ECON 104 Exam 2

What is the formula for GDP deflator?

(nominal GDP)/(real GDP)x100

Outward orientated policies

A country that eliminates trade restrictions will experience the same kind of economic growth that would occur after a major technological advance.

How does economic prosperity depend on political prosperity?

A country with an efficient court system, honest government officials, and a stable constitution will enjoy a higher economic standard of living than a country with a poor court system, corrupt officials, and frequent revolutions and coups.

What is a bond that never matures called?

A perpetuity. This bond pays interest forever, but the principal is never repaid.

What happens in the stock exchange?

After a corporation issues stock by selling shares to the public, these shares trade among shareholders on organized stock exchanges.

What is the formula for turning dollar figures from a previous year into today's dollars?

Amount in todays dollars= (amount in T dollars)x(price level today)/(price level in year T)

Mutual Fund

An institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds. If the value of the portfolio rises, the shareholder benefits; if the value of the portfolio falls, the shareholder suffers the loss.

What are the two most important financial intermediaries?

Banks and Mutual funds.

How are banks financial intermediaries?

Banks are the financial intermediaries with which people are most familiar. A primary job of banks is to take in deposits from people who want to save and use these deposits to make loans to people who want to borrow. Banks pay depositors interest on their deposits and charge borrowers slightly higher interest on their loans. The difference between these rates of interest covers the banks' costs and returns some profit to the owners of the banks.

Junk bonds

Bonds issued by finically shaky institutions with high interest rates.

Stock

Claim to partial ownership of a company.

What is the difference between stocks and bonds returns and risks.

Compared to bonds, stocks offer the holder both higher risk and potentially higher return.

GDP is divided into what four components?

Consumption (C), investment (I), government purchases (G), and net exports (NX).

Who pays the highest rates of interest on bonds; territorial and provincial governments, federal governments, or corporations?

Corporations because their revenue is likely to be more volatile.

Financial Market

Financial institutions through which savers can directly provide funds to borrowers. The two most important financial markets in our economy are the bond market and the stock market.

Financial institutions can be grouped into what two categories?

Financial markets and financial intermediaries.

What are more risky: long term or short term bonds?

Long term

Externality

The effect of one person's actions on the well-being of a bystander.

Natural resources

The inputs into the production of goods and services that are provided by nature, such as land, rivers, and mineral deposit. Natural resources are either renewable or non-renewable.

Nominal Interest Rate

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

Gross Domestic Product

The market value of all final goods and services produced within a country in a given period of time. Only includes value of final goods. The reason is that the value of intermediate goods is already included in the prices of the final goods. GDP includes both tangible and intangible. GDP includes goods and services currently produced. It does not include transactions involving items produced in the past. GDP measures the value of production within the geographic confines of a country. GDP measures the value of production that takes place within a specific interval of time.

Inflation rate

The percentage change in some measure of the price level from one period to the next.

Infaltion Rate

The percentage change in the price index from the preceding period.

What determines the price at which shares trade on the stock exchange?

The prices at which shares trade on stock exchanges are determined by the supply and demand for the stock in these companies. Because stock represents ownership in a corporation, the demand for a stock (and thus its price) reflects people's perception of the corporation's future profitability.

What are the two advantages of mutual finds?

The primary advantage of mutual funds is that they allow people with small amounts of money to diversify. A second advantage claimed by mutual fund companies is that mutual funds give ordinary people access to the skills of professional money managers.

What is the sale of a bond to raise money called?

The sale of bonds to raise money is called debt finance.

What is the sale of a stock to raise money called?

The sale of stock to raise money is called equity finance.

What is involved in the second step of computing the CPI? (Finding the prices)

The second step in computing the consumer price index is to find the price of each of the goods and services in the basket for each point in time.

Physical capital

The stock of equipment and structures that are used to produce goods and services.

Government debt

The sum of all past budget deficits minus the sum of all past surpluses.

What is the formula for the CPI Inflation rate for year 2?

(CPI in year 2 - CPI in year 1)/(CPI in year 1)x100

What is the formula for GDP inflation rate in year 2?

(GDP deflator in year 2-GDP deflator in year 1)/(GDP deflator in year 1)x100

What is the formula for total spending?

(Total quantity)x(price)

What are some things that GDP excludes?

Leisure, the environment, the distribution of income, and goods and services produced at home.

Foreign portfolio investment

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

How does health effect productivity?

In general healthier workers are more productive.

What is the CPI of the base year always?

100.

What is the GDP deflator in the base year always equal to?

100.

What happens to bondholder and stockholders of a company is it is profitable?

If the comany is very profitable, the shareholders enjoy the benefits of these profits, whereas the bondholders get only the interest on their bonds.

