Ch 10 eco.

Inflation rate in year 2 =

(GDP Deflator in year 2-GDP Deflator in year 1/GDP Deflator in year 1 ) x 100

GDP deflator is calculated as follows

(Nominal GDP)/(Real GDP) x 100 •Because nominal GDP and real GDP must be the same in the base year, the GDP deflator for the base year always equals 100. •The GDP deflator for subsequent years measures the change in nominal GDP from the base year that cannot be attributable to a change in real GDP.

In contrast, by holding prices constant at base-year levels, real GDP reflects

only the quantities produced

Happiness Index is estimated using a composite measure of six key variables that have been found to support well-being:

-Income -Life Expectancy -Social Support -Freedom -Trust -Generosity.

How is unemployment measured?

-Labor force = Number of people employed + number of people unemployed •Unemployment rate =((Number of unemployed)/(Labor force))x 100 Labor force participation rate =((Labor force)/(Adult population))x 100

GDP can be measured by using

-expenditures approach -Income approach -Product approach

two important differences between CPI and GPA Deflator are

1-GDP deflator reflects the prices of all goods and services produced domestically, whereas the CPI reflects the prices of all goods and services bought by consumer. 2-how various prices are weighted to yield a single number for the overall level of price. The CPI compares the price of a fixed basket of goods and services with the price of the basket in the base year. Whilst, the GDP deflator compares the price of currently produced goods and services with the price of the same goods and services in the base year. A prices index such as the CPI measures the price level and determines the size of the inflation correction.

Problem in Measuring the Cost of Living using CPI include

1-Substitution Bias 2-Introduction of New Goods 3-Unmeasured Quality Change

what happens to GDP deflator and CPI in the following: 1-Starbucks raises the price of Cappuccinos 2-Caterpillar raises the price of the industrial tractors it manufactures at its Illinois factory 3-Armani raises the price of the Italian jeans it sells in the U.S

1-The CPI and GDP deflator both rise. 2-The GDP deflator rises, the CPI does not. 3-The CPI rises, the GDP deflator does not

1.James and Elyse are high school students. James works after school at a fast food restaurant, and Elyse is seeking a part-time job at the same establishment (also after school). Therefore, James is counted as employed and Elyse is counted as unemployed. 2.Garrett is 16 years old, and he has no job from which he receives any pay or profit. However, Garrett does help with the regular chores around his parents' farm and spends about 20 hours each week doing so. 3.Lisa spends most of her time taking care of her home and children, but she helps in her husband's computer software business all day Friday and Saturday.

1.Both Garrett and Lisa are considered employed. They fall into a group called unpaid family workers, which includes any person who worked without pay for 15 hours or more per week in a business or farm operated by a family member with whom they live. 2.Kate was thinking about looking for work in the prior 4 weeks but she has made no specific efforts since then. Kate does not meet the criteria for being unemployed and is, therefore, counted as not in the labor force.

Four steps in calculating CPI.

1.Fix the basket of typical goods and services. 2.Survey the prices. 3.Compute the basket's cost. 4.Choose a base year and compute the index.

1.The normal turnover of labor and the usual time it takes to find a satisfactory job opening causes________ unemployment to persist even at potential GDP. A) frictional B) involuntary C) structural D) Cyclical

A

. In the case of frictional unemployment,____________. A.there is a mismatch between the needs of employers with job vacancies and the unemployed workers. B.the unemployed workers and the employers with available job vacancies have not yet found each other. C.the only possible cure comes from shifting the aggregate demand curve to the left. D.there are no jobs for the unemployed people in the economy.

B

Publicly subsidized education and retraining schemes are_________. A)aimed at reducing cyclical unemployment. B)used to encourage employment in low-paying jobs. C)aimed at reducing structural unemployment. D) used to encourage the use of efficiency-wages.

C

product appraoch

Calculating total output Using Value Added

•If U.S. citizens are working in Canada, they do not contribute to the U.S. GDP, but

Canada's GDP and U.S. GNP.

