BMAL-590 Macroeconomics

GDP includes both goods and services:

- Goods Tangibles Food, clothing, cars, houses, etc - Services Intangibles Health care, entertainment, advice, travel, banking, etc A higher percentage of our GDP comes from services today than ever before. Today, services account for over two-thirds of total output/GDP. The composition of our industries and economy has greatly changed over the last 50 years.

Services as a Share of U.S. GDP

A majority of U.S. GDP is service output such as financial, transportation, retail, and technology services. This graph shows services as a share of U.S. GDP since 1960, which have grown from 50 percent in 1960 to about 70 percent in 2013

National Income

A nation is comprised of individuals, households, firms, and the government. A nation is said to be doing well when its people are doing well. Thus, while measuring a nation's income (measures the monetary value of the flow of output of goods and services produced in an economy over a period of time), it is also important to look at the incomes of all the individuals in the economy. At the national level, an important requirement is for the total income to be equal to the total expenditure. Every exchange and every transaction has a buyer and a seller. A dollar spent by someone should be a dollar earned by someone else. The market for goods and services cause multiple touch points between the government, firms, households, and individuals. For example, the government collects taxes and invests in infrastructure and welfare programs. This creates employment opportunities and the potential for people to earn an income. This income is spent on goods and services produced by firms. The firms also generate employment and provide avenues for income for individuals. Firms interact with one another in the buying of inputs and the selling of outputs. GDP may be considered as the sum of the Consumption (C), Investments (I), Purchases made by the government (G), and Net exports (NX). Where Y is GDP (Y) = C + I + G + NX

circular flow

A particular economy may have goods and services that other economies need. These are produced and exported to those economies or countries and constitute a receipt. Thus, there is a circular flow of receipts and expenditure through exchanges involving goods and services at the level of the individual, households, firms, the government, and other economies.

Real GDP: Adjusting GDP for Price Changes

Generally, prices rise over time. Therefore, if we do not take this into account when measuring GDP and trying to make historical comparisons, we will likely overestimate increases in GDP. Nominal GDP is calculated by aggregating the market value (price times quantity) of goods and services produced in a country during a given time period. The prices used are those at the time GDP is calculated. GDP is a measure of production and when making comparisons over time, we want to hold prices constant over time to be able to differentiate between changes in quantities and changes in prices. Real GDP is adjusted for inflation. A particular year is designated as the base year, and then the prices of goods and services in the base year are used to calculate the market value of goods and services. The GDP deflator is a broad price level index used to remove inflation from nominal GDP and calculate real GDP.

Durable goods:

Goods consumed over a long period of time, such as cars and appliances. They are more subject to cyclical fluctuations, as people tend to postpone buying goods that last for many years when the economy is struggling. Fore example, if the economy is week (job loss, high levels of uncertainty, lower incomes), people can usually delay the purchase of a new refrigerator/other appliance and use the old one for a few more months.

Cost of Living and its Measurement

Cost of living refers to the amount of money needed to sustain a given standard of living, including basic expenses such as housing, food, taxes and health care. Cost of living is often used to compare how much it costs to live in one city versus another city. Cost of living is tied to wages, as salary levels are measured against expenses required to maintain a basic standard of living in specific geographic regions. For instance in 2015 a family of four, with two adults and two children, the average cost of living in the United States hovered around $65,000 per year. This figure does not include the discretionary spending on the nonessential goods and services, such as leisure, entertainment and luxury items.

In the short run, the supply curve may shift adversely to the left and cause:

Decreased output. An increase in unemployment. An increase in price level. Adverse short run supply curve's shift to the left could lead to a combination of Stagnation and Inflation (Stagflation). NOTE: Stagflation is an unusual phenomenon when the prices of goods and services increase and output decreases. The two common theories proposed for stagflation are supply side shocks (like the oil crisis of the 1970s) and poor economic policies that tend to follow knee-jerk reactions to major problems in the economy.

If there is an increase in the supply of money in an economy, any of the variables may be affected:

Either the price level will rise. Or the quantity of output will rise. Or the velocity of money will be reduced. Of course, a combination of the three is also possible.

double-entry system of bookkeeping

Even at the global level, the norm is to follow this system Thus, all the transactions that involve payments to other countries are treated as debits. All transactions that result in money flowing into a country are treated as credits. Ideally, a perfect balance of payments would result in dollar outflows and dollar inflows matching. This is rarely the case. Some countries have exports in excess of imports. This leads to a trade surplus. Other countries import more than they export. These countries will have a trade deficit.

equity

Financing through shares or stocks As owners, shareholders are entitled to a share in the profits of the firm. This distribution is usually in the form of dividends. Firms that perform very well may also issue bonus shares either without any cost or at a discount. Equity offers (or at least promises to offer) a higher return. With higher returns, the risk also increases. In the extreme case of a firm going bankrupt, equity shareholders are placed at the very end in terms of whether they can get any of their investment back.

The market for loanable funds

Firms require funds to carry out their operations. They get funds (demand) from individuals and financial institutions (debt, equity, and working capital). Individuals and financial institutions provide (supply) the money in the money market in the hope of getting adequate returns through interest, dividends, and capital appreciation.

a "Flat World"

Free trade can accelerate growth across nations. This notion came about primarily due to the convergence of information, communication, and technology. Innovation is another accelerator for growth. It is no longer the case that the traditional dispersion of innovation starts with developed countries. New concepts such as disruptive innovation and reverse innovation can happen anywhere in the world.

