AP Macroeconomics: Unit 2

Leakage

(1) A withdrawal of potential spending from the income-expenditures stream via saving, tax payments, or imports; (2) a withdrawal that reduces the lending potential of the banking system.

economic growth

(1) an outward shift in the production possibilities curve that results from an increase in resource supplies or quality or an improvement in technology; (2) an increase of real output (gross domestic product) or real output per capita.

aggregate supply

A schedule or curve showing the total quantity of goods and services supplied (produced) at different price levels.

cyclical unemployment

A type of unemployment caused by insufficient total spending (or by insufficient aggregate demand).

frictional unemployment

A type of unemployment caused by workers voluntarily changing jobs and by temporary layoffs; unemployed workers between jobs.

Hyperinflation

A very rapid rise in the price level; an extremely high rate of inflation.

recovery

Also known as the expansion phase, output and employment rise toward full employment. As this intensifies, the price level may begin to rise before full employment and full-capacity production return.

Trough

At this phase, output and employment "bottom out" at their lowest levels. This phase may be either short-lived, or quite long.

discouraged workers

Employees who have left the labor force because they have not been able to find employment.

gross private domestic investment (Ig)

Expenditures for newly produced capital goods (such as machinery, equipment, tools, and buildings) and for additions to inventories.

net exports (Xn)

Exports minus imports

Employment Act of 1946

Federal legislation that committed the Federal government to the maintenance of economic stability ( a high level of employment, a stable price level, and economic growth); established the Council of Economic Advisers and the Joint Economic Committee; and required an annual economic report by the president to Congress.

average propensity to save (APS)

Fraction ( or percentage) of disposable income that households save; saving divided by disposable income.

average propensity to consume (APC)

Fraction (or percentage) of disposable income that households plan to spend for consumer goods and services; consumption divided by disposable income.

real GDP

Gross Domestic Product adjusted for inflation; gross domestic product in a year divided by the GDP price index for that year, the index expressed as a decimal.

demand-pull inflation

Increases in the price level (inflation) resulting from an excess of demand over output at the existing price level, caused by an increase in aggregate demand.

cost-push inflation

Increases in the price level (inflation) resulting from an increase in resource costs (for example, raw-material prices) and hence in per-unit production costs; inflation caused by reductions in aggregate supply.

interest-rate effect

The interest rate expressed in dollars of constant value (adjusted for inflation) and equal to the nominal interest rate less the expected rate of inflation.

national income accounting

The techniques used to measure the overall production of the economy and other related variables for the nation as a whole.

gross domestic product

The total market value of all final goods and services produced annually within the boundaries of the United States, whether by U.S. or foreign-supplied resources.

value added

The value of the product sold by a firm less the value of the produces (materials) purchased and used by the firm to produce the product.

cyclical deficit

a Federal budget deficit that is caused by a recession and the consequent decline in tax revenues.

full-employment budget

a comparison of the government expenditures and tax collections that would occur if the economy operated at full employment throughout the year.

investment schedule

a curve or schedule that shows the amounts firms plan to invest at various possible values of real gross domestic product.

investment demand curve

a curve that shows the amounts of investment demanded by an economy at a series of real interest rates.

Deflation

a decline in the economy's price level.

contractionary fiscal policy

a decrease in government purchases for goods and services, an increase in net taxes, or some combination of the two, for the purpose of decreasing aggregate demand and thus controlling inflation.

Council of Economic Advisers (CEA)

a group of three persons that advisers and assists the president of the United States on economic matters (including the preparation of the annual Economic Report of the President).

45 degree line

a line along which the value of GDP (measured horizontally) is equal to the value of aggregate expenditures (measured vertically).

productivity

a measure of average output or real output per unit of input. For example, the productivity of labor is determined by dividing real output by hours of work.

built-in stabilizer

a mechanism that increases government's budget deficit (or reduces its surplus) during a recession and increases government's budget surplus (or reduces its deficit) during inflation without any action by policymakers. The tax system is one such mechanism.

rule of 70

a method for determining the number of years it will take for some measure to double, given its annual percentage increase. Example: To determine the number of years it will take for the price level to double, divide 70 by the annual rate of inflation.

Recession

a period of declining real GDP, accompanied by lower real income and higher unemployment.

crowding-out effect

a rise in interest rates and a resulting decrease in planned investment caused by the Federal government's increased borrowing in the money market.

