Krugman's Economics for AP Module 10-15

How is price index calculated (formula)?

(cost of market basket in a given year)/ (cost of market basket in base year) x 100

How is the inflation rate calculated (formula)?

(price index in year 2-price index in year 1)/(price index in year 1) x 100

What is the equation for the inflation rate?

(price level in year 2-price level in year 1)/(price level in year 1) x 100

Ideas/Characteristic Not included in GDP

- Happiness - Leisure time -

A real GDP...

- doesn't address how a country uses that output to affect living standards - doesn't include some sources of wellbeing - does include some things that are detriments to well-being - increases with expenditures on some things that make people unhappy, including disease, divorce, crime, and natural disasters.

simple circular flow diagram

-shows economy with only two inhabitants: households and firms -shows two kinds of markets in circular flow: product markets and factor markets (best known is labor market)

circular flow diagram

-shows flow of money, goods, and services, and factors of production through the economy -underlying principle: flow of money into each market or sector is equal to the flow of money coming out of that market/sector -two flows: physical things versus money

In what three ways does the rest of the world participate in the U.S. economy?

1) Some of the goods and services produced in the US are sold to residents of other countries 2) Some of the goods and services purchased by residents of the US are produced abroad 3) Foreigners can participate in US financial markets

What are the three ways to calculate GDP?

1) Survey firms and add up the total value of their production of final goods and services 2) Add up aggregate spending on domestically produced final goods and services in the economy 3) Sum the total factor income earned by households from firms in the economy

Why do some economists believe that the CPI systematically overstates the actual rate of inflation (two reasons)?

1) The CPI measures the cost of buying in a given market basket, but consumers typically alter the mix of goods and services they buy, reducing the purchases of products that have become relatively more expensive and increasing purchases of products that have become relatively cheaper. 2) Innovation: by widening the range of consumer choice, innovation makes a given a given amount of money worth more (like a fall in consumer prices)

A certain amount of frictional unemployment is inevitable for these two reasons:

1) The constant process of job creation and job destruction. 2) New workers are always entering the labor market.

What are the two reasons why markets don't absorb all of a household's income?

1) taxes 2) private savings

1. Which of the following is true of real GDP? I. It is adjusted for changes in prices. II. It is always equal to nominal GDP. III. It increases whenever aggregate output increases. 2. The best measure for comparing a country's aggregate output over time is 3. Use the information provided in the table below for an economy that produces only apples and oranges. Assume the year 1 is the base year. What was the value of real GDP in each year? 4. Real GDP per capita is an imperfect measure of the quality of life in part because it 5. Refer to the 2009 data in the table below. Which of the following must be true? I. Residents of Japan were worse off than residents of the United States or the European Union. II. The European Union had a higher nominal GDP per capita than the United States. III. The European Union had a larger economy than the United States.

1. D - I & III only 2. B - Real GDP 3. C - 1,400 2,000 4. C - includes expenditures on natural disasters 5. C - III only

What is included in GDP?

Domestically produced final goods and services, including capital goods, new construction of structures, and changes to inventories

1.A person who moved to a new state and took two months to find a new job experienced which type of unemployment? a. frictional b. structural c. cyclical d. natural e. none of the above 2. What type of unemployment is created by a recession? a. frictional b. structural c. cyclical d. natural e. none of the above 3. A person who is unemployed because of a mismatch between the quantity of labor supplied and the quantity of labor demanded is experiencing what type of unemployment? a. frictional b. structural c. cyclical d. natural e. none of the above 4. Which of the following is true of the natural rate of unemployment? I. It includes frictional unemployment. II. It includes structural unemployment. III. It is equal to 0%. a. I only b. II only c. III only d. I and II e. I, II, and III 5. Which of the following can affect the natural rate of unemployment in an economy over time? a. labor force characteristics such as age and work experience b. the existence of labor unions c. advances in technologies that help workers find jobs d. government job training programs e. all of the above

1. a 2. c 3. b 4. d 5. e

Why does collective bargaining have the same general effect on unemployment as a minimum wage? Illustrate your answer with a diagram.

A binding minimum wage represents a price floor below which wages cannot fall. As a result, actual wages cannot move toward equilibrium. So a minimum wage causes the quantity of labour supplied to exceed the quantity of labour demanded. Because this surplus of labour reflects unemployed workers, it affects the unemployment rate. Collective bargaining has a similar effect—unions are able to raise the wage above the equilibrium level to a level like WU in the accompanying diagram. This will act like a minimum wage by causing the number of job-seekers to be larger than the number of workers firms are willing to hire. Collective bargaining causes the unemployment rate to be higher than it otherwise would be, as shown in the accompanying diagram.

What is the most important use of GDP?

A measure of the size of the economy, providing us a scale against which to compare the economic performance of other year or other countries

2. From 1990 to 2000 the price of housing rose dramatically. What are the implications of this in deciding where to use 1990 or 2000 as the base year in calculating 2010 real GDP?