Full employment means that there exists__________. A) an unemployment rate of less than 5 percent. B) only involuntary unemployment. C). no job vacancies at the time. D) only structural and/or frictional unemployment E) a measured unemployment rate of zero.

D

The main cause of cyclical unemployment is that________. A) the AD curve shifts to the right. B) some individuals skills do not have marketable skills for the jobs that do exist. C) firms engage in race, gender and sex discrimination in their hiring practices. D) workers often voluntarily quit a job to look for a better job. E) the level of overall economic activity fluctuates.

E

Business Cycle-one cycle through 4 phases

Expansion, Recession, Trough, Recovery

market value of all final goods and services produced within a country in a given period of time. meaning...........

GDP adds together many different kinds of products into a single measure of the value of economic activity. To do this, it uses market prices. - add only final goods and services not intermediate good -All legal goods, tangible and intangible - GDP includes goods and services currently produced. It does not include transactions involving items produced in the past - items are included in a nation's GDP if they are produced domestically, regardless of the nationality of the producer. -GDP measures the value of production that takes place within a specific interval of time such as a year or a quarter.

•suppose that the price of an airplane produced by Dassault, a French aerospace is part of GDP in France, it is not part of the basket of goods and services bought by typical consumer. Thus, , the price increase shows up in the

GDP deflator for France but not in the CPI.

Unmeasured Quality Change is when

If the quality of a good deteriorates from one year to the next, the effective value of a unit of currency falls, even if the price of the good stays the same. •Similarly, if the quality rises from one year to the next, the effective value of a unit of currency rises. Example, Computers are much more powerful each year.

Causes of Fluctuations

Innovation Random events: Wars ; political events Level of consumer spending: Seasonal fluctuations Cyclical Impacts — durable and non durable

Seasonal unemployment

It occurs in regular patterns, usually on an annual basis, and is caused by predictable changes in demand. •Unlike cyclical unemployment, seasonal unemployment occurs on a more or less fixed and predictable basis. •Some businesses and industries experience a peak in consumer demand during the last half of the year leading up to Christmas. •Snow skiing and Florida beach resorts are busiest during the winter.

•The relationship between the nominal interest rate and the real interest rate is expressed as follows:

Real interest rate = Nominal interest rate - Inflation rate

............................: either government or private transfer payments are not included because goods and services are not produced in this process. Examples are social security benefits or kid's allowances

Transfer payments

..................... illegal or cash transactions have no record in GDP. Government's estimates on these transactions are not accurate.

Underground activities:

introduction of new goods

When a new good is introduced, consumers have more variety from which to choose. •Greater variety, in turn, makes each unit of currency more valuable, so consumers need fewer units to maintain any given standard of living. • Yet because the CPI is based on fixed basket of goods and services, it does not reflect this change in the purchasing power of the currency.

Real GDP

a measure of the amount produced that is not affected by changes in prices.

Substitution Bias

When prices change from one year to the next, they do not all change proportionately: some prices rise more than others and some prices fall. •Consumers respond to these differing changes by buying less of the goods whose prices have risen •That is, consumers substitute towards goods that have become relatively less expensive.

Although structural unemployment can cause transitional problems, it is often a sign of

a healthy, growing economy.

Paasche index

a price index with a changing basket •(e.g. GDP deflator).

Laspeyres index

a price index with a fixed basket of goods (e.g CPI)

To a large extent, knowledge is

a public good: once one person discovers an idea, the idea enters society's pool of knowledge and other people and businesses can freely use it (subject to any legal restrictions such as those imposed by intellectual property rights).

