Exam 2 Macroeconomics

Look at the following data: durable goods = $200 billion; nondurable goods = $350 billion; services = $600 billion; fixed investment + inventory investment = $200 billion; government purchases = $400 billion; exports = $30 billion; imports = $79 billion. What is GDP?

$1,701 billion

For problem 22, what is NDP?

$1,760.4 b

Jim earned an annual salary of $15,000 in 1965. What is this equivalent to in 2005 dollars? (Assume the CPI in 2005 is 195.3 and 31.5 in 1965).

$15,000 x 195.3/31.5

Suppose there are five goods in the economy, A-E. The current-year quantity of each is 10A, 20B, 30C, 40D, and 50E. Current-year prices are $1 for each unit of A, $2 for each unit of B, $3 for each unit of C, $4 for each unit of D, and $5 for each unit of E. Base-year prices are $1 for each good. Real GDP in the current year equals __________ and GDP equals __________.

$150; $550

Suppose Consumption = $1, 149.5, Investment = $400.3, Capital Consumption Allowance = $303.8, Government Purchases = $425.3 and Net Exports=$89.1 (all in billions), How much is GDP?

$2,064.20 b

If a house cost $10,000 in 1976, what is this equivalent to in 2001 dollars if the CPI in 2001 is 177.1 and in 1976 it's 56.9?

$31,124.78

If the CPI is 170 and nominal income is $75,000, approximately what does real income equal?

$44,118

If the CPI is 150 and nominal income is $100,000, what does real income equal?

$66,666

Your grandfather earned $12,000 in 1960 and the CPI was 29.3 in 1960. You earned $62,000 in 2007 and cannot imagine how your grandpa made it on so little. The CPI in 2007 was 207.342. Approximately how much did your Grandpa earn in 2007 dollars?

$84,918

Net exports are -$114 billion and exports are $857 billion. What are imports?

$971 billion

Percent Change in Real GDP Formula

((Real GDP later year - Real GDP earlier year)/Real GDP earlier year) x 100

Percent Change in Prices

(CPI later year - CPI earlier year / CPI earlier year) x 100

Consumer Price Index (CPI)

(Total $ expended in current year/Total $ expended in base year) x 100

Real Income Formula

(nominal income/CPI) x 100

Consider the information given in question 9, what is the employment rate?

.63 or 63%

Chapter 7 Key Ideas

1. Economists take measurements of the economy to find out how the economy is doing. 2. GDP is the total market value of all final goods and services produced annually within a country's borders. 3. We measure real GDP in order to determine whether we are achieving high and sustained economic growth. 4. Economists study two major macroeconomic topics that have to do with Real GDP: economic growth and business cycles.

Advice

1. It is easy for students to lose sight of "the big picture" as they struggle to learn the measurements presented in this chapter and the next one. To keep this from happening, remind them that there are important goals that policymakers want to achieve: price level stability, high and sustained economic growth, and low unemployment rates. It is because they (and we) want to see if the goals have been achieved that these measurements are necessary. 2. Have students use an inflation calculator like the one at http://www.jsc.nasa.gov/bu2/inflateCPI.html to see how many dollars they would need today to equal the purchasing power of $100 the year they were born. Have them go to www.bls.gov/cpi, click on "Tables Created by BLS," then click on "Table Containing History of CPI" to collect the data necessary to check their calculations. Students also enjoy using these tables to calculate the inflation rate over their lifetime.

Chapter 6 Key Ideas

1. Macroeconomics is the branch of economics that deals with the entire economy. 2. There are three macroeconomic organizational categories. 3. Economists take measurements of the economy to find out how the economy is doing. 4. We measure prices in order to determine whether we are achieving price level stability. 5. The CPI is used as an economic indicator, to find the real value of an economic variable, to adjust certain income payments, and to convert dollars from one year to another. 6. We measure unemployment in order to determine whether we are achieving low unemployment. 7. Full employment exists when the economy is operating at its natural unemployment rate.

Business Cycle

1. Peak. At the peak of the business cycle, Real GDP is at a temporary high. In the exhibit, Real GDP is at a temporary high at Q1. 2. Contraction. The contraction phase represents a decline in Real GDP. According to the standard definition of recession, two consecutive quarter declines in Real GDP constitute a recession. 3. Trough. The low point in Real GDP, just before it begins to turn up, is called the trough of the business cycle. 4. Recovery. The recovery is the period when Real GDP is rising. It begins at the trough and ends at the initial peak. The recovery in the exhibit extends from the trough until Real GDP is again at Q1. 5. Expansion. The expansion phase refers to increases in Real GDP beyond the recovery. In the exhibit, it refers to increases in Real GDP above Q. The typical business cycle is approximately four to five years, although a few have been shorter and some have been longer.

GDP-Income Approach

1. Purchases (expenditures) made in product markets flow to business firms. 2. Business firms then use these monies to buy resources in resource markets. 3. These monies flow to the owners (suppliers) of land, labor, capital, and entrepreneurship. 4. The sum of these resource payments is total income, which flows to households. In this simple economy total purchases (expenditures) equal total income. 5. Because total purchases (expenditures) equal GDP and total purchases equal total income, it follows that GDP equals total income.

Chapter 8 Key Ideas

1. The economy has two sides. One side is the aggregate demand side and the other is the aggregate supply side. 2. There is a difference between a change in the quantity demanded of Real GDP and a change in aggregate demand. 3. Most economists would say that a change in the money supply would shift the AD curve. 4. There is a difference between moving along a given SRAS curve and shifting to a new SRAS curve. 5. Economic forces will eliminate shortages and surpluses. 6. A change in a factor of AD or a factor of SRAS (or both) will change the point of market equilibrium in a predictable way. 7. Aggregate supply includes both short-run and long-run aggregates supply.

Refer to Exhibit 5-1. Prices rose by __________ percent from 2001 to 2002.

1.94

What does the CPI in the base year equal?

100

Suppose there are 60 million people employed, 10 million unemployed, and 30 million not in the labor force. What does the civilian non-institutionalized population equal?

