AP MACRO UNIT 2

How do you calculate the inflation rate?

% change in prices = (year 2 - year 1)/(year 1) x 100

Fiscal Policy

Changes in government spending (G) and tax collections (T) implemented by government with the aim of either increasing or decreasing aggregate demand to achieve the macroeconomic objectives of full employment and price-level stability.

Structural Unemployment

Changes in labor force make some skills obsolete Workers DO NOT have transferable skills and these jobs won't come back Permanent loss of jobs = creative destruction Workers must learn new skills

GDP Per Capita

GDP divided by the population. It identifies on average how many products each person makes Best measure of standard of living

Real GDP

GDP expressed in constant or unchanging dollars -- adjusts for inflation Best measure of economic growth

Nominal GDP

GDP measured in current prices. It doesn't account for inflation from year to year.

Full Employment Output (Y)

The Real GDP created when there is no cyclical unemployment

Unemployment

Workers that are actively looking for a job but currently aren't working

How do you calculate the GDP Price Index (Deflator)?

(Nominal GDP)/(Real GDP) x 100

What is the formula to calculate the percent change in GDP?

(year 2 - year 1)/year 1 x 100

Who is in the labor force?

-Above 16 years -Able/willing to work -Not institutionalized (jail/hospital) -Not in military, in school full time, or retired

Who is helped by unanticipated inflation?

-Borrowers (people who borrow money) -A business where the price of the product increases faster than the price of resources

What is NOT included in GDP?

-Intermediate goods (goods inside final goods) -Non production transactions (stocks, bonds, real estate) -Non market/illegal activities (household production)

Who is hurt by unanticipated inflation?

-Lenders (people who lend money at fixed interest rates) -People with fixed incomes -Savers

Four components of GDP

1. Consumer Spending 2. Investment (business spending on tools/equipment 3. Government spending (NOT transfer payments) 4. Net exports -- exports (x) - Imports (M)

What are the 5 factors of productivity?

1. Economic system 2. Property rights 3. Capital -- countries with it can produce more 4. Human capital (knowledge, education, skills) 5. Natural resources

Income approach adds up

1. Labor income 2. Rental income 3. Interest income 4. Profit Factor payments

Three Major Economic Goals for Every Country

1. Promote economic growth 2. Limit unemployment 3. Keep prices stable (limit inflation)

Problems with the CPI

1. Substitution bias 2. New products 3. Product quality

Causes of Inflation

1. The government prints too much money ---If the government keeps printing money to pay off debts they could end up with hyperinflation 2. Demand - Pull Inflation: Demand pulls up prices -- overheated economy with excessive spending but the same goods 3. Cost - Push Inflation: Higher production costs increase Prices

The US is at full employment when there is what percent unemployment?

4-6%

Spending multiplier

= 1/(1-MPC) or 1/MPS. This tells you how much total spending an initial interjection of spending in the economy will generate. For example, if the MPC = .8 and the government spends $100 million, then the total increase in spending in the economy = $100 x 5 = $500 million.

Expansionary Fiscal Policy

A demand-side (AD) policy whereby government decreases taxes or increases its expenditures in order to increase aggregate demand. Could be used in a period of high unemployment (recession) to increase national output (real GDP). T down, G up so AD increases.

Contractionary Fiscal Policy

A demand-side (AD) policy whereby government increases taxes or decreases its expenditures in order to reduce aggregate demand. Could be used in a period of high demand-pull inflation to bring down the inflation rate. T up and/or G down

Stagflation

A macroeconomic situation in which both inflation and unemployment increase. Caused by a negative supply shock (i.e., Aggregate Supply decreases).

Transfer Payment

A payment made when no good or service is exchanged. Allowances are private transfer payments; social security checks are governmental transfer payments. Transfer payments are NOT included in GDP because they do NOT represent production.

Aggregate Demand (AD)

A schedule or curve that shows the total quantity demanded for all goods and services of a nation at various price levels in a given period of time. AD is downward sloping.

Income Approach

Add up all the income that resulted from selling all final goods and services produced in a given year -- Labor Income/Rental Income/Interest Income/Profit

Expenditures Approach

Add up all the spending on final goods and services produced in a given year

Wealth

An important determinant of consumption. Wealth is the total value of a household's assets minus all its liabilities.

Economic Growth

An increase in the potential output of goods and services in a nation over time. PPC is shifting outward or could also be depicted as Long Run Aggregate Supply (LRAS) curve shifting to the right.

Supply Shock

Anything that leads to a sudden, unexpected change in aggregate supply. Can be negative (decreases in AS) or positive (increases in AS). May include a change in energy prices, wages, or business taxes, or may result from a natural disaster or a new discovery of important resources.

Automatic Stabilizers

Built-in mechanisms in the tax code and transfer payment programs that increase government spending and reduce tax revenue automatically when aggregate demand decreases. They reduce government spending and collect more in tax revenues when aggregate demand increases.

GDP = ?

C + I + G + Xn

What are the criticisms of the unemployment rate?

Discouraged workers: some people are no longer looking for a job because they have given up Underemployed workers: Someone who wants more hours but can't get them is still considered employed

2 Tools of Fiscal Policy

Federal Government engages in fiscal policy. Tool # 1 = Government Spending. Tool # 2 = Personal Income Taxes.

Natural Rate of Unemployment (NRU)

Frictional + structural unemployment The amount of employment that exists when the economy is healthy and growing

Why is zero percent unemployment not our goal?