Which of the following are actually included in this year's GDP? Explain your answer in each case: a.Social security payments received by a retired factory worker. b.The unpaid services of a family member in painting the family home. c.The income of a dentist. d.The money received by Smith when she sells her economics textbook back to the bookstore. e.The monthly allowance a college student receives from home. f.Rent received on a two-bedroom apartment. g.The money received by Josh when he resells his current-year-model Honda automobile to Kim. h.The purchase of 100 shares of GM common stock.

a.Excluded. - A transfer payment from taxpayers for which no service is rendered (in this year). b.Excluded. - Not a market transaction. If any payment is made, it will be within the family. c.Included. - Payment for a final service. You cannot pass on a tooth extraction! d.Excluded. - Secondhand sales are not counted; the textbook is counted only when sold for the first time. e.Excluded. - A private transfer payment; simply a transfer of income from one private individual to another for which no transaction in the market occurs. f.Included. - Payment for the final service of housing. g.Excluded. - The production of the car had already been counted at the time of the initial sale. h.Excluded. - Merely the transfer of ownership of existing financial assets.

Dollar figures from different times

amount in today's dollars = amount in year T dollars x (price level today/price level in year T)

An important prerequisite for the price system in a capitalist system to work is

an economy-wide respect for property rights.

For business, productivity is

an important factor in efficiency and the control of costs.

The central challenge in measuring GDP is to

avoid double counting the same output more than once.

Frictional unemployment is often the result of

changes in the demand for labor among different firms. •When consumers decide that they prefer Dell to Apple computers, Dell increases employment and Apple lays off workers. •The former Apple workers must now search for new jobs, and Dell must decide which new workers to hire for the various jobs that have opened. •The result of this transition is a period of frictional unemployment.

1.In 2014, Mr. Kim bought a used Hyundai Equus from his local automobile dealer. The Hyundai Equus was originally produced in the year 2010 and sold for $45,000 to the first owner who bought the car in 2010. The used car dealer bought the car in 2014 for $6000 from the original owner. Then, the dealer washed and waxed the car right before selling it to Mr. Kim. Which of the following is counted towards GDP in 2014? a.The total price paid by Mr. Kim for the car. b.The original market price of the car. c.The amount the dealer paid the previous owner for the car. d.The value of the wash and wax right before selling the car.

d

Which of the following would be counted in 2007's GDP? a.The value of a refrigerator manufactured in 2007 but not sold in 2007. b.The 2007 salary of a used motorcycle salesperson. c.The commissions earned by a real estate agent in 2007 in selling condominiums built in 1997. d.All of the above e.None of the above

d

There are two types of expenditures, however, that are included in the expenditure approach to GDP measurement but do not provide households or firms with any form of income:----------

depreciation expenditures and indirect business taxes

Poor countries have the potential to grow at a faster rate than rich countries because

diminishing returns are not as strong as in capital-rich countries •poorer countries can replicate the production methods, technologies, and institutions of developed countries. •A second argument is that low-income countries may find it easier to improve their technologies than high-income countries. •High-income countries must continually invent new technologies, whereas low-income countries can often find ways of applying technology that has already been invented and is well understood.

The term human capital usually refers to

education or expenditures that lead to a healthier population. •healthier workers are more productive. The right investments in the health of the population provide one way for a nation to increase productivity and raise living standards and reduce business costs through days lost at work through illness.

Because every transaction has a buyer and a seller, the total expenditure in the economy must

equal the total income in the economy §This implies that every dollar of expenditure by a buyer must become a dollar of income to a seller. §When Joe paints Jane's house for $1,000, that $1,000 is income to Joe and expenditure by Jane.

unemployment rate

expresses the number unemployed as a percentage of the labor force, which in turn can be defined as the total number of people who could possibly be employed in the economy at any given point in time.

Another way of avoiding the over-counting problem is to focus exclusively on

final sales.

A capital investment is owned and operated by a foreign entity is called

foreign direct investment

Investment from abroad takes several forms

foreign direct investment foreign portfolio investment

An investment that is financed with foreign money but operated by domestic residents is called

foreign portfolio investment

Natural unemployment is thus, from a practical viewpoint, considered synonymous

full employment

Economists and policy makers monitor both the GDP deflator and the CPI to gauge

gauge how quickly prices are rising.