100m

In year 1, the prices for goods x, y and z are $2, $4, and $6 per unit. In year 2, the prices for goods x, y, and z are $3, $4 and $7 respectively. In year 2, twice as many units of each good are produced as in year 1. In year 1, 20 units or x, 40 units of Y and 60 units of z are produced. If year 1 is the base year, what does Real GDP equal in year 2?

1120

Suppose the market basket consists of 10X, 20Y, and 30Z. Current-year prices are $1.20 for each unit of X, $0.96 for each unit of Y, and $1.30 for each unit of Z. Base-year prices are $1.00 for each unit of X, Y, and Z. What is the approximate CPI in the current year?

117

Assume the market basket contains 10 X, 20Y and 45Z. The current-year prices for goods X, Y, and Z are $1, $4, and $6 respectively. The base year prices are $1, $3, and $5 respectively. What is the CPI for the current year?

122

Compute the CPI if the following is true: Good | Current Price | Base Price 10 pens | $1.00 each | $.50 each 5 shirts | $28.00 | $15.00 3 shoes | $32.00 | $25.00

158

Look at the following data: The structural unemployment rate is 4 percent, the natural unemployment rate is 5 percent, and the cyclical unemployment rate is 3 percent. The frictional unemployment rate is __________ percent and the actual unemployment rate is __________ percent.

1; 8

If Real GDP was $8,742 billion in year 2 and it had been $8,509 billion in year 1, what was the approximate economic growth rate during this time period?

2.74 percent

Compute the percentage change in prices between 1990 and 1999. Assume the CPI is 166.6 in 1999 and 130.7 in 1990.

27.4%

If the CPI is 100 in the base year and 140 in the current year, how much did prices rise between these two years?

40%

Consumption spending is $3.708 trillion, spending on non-durable goods is $1.215 trillion, and spending on services is $2.041 trillion. What does spending on durable goods equal?

452 b

Suppose there are 50 million people in the population, 25 million people in the civilian labor force, and 20 million people are employed. The number of people unemployed is __________ million and the unemployment rate is __________ percent.

5; 20

An economic policy initiative results in the AD curve shifting to the right. As a result,

A and D: The price level will rise; Real GDP will rise in the short run.

Depreciation

A decrease in the value of one currency relative to other currencies.

Macroeconomic Problems

A few macroeconomic problems are high inflation rate, high unemployment rates, high interest rates, and low economic growth. Macroeconomists want to know the cause of each problem and what needs to be done to end it.

Suppose a drop in stock prices makes people feel less wealthy. This would cause __________ the economy's AD curve.

A leftward shift of

A change in Aggregate demand is represented by:

A shift in the aggregate demand curve brought about by something other than a price level change.

If households expect lower prices in the future, what affect does this have on AD?

AD decreases

What happens to Aggregate demand if the dollar appreciates in value?

AD decreases

How does an increase in the money supply affect Aggregate Demand?

AD increases

Reasons for Unemployment

According to the BLS, an unemployed person may fall into one of four categories: job loser, job leaver, reentrant, or new entrant.

PUTTING AD AND SRAS TOGETHER: SHORT-RUN EQUILIBRIUM

Aggregate demand and short-run aggregate supply determine the price level, Real GDP, and the unemployment rate in the short run.

Aggregate Demand

Aggregate demand refers to the quantity demanded of (U.S.) Real GDP, at various price levels, ceteris paribus. There is an inverse relationship between the price level and the quantity demanded of Real GDP. An AD curve is the graphical representation of AD.

SHORT-RUN AGGREGATE SUPPLY

Aggregate supply refers to the quantity supplied of Real GDP at various price levels, ceteris paribus. Aggregate supply includes both short-run and long-run aggregate supply.

Net domestic product (NDP) is the total value of

All final goods and services produced within a country's borders in a year minus capital consumption allowance.

Which of the following will cause the short-run aggregate Supply curve to increase?

All of the above: A beneficial supply shock; An increase in productivity; A decrease in wage rates.

Which of the following factors can shift the AD curve?

All of the above: Net exports; Government purchases; The money supply.

Bureau of Economic Analysis (BEA)

An agency of the U.S. Department of Commerce. One of its major functions is to assemble the data which is then used to calculate GDP.

Three States of an Economy

An economy can be in short-run equilibrium, long-run equilibrium, or disequilibrium. When the economy is in neither short-run nor long-run equilibrium, it is said to be in disequilibrium. Essentially, disequilibrium is the state of the economy as it moves from one short-run equilibrium to another or from short-run equilibrium to long-run equilibrium. In disequilibrium, the quantity supplied and the quantity demanded of Real GDP are not equal.

Appreciation

An increase in the value of one currency relative to other currencies

Economic Growth

Annual economic growth has occurred if Real GDP in one year is higher than Real GDP in the previous year.

The Substitution Bias in Fixed-Weight Measures

Any price index that uses fixed quantities of goods, instead of regularly accounting for the substitutions that individuals are likely to make, has a substitution bias, that is, it can overstate the cost of living. In July 2002, the BLS started releasing what is called a "chained CPI," which essentially is a price index (based on the CPI) which does incorporate substitutions made. Stated differently, the chained CPI is not a fixed-weighted measure.

Suppose the real exchange rate of 105 Japanese yen to the dollar moves to 115 yen to the dollar. The dollar has __________, making Japanese goods __________ expensive for Americans.

Appreciated; less

Factors That Change Net Exports/Dollar Depreciates

As foreign real national income rises, foreigner buy more U.S. goods and services. Thus U.S. exports (EX) rise. As exports rise, net exports (X) rise, ceteris paribus. As net exports rise, aggregate demand increases. This process works in reverse. As foreign real national income falls, foreigners buy fewer U.S. goods and exports fall. This lowers net exports, reducing aggregate demand.

Factors That Change Net Exports/Exchange Rate

As the dollar depreciates, foreign goods become more expensive, Americans cut back on imported goods, and foreigners (whose currency has appreciated) increase their purchases of U.S. exported goods. If exports rise and imports fall, net exports increase and aggregate demand increases As the dollar appreciates, foreign goods become cheaper, Americans increase their purchases of imported goods, and foreigners (whose currency has depreciated) cut back on their purchases of U.S. exported goods. If exports fall and imports rise, net exports decrease, thus lowering aggregate demand.

