Unit 2

Circular-Flow Diagram

Simple model of macroeconomics representing inflows and outflows.

• Contains households and firms

  • household - a person or group of people who share income

  • firm - an organization that produces goods and services for sale

Expanded Circular-Flow Diagram

• inflow must equal outflow

• government, households, firms, rest of the world

Gross Domestic Product (GDP)

GDP - total value of all final goods and services produced in the economy during a given year.

Three ways to calculate GDP:

• value added approach - survey firms and add up their contributions to the value of final goods and services

• expenditure approach - to add up aggregate spending on domestically produced final goods and services in the economy

  • consumer spending + investment spen + gov purchases + exports - imports

• income approach - add up the total factor income earned by households from firms in the economy, including rent, wages, interest, and profit

• IF IF U -

  • Intermediate goods/services

  • Financial assets and transfer payments

  • Inputs used in production

  • Foreign-produced goods and services

  • Used goods

aggregate output - the total quantity of final goods and services the economy produces.

real gdp - the total value of all final goods and services produced in the economy during a given year, calculated using the prices of a selected base year in order to remove the effects of price changes.

• comes with information about what the base year is.

nominal gdp - gdp at current prices.

chain linking - the method of calculating changed in real GDP using the average between the growth rate calculated using an early base year and the growth rate calculated using a late base year.

• adopted measure by u.s. national accounts

GDP per capita - GDP divided by the size of population; equivalent to the average GDP per person.

• eliminates effect of differences in population size.

• useful for comparison of labor productivity.

• not sufficient measure of real gdp.

Unemployment

employment - people are currently holding a job in the economy, either full time or part time.

• retired and disabled do not count

unemployment - people are actively looking for work but aren’t currently employed

• unemployed considered to be “jobless, looking for jobs, available for work.”

labor force - equal to the sum of employed and unemployed.

labor force participation rate - percentage of population aged 16+ that is in the labor force.

• labor force/population age 16+ x 100

unemployment rate - percentage of the total number of people in the labor force who are unemployed

• # of unemployed workers/labor force x 100

• estimated based on surveys sent to 60,000 american families

• indicator of how difficult it is to find a job in the economy

Overstating and Understating Employment

Unemployment never falls to zero, despite many unemployed.

discouraged workers - nonworking people who are capable of working but have given up looking for a job due to the state of the job market.

• understated unemployment because they were originally looking for jobs, but gave up

• known as marginally attached - would like to be employed and have looked for a job in the recent past but are not currently looking for work.

  • marginally attached workers ended their job search for a reason other than belief that no job was available for them.

• not included when calculating the unemployment rate.

underemployed - workers who would like to work more hours or who are overqualified for their jobs.

Job Creation and Destruction

structural changes in technology can result in job loss & creation.

• ex: employment rise in high-tech industries because of the new technologies emerging.

Types of Unemployment

frictional unemployment - unemployment due to the time workers spend in job search.

• workers lose a job and chose to not take the first new job offered.

• always exist in the economy

job search - workers who spend time looking for employment.

structural unemployment - unemployment that results when workers lack the skills required for the available jobs, or there are more people seeking jobs in a labor market than there are jobs available at the current wage rate.

Wages - Money

minimum wage government mandated floor on the price of labor.

• binded minimum wages are for less skilled workers

  • lead to structural unemployment

labor unions are organizations between workers to maintain or improve it

• lead to structural employment

• exercise bargaining power by threatening firms with a labor strike.

  • greater bargaining power = higher wages demanded

efficiency wages - wages that employers set above the equilibrium wage rate as an incentive for better employee performance.

natural rate of unemployment - unemployment rate that arises from the effects of frictional plus structural unemployment.

• natural unemployment = frictional unemployment + structural unemployment

cyclical unemployment - the deviation of the actual rate of unemployment from the natural rate.

• actual unemployment = natural unemployment + cyclical unemployment

unemployment rates are lower for experienced than low-skilled workers.

in result, their wages are higher than low skilled

Inflation

real wage - the wage rate divided by the price level to adjust for the effects of inflation or deflation

real income - income divided by the price level to adjust for the effects of inflation or deflation

inflation rate - the percentage increase in the overall level of prices per year

inflation rate = price level in year 2 - price level in year 1/ price level in year 1 × 100

shoe-leather costs - the increased costs of transactions caused by inflation

• allusion to wear and tear caused by extra running around that takes place when people try to avoid holding money

menu cost - the real costs of changing listed prices

unit-of-account costs - arise from the way inflation makes money a less reliable unit of measurement

• not useful because of inflation - worth of a dollar changes over time

effect of inflation on borrowers/lenders are nominal and real interest rates

• nominal interest rates - the interest rate actually paid for a loan

• real interest rate - the nominal interest rate minus the rate of inflation

  • inflation discourages from long-term contracts

disinflation - the process of bringing the inflation rate down

• difficult an costly

Module 15

aggregate price level - measure of the overall level of prices in the economy.

price index - measures the cost of purchasing a given market basket in a given year. The index value is normalized so that it is equal to 100 in the selected base year.

• price index in given year = cost of market basket in a given year/ cost of market basket in base year x 100

• inflation rate = price index in year 2 - price index in year 1/price index in year 1 × 100

consumer price index - measures the cost of the market basket of a typical urban american family.

• surveys sent to ifferent industries; food, housing, clothing, education, etc.

producer price index - measures the prices of goods and services purchased by producers.

• regarded as warning sign

gdp deflator - 100 times the ratio of nominal gdp to real gdp in that year

• onflation rises nonimal but not real