National saving

The total income in the economy that remains after paying for consumption and government purchases. In equation form it is a rearranged GDP formula: Y-G-C=I. This is equal to S=I. This equation stated that savings equal investment. If you Let T denote the amount that the government collects from households in taxes minus the amount it pays back to households in the form of transfer payments (such as Employment Insurance and social assistance). We can then write national saving in either of two ways: S=Y-C-G or S=(Y-T-C)+(T-G)

Public saving

is the amount of tax revenue that the government has left after paying for its spending. The government receives T in tax revenue and spends G on goods and services. The formula for this is T - G.

In reference to public saving what is a budget surplus?

If T exceeds G, the government runs a budget surplus because it receives more money than it spends. This surplus of T - G represents public saving.

In reference to public saving what is a budget deficit?

If the government spends more than it receives in tax revenue, then G is larger than T. In this case, the government runs a budget deficit, and public saving T - G is a negative number.

When does real GDP equal nominal GDP?

In the base year.

Consumption

Is spending by households on goods and services.

Bond

Certificate of indebtedness. Put simply, a bond is an IOU. It identifies the time at which the loan will be repaid, called the date of maturity, and the rate of interest that will be paid periodically until the loan matures. The buyer of a bond gives his or her money in exchange for this promise of interest and eventual repayment of the amount borrowed (called the principal). The buyer can hold the bond until maturity or can sell the bond at an earlier date to someone else.

What are the three problems with the CPI?

Commodity substitution bias, introduction of new goods, unmeasured quality change.

What is the formula for computing the CPI?

(price of basket of goods and services in current year)/(price of basket in base year)x100

Foreign direct investment

A capital investment that is owned and operated by a foreign entity. For example a factory.

Crowding out

A decrease in investment that results from government borrowing.

Financial intermediaries

A financial institutions through which savers can indirectly provide funds to borrowers. The term intermediary reflects the role of these institutions in standing between savers and borrowers.

Consumer Price Index

A measure of the overall cost of the goods and services bought by a typical consumer. The goal of the consumer price index is to measure changes in the cost of living. In other words, the consumer price index tries to gauge how much incomes must rise in order to maintain a constant standard of living.

GDP Deflator

A measure of the price level calculated as the ratio of nominal GDP to real GDP times 100. GDP deflator reflects the prices of goods and services but not the quantities produced. The GDP deflator for years after the base year, measures the change in nominal GDP from the base year that cannot be attributable to a change in real GDP.

Core inflation

A measure of the underlying trend of inflation.

What are the five steps used in computing the Consumer Price Index?

Determine the basket, find the prices, compute the baskets cost, choose a base year and compute the index, and compute the inflation rate.

What are the two ways in which GDP can be calculated?

Either by adding up the total expenditure by households or by adding up the total income paid by firms.

Net exports

Equal the purchases of domestically produced goods by foreigners (exports) minus the domestic purchases of foreign goods (imports).

What does the S=I identity (saving=investment) reveal about the economy as a whole?

For the economy as a whole, saving must be equal to investment.

What are the eight excluded components of the typical CPI basket?

Fruit, vegetables, gasoline, fuel oil, natural gas, mortgage interest, intercity transportation, and tobacco products.

What items does GDP exclude?

GDP excludes most items produced and sold illicitly, such as illegal drugs. It also excludes most items that are produced and consumed at home and, therefore, never enter the marketplace.

What does GDP per person tell us?

GDP per person tells us the income and expenditure of the average person in the economy.

What is thought to the the best indicator of an economy's well being?

GDP.

How does high population growth decrease GDP per worker?

High population growth reduces GDP per worker because rapid growth in the number of workers forces the capital stock to be spread more thinly.

What happens to the GDP deflator when the quantities produced in the economy rise over time but prices remain the same.

In this case, both nominal and real GDP rise together, so the GDP deflator is constant.

What happens to the GDP deflator when prices rise over time but the quantities produced stay the same.

In this case, nominal GDP rises but real GDP remains the same, so the GDP deflator rises as well.

Government sending

Includes spending on goods and services by local, territorial, provincial, and federal governments. It includes the salaries of government workers and spending on public works.

What are two ways to increase future productivity?

Invest more current resources in the production of capital, and a well-functioning and carefully regulated financial market, one that quickly and efficiently brings savings and investment together with minimal risk and in a transparent way.

Down Jones Industrial Average

Is a stock index based on the prices of the stocks of 30 major U.S. companies, such as Boeing, General Electric, Microsoft, Coca-Cola, AT&T, and IBM.

Private saving

Is the amount of income that households have left after paying their taxes and paying for their consumption. In particular, because households receive income of Y, pay taxes of T, and spend C on consumption, private saving is Y - T - C.

Investment

Is the purchase of goods that will be used in the future to produce more goods and services.

What does the World Bank do?

It obtains funds from the worlds most advanced countries and uses these resources to make loans to less developed countries so that they can invest in roads, sewer systems, and schools.

What are the four determinants of productivity?

Physical capital, human capital, natural resources, and technological knowledge.