Factors That Change Investment/Interest Rate

As the interest rate falls, the cost of an investment project falls and businesses invest more. Consequently, aggregate demand increases. As the interest rate rises, the cost of an investment project rises and businesses invest less. As investment decreases, aggregate demand decreases.

Real GDP Formula

Base year prices x current year quantities

To be unemployed, an individual must:

Be out of work, but actively seeking work

OTHER NATIONAL INCOME ACCOUNTING MEASUREMENTS

Besides GDP and national income, three other national income accounting measures are important. They include net domestic product, personal income, and disposable income.

Factors That Change Investment/Expectations About Future Sales

Businesses invest because they expect to sell the goods they produce. If businesses become optimistic about future sales, investment spending grows and aggregate demand increases. If businesses become pessimistic about future sales, investment spending contracts and aggregate demand decreases.

Factors That Change Investment/Business Taxes

Businesses naturally consider expected after-tax profits when making their investment decisions. An increase in business taxes lowers expected profitability. With less profit expected, businesses invest less. As investment spending declines, so does aggregate demand. A decrease in business taxes, on the other hand, raises expected profitability and investment spending. This increases aggregate demand.

How would you calculate GDP using the expenditure approach?

C + I + GP + NE

Capital consumption allowance refers to

Capital goods being used up in production through natural wear, obsolescence, and accidental destruction.

A rise in wage rates

Causes the SRAS curve to shift leftward.

Net Exports

Changes in foreign real national income and the exchange rate will cause net exports to change and therefore shift the AD curve. If foreign real national income rises then U.S. exports will rise, causing U.S. net exports to rise and the AD curve will shift rightward, and vice versa. If the dollar depreciates, U.S. exports will rise and U.S. imports will fall, causing U.S. net exports to rise and the AD curve will shift rightward, and vice versa. Exports (X) - Total foreign spending on domestic (U.S.) goods. Imports (M) - Total domestic (U.S.) spending on foreign goods.

Interest Rate Effect

Changes in household and business buying as the interest rate changes.

Investment

Changes in the interest rate, expectations about future sales, and business taxes will cause investment to change and therefore shift the AD curve. If the interest rate falls, business taxes fall, or if businesses become optimistic about future sales, investment will rise and the AD curve will shift rightward. If the interest rate rises, business taxes rise, or if businesses become pessimistic about future sales, investment will rise and the AD curve will shift rightward. The sum of all purchases of: Fixed Investment -Newly produced capital goods - Business purchases of capital goods, such as machinery and factories; Inventory Investment -Changes in business inventories (stock of unsold goods); and Purchases of new residential housing.

Changes in the Price of Non-labor Inputs

Changes in the prices of non-labor inputs affect the SRAS curve in the same way as changes in wage rates do. An increase in the price of a non-labor input (e.g., oil) shifts the SRAS curve leftward; a decrease in their price shifts the SRAS curve rightward.

Consumption

Changes in wealth, expectations about future prices and income, the interest rate, or income taxes will cause consumption to change and therefore shift the AD curve. If wealth rises, the interest rate falls, income taxes fall, or consumers expect higher prices or incomes in the future, consumption will rise and the AD curve will shift rightward. If wealth falls, the interest rate falls, income taxes fall, or consumers expect lower prices or incomes in the future, consumption will fall and the AD curve will shift leftward. The sum of household spending on: durable goods, nondurable goods, and services.

Chapter 6 Overview

Chapter 5 begins with a discussion of what macroeconomics is about and how best to approach the study of macroeconomics. The core of the chapter provides an introduction to two of the economic measurements that are important to economists in determining the economic health of the country. Prices are measured using the CPI or the GDP implicit price deflator and unemployment is measured using the unemployment rate. This chapter shows how the CPI, the GDP implicit price deflator, the inflation rate, the unemployment and employment rates, the labor force participation rate, and the natural unemployment rate are defined, constructed, and used.

Chapter 8 Overview

Chapter 7 develops the aggregate demand-aggregate supply model of the economy that will be used to analyze the material in coming chapters. It examines aggregate demand and short-run aggregate supply (and the AD and SRAS curves) and the factors that affect them. It shows how changes in these factors lead to changes in the price level, Real GDP, and the unemployment rate. Finally, it defines the two equilibrium states in an economy—short-run and long-run equilibrium—and uses the AD, SRAS, and long-run aggregate supply (LRAS) curves to depict these states. This chapter shows how both P and Q in the P-Q category are determined in the economy in the short run.

Labor Force Participation Rate Formula

Civilian labor force/ Civilian noninstitutional population

National Income Forumula

Compensation of employees + Proprietors' income + Corporate profits + Rental income + Net interest

Compensation of Employees

Compensation of employees consists of wages and salaries paid to employees plus employers' contributions to Social Security and employee benefit plans plus the monetary value of fringe benefits, tips, and paid vacations.

National Income equals:

Compensation of employees+ proprietor's income + corporate profits + rental income + net interest

Factors That Can Change C, I, G, and NX (EX - IM) and Therefore Can Change AD

Consumption Investment Net Exports

Total Expenditures on U.S. Goods and Services Formula

Consumption + Investment + Government Purchases + Net Exports

The expenditure approach to measuring GDP sums

Consumption, investment, government purchases, and net exports.

Corporate Profits

Corporate profits include all the income earned by the stockholders of corporations.

Cyclical Unemployment

Cyclical unemployment is the difference between the existing unemployment rate and the natural unemployment rate.

Assume that Ms. Sawyers salary is $75,000, up from $70,000 last year, while the CPI is 165 this year, up from 150 last year. This means that Ms. Sawyers real income has

Decreased

As income taxes rise, disposable income __________, causing __________ the AD curve.

Decreases; a leftward shift of

Suppose consumption decreases at each price level. As a result, aggregate demand __________, and the AD curve shifts __________.

Decreases; leftward

Aggregate demand curves are

Downward sloping.

Durable Goods

Durable goods are goods that are expected to last for more than three years, such as refrigerators, ovens, or cars.

Equilibrium State of the Economy

During the time an economy moves from one equilibrium to another, it is said to be in disequilibrium.