Diff. between GDP and GNP (gross national product)

gross domestic product (GDP) is the income earned within a country by both residents and non-residents, whereas gross national product (GNP) is the income earned by residents of a country both at home and abroad.

In general, the macro environment includes trends in

gross domestic product (GDP), inflation, employment, spending, and monetary and fiscal policy

Government purchases

include spending on goods and services by local, state and national governments.

The consumer prices index (CPI)

is a measure of the overall prices of the goods and services bought by a typical consumer. It is used to monitor changes in the cost of living over time

A product will only be counted in GDP

one time in its life

macro environment

is the condition that exists in the economy as a whole, rather than in a particular sector or region

A nation can enjoy a high standard of living only if

it can produce a large quantity of goods and services.

GDP-not a perfect measure of well-being because

it doesn't include •Leisure •Value of almost all activity that takes place outside markets •Quality of the environment Nothing about distribution of income

investment from abroad is one way for poorer countries to

learn the state-of-the-art technologies developed and used in richer countries. •Often this means removing restrictions that governments have imposed on foreign ownership of domestic capital.

GDP refers to

market value of all final goods and services produced within a country in a given period of time.

income approach

measures the income received for producing products and services.

Higher productivity also means

more products are available for consumption which improves living standards.

If one subtracts depreciation and indirect business taxes from these expenditures, one arrives at

national income, which is the sum of all wage, profit, rent, and interest incomes earned in the same year.

GNP equals GDP plus

net receipts of factor income from the rest of the world. for instance, for the U.S., these net receipts are primarily the income domestic residents earn on wealth they hold in other countries less the payments domestic residents make to foreign owners of wealth that is located in the domestic country.

Value added refers to

new output created at each stage of production

the difference between the GDP deflator and the CPI is usually

not large in practice.

One threat to property rights is

political instability •When revolutions and coups are common, there is doubt about whether property rights will be respected in the future.

investment in high quality education can also mean that firms can recruit employees who have the capacity to be more

productive, efficient, innovative and flexible.

GDP deflator

reflects the prices of goods and services but not the quantity produced.

•Non-marketable goods and services that do not involve market transactions, such as .................... are not part of GDP.

subsistence production

expenditures approach

sums the amount paid for final goods and services

the fact that a country is poor does not guarantee

that catch-up growth will be achieved.

•When policy makers use the term full employment, they do not mean that absolutely everyone has a job at any given moment. What they mean is

that cyclical unemployment has been eliminated. What remains are frictional and structural unemployment that is a natural part of the economy

Research and Development:The primary reason that living standards are higher today than they were a century ago is

that technological knowledge has advanced.

Cyclical unemployment

the deviation of unemployment from its natural rate •arises due to changes in the business cycle; it occurs when the GDP falls and the economy enters a phase of contraction.

Net factor income earned from abroad is

the difference between factor incomes received from abroad and factor income paid abroad.

Natural rate of unemployment

the normal rate of unemployment around which the unemployment rate fluctuates

Nominal GDP

the production of goods and services valued at current prices.

Gross National Product (GNP)is

the total market value of all final goods and services produced annually by the citizens of a country.

Out of the labor force

those not working and not actively seeking employment.

one way for a country to grow is

through Investment from abroad •Even though some of the benefits from this investment flow back to the foreign owners, this investment does increase the economy's stock of capita, leading to higher productivity and higher wages.

The income approach to measuring GDP is

to add up all the income earned by households and firms in a single year.

Trade is, in some ways, a

type of technology. When business in a country export wheat and other business import steel, the country as a whole benefits in the same way as if it had invented technology for turning wheat into steel.

•Some..................... such as baby-sitting, house cleaning are not counted in GDP.

unpaid employment

Because firms eventually pass on their costs to consumers in the form of higher consumer prices, change in the producer prices index are often thought to be

useful in predicting changes in the CPI.