Shortcomings of GDP

GDP is a measure of production and typically used as a primary indicator of economic well-being. However, there are several shortcomings of this measure including: Non-market goods Underground economy Environmental quality Leisure Non-market goods are goods and services produced but not sold. For example, uncompensated household activities such as: Washing dishes Mowing lawns Cleaning GDP is unable to distinguish how goods are produced. For example: Non-market goods still create value for society. When the non-market segment of an economy is large, this can led to a dramatic undercounting of the annual output being produced. This is more prevalent in less-developed countries. Therefore, in less-developed societies where houses produce many of their own goods, GDP may be a poor measure of economic output.

Nominal GDP

GDP measured in current prices

Real GDP

GDP measured with prices held constant over time

Non-durable goods:

Goods consumed over a short period of time, such as groceries, magazines, and medicines. They are not affected as much by cyclical fluctuations. They are usually purchased irrespective of the economic environment. Groceries are an example of non-durable goods. People will always need to eat and will purchase groceries regardless of economic conditions. However, people may substitute lower-quality (lower-cost) non-durable goods during economic contractions.

Government Purchases

Government purchases refer to spending by state, local, and federal governments on goods and services. Transfer payments are not included. Transfer payments are government outlays to households, including welfare and social security. While transfer payments do increase household income, this does not fit into the expenditure definition of GDP. However, when households spend this income, it does enter into GDP as part of consumption or investment.

National Income - Indices

In general a Price Index in a given year = (Price of a representative basket of goods and services in the stated year / Price of a same basket of goods and services in a base year) x 100. The Consumer Price Index (CPI) reflects changes in a basket of goods and services that consumers typically use in a given country. The Wholesale Price Index (WPI) or Producer Price Index (PPI) reflects changes in a basket of goods and services at the point of production (ignoring the costs of distribution and retailing).

The theory of comparative advantage

implies that even when a country has an absolute advantage in many goods and services, it would still be better off by trading with countries in goods and services where the opportunity costs are higher. Comparative advantage assumes low or zero transaction costs. This may not hold in many cases. For example, if the distance between two countries is large, the transportation costs may offset the comparative advantage. The other assumption is that different goods and services have different production costs. If relative production costs are the same, trade may not benefit the countries. Even with these limitations, the theory of comparative advantage is an important aspect of international trade. Trade expands production, and therefore of consumption , possibilities.

The current account of any economy comprises:

Merchandise - that is, trade in goods. Services - that is, trade in various types of services. Investment income - that is, payment for capital services (interest). Unilateral transfers - that is, payments made without any goods or services being exchanged.

Three key policy frameworks are used for the purpose of stimulating growth and stabilizing the prices are:

Monetary Policy Fiscal Policy Supply-side Policy

The aggregate supply curve may shift to the right in the short run due to:

More people being employed and / or higher level of productivity. New investments because of favorable conditions. Discovery of natural resources (such as copper or tin ore, or other minerals) may spur investments in that sector. Technological changes can dramatically alter output. Changes at the macro-level (better governance, a friendly tax regime, or incentives for new investment) that alter the natural rate of output would bring about a shift in the long run supply curve, indicating more prosperity for the people.

Some challenges in countries with uncertain institutions:

No well-defined set of laws to follow to establish business. Rules are not the same for everyone. Licensing fees and taxes may vary over time and without warning. Corruption and bribes. Imports may be challenging to receive. Profits may be "taxed" away or stolen due to insufficient property rights. A coup or war could change the environment overnight.

NGP

Nominal GDP tends to increase because production increases. Nominal GDP can also increase due to a rise in prices. To provide a clear picture of the economy, we use a GDP Deflator to reflect Real GDP. GDP Deflator = Nominal GDP / Real GDP * 100.

U.S. Nominal and Real GDP

Nominal GDP usually rises faster than real GDP. This is because nominal GDP reflects both an increase in prices over time and an increase in production. For example, nominal GDP rose 24 percent from 2009 to 2015; however, the increase in real GDP over this period was 13 percen

every transaction or exchange has two elements

One element is expenditure and the other is receipt. Each participant's expenditure is some other participant's receipt. firms buy raw materials, borrow money, and hire people to produce goods and services. These are all expenditures for the firm. Firms then sell their products and services in the market - either to consumers, to other firms, or the government. They receive a consideration - usually money - for their products and services. individuals and households work for firms. They receive salaries and wages. This is a receipt for them. They then spend it on goods and services that they need. This constitutes their expenditure.

(pt 2) Productivity and Growth

One of the most important principles in economics is that of diminishing returns. This is true of economies as well. After a certain level of prosperity has been achieved, countries will find that additional investments do not yield the kind of results they once did. Hence, there is an economic imperative for Foreign Direct Investments (FDI) in less privileged countries. It is easier to see high rates of growth when one is starting at a low level. The relationship between investments today and growth tomorrow is unmistakable.

Why does GDP count the "market value"?

Quantities do not provide enough information. For example, in 2010, the United States produced: 12 billion bushels of corn 8 million cars Quantities would suggest that corn is more "important" to GDP relative to cars We need to compute the market value of goods and services in order to aggregate and form the measure of GDP. Market value of a good or service can be defined as the price per unit multiplied by the number of units produced. The units for various quantities cannot be added together (e.g., gallons of milk, cups of coffee, pounds of steak, bottles of perfume, etc.).

How is real GDP different from nominal GDP?

Real GDP is adjusted for inflation, and nominal GDP is just measured in current prices.

Real Interest Rate

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

the steady state condition of unemployment is:

S x E = F x U The left-hand side is the number of employed people who become unemployed (either they leave or lose their jobs) and the right-hand side is the number of unemployed people who are able to be employed (that is, they are able to find jobs). Rearranging the terms, we get, U(F + S) = L x S policies will reduce the unemployment rate only if it lowers S or increases F.