Short-Run Aggregate Supply Curve: What it is and Why it is Upward-Sloping

Economists have put forth the following explanations as to why the SRAS curve is upward-sloping.

REAL GDP, ECONOMIC GROWTH, AND BUSINESS CYCLES

Economists study two major macroeconomic topics that have to do with Real GDP: economic growth and business cycles.

The "Ups and Downs" in the Economy, or the Business Cycle

Economists talk about four or five phases of the business cycle, including peaks, contractions, troughs, recoveries, and expansions. An entire business cycle is measured from peak to peak. The standard definition of recession is two consecutive quarter declines in Real GDP.

Expenditures in a Real-World Economy

Economists talk about four sectors of the economy: the household sector, the business sector, the government sector, and the foreign sector. Expenditures of the sectors are called consumption, gross private domestic investment (or investment), government consumption expenditures and gross investment (or government purchases), and net exports.

Three Ways to Compute GDP

Economists use three approaches to compute GDP—the expenditure approach, the income approach, and the value-added approach. Expenditure Approach: Add the amount of money spent by buyers of final goods and services*; Avoid double counting.; Do not count intermediate goods** *Goods in the hands of their final users. **Goods that are inputs for the production of final goods. Income and Value-Added Approach: Income Approach - add the sum of all incomes earned (wages, interest, rents, and profits) in producing goods and services. Value-added Approach - add the value added at each stage of production of all goods and services.

Macroeconomic Measurements

Economists want to take measurements of the economy to find out how the economy is doing.

Civilian Labor Force Formula

Employed persons + Unemployed persons

An Important Exhibit

Exhibit 12 in the text brings together much of the material discussed in this chapter.

Net Exports Formula

Exports - Imports

What would happen to US export and Import spending as a result of the dollar depreciating in value?

Exports increase, Imports decrease

You can easily compare the GDP of two countries like China and the United States, for example.

False

Gross Domestic Product (GDP) is the total market value of all

Final goods and services produced annually within a country's borders.

Sticky Wages

Firms pay nominal wages, but they often base their decision on how many workers to hire on real wages (nominal wages divided by the price level). When the price index falls, real wages rise and firms cut back on labor. With fewer workers working, less output is produced.

The Effective-Ineffective Category

Fiscal policy refers to changes in government expenditures and/or changes in taxes to achieve particular macroeconomic goals, while monetary policy refers to changes in the money supply, or rate of growth of the money supply, to achieve particular macroeconomic goals. Macroeconomists have different beliefs about how effective or ineffective fiscal and monetary policy are.

Investment Formula

Fixed investment + Inventory investment

Unemployment that arises as a result of the time it takes for unemployed people to locate a job utilizing their transferable skills is called __________ unemployment.

Frictional

Types of Unemployment

Frictional unemployment occurs when individuals with transferable skills change jobs or enter the labor force; Unemployment due to the natural "frictions" of the economy, which is caused by changing market conditions and is represented by qualified individuals with transferable skills who change jobs. Structural unemployment occurs when structural changes in the economy eliminate some jobs and create others for which the unemployed are unqualified; Unemployment due to structural changes in the economy that eliminate some jobs and create other jobs for which the unemployed are unqualified. The natural unemployment rate is the sum of frictional plus structural unemployment; Unemployment caused by frictional and structural factors in the economy. Full employment exists when the economy is operating at its natural unemployment rate; Natural unemployment rate = Frictional unemployment rate + Structural unemployment rate.

Natural Unemployment Rate

Frictional unemployment rate + Structural unemployment rate

Net Domestic Product Formula

GDP - Capital consumption allowance

Per capita GDP is found by dividing a country's GDP by its population.

GDP figures are useful for obtaining an estimate of the productive capabilities of an economy, but they do not necessarily measure happiness or well-being.

Computing GDP Using the Expenditure Approach

GDP is the sum of consumption, investment, government purchases, and net exports.

Gross Domestic Product

Gross domestic product (GDP) is the total market value of all final goods and services produced annually within a country's borders. In 2007, people living and working in the United States produced $13.84 trillion worth of goods and services.

Changes in Wage Rates

Higher wage rates mean higher costs and, at constant prices, translate into lower profits and a reduction in the number of units (of a given good) that firms will want to produce. Lower wage rates mean lower costs and, at constant prices, translate into higher profits and an increase in the number of units (of a given good) firms will decide to produce.

Chapter 7 Outline

I. Gross Domestic Product A. Three Ways to Compute GDP B. What GDP Omits C. GDP is Not Adjusted for Bads Generated in the Production of Goods D. Per Capita GDP E. Is Either GDP or Per Capita GDP a Measure of Happiness or Well-Being? II. The Expenditure Approach to Computing GDP for a Real World Economy A. Expenditures in a Real-World Economy B. Computing GDP Using the Expenditure Approach III. The Income Approach to Computing GDP for a Real-World Economy A. Computing National Income B. From National Income to GDP: Making Some Adjustments IV. Other National Income Accounting Measurements V. Real GDP A. Why We Need Real GDP B. Computing Real GDP C. The General Equation for Real GDP D. What Does it Mean if Real GDP is Higher in One Year Than in Another Year? VI. Real GDP, Economic Growth, and Business Cycles A. Economic Growth B. The "Ups and Downs" in the Economy, or the Business Cycle C. NBER and Recessions

Chapter 6 Outline

I. How to Approach the Study of Macroeconomics A. Macroeconomic Problems B. Macroeconomic Theories C. Macroeconomic Policies D. Different Views of How the Economy Works II. Three Macroeconomic Organizational Categories A. The P-Q Category B. The Self-Regulating Economic Instability Category C. The Effective-Ineffective Category III. Macroeconomic Measurements IV. Measuring Prices A. Measuring Prices Using the CPI B. More About the Base Year C. When We Know the CPI for Various Years, We Can Compute the Percentage Change in Prices D. Inflation and the CPI E. The Substitution Bias in Fixed-Weight Measures F. GDP Implicit Price Deflation G. Converting Dollars from One Year to Another V. Measuring Unemployment A. Who are the Unemployed? B. The Unemployment and Employment Rates C. Reasons for Unemployment D. Discouraged Workers E. Types of Unemployment F. Cyclical Unemployment VI. Advice

