Economics Exam Review: Inflation, GDP, and Unemployment

Four Parts of the Business Cycle:
- Recessionary Gap: Economy is below potential output, typically characterized by high unemployment.
- Inflationary Gap: Economy is above potential output, often leads to price increases and inflation.
- Natural Rate of Unemployment: Where the economy can function optimally in the long-term without perpetuating inflation.
- Long Run Equilibrium: Economic state where supply equals demand without outside pressures.

Intermediate Goods:
- Definition: Goods used in the production of final goods.
- Example: Tires bought by consumers are final goods, but tires bought by manufacturers (e.g., Ford) are not counted in GDP until the final car is sold.
- Includes in GDP:
- Final Goods: Goods sold to final consumers, e.g., tires, vehicles.
- Capital Goods: Machines, robots, and construction equipment.
- New Construction: e.g., residential or commercial buildings.
- Changes in Inventories: Any increase in inventory counts towards GDP.
- Excludes from GDP:
- Intermediate goods
- Used goods
- Financial assets (stocks/bonds)
- Goods produced outside the US
- Non-taxed transactions (e.g., informal labor)
- Transfer payments (e.g., Social Security)

Nominal GDP: Measures output using current prices.
Real GDP: Adjusts nominal GDP by removing the effects of inflation; uses base year prices.
- Importance of Real GDP: More accurately reflects the true economic output without the distortions caused by inflation.
GDP Deflator: Compares current prices to base year prices for an accurate economic picture.

Calculation: ext{Real GDP per capita} = rac{ ext{Real GDP}}{ ext{Population}}
Significance: Better indicator of economic well-being as it accounts for population size.
Limitations of GDP: Does not measure quality of life, happiness, or societal well-being.

Definitions:
- Employed: Individuals with jobs.
- Unemployed: Individuals without jobs who are actively looking for work.
- Not in Labor Force: Those who are neither employed nor actively seeking work (e.g., retirees, caregivers).
Labor Force Participation Rate: ext{Labor Force Population} = rac{ ext{Labor Force}}{ ext{Total Adult Population}}
Types of Unemployment:
- Cyclical: Caused by economic downturns. Most serious type.
- Frictional: Normal job transition; people searching for better jobs.
- Structural: Mismatch between skills of workers and job requirements.

Definition: General increase in prices leads to decreased purchasing power.
- You may still hold the same amount of money, but you can buy less with it.
Types of Inflation:
- Cost-Push Inflation: Increased production costs lead to reduced supply and higher prices.
- Associated with economic conditions like stagflation (high unemployment and high inflation).
Consumer Price Index (CPI): Measures changes in the price level of a market basket of consumer goods and services.
- Weaknesses of CPI:
- Substitution Bias: Consumers change preferences when prices rise, not accounted for in CPI.
- Measurement Bias: CPI uses outdated year ranges, missing new goods in the market.
Producer Price Index (PPI): Measures average changes in selling prices received by domestic producers.
- Useful for understanding price trends affecting producers.

Text to compare nominal interest rates and inflation.
Example: If the nominal interest rate is 8\% and inflation is 5\%, the real interest rate is 3\%.

Savers: Lose purchasing power if not earning interest higher than inflation.
Lenders: Hurt by inflation, as loans repaid are in less valuable dollars.
Borrowers: Benefit during inflation; they repay loans with less valuable money.
Individuals on Fixed Income: If income adjusts with inflation (e.g., cost-of-living adjustments), they are less affected.
Disinflation: The process of reducing inflation rates without entering deflation.
Deflation: A decline in the general price level of goods and services.
Hyperinflation: Extremely high and typically accelerating inflation that is uncontrollable.