The Business Cycle Journey Since 1929

The great depression lasted 3 years and 7 months. GDP contracted 26.7% Recessions since then have averaged 10 months with a median of 9 months. Median GDP contraction has been 2.7%. The exception: the recession of 2007/2008 from which full recovery (growth greater than 2%) is still not in sight. Contraction has already crossed 5%.

Expected Inflation

The central bank's ability to alter the rate of inflation is valid only for the short run. When people anticipate a certain level of inflation, the only method by which unemployment can be brought down below the natural unemployment rate is for the actual inflation to be above the anticipated rate of inflation. Thus, Unemployment rate = Natural rate of unemployment - a (actual rate of inflation - expected rate of inflation). The concept that unemployment ultimately tends towards its natural state. Irrespective of the level of inflation, is called the natural-rate hypothesis. Empirical evidence appears to support this view.

Keynesian economics

The central theme is the role of government in the economy. Keynes argued that government intervention could be an effective toolin addressing the problems of unemployment and sluggishness output. Thus, government becomes a facilitator in stimulating aggregate demand and lifting the economy out of a recession. The definition of people not working according to Keynes are those not able to find a job at the current wage rate. Keynesian economics was deemed to be the answer until the events of the 1970s and 1980s demonstrated the limitations of government intervention and led to considerable disillusionment.

What explains these sharp differences in economic performance between rich and poor countries?

The clear difference between the neighboring Korean countries are government policies and in the rules and regulations that economists call "institutions." Some challenges in countries with uncertain institutions: No well-defined set of laws to follow to establish business. Rules are not the same for everyone. Licensing fees and taxes may vary over time and without warning. Corruption and bribes. Imports may be challenging to receive. Profits may be "taxed" away or stolen due to insufficient property rights. A coup or war could change the environment overnight.

Phillips Curve

a curve that shows the short-run trade-off between inflation and unemployment An increase in the quantity of output (lower unemployment) leads to a higher price level (inflation). A shift in the aggregate demand curve has the tendency of pushing unemployment and inflation in opposite directions in the short-run. a higher aggregate demand means higher output and a higher price level; that is, lower unemployment but higher inflation. lower aggregate demand means lower output and a lower price level; that is, higher unemployment but lower inflation. As inflation increases, the Phillips curve would shift to the right. NOTE: If input prices are adjusted very slowly to output prices, the Phillips curve would be near horizontal.

business cycles

are fluctuation in economic activity that an economy experiences over a period of time. A business cycle is basically defined in terms of periods of expansion or recession. The business cycle tends to follow a pattern. During a period of growth or expansion or economic boom, both output and employment in the economy increase. In contrast, during a period of sluggishness or contraction or recession or economic downturn, the economy slumps to a low point with the result that both output and employment decrease. It is similarly analogous to ocean tides - every economy will have its highs or peaks and lows or troughs. The only differences could be in the rate of growth (or the lack of it) and the rate of employment along with the duration of each cycle.

Friedman and Phelps

argued that unemployment and inflation are unrelated in the long run. Thus, the long-run Phillips curve is a vertical line representing the natural rate of unemployment. Therefore, monetary policy can at best be effective in the short run but not in the long run.

The index most often used to measure inflation is the

consumer price index

What is the biggest component of GDP?

consumption [C]

sacrifice ratio

could be smaller in reality due to the Theory of Rational Expectations. This theory suggests that over time, people will process and use all the information available to them in an optimal manner, and the notion of expected inflation has the potential to dispel with the trade-off between unemployment and inflation.

Structural Unemployment

defined as unemployed workers who lack required skills for the job. Suppose the government enacts a law that increases minimum wages to a point above the equilibrium level. Firms are likely to reduce hiring. Of course, the minimum wage argument does not explain the natural rate of unemployment since most workers earn more than the minimum wage. Labor unions have an important role to play. Their objective is to ensure workers are paid much more than the minimum wage. If the demanded wage rate is more than the equilibrium rate, unemployment is inevitable. Just as there is considerable debate about the role of insiders and outsiders at the board level, there is debate about the desirability or otherwise of having outsiders in unions. Insiders have a vested interest in ensuring high wages while outsiders are likely to work within a narrow range of the equilibrium wage. Structural Unemployment can also occur if firms focus on higher efficiency and productivity. This translates into hiring people with better skill sets, positive attitudes, aligning personal goals with organizational goals, reduced turnover because of high levels of satisfaction, and providing benefits beyond those stipulated by law.

One of the major characteristics of the modern corporation:

dispersion of ownership. The concept is that a large number of people invest in a company and thus become part-owners. Corporations issue shares or stocks to indicate that the holder is a part-owner of the firm. Shares or stocks are tradable securities that can be bought and sold on the stock market.

Macroeconomics

examines the economy as a whole. When all the individuals, households, firms, governments and foreign countries act together and make decisions, the entire economy is affected. Thus, Macroeconomics explores the determinants of aggregate income, investment, consumption, growth, interest rates, and overall level of prices. Macroeconomics posits that the notion of perfect markets and equilibrium do not hold for all goods and services, and certainly not at all times. In fact, the impetus for the growth of Macroeconomics was the great depression as classical macroeconomic theories could not explain why high levels of unemployment persisted.

Suppose in an economy, the national output increases, the economy is in a state of

expansion

Keynesian economics looks at the role of the government as a(n)

facilitator

The Circular Flow Concept

helps you to understand how the market for goods and services, the market for the factors of production, individuals, households and firms are intricately linked. It should be noted that government purchases are not considered a "leakage".