Chapter 8 Outline

I. The Two Sides to an Economy II. Aggregate Demand A. Why Does the Aggregate Demand Curve Slope Downward? B. A Change in the Quantity Demanded of Real GDP Versus a Change in Aggregate Demand C. Changes in Aggregate Demand: Shifts in the Aggregate Demand Curve D. How Spending Components Affect Aggregate Demand E. Factors That Can Change C, I, G, and NX (EX-IM) and Therefore Can Change Aggregate Demand (Consumption, Investment, and Net Exports) F. Can a Change in the Money Supply Change Aggregate Demand? III. Short-Run Aggregate Supply A. Short-Run Aggregate Supply Curve: What it is and Why it is Upward-Sloping (Sticky Wages and Worker Misperceptions) B. What Puts the "Short Run" in SRAS? C. Changes in Short-Run Aggregate Supply: Shifts in the SRAS Curve D. Something More to Come: People's Expectations IV. Putting AD and SRAS Together: Short-Run Equilibrium A. How Short-Run Equilibrium in the Economy is Achieved B. Thinking in Terms of Short-Run Equilibrium Changes in the Economy C. An Important Exhibit V. Long-Run Aggregate Supply A. Going From the Short-Run to the Long Run B. Short-Run Equilibrium, Long-Run Equilibrium, and Disequilibrium C. Something More to Come: Shifts in the LRAS Curve

Money Supply and Aggregate Demand

If both the money supply and velocity *are constant, a rise in one spending component (such as consumption) necessitates a decline in one or more other spending components. If either the money supply or velocity rises, one spending component can rise without requiring other spending components to decline. * Velocity - The average number of times a dollar is spent to buy final goods and services in a year.

Changes in Aggregate Demand: Shifts in the AD Curve

If spending on U.S. goods by U.S. residents, firms, governments, or foreigners increases at a given price level, then AD rises (shifts rightward). If spending on U.S. goods by U.S. residents, firms, governments, or foreigners decreases at a given price level, then AD falls (shifts leftward).

Who are the Unemployed?

If you take the total population of the United States and subtract all persons who are under 16 years of age, on active military duty, or institutionalized, what is left is called the civilian noninstitutional population. The civilian noninstitutional population can be divided into two groups: persons not in the labor force and persons in the labor force. Persons in the civilian labor force are either employed or unemployed. A person is employed if he did any work for pay or profit during the survey reference week, or if he did at least 15 hours of unpaid work in a family-operated enterprise, or if he was temporarily absent from his regular job because of illness, vacation, bad weather, industrial dispute, or various personal reasons. A person is unemployed if he did not have jobs during the survey reference week but made specific active efforts to find a job during the prior 4 weeks and was available for work, or if he was not working but was waiting to be called back to a job from which he had been temporarily laid off. According to the BLS, unemployed persons consist of: All persons who did not have jobs, who made specific active efforts to find a job during the prior four weeks, and who were available for work; All persons who were not working and who were waiting to be called back to a job from which they had been temporarily laid off. Job loser. This is a person who was employed in the civilian labor force and was either fired or laid off. Job leaver. This is a person employed in the civilian labor force who quits his or her job. Reentrant. This is a person who was previously employed, hasn't worked for some time, and is currently reentering the labor force. New entrant. This is a person who has never held a full-time job for two weeks or longer and is now in the civilian labor force looking for a job.

Something More to Come: People's Expectations

In Chapter 15 we will add another factor that can shift the SRAS curve—the expected price level.

How Short-Run Equilibrium in the Economy is Achieved

In instances of both surplus and shortage, economic forces move the economy towards the point of short-run equilibrium where the quantity demanded of Real GDP equals the short-run quantity supplied of Real GDP. A change in AD or SRAS or both will affect the price level and/or Real GDP.

The number of employed persons plus the number of unemployed persons equals the number of persons

In the civilian labor force.

Government Purchases

Includes: Federal, state, and local government purchases of goods and services and gross investment in highways, bridges, and so on. Excludes: Government transfer payments to persons that are not made in return for goods and services currently supplied.

How does an increase in wealth affect the price level and Real GDP in the short-run?

Increase in the price level, increase in real GDP

An increase in the money supply may __________ total expenditures, leading to a __________ shift of the AD curve.

Increase; rightward

When We Know the CPI for Various Years, We Can Compute the Percentage Change in Prices

Inflation is an increase in the price level and is usually measured on an annual basis.

Inflation

Inflation is an increase in the price level and is usually measured on an annual basis. The inflation rate is the positive percentage change in the price level on an annual basis. When you know the inflation rate, you can find out whether your income is (1) keeping up with, (2) not keeping up with, or (3) more than keeping up with inflation. How you are doing depends on whether your income is rising by (1) the same percentage as, (2) a smaller percentage than, or (3) a greater percentage than the inflation rate, respectively. When you make this computation and comparison, you are determining your real income for different years. Real income is a person's nominal income (or current dollar amount of income) adjusted for any change in prices. Real income is computed as follows: Real Income = (Nominal Income/CPI) x 100

The ____________effect states that the inverse relationship between the price level and the quantity demanded of Real GDP is established through changes in household and business spending that is sensitive to interest rate changes:

Interest rate effect

What Puts the "Short Run" in SRAS?

It is only for a period of time—identified as the short run—that the issues of sticky wages and prices and producer and worker misperceptions are likely to be relevant. Wages will not be sticky forever, prices won't be sticky forever, producers will figure out that they misperceived relative price changes, and workers will figure out that they misperceived real wage changes.

How to Approach the Study of Macroeconomics

Macroeconomics is the branch of economics that deals with the entire economy. Most discussions in macroeconomics focus on one or more of the following: macroeconomic problems, macroeconomic theories, macroeconomic policies, different views of how the economy works.

Macroeconomic Theories

Macroeconomists often build theories to try to understand macroeconomic problems. Not all macroeconomists agree on the causes of certain macroeconomic problems.

Supply Shocks

Major natural or institutional changes that affect aggregate supply are referred to as supply shocks. Supply shocks are of two varieties. Adverse supply shocks shift the SRAS curve leftward. Beneficial supply shocks shift the SRAS curve rightward.