Capital Gains, by their definition, are

zero-sum transaction

Unemployed:

§the number unemployed in an economy is the number of people of working age who are able and available for work at current wage rates and who do not have a job.

•William Howard Taft was paid $75,000 per year for his service as US president in 1909. In 2013, the U.S. President, Barak Hussein Obama was paid $400,000. Assume that the price index in 1909 and 2013 were 9 percent and 233 percent, respectively. What was the value of President Taft's salary in 2013 dollars? Whose salary was worth more in 2013?

ØPresident Howard Taft Salary in 2013= (Salary in 1909) X (Price level in 2013)/ Price level in 1909 =$75,000 X (233/9) = $1,941,667 It is about 4.8 times higher than President Obama's salary in 2013 value.

Catch-up effect (Convergence)

•Countries that start off poor tend to grow more rapidly than countries that start off rich.

Inflation is

•Economy's overall price level is rising

Why financial stocks not included in GDP

•Financial securities such as stocks and bonds don't represent real production, but simply represent a transfer of claims (ownerships). •Financial securities are means of financing production.

diff between frictional and structural unemployment

•Frictional unemployment is more short term and is associated with people changing jobs and entering the labor force. •Structural unemployment is more long term and is associated with changes in the structure of the economy that require people to learn new skills.

Statistics about the macroeconomic economy include data on

•GDP •Inflation •Unemployment •Retail sales •Trade

Diminishing Returns

•If the variable factor of production increases, the output will increase up to a certain point.After a certain point, that factor becomes less productive; therefore, there will eventually be a decreasing marginal return and average product decreases

Which prices indices is a better measure of the cost of living? Laspeyres index or Paasche index

•Neither is clearly superior. •When prices of different goods are changing by different amounts, a Laspeyres (fixed basket) index tends to -overstate -the increase in the cost of living. •Because it does not take into account that consumers have the opportunity to substitute less expensive goods for more expensive ones. (e.g. CPI ignores consumers' ability to substitute apples for oranges.) •By contrast, a Paasche (changing basket) index tends to understate the increase in the cost of living. Although it accounts for the substitution of alternative goods, it does not reflect the reduction in consumers' welfare that may result from such substitutions (e.g. GDP deflator understates the impact on consumers: it shows no rise in prices, yet surely the higher price of oranges makes consumers worse off.

•Imagine that Company A, a forestry company, cuts trees in a forest it owns and sells the wood to company B for $1000. Company B, a furniture company used the wood and produced tables and chairs, which it then sells to a retailer (Company C) for $2,500. Company C ultimately sells the tables and chairs to consumers for $3000. Calculate total output.

•One may add up the sales price of every transaction ($1000 +$2500+$3000)=$6500 (?) Or One may sums the value added at each stage ($1000+1500+$500)=$3000

inflation rate

•Percentage change in some measure of the price level from one period to the next

regarding diminishing returns, difference between rich and poor countries is

•Rich countries •High productivity •Additional capital investment leads to a small effect on productivity. •Poor countries tend to grow faster than rich countries. •Even small amounts of capital investment may increase workers' productivity substantially.

Problems with population growth is

•Stretching natural resources •Malthus: an ever-increasing population •Strain society's ability to provide for itself •Mankind - doomed to forever live in poverty •population multiplies geometrically and food arithmetically; therefore, whenever the food supply increases, population will rapidly grow to eliminate the abundance.

•what happens when the government pays a social security benefit to one of the elderly?

•Such government spending is called a transfer payment because it is not made in exchange for a currently produced good or service. •From a macroeconomic standpoint, transfer payments are like negative taxes.

•Say you buy 100 shares of Samsung for $10 each at the beginning of the year. You sell them for $20 on December 31, for a gain of $1000. What was produced?

•There was no tangible product or service that was produced as a result of your buying, holding, or selling those shares. And the $1000 profit you made came from someone else's pocket.