The Production Possibilities Frontier

illustrates the combination of two goods that can be produced by a firm. Assuming only two goods, and fixed factors of production, the frontier helps to optimize the production of the two goods. The concept illustrates issues related to trade-offs, opportunity cost, efficiency, and economic growth.

Theory of Liquidity Preference

states that the interest rate adjusts to balance the supply of and demand for money. The equilibrium interest rate is the rate at which the quantity of money demanded is equal to the quantity of money supplied. The price level is stuck at some level to satisfy this state of equilibrium. Interest rates do not affect the quantity supplied of money. Depending on the shift of the demand for money, interest rates can move up or down.

Gross Domestic Product (GDP)

tal (gross) amount of everything produced within a specific economy Used to analyze economic growth Can compare regions or nations Note: Some quality-of-life measures are not easily captured quantitatively. The market value of all final goods and services produced in a nation within a specific period of time. Sum of output from all economic activity Output = GDP = Income

treasury securities

tax free and taxable bonds, savings certificates, notes, and bills. These can be characterized as promissory notes.

Numerous factors influence unemployment rates:

technological shifts can result in new skills being required and this may render certain sections of the population jobless. Acquiring new skills requires time as well as a mindset of learning and adaptation. Outsourcing of jobs to low-cost economies may render many domestic jobs redundant. Globalization and trade has led to shifts in some jobs from developed to developing countries. Automation can render jobs redundant. Over the last two centuries, we have seen dramatic shifts from agrarian economies to manufacturing economies to service-oriented economies to knowledge-based economies. Each of these changes poses challenges for society and policy makers to manage unemployment rates.

The Bureau of Economic Analysis (BEA)

the U.S. government agency that tallies GDP data. The task is called national income accounting.

Quantity supplied

the amount of a good that sellers are willing and able to sell.

The aggregate demand and aggregate supply graph represents

the behavior of the economy as a whole

Market Supply

the combined supply of everyone willing and able to sell a good in a market. Market supply is graphically represented by a positively-sloped market supply curve (remember previous slide), which can be derived by combining, or adding, the individual supplies of every seller in the market.

Aggregate Output

the economy's total production of goods and services for a given time period Aggregate output refers to the total quantity of final goods and services produced in an economy in a given time period; usually measured quarterly.

Real interest rate

the interest rate that has been adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower and the real yield to the lender or to an investor. It can be obtained by applying the inflation rate to the Nominal interest rate.

In the long run, the Phillips curve will be vertical at the natural rate of unemployment if __________

the long run aggregate supply curve is vertical at potential GDP

The law of supply states:

the quantity supplied of a good rises when the price of the good rises, as long as all other factors that affect suppliers' decisions are unchanged

Monetary Policy

the set of tools used by a country's central bank (the Federal Reserve in the U.S.) to regulate the availability of money in the economy. The most important tool used is to manage interest rates.

Corporations also issue shares of stock that are essentially a form of distributed ownership

the shareholders together "own" the corporation. As "owners" shareholders expect to get some return in the form of dividends declared from profits. Of course, investors also look for the stock to appreciate in value so their own (investors') wealth increases.

In any economy, what happens at the macro level is

the sum of all activities at the micro level. Thus, decisions made by individuals, households, and firms have an impact on the economy as a whole. Similarly, policy frameworks in the form of taxes, interest rates, and the general environment for carrying out economic activity - all of which are determined at the level of the economy - have an impact on firms and their profitability, and on households and individuals on the amount they would be left with after paying income and other taxes. Thus, the two branches influence each other.

The natural rate of unemployment is closely associated with this percentage

0.05

Why is GDP useful to examine?

1. Estimate living standards across time and nations 2. Measure economic growth 3. Determine whether an economy is experiencing a short-run expansion or recession

promissory notes

Corporations also issue bonds when they wish to borrow money

Open Economy Principles

A country is said to have a trade surplus when net exports are positive. A country is said to have a trade deficit when net exports are negative. A country is said to have a balanced trade when net exports are zero. In other words, exports and imports are equal. A country's net foreign investment refers to the purchase of foreign assets by the country's residents less the purchase of the country's assets by foreigners. Factors that affect the net foreign investment include: real interest rates on foreign and domestic assets; the political and economic risks of holding assets in other countries as perceived by investors, and government policies that determine the extent to which foreigners can own assets in a given country. Net Exports (NX) and Net Foreign Investment (NFI) are inter-related. For any economy, NX and NFI must balance each other since every transaction that has an effect on one must have the same effect on the other as well. Thus, NX = NFI Nominal Exchange Rate refers to the rate at which the currency of one country can be traded with the currency of another country. For the US, the nominal exchange rate can be expressed in two ways: units of a foreign currency per one dollar or units in US dollars per one unit of foreign currency.

Which one of the following holds for every point on the aggregate demand curve?

Y = C + I + G+NX

__________ refers to the total quantity of final goods and services produced in an economy in a given time period.

Aggregate output

measuring the income that arises out of production.

An alternate method of measuring GDP Thus, GDP = Wages and Salaries + Rent + Interest + Profits - Net Income from Overseas + Capital Consumption Allowance(Depreciation) + Indirect Taxes on Businesses. Personal Income (PI) = National Income + Income received though not earned - Income earned but not yet received. Disposable Personal Income (DPI) = Personal Income (PI) - Personal Taxes Disposable Personal Income can also be expressed as Consumption C + Savings S.

recession

An economy is said to be in recession if aggregate output falls in two consecutive quarters. If the recession is prolonged, a depression results. The objective of policy makers is to smooth out fluctuations in the short run, and to increase the growth rate of output in the long run. Unemployment refers to the percentage of the labor force that is not employed. The level of employment is a key indicator of an economy's health. The ideal of no unemployment is impossible due to frictional and structural unemployment.