Common Misconceptions about Unemployment

Many people mistakenly think that if the unemployment rate is, say, 7%, the employment rate must be 93%. Their assumption is that the unemployment rate plus the employment rate must equal 100 percent. But the unemployment and employment rates do not add up to 100%, because the denominator of the unemployment rate is not the same as the denominator of the employment rate. The unemployment rate is a percentage of the civilian labor force The employment rate is a percentage of the civilian noninstitutional population, which is a larger number than the civilian labor force.

As the price level falls, ceteris paribus, people holding some of their wealth in monetary form become

More wealthy and they buy more.

Can a Change in the Money Supply Change Aggregate Demand?

Most economists would say that a change in the money supply will shift the AD curve. One way to explain the effect is to say a change in the money supply affects interest rates, causing changes in consumption and investment, which affects aggregate demand.

Personal Income Formula

National income - Undistributed corporate profits - Social insurance taxes - Corporate profits taxes + Transfer payments

Computing National Income

National income is the sum of compensation of employees, proprietors' income, corporate profits, rental income of persons, and net interest.

Net Interest

Net interest is the interest income received by U.S. households and government minus the interest they paid out.

At the time of Carol's 10 year high school reunion she was making $30,000 and the CPI was 90. Now that it is time for her to attend her 20 year high school reunion, Carol's income has risen to $65,000 and the CPI is 200. At her 20 year reunion, can Carol rightfully brag that her real income has risen since the last time she saw her former classmates ten years ago?

No, Carol's real income fell during that 10 year period.

Real Wages Formula

Nominal Wages/Price Level

What is real income equal to?

Nominal income divided by the consumer price index times 100.

Nondurable Goods

Nondurable goods are goods that are not expected to last for more than three years, such as food.

Which of the following are included in the calculation of GDP?

None of the above

Suppose the civilian non-institutionalized population = 200m. Unemployed persons = 8m, employed persons = 126m. What is the unemployment rate?

None of the above!

Employment Rate Formula

Number of employed persons/Civilian Noninstitutional Population

Frictional Unemployment Formula

Number of frictionally unemployed persons/Civilian labor force

Structural Unemployment Formula

Number of structurally unemployed persons/Civilian labor force

Unemployment Rate Formula

Number of unemployed persons/Civilian labor force

Computing Real GDP

One way to compute Real GDP is to find the value of output for the different years in terms of base year prices.

Per Capita GDP

Per capita GDP is found by dividing a country's GDP by its population.

One measure of the inflation rate is the

Percentage change in the CPI of different years.

Disposable Income Formula

Personal income - Personal taxes

Civilian Noninstitutional Population Formula

Persons not in the labor force + Civilian labor force

Measuring Prices

Price in macroeconomics usually refers to an aggregate price, a price level, a price index, or an average price. When they talk about price stability, they are referring to the average price, price level, or price index remaining constant. Price Level - A weighted average of the prices of all good and services. Price Index - A measure of the price level. Consumer Price Index (CPI) - A widely cited index number for the price level; the weighted average of prices of a specific set of goods and services purchased by a typical household. Base Year - The year chosen as a point of reference or basis of comparison for prices in other years; a benchmark year.

One of the reasons why the AD curve slopes downward is that as the

Price level falls, purchasing power rises.

Profit Per Unit Formula

Price per unit - Cost per unit

GDP Formula

Prices of all the goods x Quantity of all the goods

Changes in the Productivity

Productivity is the output produced per unit of input employed over some period of time. Although various inputs can become more productive, let's consider the labor input. An increase in labor productivity means businesses will produce more output with the same amount of labor, causing the SRAS curve to shift rightward. A decrease in labor productivity means businesses will produce less output with the same amount of labor, causing the SRAS curve to shift leftward. A host of factors lead to increased labor productivity, including a more educated labor force, a larger stock of capital goods, and technological advancements.

Proprietors' Income

Proprietors' income includes all forms of income earned by self-employed individuals and the owners of unincorporated businesses, including unincorporated farmers.

What is the effect on Real GDP and the price level in the short-run of an increase in SRAS that is greater than an increase in AD?

Real GDP increases while the price level decreases

REAL GDP

Real GDP measures allow us to compare output in different years.

What Does it Mean if Real GDP is Higher in One Year Than in Another Year?

Real GDP rises only if output rises.

"Economic growth" has occurred if the

Real GDP this year exceeds the Real GDP of last year.

Inflation and the CPI

Real income is a person's nominal income adjusted for any price changes. If real income is constant over time, you are keeping up with inflation. If real income is falling over time, you are not keeping up with inflation. If real income is rising over time, you are beating inflation.

Are all increases in GDP good for the economy?

Recall that investment can rise for one of three reasons: (1) Firms may purchase more newly produced capital goods (firms buy more factories and machinery); (2) individuals may purchase new residential housing (someone buys a new home); or (3) firms' inventory investment rises. Further, firms' inventory investment can rise in two ways: Planned inventory investment. Firms may deliberately produce more units of a good and add them to inventory. Unplanned inventory investment. Consumers don't buy as many units of output as firms have produced, and unsold units are added to inventory.

Rental Income (Of Persons)

Rental income is the income received by individuals for the use of their non-monetary assets (land, houses, offices). It also includes returns to individuals who hold copyrights and patents. Finally, it includes an imputed value to owner-occupied houses.

Salary in Today's (Current) Dollars

Salary earlier year x (CPI current year/CPI earlier year)

Services

Services are intangible items such as lawn care, car repair, and entertainment.

Something More to Come: Shifts in the LRAS Curve

Shifts in the LRAS curve are important when we discuss long-run economic growth in Chapter 16.

Going From the Short Run to the Long Run

Short-run equilibrium identifies the Real GDP the economy produces when wages are sticky or when there are worker misperceptions. In time, though, wages will become unstuck and misperceptions will turn into accurate perceptions. When this happens, the economy is said to be in the long run. Most economists argue that in the long run, the economy produces the full-employment Real GDP or the Natural Real GDP, which is identified by the long-run aggregate supply (LRAS) curve. Long-run equilibrium identifies the level of Real GDP the economy produces when wages and prices have adjusted to their (final) equilibrium levels and there are no misperceptions. This occurs at the intersection of the AD and LRAS curves.

