Focus on Expenditures Approach: This is the most common method discussed and calculated: GDP = C + I + G + NX
  - C (Consumption): Spending by households on goods and services (e.g., purchasing a pint of Ben and Jerry's ice cream).
  - I (Investment): Spending by firms on new capital goods (factories, equipment, software) and by households on new housing, as well as changes in inventories. (Note: Financial investments like stocks are not part of GDP investment).
  - G (Government Purchases): Spending by all levels of government on goods and services (e.g., the US Environmental Protection Agency purchases a new Chevrolet car). Transfer payments (e.g., Social Security) are not included.
  - NX (Net Exports): Spending by foreign residents on domestically produced goods and services (exports) minus spending by domestic residents on foreign-produced goods and services (imports). NX = Exports - Imports
    - Exports: Intel sells a new processor chip to a Canadian gamer; Exon sells crude oil to an oil refinery in Mexico.
    - Imports: Your parents purchase a bottle of French Champagne.
Real vs. Nominal GDP
- Nominal GDP: Measured in current prices. It can increase due to an increase in production or an increase in prices.
- Real GDP: Measured using constant prices from a base year. This removes the effect of price changes (inflation) and allows for comparison of output over time.
  Real hinspace GDP = rac{Nominal hinspace GDP}{GDP hinspace Deflator} imes 100 (assuming the GDP Deflator's base year is 100).
- To express an old nominal GDP in current (today's) dollars: GDP{Year hinspace 1 hinspace in hinspace Year hinspace 2 hinspace Dollars} = Nominal hinspace GDP{Year hinspace 1} imes rac{GDP hinspace Deflator{Year hinspace 2}}{GDP hinspace Deflator{Year hinspace 1}}
GDP Growth Rates
- Nominal GDP Growth Rate: ext{Nominal Growth Rate} = rac{GDP{Current hinspace Year} - GDP{Previous hinspace Year}}{GDP_{Previous hinspace Year}} imes 100
- Real GDP Growth Rate: ext{Real Growth Rate} = rac{Real hinspace GDP{Current hinspace Year} - Real hinspace GDP{Previous hinspace Year}}{Real hinspace GDP_{Previous hinspace Year}} imes 100
Shortcomings of GDP as a Measure of Well-being:
- Excludes Non-Market Production: Activities like household chores (e.g., who cleans your home), volunteer work, and subsistence farming are not counted, even though they produce valuable goods and services.
- Excludes Underground Economy: Illegal activities and undeclared cash transactions (e.g., babysitting for cash) are not included, leading to an underestimation of economic activity.
- Does Not Account for Environment: Fails to subtract the costs of environmental degradation or depletion of natural resources.
- Does Not Account for Leisure Time: A higher GDP might come at the cost of less leisure, which is valuable to people.
- Is Not a Perfect Measure of Happiness or Welfare: GDP per capita can be an indicator of material well-being, but it does not capture subjective measures like happiness, life satisfaction, income inequality, or social progress.

Unemployment

Definition: An individual is unemployed if they are actively looking for a job but currently do not have one.
Three Types of Unemployment:
- Frictional Unemployment:
  - Temporary unemployment caused by the time it takes for workers to search for and find new jobs, or for firms to find suitable workers. This is a natural and healthy part of a dynamic economy.
  - Often voluntary (e.g., a CFO deciding to change industries and resigning before finding a new job, then actively looking).
  - Example: Target fires a cashier after they are discovered stealing money (the cashier must now search for a new job).
- Structural Unemployment:
  - Unemployment caused by a mismatch between the skills workers have and the skills demanded by employers, or by geographic mismatches where jobs are available but workers cannot relocate.
  - Often results from technological changes, shifts in consumer demand, or global competition, which can lead to creative destruction (the process by which new industries and technologies replace old ones).
  - Example: A coal mine in West Virginia fires all its staff when it closes because coal is no longer economically viable. These workers may need to be retrained for new industries.
- Cyclical Unemployment:
  - Unemployment that rises and falls with the business cycle. It increases during economic recessions and depressions (economic slowdowns) and decreases during periods of economic expansion.
  - This type of unemployment indicates insufficient aggregate demand in the economy.
  - Example: Citigroup fired 50,000 employees in October 2008 at the start of the Financial Crisis recession; a construction worker cannot find a job due to less new building in an economic slowdown; losing a job as a waiter because there is less business in a recession.
  - Low cyclical unemployment occurs when demand for products is high, leading firms to hire more workers and operate longer hours.
Labor Force:
- Consists of all individuals who are either employed or actively looking for a job (unemployed).
- Labor hinspace Force = Employed + Unemployed
- Individuals not in the labor force include retirees, full-time students, homemakers, and discouraged workers (who have given up looking for jobs).
Unemployment Rate:
- The percentage of the labor force that is unemployed.
- ext{Unemployment Rate} = rac{Unemployed}{Labor hinspace Force} imes 100
- U-6 Unemployment Rate: A broader measure of unemployment that includes not only the officially unemployed but also underemployed workers (part-time for economic reasons), discouraged workers, and marginally attached workers (who want and are available for a job and have recently searched for work).
Labor Force Participation Rate:
- The percentage of the work-eligible population that is in the labor force.
- ext{Labor Force Participation Rate} = rac{Labor hinspace Force}{Work ext{-}Eligible hinspace Population} imes 100
- Work-Eligible Population: Typically includes non-institutionalized individuals aged 16 and over.
Note on Unemployment Rate Changes: It's possible for the economy to add new jobs while the unemployment rate rises if the labor force grows even faster (e.g., more people start looking for jobs and enter the labor force, but not all immediately find one).

Inflation and Price Levels

Inflation:
- The growth rate of price levels.
- A general increase in the overall level of prices in an economy over a period of time, leading to a fall in the purchasing power of money.
- ext{Inflation Rate} (i) = rac{Price hinspace Level{Current hinspace Year} - Price hinspace Level{Previous hinspace Year}}{Price hinspace Level_{Previous hinspace Year}} imes 100
Price Levels:
- GDP Deflator: A measure of the average level of prices of all new, domestically produced final goods and services in an economy during a given period.
- Consumer Price Index (CPI): A measure of the average change over time in the prices paid by urban consumers for a fixed basket of consumer goods and services. It reflects the cost of living for a