Aggregate Demand

An increase in the price level lowers aggregate quantity demanded. A decrease in the price level raises aggregate quantity demanded

What of the following is not a main function of money?

As a back-up for gold

Unemployment

As with other concepts in economics, the problem of unemployment can be looked at from a short-term or a long-term perspective. We can define the natural rate of unemployment as the average rate of unemployment around which an economy tends to oscillate. That is, during an economic boom, the actual unemployment rate tends to fall below the natural rate and during a slowdown or a recession, the actual unemployment rate tends to rise above the natural rate. L Denotes the number of workers in the labor force. E Denotes the number of employed workers. U Denotes the number of unemployed workers. Then, U/L denotes the unemployment rate. If S represents the fraction of employed workers who became unemployed, S is referred to as the rate of job separation. Similarly, if F represents the fraction of unemployed workers that became employed during the month, F is referred to as the rate of job finding.

Business Cycles

Business and Economic Cycles follow the pattern shown. A period of expansion leads to an economic boom and all-round prosperity. Inevitably, this is followed by a slowdown, down turn or a recession. In extreme cases, a depression follows. The cycle tends to repeat. The big questions for policy makers and individuals alike are the timing, duration and extent of a slowdown or recession. The field of economics has evolved to a point that there are a set of principles that help us understand the how and why of economic changes. At the heart of economic thought are the concepts of scarcity and choice. Resources are limited and finite. It is therefore incumbent to make the best possible use of these resources. The best possible use involves trade-offs. If we want something, we should be willing to give up something else. This process implies choice - a choice among alternatives. Since no society or economy can produce all that it wants or desires, a degree of interdependence is inevitable with other economies.

Investments

Capital purchases including small purchases such as tools, as well as other more substantial spending such as equipment, computers, and factories. Changes in business inventories such as goods that have been produced but not yet sold, representing a future increase in output. New residential housing purchases are counted as investments; not consumption. Note: Investment does not include purchases of stocks and bonds.

Trade and Advantages

Consider two countries; A and B. A has an absolute advantage in agriculture - the land is fertile, water is readily available, agricultural labor is present, and the weather is conducive to cultivation. Thus, country A can produce the food that its people want and have some surplus. B has an absolute advantage in producing apparel - manufacturing facilities, equipment, a skilled work force, and capital. Thus, country B can produce all the apparel that its people want and have some surplus. Economics applies the concept of Absolute Advantage. Country A should produce all the food it can and country B should produce all the apparel it can. Then, countries A and B can exchange the surplus of food and apparel respectively and people in both countries can have the benefits of food and apparel. When a comparative advantage exists, countries could benefit from trade. When a country can produce a good or service at a lower opportunity cost than another country, the first country has a comparative advantage in the specific good or service.

examples of how factors can shift an entire demand curve include:

Consumer Income: - As income increases, the demand for a normal good will increase. - As income increases, the demand for an inferior good will decrease. Prices of Related Goods: - When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. - When a fall in the price of one good increases the demand for another good, the two goods are called complements. When considering the factors involved one should be able to understand how changes in the factors cause changes in demand, with an entire shift not a movement along the demand curve.

catch-up effect

Holding other factors the same, the catch-up effect refers to the abilityof the least developed countries and developing countries to grow rapidly and improve the standards of living for their people. However, as the country moves through an emerging economy to what might promise to be a developed economy, the law of diminishing returns starts operating. An additional dollar invested at this stage does not yield the same results as before.

Underground economy:

If transactions are not directly measurable (because the income is not reported), they are not included in official measures of GDP. Legal: waitress tips babysitting illegal: prostitution narcotics exchange Size of underground economy? 10 percent of GDP (estimated) in United States 45 percent in developing countries

Net Exports

Imports are subtracted from the total level of GDP because they were not produced here (even though they are used here) and GDP is a measure of domestic production. Exports enter positively into the GDP equation because they are part of domestic production. A trade deficit is not necessarily "bad" even though it does decrease GDP. All else equal, a trade deficit implies that people are consuming more goods and services.

Macroeconomics attempts to address three major concerns:

Inflation Growth Unemployment

Which of the following statements are correct concerning unemployment insurance (UI)

UI pays a part of the worker's wages for a limited period after losing a job. UI can facilitate people to look for jobs that match their skills. Studies show that the longer a person gets UI, the longer is the duration of unemployment.

Intermediate verses Final Goods

Intermediate goods are goods that firms repackage or bundle with other goods to be sold at a later stage. For example, ingredients sold to a coffee shop, such as milk and coffee, are intermediate goods. Note: If milk or coffee are sold directly to a consumer (e.g., in a grocery store), the same goods are now considered final goods. The tires sold to a car manufacturer are intermediate goods where as those sold directly to a consumer from an auto store are considered to be final goods. Final goods Goods sold to the final users or consumers. To get an accurate GDP estimate and avoid double counting final goods are included in GDP and intermediate goods are not. NOTE: If intermediate goods were counted as part of GDP, they would essentially be counted twice. Their value also increases the market value of the final good. Double-counting would bias the measure of GDP upward.