GDP is Not Adjusted for Bads Generated in the Production of Goods

Some economists argue that GDP overstates our overall economic welfare, since it does not net out bads. GDP counts the goods and services, but it does not net out the air and water pollution.

The Self-Regulating Economic Instability Category

Some economists believe that market economies are inherently instable, while others believe that market economies are inherently stable or self regulating.

Different Views of How the Economy Works

Some economists believe the economy is inherently stable and self-regulating, while others do not.

What GDP Omits

Some exchanges that take place in an economy are not included in GDP. These include some nonmarket goods and services, legal and illegal underground activities, sales of used goods, financial transactions, government transfer payments, and leisure.

Discouraged Workers

Someone who wants a job but is not actively looking for work is called a discouraged worker. Because discouraged workers are not considered unemployed, the unemployment rate may be biased downward. They are former workers who are not actively looking for work and are not waiting to be called back to a job or to report for a job. Discouraged workers are not counted as unemployed workers.

If the percentage rise in prices is equal to the percentage rise in nominal income, then real income:

Stays the same

To compute GDP using the income method, how would you handle Income earned from the rest of the world?

Subtract it from National Income

The base year is the year

That serves as a reference point or benchmark.

Converting Dollars From One Year to Another

The CPI can be used to compare dollar incomes or dollar prices in different years.

GDP Implicit Price Deflator

The GDP implicit price deflator is based on all goods and services produced in an economy.

Long-Run Aggregate Supply Curve

The LRAS curve is a vertical line at the level of Natural Real GDP. It represents the output the economy produces when all economy wide adjustments have taken place and workers do not have any relevant misperceptions.

NBER and Recessions

The NBER definition of a recession is different from the standard definition of a recession. According to the NBER, "a recession is a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade."

National Bureau of Economic Research (NBER) and Recessions

The National Bureau of Economic Research has this to say about a recession. A recession is a period between a peak and a trough . . . During a recession, a significant decline in economic activity spreads across the economy and can last from a few months to more than a year.

Natural Real GDP and Natural Unemployment

The Real GDP that is produced at the natural unemployment* rate. The Real GDP that is produced when the economy is in long-run equilibrium. *Unemployment caused by frictional and structural factors in the economy.

More About the Base Year

The base year is a benchmark year that serves as a basis of comparison for prices in other years.

International Trade Effect

The change in foreign sector spending as the price level changes.

Real Balance Effect

The change in the purchasing power of dollar-denominated assets that results from a change in the price level. Monetary Wealth is the value of a person's monetary assets. Wealth, as distinguished from monetary wealth, refers to the value of all assets owned, both monetary and nonmonetary. In short, a person's wealth equals his or her monetary wealth (e.g., $1,000 cash) plus nonmonetary wealth (e.g., a car or a house). Purchasing Power is the quantity of goods and services that can be purchased with a unit of money. Purchasing power and the price level are inversely related: As the price level goes up (down), purchasing power goes down (up).

Short-Run Equilibrium

The condition that exists in the economy when the quantity demanded of Real GDP equals the (short-run) quantity supplied of Real GDP. This condition is met where the aggregate demand curve intersects the short-run aggregate supply curve.

Long-Run Equilibrium

The condition that exists in the economy when wages and prices have adjusted to their (final) equilibrium levels and workers do not have any relevant misperceptions. Graphically, long-run equilibrium occurs at the intersection of the AD and LRAS curves.

In the business cycle, what is the difference between the recovery phase and the expansion phase?

The expansion phase is the period when Real GDP increases beyond the recovery phase.

THE EXPENDITURE APPROACH TO COMPUTING GDP FOR A REAL-WORLD ECONOMY

The expenditure approach is one of the methods used to compute GDP.

Changes in Short-Run Aggregate Supply: Shifts in the SRAS Curve

The factors that can shift the SRAS curve include wage rates, prices of nonlabor inputs, productivity, and supply shocks. If wage rates or prices of nonlabor inputs fall, or if productivity rises, or if there is a beneficial supply shock, the SRAS curve will shift rightward. If wage rates or prices of nonlabor inputs rise, or if productivity falls, or if there is an adverse supply shock, the SRAS curve will shift leftward.

The General Equation for Real GDP

The general equation used to compute real GDP is: Real GDP = Σ (Base-year prices x Current-year quantities).

THE INCOME APPROACH TO COMPUTING GDP FOR A REAL-WORLD ECONOMY

The income approach is a second method used to compute GDP.

From National Income to GDP: Making Some Adjustments

The income approach to computing GDP requires that we subtract income earned by citizens who work and live in other countries and then add income earned by foreigners who work and live in this country, indirect business taxes, and the capital consumption allowance to national income. Since GDP and national income are computed using different sets of data, statistical discrepancies must also be accounted for in the national income accounts.

"Full employment" is said to exist when the unemployment rate equals

The natural unemployment rate.

Changes in which of the following will not cause the SRAS curve to shift?

The price level

Measuring Prices Using the CPI

The price level is a weighted average of the prices of all goods and services, and it is measured by constructing a price index. One major price index is the consumer price index (CPI). The CPI is based on a market basket of goods and services purchased by a typical household.

Why Does the Aggregate Demand Curve Slope Downward?

The real balance effect, the interest rate effect, and the international trade effect explain the inverse relationship between the price level and the quantity demanded of Real GDP. The real balance effect states that the inverse relationship is established through changes in the value of monetary wealth. As the price level changes, the purchasing power of monetary wealth changes, causing the quantity demanded of Real GDP to change. The interest rate effect states that the inverse relationship is established through changes in household and business spending that is sensitive to interest rate changes. As the price level changes, it takes a different quantity of money to purchase a fixed bundle of goods, and this leads to a change in savings (the supply of credit increases). Subsequently, the price of credit, which is the interest rate, changes, causing households and businesses to change their borrowing levels, and changing the quantity of Real GDP to change. The international trade effect states that the inverse relationship is established through foreign sector spending. As the price level in the U.S. changes, U.S. goods become relatively cheaper or more expensive than foreign goods. As a result, Americans and foreigners change the amounts of U.S. goods they buy, changing the quantity of Real GDP to change.