Employed:

•This category includes those who worked as paid employees, worked in their business, or worked as unpaid workers in a family members' business. •Both full-time and part-time workers are counted. •It also includes those who were not working but who had jobs from which they were temporarily absent because of, for example, vacation, illness, or bad weather.

GDP=

•Wages (salaries, wages, fringe benefits, unemployment insurance)+ Interest + Rent (income received from property, royalties from patent and copy right) + profits (corporate profits) - Net Factor Income from Abroad+Capital Consumption Allowance (depreciation) + Indirect Business Taxes (sales tax plus excise tax).

Productivity is

•a key determinant of living standards and growth.

Structural unemployment is the result of

•a mismatch between skills possessed in the labor force and skills demanded by employers especially in the time of structural change in the economy.

Labor force:

•all persons age 16 and over who are either employed or actively seeking work.

Education -investment in human capital - is

•at least as important as investment in physical capital for a country's long-run economic success.

GDP (which we denote as Y) is divided into four components:

•consumption (C), investment (I), government purchases (G) and net exports (NX): Y ≡ C + I + G + NX (identity )

A country that eliminates trade restriction will

•experience the same kind of economic growth that would occur after a major technological advance.

'Goods' include

•household spending on durable goods, such as cars and appliance like washing machines and fridges, and non-durable goods, such as food and clothing.

'Services' include

•intangible items such as haircuts and insurance. Household spending on education is also included in consumption of services (although argue that it would fit better in the next component).

Intermediary goods are not added in GDP except when

•intermediate good is produced and, rather than being used, is added to a firm's inventory of goods to be used or sold at a later date. •In this case, the intermediate good is taken to be 'final' at the time of the accounting, and its value as inventory investment is added to GDP.

The ability of a country to catch-up depends on

•its ability to absorb new technology, attract capital and participate in global markets, and that is why there is still divergence in the world today.

producer prices index

•measurers the change in prices of a basket of goods and services bought by firms rather than consumers.

Creative destruction

•occurs when the introduction of new products and technologies leads to the end of other industries and jobs, as some jobs become obsolete.

•Population growth:-Economists and other social scientist have long debated how population growth affects a society. The most direct effect is

•on the size of the labor force: a large population means more workers to produce goods and services.

Frictional unemployment

•refers to the unemployment that results from the time that it takes to match workers with jobs (e.g. new graduates). •Frictional unemployment also occurs as a result of people move or change occupation. Unlike cyclical and structural unemployment, it is done voluntarily.

Consumption is

•spending by households on goods and services.

creative destruction leads to

•structural unemployment, which is caused by changes in the industrial makeup (structure) of the economy.

The national income approach yields a figure which is less than

•the expenditure approach, because indirect business taxes are added to the expenditures approach. •For example, if a consumer purchases for something one dollar and there is a 6% sales tax, then the consumer will have to pay $1.06 total which is added as a whole to the expenditure approach. •Hence, indirect business taxes must be added to national income to more accurately compare it to the expenditure approach.

Nominal interest rate

•the interest rate as usually reported without a correction for the effects of inflation. •tells you how fast the number of units of currency in your bank account rises over time.

Real interest rate

•the interest rate corrected for the effects of inflation. -tell you how fast the purchasing power of your bank account rises over time.

Investment is

•the purchase of goods that will be used in the future to produce more goods and services. •It is the sum of purchases of capital equipment, inventories and structures. Investment in structures include expenditure on new housing.

Net exports is

•the purchases of domestically produced goods by foreigners (export) --minus-- the domestic purchases of foreign goods (imports).

value added (or output created) equals

•the value of production at each stage -minus- the value of intermediate goods that used to produce it.

one way to raise future productivity is to

•to invest more current resources in the production of capital.

The rationale behind the income approach is

•total expenditures on final goods and services are eventually received by households and firms in the form of wage, profit, rent, and interest income. •Therefore, by adding together wage, profit, rent, and interest income, one should obtain the same value of GDP as is obtained using the expenditure approach.