(pt 2) Shortcomings of GDP

Leisure time - Tradeoff between labor and leisure - Average work week: South Korea: 46 hours Netherlands: 28 hours USA: 36 hours Japan: 36 hours Higher GDP per capita closely correlate with a better environment, better access to quality health care, more education, more leisure time, and lower crime rates because a country with a higher GDP per capita can afford to invest more in these areas in proportion to that needed to provide basic necessities. Other measure of well-being: Life expectancy Education levels Access to health care Crime rates

The market for labor

Similarly, firms and the government buy (demand) labor from individuals and households. Individuals and households sell (supply) labor to firms and the government.

The fundamental principles of economics revolve around two concepts:

The Circular Flow Concept and The Production Possibilities Frontier

Which of the following is a benefit of the US dollar appreciating with respect to a foreign currency?

The US dollar appreciation would allow each dollar to buy more of the foreign currency than before appreciation.

The circular flow of goods, services, and money occurs at the level of individuals, households, firms, the government, and other economies in three distinct market scenarios:

The market for goods and services The market for labor The market for loanable funds

Unemployment and Inflation

The natural rate of unemployment (around 5%) is impacted by frictional and structural unemployment that in turn are a result of the time taken to find jobs, mismatch between requirements and available skills, technological changes, minimum wage legislation, the bargaining power of labor unions, the concept of efficiency wages deployed by some firms and government policies. On the other hand, the rate of inflation in an economy is primarily driven by the amount of money in circulation. This quantity is driven by the Federal Reserve Bank's policies. Both high unemployment and high inflation are problematic and are undesirable. Economists have coined the term "Misery Index" as an indicator of an economy's health. The misery index is the sum of the unemployment rate and the inflation rate. Economics is about trade-offs. The relationship between unemployment and inflation is no different. Consider a situation where a combination of policies and initiatives increases aggregate demand in an economy. The increased demand reduces the unemployment rate but fuels higher inflation. Similarly, another set of policies and initiatives can effectively reduce aggregate demand leading to a lower level of inflation, but only at the cost of triggering a spell of higher unemployment.

Global Trade and Balance of Payments

The term foreign exchange denotes money denominated in the currency of another country. The foreign exchange market is one of the largest markets and involves the exchange of currencies in global markets. Foreign exchange markets are made up of banks, commercial companies, central banks, investment management firms, hedge funds, and retail forex brokers and investors. A significant proportion of foreign exchange transactions is carried out through the sale and purchase of bank deposits. As of May 2019 1 US Dollar = 0.77 British Pound and therefore 1 British Pound = 1.29 US Dollars A domestic currency price can be expressed as the foreign currency price x the exchange rate. When a domestic currency appreciates in value in relation to a foreign currency, imports in that (foreign) currency tend to be cheaper leading to an increase in imports. At the same time, an appreciation in one currency leads to exports in that currency becoming less competitive thus affecting reducing exports. Conversely, when a currency depreciates, exports will rise because of goods and services becoming less expensive in other countries. Imports tend to be more expensive because the currency is devalued and decline in volume.

Business and Economic Cycles

Thus, macroeconomics is concerned with how a society manages its scarce resources to manage the cyclical nature of the economy. In turn, this analysis involves how individuals, households, firms, and governments make decisions and how these constituents interact with each other. In addition, macroeconomic analysis also addresses how these interactions and the environment in which the interactions take place affect the outcomes for the participants as well as for society or for the economy as a whole. Thus, the principles underlying the study of economics can be summarized as: People (individuals, households, firms, and governments) have to contend with trade-offs. The cost of any product or service is equal to what is given up (in terms of money, effort or some form of exchange) to get the desired product or service. People are rational. They act in self-interest. Decisions are made at the margin. The cost of an additional unit of a product or service is weighed against the benefit that may accrue from the additional unit. People in general respond to economic incentives. The promotional offers of firms (buy one get one free) and how people respond to such offers is an example of the incentive principle. Salary and wage increases, bonuses, salary sharing plans, employee stock options, health and insurance benefits, and retirement plans are all examples of economic incentives. People, societies and countries are better off trading with each other. If country A is very good at growing rice and country B is very good at growing wheat, both can benefit by exchanging the excess of the commodities they produce. The notion of efficient markets hypothesizes that in the long run markets can reach a state of equilibrium and thus are amenable to self-regulation and self-organization, without too much intervention by governments. However, under certain conditions, governments can play an important role in achieving or sustaining stability and in ensuring economic growth. Such interventions can take the form of monetary and fiscal policies as well as special incentives for investments in certain geographic areas or specific sectors of the economy such as infrastructure and clean energy. The wellbeing of an economy and therefore of the people who make up the economy can be measured by the goods and services that the economy produces, and the manner in which these are made available to different sections of society. Thus, growth and prosperity at the macro level is meaningful only if it spreads across segments of the economy. If governments print more paper currency, without the currency being backed up by tangible assets such as gold, prices tend to rise and this causes an inflationary spiral.

It is critical for countries to look for new opportunities:

Typically, technology needs to be deployed appropriately to delay the onset of diminishing returns. For example, the productivity in agriculture today is several times what it was a hundred years ago. The land has not changed. What has changed is the deployment of technology right from determining when and what type of seeds to sow, to micro and drip irrigation systems that constantly monitor water and nutrient requirements, to harvesting, transportation, and storage. Thus, innovation in any sectoral development can at the very least delay diminishing returns from setting in.