Is real or nominal GDP a better gauge of peoples living standards?

Real GDP

How is real interest rate calculated?

Real interest rate=(nominal interest rate)-(inflation rate)

Loanable funds

Refers to all income that people have chosen to save and lend out, rather than use for their own consumption.

Technological knowledge

Society's understanding of the best ways to produce goods and services.

Indexation

The automatic correction of a dollar amount for the effects of inflation by law or contract.

Viscous circle

The cycle that results when deficits reduce the supply of loanable funds, increase interest rates, discourage investment, and result in slower economic growth; slower growth leads to lower tax revenue and higher spending on income- support programs, and the result can be even higher budget deficits

Virtuous circle

The cycle that results when surpluses increase the supply of loanable funds, reduce interest rates, stimulate investment, and result in faster economic growth; faster growth leads to higher tax revenue and lower spending on income- support programs, and the result can be even higher budget surpluses.

Statistical discrepency

The difference between the two calculations of expenditure and income approach of GDP.

Government net debt

The difference between the value of government financial liabilities and financial assets.

If total spending rises from one year to the next what are the two possible reasons?

The economy is producing a larger output of goods and services, or goods and services are being sold at higher prices.

Brain drain

The emigration of many of the most highly educated workers to rich countries, where these workers can enjoy a higher standard of living.

What is involved in the fifth step of computing the consumer price index? (Compute the inflation rate)

The fifth and final step is to use the consumer price index to calculate the inflation rate, which is the percentage change in the price index from the preceding period.

What are the two most important characteristics of bonds?

The first characteristic is a bond's term—the length of time until the bond matures. The second important characteristic of a bond is its credit risk—the probability that the borrower will fail to pay some of the interest or principal.

What are the two important differences that cause the CPI and GDP deflator to diverge?

The first difference is that the GDP deflator reflects the prices of all goods and services produced domestically, whereas the consumer price index reflects the prices of all goods and services bought by consumers. The second and more subtle difference between the GDP deflator and the consumer price index concerns how various prices are weighted to yield a single number for the overall level of prices. The consumer price index compares the price of a fixed basket of goods and services to the price of the basket in the base year. Statistics Canada changes the basket of goods every two years. By contrast, the GDP deflator compares the price of currently produced goods and services to the price of the same goods and services in the base year.

What is involved in the first step of computing the CPI? (Determining the basket)

The first step in computing the consumer price index is to determine which prices are most important to the typical consumer.

What is involved in the fourth step of computing the CPI? (Choose a base year and computer the index)

The fourth step is to designate one year as the base year, which is the benchmark against which other years are compared. (The choice of a base year is arbitrary, as the index is used to measure changes in the cost of living.)

Financial system

The group of institutions in the economy that help to match one person's saving with another person's investment. At the broadest level, the financial system moves the economy's scarce resources from savers (people who spend less than they earn) to borrowers (people who spend more than they earn).

Real Interest Rate

The interest rate corrected for the effects of inflation. It tells you how fast the purchasing power of your bank account rises over time.

Human capital

The knowledge and skills that workers acquire through education, training, and experience. Human capital is particularly important for economic growth because human capital conveys positive externalities.

Market for loanable funds

The market in which those who want to save supply funds and those who want to borrow to invest demand funds. In the market for loanable funds, there is one interest rate, which is both the return to saving and the cost of borrowing.

Real GDP

The production of goods and services valued at constant prices. To obtain a measure of the amount produced that is not affected by changes in prices, we use real GDP. Real GDP uses constant base-year prices to place a value on the economy's production of goods and services.

Nominal GDP

The production of goods and services valued at current prices. Nominal GDP uses current prices to place a value on the economy's production of goods and services.

Catch up effect

The property whereby countries that start off poor tend to grow more rapidly than countries that start off rich.

Diminishing returns

The property whereby the benefit from an extra unit of an input declines as the quantity of the input increases

Productivity

The quantity of goods and services produced from each hour of a worker's time.

How can GDP measure both income and expenditure at once?

The reason that GDP can perform the trick of measuring both total income and total expenditure is that these two things are really the same. For an economy as a whole, income must equal expenditure.

What is involved in the third step of computing the CPI? (Computing the baskets cost)

The third step is to use the data on prices to calculate the cost of the basket of goods and services at different times.

Inward orientated policies

These policies are aimed at raising productivity and living standards within the country by avoiding interaction with the rest of the world.

How are price indexes used?

They are used to correct for the effects of inflation when comparing dollar figures from different times.

What happens when people become optimistic or un-optimistic about a companys future?

When people become optimistic about a company's future, they raise their demand for its stock and thereby bid up the price of a share of stock. Conversely, when people come to expect a company to have little profit or even losses, the price of a share falls.

What does the term default refer to in reference to a bond?

When the borrower fails to pay some of the interest or principal.

What is the formula for GDP?

Y= C+I+G+NX (GDP is Y)