AP Macro Unit 2

Vocabulary/Concepts

Private Sector:  Part of the economy that is run by individuals and businesses


Public Sector:  Part of the economy that is controlled by the government


Factor Payments:  Payments for the factors of production (rent, wages, interest, and profit)


Transfer Payments:  When the government redistributes income (welfare, social security, etc.)


Subsidies:  Government payments to businesses


Gross Domestic Product (GDP)


Vocabulary/Concepts

Gross Domestic Product:  Dollar Value of all final goods and services produced in one year

  • Only NEW Goods and Services

  • Measures only production WITHIN a country’s border

  • Annual economic performance (one year)


GDP per Capita:  A measure o f a country’s output per person.  This can function as a universal measure of prosperity, or standard of living.


Not Included in GDP: 

  1. Intermediate Goods (goods used to make final goods)

  2. Nonproduction Transactions (Pure cash transactions and sale of used goods)

  3. Nonmarket and Illegal Activities (Items made and used in the home and black market)

  4. Transfer payments made by the government (welfare, social security, subsidies, etc.)



Formulas

GDP (Expenditures Approach):

GDP (Y) = Consumer Spending (C) + Business Investment (I) + Government Spending (G) + Net Exports (X – M) 


*There is also the income approach = Wages + Rents + Interest + Profits + Statistical Adjustments


% of change in GDP = (Year 2 – Year 1/Year 1) x 100


GDP Per Capita = GDP/population



2.2 Limitations of GDP


Vocabulary/Concepts

Nonmarket Transactions:  Many goods and services provide value but do not count in GDP


*While GDP is a useful measure of a nation’s economic performance, it is not a sufficient measure of human welfare in an economy 





2.3 Unemployment


Vocabulary/Concepts

Frictional Unemployment:  Workers who are either in between jobs or waiting to take jobs in the near future.


Structural Unemployment:  Caused by changes in technology or of skills required to work


Cyclical Unemployment:  Caused by a contraction or recession in an economy because consumers have decreased their spending


Seasonal Unemployment:  Someone who is unemployed due to the season/time of year


Labor Force:  The employed (full or part time) and the unemployed (those seeking employment)


Natural Rate of Unemployment (NRU):  The amount of unemployment that exists when the economy is healthy


Full Employment:  A condition when anyone who wants to work can get work


*Not included in the labor force:

- children (below the age of 16)

- full time students

- retired persons

- stay-at-home parents 

- institutionalized persons

- those not seeking employment (chronically unemployed – not counted after 27 weeks)

- those choosing not to work

- discouraged workers (Want a job but have given up actively looking) 


Limitations of Unemployment Rate

  • Besides not including the chronically unemployed and discouraged workers the unemployment rate considers part-time and underemployed as fully employed



Formulas


Labor force participation rate: Labor force/working age population (16 and over) x 100


Unemployment rate = unemployed workers/total labor force x 100


2.4 Price Indices & Inflation


Vocabulary/Concepts

Inflation:  An overall rise in the price of goods and services


Deflation: An overall drop in the price of goods and services (the opposite of inflation)


Disinflation:  A marginal reduction in the inflation rate over a short period of time


Inflation Rate:  The measure of the change in purchasing power


Consumer Price Index (CPI):  An index that measures the prices of a fixed “market basket” of some 300 goods and services purchased by a “typical” customer


Nominal variables:  Measure of dollar amounts and is not adjusted for inflation


Real variables:  Variables whose value is adjusted for and determined by their real value in terms of goods and services (dollar amount adjusted for inflation)


*Most common cause of inflation is demand-pull inflation – consumers increase their demand and when additional supply is unavailable producers increase the price


** There is also cost-push inflation which occurs when aggregate supply decreases.  This typically occurs when the cost of production increases


***How government combats high inflation:  raise income tax rates, raise interest rates, lower government spending.  All are designed to discourage spending to curb demand.



Formulas

CPI = Cost of market basket in year A/cost of market basket in base year x 100


Inflation Rate = (CPI in year 2 – CPI in year 1)/CPI in year 1 x 100

*The base year for CPI is ALWAYS 100


Real Wage = Nominal Wage/CPI x 100






2.5 Costs of Inflation


Vocabulary/Concepts

General effect of inflation:  prices increase so purchasing power decreases


Beneficiaries of inflation:  anyone who has borrowed money


Victims of inflation:  anyone or any institution that has loaned money


*Value of money being paid back is worth less than when the borrowers incurred the debt.  In other words, the real value of the dollar amount had decreased


**Devaluation of savings – Nominal dollar amount in the account is less than the real value of the account


Inflationary Spiral:  when inflation leads to more inflation (workers negotiate higher wages due to price increases which sparks further price increases)

























2.6 Real vs. Nominal GDP


Vocabulary/Concepts


Nominal GDP:  Total value in dollars of all the goods produced in a year.  It is also called the unadjusted GDP because it does not account for inflation from year to year.


Real GDP:  Nominal GDP adjusted for inflation and deflation.


GDP Deflator:  A measurement used to determine price inflation or deflation in relation to a specific year.  It measures the price of all goods produced.


*CPI only measures the prices of goods and services purchased by consumers  



Formulas

Nominal GDP:  Real GDP x (Aggregate Price Level/100)

    Real GDP x (GDP Deflator/100)

*Value of Aggregate Output in current dollars



Real GDP:  Nominal GDP/Aggregate Price Level x 100

        Nominal GDP/GDP Deflator x 100

*Value of aggregate output (Q) in constant dollars


GDP Deflator:  (Nominal GDP/Real GDP) x 100


Inflation Rate:  (GDP Deflator CY – GDP Deflator BY/GDP Deflator BY) x 100














2.7 Business Cycles


Vocabulary/Concepts


Business Cycle:  A mix of periods of economic expansion when production output and purchases increase, economic contraction when production output and purchases decrease, and the transitions in between


Recession:  Periods of economic contraction which can last for a few months or up to several years


Depression:  A prolonged contraction or recession which last a minimum of three years and results in a decrease in real GDP by 10% or more.


Business Cycle Phases:

  • Expansion (or recovery):  Phase of increasing employment, economic growth, and pressure for price increases

  • Peak:  This is the maximum growth stage of the economy

  • Contraction (or recession):  Phase of increasing unemployment, decreased economic activity, and declining economic output

  • Trough:  This is the lowest point in economic activity     


Output gap:  Difference between an economy’s actual output (what has been achieved in reality) and its potential output (how much the economy could ideally produce if it used all its resources)


*Output gaps can be positive (producing more than the potential output) or negative (producing less than the potential output)