The P-Q Category

The two major variables that macroeconomics deals with are the price level and Real GDP. The price level is the weighted average of the prices of all goods and services and Real GDP is the value of the entire output produced annually within a country's borders, adjusted for price changes.

The Two Sides to an Economy

The two sides to an economy are the demand side and the supply side (called aggregate demand and aggregate supply.) Macroeconomists often use the AD-AS framework of analysis to discuss the price level, GDP, Real GDP, unemployment, economic growth, and other major macroeconomic topics. The AD-AS framework has three parts: AD, SRAS, and LRAS.

Macroeconomic Policies

The two types of macroeconomic policy that we will discuss include fiscal policy and monetary policy. Fiscal policy deals with changes in government expenditures and/or taxes, while monetary policy deals with changes in the money supply. High inflation rate; High unemployment rate; High interest rates; Low economic growth or stagnation.

The Unemployment and Employment Rates

The unemployment rate is the percentage of the civilian labor force that is unemployed. The employment rate is the percentage of the civilian noninstitutional population that is employed. The labor force participation rate is the percentage of the civilian noninstitutional population that is in the civilian labor force.

Underground activities are not counted in GDP because

There are no written records of underground activities.

Short-Run Equilibrium, Long-Run Equilibrium, and Disequilibrium

There are two equilibrium states in an economy—short-run equilibrium and long-run equilibrium. In short-run equilibrium, quantity supplied and demanded of Real GDP are either more than or less than Natural Real GDP. When the economy is in neither short-run equilibrium nor long-run equilibrium, it is said to be in disequilibrium.

A Change in the Quantity Demanded of Real GDP Versus a Change in Aggregate Demand

There is a difference between a change in the quantity demanded of Real GDP and a change in aggregate demand. A change in the quantity demanded of Real GDP is brought about by a change in the price level and is shown by moving from one point on another point on an AD curve, while a change in AD is brought about by a change in a factor of AD and is shown by shifting the entire AD curve.

Chapter 7 Overview

This chapter provides an introduction to two more of the economic measurements that are important to economists in determining the economic health of the country. Output is measured using GDP or real GDP. This chapter shows how GDP and real GDP are defined, computed, and used, and defines economic growth and business cycles. Everything in this chapter can be translated into P-Q language and placed in the P-Q category discussed in the last chapter.

Thinking in Terms of Short-Run Equilibrium Changes in the Economy

To a large degree, economists naturally think in terms of flow charts. Economics is about establishing a connection or link between an effect (such as a fall in Real GDP) and a correct cause (such as an adverse supply shock that shifts the SRAS curve to the left). If a factor change shifts AD rightward, the price level and Real GDP will rise and the unemployment rate will fall. If a factor change shifts AD leftward, the price level and Real GDP will fall and the unemployment rate will rise. If a factor change shifts SRAS rightward, the price level will fall, Real GDP will rise, and the unemployment rate will fall. If a factor change shifts SRAS leftward, the price level will rise, Real GDP will fall and the unemployment rate will rise.

Why We Need Real GDP

To gauge the health of the economy, economists want to know the reason for an increase in GDP. Because an increase in GDP can be due in part to an increase in price, a more meaningful measure is real GDP. Real GDP is GDP adjusted for price changes.

How Spending Components Affect Aggregate Demand

Total expenditures on U.S. goods and services is the sum of consumption, investment, government purchases and net exports. If, at a given price level, one of these components rises, then spending on U.S. goods and services will rise. If, at a given price level, one of these components falls, then spending on U.S. goods and services will fall.

National Income

Total income earned by U.S. citizens and businesses, no matter where they reside or are located. National income is the sum of the payments to resources (land, labor, capital, and entrepreneurship).

The standard definition of "recession" is

Two or more consecutive quarters of falling Real GDP.

Why Does the Aggregate Supply Curve Slope Upward?

Two possible explanations: Sticky wages and Worker misconceptions.

What is meant by the natural rate of unemployment?

Unemployment caused by frictional and structural factors in the economy.

Cyclical Unemployment Rate

Unemployment rate - Natural unemployment rate

The NBC news anchor reported that GDP is higher this year than last year. What does this mean?

Unless the anchor specified that this was arise in real GDP, we cannot speculate that the economy is actually doing better. It could have been a rise in prices, output or both.

The short-run aggregate supply curve is

Upward sloping.

The sale of __________ goods is omitted from current GDP because __________.

Used goods; these goods were counted in an earlier year.

Which of the following would definitely not be included in the measurement of GDP?

Value of the services of a person who mows his or her own lawn.

Sticky Wages, the Real Wage Rate, and SRAS

Wages are "locked in" for a few years due to labor contracts or perhaps because of social conventions or perceived notions of fairness. Price level ↑→Real wage ↓, ceteris paribus Price level ↓→Real wage ↑, ceteris paribus More individuals are willing to work, and current workers are willing to work more at higher real wages than at lower real wages and vice versa. Real wage↑→ Quantity supplied of labor ↑ Real wage↓→ Quantity of labor supplied ↓ Firms will employ more workers the cheaper it is to hire them. Real wage↑→ Quantity of labor demanded↓ Real wage↓→ Quantity of labor demanded↑ Thus, if wages are sticky, an increase in the price level (which pushes real wages down) will result in a increase in output. This is what an upward-sloping SRAS curve represents: As the price level rises, the quantity supplied of goods and services rises. The opposite occurs if price levels fall.

Worker Misperceptions

Workers change the quantity of labor they are willing to supply when their real wage changes. If workers overestimate the drop in their real wage rate they may reduce the quantity of labor they are willing to supply, and firms will end up producing less.

A business firm produces a good this year that it does not sell. As a result, the good is added to the firm's inventory. Is this good included in GDP?

Yes, it is a part of Investment called Inventory Investment.

Is it possible for a country with a relatively large GDP to have a relatively small per-capita GDP?

Yes, since the country with a relatively large GDP could have a relatively large population.

Net exports equals

exports minus imports.