Which of the following statements are incorrect concerning unemployment insurance (UI)

UI has tendency to make people energetic.

productivity and growth

We define productivity as the value of goods and services produced for a given unit of time (hour, day, week, month, or year) of a person's time. Thus, among all factors of production, the key to determining economic development and thereby prosperity and standards of living is human productivity. During the 20th century the economy of OECD (Organization for Economic Cooperation and Development) countries grew at about 2% per year. Some emerging economies also grew at or just below this rate. The standard of living in a country is generally expressed in terms of per capita real GDP (that is, Real GDP per Person). If a certain rate of growth is maintained year after year, the economy would be able to move faster towards prosperity than would be the case if the economy were to be erratic in its growth trajectory. A simple method of determining how long would it take for an investment to double or similarly for the GDP per capita to double based on either the interest rate or the growth rate is the "Rule of 72." Compounded year after year at n%, it would take 72 / n years for the investment or growth to double. Thus, if an economy were to grow at a constant 6% per year, the per capita GDP would double in 72 / 6 = 12 years.

closed economy

We refer to an economy as a closed economy if it does not interact with other economies in the world. In the era of globalization, closed economies are uncommon. Certain countries that follow policies that are not acceptable to the rest of the world come close to the concept. Also, embargos placed by multi-lateral forums such as the United Nations may make it difficult for certain countries to trade with other countries.

Institutions:

Well managed institutions, sound government policies and laws create a climate for economic growth. For example, North Korea is one of the poorest regions of the world today and South Korea is one of the growth miracles.

hyperinflation

When inflation reaches unmanageable levels (some countries have experienced inflation rates of over 3% per day!) Due to hyperinflation, the Zimbabwean dollar became worthless with one quadrillion (one hundred trillion) Zimbabwe dollars being worth just US$1 in 2015. The country was forced to abandon its currency in favor of the U.S. dollar.

(pt 2) Open Economy Principles

When the US dollar is able to buy more of a foreign currency, we would say that the dollar has appreciated with respect to the other currency. Similarly, when the US dollar is able to buy less of a foreign currency, we would say that the dollar has depreciated. An appreciation/increase of the US dollar is likely to hurt US exports. But an appreciation of the US dollar helps US tourists when traveling abroad because it gives them more purchasing power. A depreciation of the US dollar would help boost exports. It would hurt US tourists because it would reduce their purchasing power. An appreciation of the US dollar helps imports as imports become cheaper. A depreciation has the opposite effect as it would make imports costlier. A widely accepted principle in international economics is Purchasing Power Parity. Purchasing Power Parity is based on a concept called the law of one price. According to the law of one price, a good or service must sell for the same price irrespective of location. If the law of one price does not hold, opportunities for exploitation would arise. In reality, such exploitation does happen. The mechanism by which one takes advantage of the differences in prices in different markets is called arbitrage.

the financial system

a device for moving resources from those who have funds to those who wish to borrow. The financial system consists of federal or central banks, commercial banks that focus on corporations, retail banks that focus on individuals, households, and small businesses, and financial intermediaries such as investment firms, pension funds, mutual funds, brokers, and other players. The financial market consists of the stock market, the bond market, and the market for government and municipal securities. The financial markets also include foreign exchange and derivative security markets. Financial intermediaries are banks, investment firms, and mutual funds. Other important institutions include pension funds, insurance companies (life, home, auto, and health) and credit unions; sometimes called cooperatives. The latter are non-profit entities whose members pool resources and make them available at relatively low interest rates. Of course, no financial system is complete without operators who remain in the background but who nevertheless cannot be ignored. These are money lenders or loan sharks who provide money at inflated rates of interest to those who need money but for whom traditional institutions are not accessible due to a poor credit record or status as a citizen.

Supply

a full description of how the quantity supplied of a commodity responds to changes in its price.

Price level

a measure of the average prices of goods and services in the economy "GDP deflator" is a Price Level Index that includes prices of final goods and services in GDP but removing the effect of inflation

Which of the following is a main function of money

a medium of exchange, a store of value, a unit of account, and a standard of deferred payment

Stagflation

a period of slow economic growth and high unemployment (stagnation) while prices rise (inflation) a phenomenon that has baffled economists. Stagflation is often caused by a supply side shock. For example, rising commodity prices, such as oil prices, will cause a rise in business costs (transport more expensive) and short run aggregate supply will shift to the left. This causes a higher inflation rate and lower GDP output. An economy is said to be in stagflation when overall price levels increase rapidly (inflation) even as the economy itself is in a recession or high levels of unemployment (stagnation). This is precisely what happened in the U.S. during the 1970s. Oil prices increased dramatically. The production costs of goods spiraled leading to an increase in unemployment. The stagnation that followed inflamed the inflationary effects on the economy. Scholars have tried to explain this phenomenon in terms of an economy's productive capacity itself declining or the failure of government policies. However there is no consensus on the solution, if any, to the problem.

Suppose in an economy, the aggregate supply curve shifts to the left, but the aggregate demand curve does not shift. The Phillips curve would then show

a positive relationship between unemployment and inflation

Inflation is closely related to the

increase in prices, in particular the increase in the CPI

All of these factors are closely associated with business cycles except

individual policies of firms

goods and services market

individuals, households, and the government buy (demand) goods and services from firms in the goods and services market. Firms in turn sell (supply) to the goods and services market.

Macroeconomics tries to address three major concerns: ______, growth, and unemployment.

inflation

The law of demand states that the quantity demanded of a good is _________ related to its price, provided all other factors are unchanged.

inversely

Municipalities and city councils

issue bonds to raise money for improving facilities within their jurisdiction

Consumer Price Index (CPI)

measures the overall cost of goods and services purchased by a typical urban consumer.

