Econ 102 Final Exam

Chapter 10: Measuring a Nation's Income (GDP)

• GDP Definition: Total market value of all final goods and services produced within a country in a given period.

• Three Approaches to GDP:

  • Expenditures Approach: Y=C+I+G+NX 

    • C: Consumption

    • I: Investment

    • G: Government Spending

    • NX: Net Exports (Exports - Imports)

  • Income Approach: Sum of all incomes earned by resources used to produce output.

  • Production Approach: Sum of all outputs in the economy.

• Real vs. Nominal GDP:

  • Nominal GDP: Measures output using current prices.

  • Real GDP: Adjusted for inflation (uses constant base-year prices).

  • GDP Deflator: Nominal GDP/Real GDP x 100

• Limitations of GDP:

  • Does not measure informal economies or non-market transactions.

  • Does not capture environmental factors, inequality, or overall well-being.

Chapter 11: Measuring the Cost of Living (CPI)

• Consumer Price Index (CPI):

  • Measures the overall cost of goods and services bought by a typical consumer.

  • Formula: CPI= (Cost of Basket in current year)/(Cost of basket in base year) x 100 

  • Major categories include housing (40%), transportation (15%), and food (15%).

• Problems with CPI:

  • Substitution Bias: CPI doesn’t account for consumers substituting cheaper goods.

  • Unmeasured Quality Changes: Improvement in quality over time is not fully captured.

  • Introduction of New Goods: New products aren't included in the basket immediately.

• Comparing Prices Across Time:

  • Formula to adjust prices over time: Adjusted Price = Old price x CPI Today/CPI in Old year

• Real vs. Nominal Interest Rates:

  • Real Interest Rate = Nominal Interest Rate - Inflation Rate.

Chapter 12: Production and Growth

• Economic Growth: Higher GDP per capita leads to a better standard of living.

• Worker Productivity: Main determinant of a country’s income level.

  • More productivity → higher wages and living standards.

• Determinants of Productivity:

  • K/L = Physical Capital per worker.

  • H/L = Human Capital per worker.

  • N/L = Natural Resources per worker.

  • A= Technology (biggest driver of growth).

• Production Function: Y=A⋅F(K,L,H,N)

  • Exhibits diminishing returns to capital.

  • The production function has the property constant returns to scale: 

    • Changing all inputs by the same percentage causes output to change by that percentage 

• Policies to Raise Productivity:

  • Education, research and development, property rights, and encouraging saving/investment.

• Population Growth:

  • May promote or inhibit economic growth depending on how resources are managed.

Chapter 13: Saving, Investment, and the Financial System

• Financial System:

  • Consists of financial markets (e.g., stock markets) and financial intermediaries (e.g., banks).

• Saving = Investment (in a closed economy): Y−C−G

• National Saving = Public Saving + Private Saving: S=(Y−T−C)+(T−G)

  • Public Saving: (Y-T-C)

  • Private Saving: (T-G)

• Loanable Funds Market:

  • Supply of Loanable Funds: Savers.

  • Demand for Loanable Funds: Investors.

  • Equilibrium occurs where supply = demand, determining the interest rate.

• Government Deficits and Debt:

  • Deficits reduce national savings, leading to higher interest rates.

Chapter 14: The Basic Tools of Finance

• Time Value of Money:

  • Present Value (PV) Formula: PV=FV/(1+r)^t

    • FV: Future Value

    • r: Interest rate

    • t: Time period

  • Rule of 70: Time to double 70/growth rate in %

• Risk Aversion: People prefer less risk; as wealth increases, utility from additional wealth decreases.

• Insurance Markets:

  • Adverse Selection: High-risk individuals are more likely to get insurance.

  • Moral Hazard: People take more risks when insured.

• Diversification: Reduces firm-specific risk but cannot eliminate market risk.

• Efficient Markets Hypothesis: Asset prices reflect all publicly available information.

Chapter 15: Unemployment

• Categories of Employment:

  • Employed, Unemployed, and Not in Labor Force.

  • Labor Force Participation Rate: Percentage of adults in the labor force.

• Types of Unemployment:

  • Cyclical Unemployment: Due to economic downturns.

  • Natural Unemployment: Includes frictional and structural unemployment.

    • Frictional Unemployment: Short-term, occurs when workers transition between jobs.

    • Structural Unemployment: Long-term, mismatch between workers’ skills and job requirements.

• Public Policies for Unemployment:

  • Government policies such as unemployment benefits, job training programs, and labor market regulations

Chapter 16: The Monetary System

• Functions of Money:

  • Medium of Exchange: Used to facilitate transactions.

  • Unit of Account: Provides a standard measure for prices.

  • Store of Value: Holds purchasing power over time.

    • Sometimes economists label “medium of deferred payment” as a fourth function of money, but it is really just a combination of which two functions: medium of exchange & store of value

• Types of Money:

  • Commodity Money: Has intrinsic value (e.g., gold).