Frictional/structural unemployment are present always because people will always be between jobs or replaced by technology

Cost-push inflation

Inflation resulting from a decrease in AS (from higher wage rates and raw material prices, such as the price of oil) and accompanied by a decrease in real output (real GDP) and decreases in employment. Also referred to as "stagflation" or "adverse/negative aggregate supply shock." AS decreases. The USA had cost-push inflation during the 1970's and early 1980's.

Demand-Pull Inflation

Inflation resulting from an increase in aggregate demand without a corresponding increase in aggregate supply. AD is increasing.

Real Balances Effect = Wealth Effect

One of the reasons the aggregate demand curve slopes downward: The tendency for increases in price level to lower the real value (or purchasing power) of financial assets with fixed money value and, as a result, to reduce total spending and real output. The idea that any wealth that you may have in the form of a cushion or securities becomes less valuable as prices rises because higher prices reduce real spending power, prices and output are negatively related.

Nominal Interest Rates

Percent increase in money that a borrower pays not adjusting for inflation

How do you calculate the unemployment rate?

Percent of people unemployed (# unemployed)/(# in labor force) x 100

Labor Force Participation Rate

Percent of population in the labor force. If people leave the labor force, the unemployment rate falls

Real Interest Rates

Percentage increase in purchasing power that a borrower pays Real = Nominal - Inflation

Short Run Aggregate Supply (SRAS)

Positive relationship between the aggregate amount of GDP produced and the price level in an economy in the short run, when it is presumed that prices of goods are flexible but wage rates are fixed.

Aggregate

Sum total; a collection of separate things mixed together.

Frictional Unemployment

Temporary unemployment or being between jobs Individuals are qualified workers with transferable skills

Inflationary Gap

The difference between a nation's equilibrium level of output and its full employment level of output when the nation is overheating (producing beyond its full employment level).

Recessionary Gap

The difference between an economy's equilibrium level of output and its full employment level of output when an economy is below full-employment.

Gross Domestic Product

The dollar value of all final goods and services produced within a country's borders in one year Most important measure of economic growth

MPC + MPS = 1

The fraction of an increase in disposable income that is spent (MPC) plus the fraction that is saved (MPS) must equal 1.

Marginal Propensity to Consume (MPC)

The fraction of any change in income spent on domestically produced goods and services; equal to the change in consumption divided by the change in disposable income.

Marginal Propensity to Save (MPS)

The fraction of any change in income that is saved; equal to the change in savings divided by the change in disposable income.

Self-correction

The idea that an economy producing at an equilibrium level of output that is below or above its full employment level will return on its own to it full employment level if left to its own devices. Requires fully flexible wages and prices and is associated with classical economic views.

Multiplier Effect

The increase in total spending in an economy resulting from an initial injection of new spending. The size of the multiplier effect depends upon the spending multiplier. An effect in economics in which an increase in spending produces an increase in national income and consumption greater than the initial amount spent.

Macroeconomic Equilibrium

The level of output at which a nation is producing at any particular period of time. May be below its full employment level (if the economy is in recession) or beyond its full employment level (if the economy is overheating). In the picture, short-run equilibrium is at P1 and Y1

Long Run Aggregate Supply (LRAS)

The level of output to which an economy will always return in the long run. The LRAS curves intersects the horizontal axis at the full employment or potential level of output. "at the full-employment level of real GDP"

Inflation Rate

The percent change in prices from year to year Can use CPI to calculate this

Long Run

The period of time over which the wage rate and price level of inputs in a nation are flexible. In the long run, any changes in AD are cancelled out due to the flexibility of wages and prices and an economy will return to its full employment level of output. Sometimes referred to as the "flexible wage period."

Disposable Income

The portion of income that an individual can choose to spend or save; after-tax income = take home pay. Disposable income is the main factor that drives both spending and savings decisions. DI = C + S. Where "C" is Consumption/Consumer Spending. "S" is savings.

Crowding-out Effect

The rise in interest rates and the resulting decrease in investment spending (I) in the economy caused by increased government borrowing in the loanable funds market. This occurs because of budget deficits, so the government must borrow money, which drives up real interest rates. The crowding-out effect is seen as a disadvantageous side effect of expansionary fiscal policy.

Inflation

The rising in the general level of prices and it reduces the "purchasing power" of money

Sticky wage and price model

The short-run Aggregate-Supply Curve is sometimes referred to as the "sticky wage and price model," because workers' wage demands take time to adjust to changes in the overall price level, and therefore, in the short-run an economy may produce well below or beyond its full employment level of output.

Aggregate Supply

The total amount of goods and services that all firms in all the industries in a country will produce at various price levels in a given period of time. Short Run Aggregate Supply is upward sloping. (SRAS)

Cyclical Unemployment

Unemployment caused by a recession As demand for goods/services falls, demand for labor falls and workers are fired "Demand deficient unemployment"

Real Wage

Wage adjusted for inflation Inflation -- workers have to ask their boss for a raise

Nominal Wage

Wage measured by dollars rather than in purchasing power

Foreign Trade Effect

When U.S. price level increases, foreign buyers purchase fewer U.S. goods and Americans buy more foreign goods. Exports fall and imports rise causing real GDP demanded to decrease. One of the reasons why AD is downward sloping.

Budget Surplus

When a government collects more in tax revenues than it spends in a given year. T > G

Budget Deficit

When a government spends more than it collects in tax revenues in a given year. The USA typically runs a budget deficit each year. G > T

National Income Accounting

When economists collect statistics on production, income, investment, and savings

Interest Rate Effect

if the average price level rises, consumers and firms might need to borrow more money for spending and capital investment, which increases the interest rate and delays current consumption. Reduces current consumption of domestic products and the price level rises. One of the reasons why AD is downward sloping.