Inflation

a rise in the general level of prices in an economy.

aggregate expenditures schedule

a schedule or curve showing the total amount spent for final goods and services at different levels of real GDP.

aggregate demand

a schedule or curve that shows the total quantity of goods and services demanded (purchased) at different price levels.

consumption schedule

a schedule showing the amounts households plan to spend for consumer goods at different levels of disposable income.

saving schedule

a schedule that shows the amounts households plan to save (plan not to spend for consumer goods), at different levels of disposable income.

lump-sum tax

a tax that is a constant amount ( the tax revenue of government is the same) at all levels of GDP.

efficiency wages

a wage that minimizes wage costs per unit of output by encouraging greater effort or reducing turnover.

Injection

an addition of spending to the income-expenditure stream: investment, government purchases, and net exports.

cost of living adjustments COLAs

an automatic increase in the income (wages) of workers when inflation occurs; guaranteed by a collective bargaining contract between firms and workers.

consumption of fixed capital

an estimate of the amount of capital worn out or used up (consumed) in producing the gross domestic product; also called depreciation.

expansionary fiscal policy

an increase in government purchases of goods and services, a decrease in net taxes, or some combination of the two for the purpose of increasing aggregate demand and expanding real output.

price index

an index number that shows how the weighted-average price of a "market basket" of goods changes over time.

consumer price index (CPI)

an index that measures the prices of fixed "market basket" of some 300 goods and services bought by a "typical" consumer.

fiscal policy

changes in government spending and tax collections designed to achieve a full-employment and noninflationary domestic output; also called discretionary fiscal policy.

unplanned changes in inventories

changes in inventories that firms did not anticipate; changes in inventories that occur because of unexpected increases or decreases of aggregate spending (of aggregate expenditures).

equilibrium real output

determined by the intersection of the aggregate demand curve and aggregate supply curve

supply-side fiscal policy

emphasizes the role of costs and aggregate supply in explaining inflation, unemployment, and economic growth.

government purchases (G)

expenditures by government for goods and services that government consumes in providing public goods and for public (or social) capital that has a long lifetime; the expenditures of all governments in the economy for those final goods and services.

net exports

exports minus imports

determinants of aggregate demand

factors such as consumption spending, investment, government spending, and net exports that, if they change, shift the aggregate demand.

determinants of aggregate supply

factors such as input prices, productivity, and the legal-institutional environment that, if they change, shift the aggregate supply curve.

per capita output

found by dividing real GDP by population.

final goods

goods that have been purchased for final use and not for resale or further processing or manufacturing.

net domestic product (NDP)

gross domestic product less the part of the year's output that is needed to replace the capital goods worn out in producing the output; the nation's total output available for consumption or additions to the capital stock.

net private domestic investment

gross private domestic investment less consumption of fixed capital; the addition to the nation's stock of capital during a year.

unanticipated inflation

increases in the price level (inflation) at a rate greater than expected.

anticipated inflation

increases in the price level (inflation) that occur at the expected rate.

menu costs

named after the cost of printing new menus when a restaurant changes its prices. When menu costs are substantial, firms may choose to avoid them by retaining current prices. They will wait to see if the decline in aggregate demand is permanent.

disposable income (DI)

personal income less personal taxes; income available for personal consumption expenditures and personal saving.

labor force

persons 16 years of age and older who are not in institutions and who are employed or are unemployed (and seeking work).

intermediate goods

products that are purchased for resale or further processing or manufacturing.

business cycle

recurring increases and decreases in the level of economic activity over periods of years; consists of peak, recession, trough, and recovery.

indirect business taxes

such taxes as sales, excise, and business property taxes, license fees, and tariffs that firms treat as costs of producing a product and pass on (in whole or in part) to buyers by charging higher prices.

nominal GDP

the GDP measured in terms of the price level at the time of measurement (unadjusted for inflation).

political business cycle

the alleged tendency of Congress to destabilize the economy by reducing taxes and increasing government expenditures before elections and to raise taxes and lower expenditures after elections.

GDP gap

the amount by which actual gross domestic product falls below potential output.

inflationary gap

the amount by which the aggregate expenditures schedule must shift downward to decrease the nominal GDP to its full-employment noninflationary level.

recessionary gap

the amount by which the aggregate expenditures schedule must shift upward to increase the real GDP to its full-employment, noninflationary level.

budget deficit

the amount by which the expenditures of the Federal government exceed its revenues in any year.

budget surplus

the amount by which the revenues of the Federal government exceed its expenditures in any year.

real income

the amount of goods and services that can be purchased with nominal income during some period of time; nominal income adjusted for inflation.

actual investment

the amount that firms do invest; equal to planned investment plus unplanned investment.

planned investment

the amount that firms plan or intend to invest.

per-unit production costs

the average production cost of a particular level of output; total input cost divided by units of output.