  • Fiat Money: Value derived from government decree (e.g., U.S. dollar).

• Federal Reserve (Fed):

  • Central Bank of the U.S. controlling money supply.

  • Tools of Monetary Policy:

    • Open Market Operations: Buying/selling government bonds.

    • Reserve Requirements: Minimum reserves banks must hold.

    • Discount Rate: Interest rate on loans from Fed to banks.

• Fractional Reserve Banking:

  • Banks hold a fraction of deposits and lend out the rest.

  • Money Multiplier: 1 / Reserve Ratio, determines money supply impact from deposits.

Chapter 17: Money Growth and Inflation

• Quantity Theory of Money:

  • M×V=P×Y

    •  Money supply (M), velocity (V), price level (P), output (Y).

  • Implication: Increase in money supply leads to proportional price level increase if velocity and output are stable.

• Hyperinflation:

  • Extremely high inflation, typically due to excessive money printing.

• Inflation Tax:

  • Reduction in value of money due to inflation, acting as a ‘tax’ on holders of cash.

• Fisher Effect:

  • Relationship between nominal and real interest rates: Nominal Rate = Real Rate + Inflation Rate.

  • Anticipated inflation increases nominal rates, leaving real rates unaffected.

Chapter 18: Open-Economy Macroeconomics: Basic Concepts

• Key Concepts:

  • Net Exports (NX): Exports - Imports.

  • Net Capital Outflow (NCO): Domestic purchase of foreign assets - Foreign purchase of domestic assets.

• Open Economy Balance:

  • NX=NCO: Trade balance equals net capital outflow.

• Exchange Rates:

  • Nominal Exchange Rate: Rate at which one currency trades for another.

  • Real Exchange Rate: Adjusted for price levels, affects relative cost of domestic vs. foreign goods.

• Purchasing-Power Parity (PPP):

  • Theory stating that exchange rates should adjust to equalize price levels across countries.

    • Is a long term thing

Chapter 19: A Macroeconomic Theory of the Open Economy

• Loanable Funds Market in an Open Economy:

  • National Saving supplies funds.

  • Domestic Investment and Net Capital Outflow (NCO) demand funds.

• Market for Foreign-Currency Exchange:

  • Supply of currency from NCO; demand driven by net exports.

  • Equilibrium: Determines real exchange rate.

• Effects of Policies:

  • Trade Policy (tariffs, quotas): Generally does not affect trade balance but shifts NX, affecting exchange rates.

  • Capital Flight: Sudden increase in NCO, depreciates currency, and increases interest rates due to reduced domestic savings.

Chapter 20: Aggregate Demand and Supply Deeper Dive

• Aggregate Demand (AD)

  • Definition: The total amount of goods and services demanded in an economy at a given overall price level during a specific time period.

Formula: AD = C + I + G + NX

• C (Consumption): Total consumer spending

• I (Investment): Business spending on capital goods

• G (Government Spending): Total government expenditures

NX (Net Exports): Exports minus imports

Effects to Master

1. Wealth Effect Definition: Changes in perceived personal wealth that influence spending behavior

2. Interest Rate Effect Definition: How changes in interest rates impact borrowing, spending, and investment decisions

3. Exchange Rate Effect Definition: How currency valuation impacts the purchasing power and international trade competitiveness of an economy

• Aggregate Supply (AS)

  • Definition: The total quantity of goods and services that firms are willing to produce and sell at a given price level during a specific time period.

Short-Run Aggregate Supply (SRAS) Characteristics

Definition of Sticky Prices: Prices that do not adjust quickly to changes in economic conditions

Definition of Sticky Wages: Wages that resist immediate changes in response to economic shifts

Misperceptions: Temporary economic misconceptions that can create real short-term economic effects

Chapter 21: Policy Mechanics

Monetary Policy

Definition: Actions taken by a central bank to influence the money supply, interest rates, and overall economic conditions

Theory of Liquidity Preference

Definition: An economic theory explaining how people decide to hold money based on its opportunity cost and potential returns

Fiscal Policy

Definition: Government's use of spending and taxation to influence economic conditions

Multiplier Effect

Definition: The proportional increase in economic output resulting from an initial injection of spending

Calculation: MPC (Marginal Propensity to Consume) = Change in Consumption / Change in Income

Crowding Out Effect

Definition: A situation where increased government spending reduces or eliminates private sector spending and investment

Chapter 22: Inflation Dynamics

Phillips Curve

Definition: A graphical representation of the relationship between unemployment and inflation rates

Disinflation

Definition: The process of reducing the rate of inflation

Sacrifice Ratio Definition: The cumulative loss of output during a period of reduced inflation, measuring the cost of lowering inflation

Rational Expectations

Definition: An economic theory suggesting that people make choices based on their rational outlook, available information, and past experiences