Consider the following situation: the Phillips curve is vertical in the long run. An increase in money supply from year to year will likely ______ the unemployment rate and will likely _______ the inflation rate.

not change; increase

Governments levy taxes

on individuals, corporations, and on goods and services. These taxes constitute receipts for the government. Governments then spend the amount on infrastructure, on defense, and other services. They also pay salaries to employees working for the government. These constitute expenditure for the government.

open economy

one that interacts with other countries of the world. The interaction can be in the form of trade, people (tourism), technology transfer, and cooperation in different sectors for mutual benefit.

Governments also make payments to individuals who may not supply anything in exchange.

or example, governments may provide food stamps to enable the very poor to be able to survive. During natural calamities, governments may arrange to supply food, provide temporary shelter, and emergency health care to those affected. In some countries, direct transfers are made to the accounts of vulnerable sections and such amounts can be used by those households to buy essential goods and services. In many countries, senior citizens are paid either pensions or other forms of payment to help them financially in their later years. These people may not be providing any goods and services. Yet, governmentshave an obligation to care for them. All these are a part of the concept of welfare and are called transfer payments.

An example of an intermediate good would be

pencils purchased by a restaurant to be used to take orders

The law of demand states that

price and quantity demanded are inversely related The law of demand states that the quantity demanded of goods falls when the price of the goods rises, and vice versa, provided all other factors that affect buyers' decisions are unchanged. The quantity demanded of a consumer good such as ice cream depends on: - The price of ice cream - The prices of related goods - Consumers' incomes - Consumers' tastes - Consumers' expectations about future prices and incomes - Number of buyers, etc. The law of demand says that the quantity demanded of a good is inversely related to its price, provided all other factors are unchanged. Shifts in demand are caused by changes in the factors of demand: - Economics (the economy, consumer income, GDP, xfc etc.) - Prices of related goods - Consumer tastes and preferences - Legal/Government - Expectations about future prices and prospects - Technology - Number of buyers

Inflation

refers to an increase in the overall price level. Inflation erodes the purchasing power of consumers.

Net Domestic Product (NDP)

refers to the annual economic output of a country adjusted to reflect depreciation of assets. In the production of goods and services, equipment, machinery, buildings, vehicles, and other assets are used. The value of these diminishes with time and is provided for as depreciation. This depreciation is sometimes referred to as Capital Consumption Allowance because it is a measure of the amount required to replace the depreciated assets. NDP = GDP - Depreciation. Similarly, Net National Product (NNP) represents the amount of goods and services that can be consumed within a country each year without affecting the amount that can be consumed in the following years. NNP = GNP - Depreciation.

Nominal interest rates

refers to the interest rate before taking inflation into account. Nominal can also refer to the stated interest rate on a loan, without taking into account any fees or compounding of interest

Frictional Unemployment

refers to unemployment that results from time spent between jobs when a worker is searching for, or transitioning from one job to another. It is sometimes called search unemployment and can be based on the circumstances of the individual.

Deflation

represents a decrease in the overall price level. Prolonged periods of deflation are as catastrophic for the economy as inflation. As an example, the once mighty economic superpower Japan has been facing deflation for almost two decades.

The long-run output of an economy depends on:

resources, technology, and institutions It is not affected by the price level. In the long-run, the economy moves toward full-employment output . The level of output produced when an economy is at the natural rate of unemployment. The long-run aggregate supply curve is perfectly vertical; this reflects why economists believe the changes in aggregate demand only cause a temporary change in an economy's total output . In the long-run, there is exactly one quantity that will be supplied because only capital, labor and technology effect supply.

The oil shocks and instability in the 1970s

saw a breakdown of the Phillips curve. The conclusion was that high unemployment and high inflation could co-exist in the face of major supply shocks and events that are beyond the control of any one country. When the Organization of Petroleum Exporting Countries (OPEC) cut output thereby increasing the price of crude oil, policymakers had to make difficult choices when facing "stagflation" in 1970s. Either fight unemployment even if it meant high inflation or fight inflation thus triggering high unemployment.

Economics is about:

scarcity and choice

Gross National Income (GNI)

the sum of the GDP and the net income received from overseas. GNI is a measure of income received by a country both within the country and from overseas. Thus, GNI is similar to Gross National Product GNP, which is a measure of the output of the citizens and firms of a country, irrespective of whether the citizens are located within the country or overseas. For most countries, the difference between GDP and GNI is small, since incomes received from other countries and payments made to other countries tend to balance out each other. However, the difference can be significant for countries that are home to large multinational corporations, where the profits of the corporations are repatriated to other countries,. For example, the difference is over 20% in Ireland which is "home" to many large corporations. For such countries, GNI may be a better indicator of the nation's wellbeing than GDP. GNI = GDP + Net Compensation Receipts + Net Property Income Receivable + Net Taxes (less subsidies) Receivable on production and imports. For example, Luxembourg has a per capita GDP of $87,400 but a GNI of only $45,360. The World Bank currently uses GNI in preference to GNP.

aggregate supply

the total supply of all final goods and services in any economy

iteracy and development

the two are interrelated The countries with the highest per capita income are also happen the countries with higher literacy. In general, investment in education is an investment for the future. Since the key determinant to economic development is human productivity, the more skills that people develop, higher is the level of human productivity. In the emerging economies, school education can increase earning potential nearly five times. In the United States, statistics show that each year's additional education has the potential to raise income by 10%. Government can play an important role in ensuring that all childrenhave access to quality education.

Supply side or growth policies

those that try to improve aggregate supply rather than addressing aggregate demand. These can include special incentives to set up businesses in certain areas or to provide a stimulus to certain sectors of the economy

Walter Heller

used the term "Fine-tuning" to explain the role of government in regulating unemployment and inflation.