progressive tax system

the average tax rate (=tax revenue/GDP) rises with GDP.

regressive tax system

the average tax rate falls as GDP rises.

proportional tax system

the average tax rate remains constant as GDP rises

personal income (PI)

the earned and unearned income available to resource suppliers and others before the payment of personal taxes.

personal consumption expenditures (C)

the expenditures of households for durable and nondurable consumer goods and services.

balanced-budget multiplier

the extent to which an equal change in government spending and taxes changes equilibrium gross domestic product; always has a value of 1, since it is equal to the amount of the equal changes in G and T.

marginal propensity to consume (MPC)

the fraction of any change in disposable income spent for consumer goods; equal to the change in consumption divided by the change in disposable income.

marginal propensity to save (MPS)

the fraction of any change in disposable income that households save; equal to the change in saving divided by the change in disposable income.

natural rate of unemployment (NRU)

the full-employment unemployment rate; the unemployment rate occurring when there is no cyclical unemployment and the economy is achieving its potential output; the unemployment rate at which actual inflation equals expected inflation.

Okun's Law

the generalization that any 1-percentage-point rise in the unemployment rate above the full-employment unemployment rate will increase the GDP gap by 2 percent of the potential output (GDP) of the economy.

horizontal range (of AS curve)

the horizontal segment of the aggregate supply curve along which the price level is constant as real domestic output changes.

net export effect

the idea that the impact of a change in monetary policy or fiscal policy will be strengthened or weakened by the consequent change in net exports. The change in net exports occurs because of changes in real interest rates, which affect exchange rates.

expected rate of return

the increase in profit a firm anticipates it will obtain by purchasing capital (or engaging in research and development); expressed as a percentage of the total cost of the investment (or R&D) activity.

real interest rate

the interest rate expressed in dollars of constant value (adjusted for inflation) and equal to the nominal interest rate less the expected rate of inflation.

nominal interest rate

the interest rate expressed in terms of annual amounts currently charged for interest and not adjusted for inflation.

foreign purchases effect

the inverse relationship between the net exports of an economy and its price level relative to foreign price levels.

equilibrium GDP

the level at which the total quantity of goods produced (GDP) equals the total quantity of goods purchased (C + Ig ).

break-even income

the level of disposable income at which households plan to consumer (spend) all their income and to save none of it; also, in an income transfer program, the level of earned income at which subsidy payments become zero.

aggregate demand-aggregate supply (AD-AS) model

the macroeconomic model that uses aggregate demand and aggregate supply to determine and explain the price level and real domestic output.

expenditures approach

the method that adds all expenditures made for final goods and services to measure the gross domestic product.

income approach

the method that adds all the income generated by the production of final goods and services to measure the gross domestic product.

nominal income

the number of dollars received by an individual or group for its resources during some period of time.

unemployment rate

the percentage of the labor force unemployed at any time.

Peak

the point where business activity has reached a temporary maximum. Here the economy is at full employment and the level of real output is at or very close to the economy's capacity. The price level is likely to rise during this phase.

equilibrium price level

the price level at which the aggregate demand curve intersects the aggregate supply curve.

multiplier

the ratio of a change in the equilibrium GDP to the change in investment or in any other component of aggregate expenditures or aggregate demand; the number by which a change in any component of aggregate expenditures of aggregate demand must be multiplied to find the resulting change in the equilibrium GDP.

potential output

the real output (GDP) an economy can produce when it fully employs its available resources.

real-balances effect

the tendency for increases in the price level to lower the real value (or purchasing power) of financial assets with fixed money value and, as a result, to reduce total spending and real output, and conversely for decreases in the price level.

wealth effect

the tendency for people to increase their consumption spending when the value of their financial and real assets rises and to decrease their consumption spending when the value of those assets falls.

full-employment rate of unemployment

the unemployment rate at which there is no cyclical unemployment of the labor force; equal to between 4 and 5 percent in the United States because some frictional and structural unemployment is unavoidable.

intermediate range (of AS curve)

the upsloping segment of the aggregate supply curve lying between the horizontal range and the vertical range.

vertical range (of AS curve)

the vertical segment of the aggregate supply curve along which the economy is at full capacity.

national income

total income earned by resource suppliers for their contributions to gross domestic product; equal to the gross domestic product minus nonincome charges, minus net foreign factor income.

structural unemployment

unemployment of workers whose skills are not demanded by employers, who lack sufficient skills to obtain employment, or who cannot easily move to locations where jobs are available.

multiple counting

wrongly including the value of intermediate goods in the gross domestic product; counting the same good or service more than once.