A price index based on 1990 prices will contain a relatively low price of housing compared to a price index based on 2000 prices. This means that a 2000 price index used to calculate real GDP in 2010 will magnify the value of housing production in the economy and increase the relative size of the housing sector as a component of real GDP.

What is "Eurosclerosis"?

An example of the side effect of generous public policies; is the persistent high unemployment that afflicts a number of European economies.

Suppose that at the peak of the business cycle the Government of Canada dramatically increases benefits for unemployed workers. Explain what will happen to the natural rate of unemployment.

An increase in unemployment benefits at the peak of the business cycle reduces the cost to individuals of being unemployed, causing them to spend more time searching for new jobs. So the natural rate of unemployment would increase.

Why does a high inflation rate discourage people from holding money?

Because the purchasing power of cash steadily erodes as the overall level of prices rises.

What happens if the actual inflation rate is higher than expected?

Borrowers gain at the expense of lenders: borrowers will repay their loans with funds that have a lower real value than had been expected.

How is the effect of inflation summarized?

By distinguishing nominal interest and real interest rates.

How do labor unions exercise bargaining power?

By threatening firms with a labor strike (collective refusal to work).

What causes the natural rate of unemployment to change?

Changes in the characteristics of the labor force, changes in the labor market institutions, and changes in government policies.

GDP per capita

GDP divided by the size of the population; it is equivalent to the average GDP per person

What is the equation for GDP?

GDP= C+I+G+X-IM (C= consumer spending, I= investment spending, G= government purchase of goods and services, X= sales to foreigners, IM= spending on imports)

What factors lead to a wage rate in excess of the equilibrium wage rate (WE)?

Government policies - Welfare, Subsidy, Minimum Wage Labor unions Efficiency wages

What is not included in GDP?

Intermediate goods and services, inputs, used goods, financial assets, foreign-produced goods and services

c. Due to the current slump in investment spending, Melanie has been laid off from her programming job. Her employer promises to rehire her when business picks up.

Melanie is cyclically unemployed because her bout of unemployment is tied to the business cycle. It is likely she will be re-employed once the economy picks up.

a. After completing a complex programming project, Melanie is laid off. Her prospects for a new job requiring similar skills are good, and she has signed up with a programmer placement service. She has passed up offers for low-paying jobs.

Melanie is frictionally unemployed because she is refusing offers for low-paying jobs in favor of engaging in job search for a higher-paying job.

b. When Melanie and her co-workers refused to accept pay cuts, her employer outsourced their programming tasks to workers in another country. This phenomenon is occurring throughout the programming industry.

Melanie is structurally unemployed because she is demanding a higher wage than the current equilibrium wage in her industry. In this case, the equilibrium wage has been lowered by the outsourcing of work to other countries.

How are the prices of all goods and services summarized with a single number?

Price index.

What are the two other price measures that are widely used to track economy-wide price changes?

Produce price index (PPI) and the GDP deflator.

What are the most important costs imposed by high rates of inflation?

Shoe-leather costs, menu costs, and unit-of-account costs.

What is the result of increased wages?

Similar to result of minimum wage: labor unions push the wage that workers receive above the equilibrium wage so there are more people willing to work at the wage being paid than there are jobs available (leads to structural unemployment).

What happens the inflation rate is lower than expected?

The lenders will gain at the expense of borrowers: borrowers must repay their loans with funds that have a higher real value than had been expected.

Who are "re-entrants"?

The people who have come back altering being out of the workforce for a time.

What is one structural change in the economy?

The rise and fall of industries as new technologies emerge and consumers' tastes change.

What are the side effects of public policies?

They reduce the incentive to quickly find a new job, and by keeping more people searching longer, the benefits increase structural and frictional unemployment.

How do economists measure the average price changes for consumer goods and services?

They track changes in the cost of typical consumer's consumption bundle (the typical basket of goods and services purchased before the price changes).

What is collective bargaining intended to do?

To tip the scales of bargaining power more toward workers and away from employers.

From where do households derive income?

Wages earned and indirect ownership of physical capital (in the form of stocks and bonds)

When does structural unemployment occur (point on a graph)?

When the wage rate is persistently above WE (WE is the equilibrium wage rate).

What is collective bargaining?

When unions win higher wages from employers than workers would have obtained by bargaining individually (the people bargain collectively).

The economy is more productive if?

Workers take the time to find jobs that are well matched to their skills, and workers who are unemployed for a brief period while searching for the right job don't experience great hardship.

bond

a loan in the form of an IOU that pays interest

aggregate price level

a measure of the overall level of prices in the economy

household

a person or group of people who share income

stock

a share in the township of a company held by a shareholder

1. Assume there are only two goods in the economy, french fries and onion rings. In 2009, 1,000,000 servings of french fries were sold for $0.40 each and 800,000 servings of onion rings were sold for $0.60 each. From 2009 to 2010, the price of french fries rose to $0.50 and the servings sold rose to 840,000. term-9 a. Calculate nominal GDP in 2009 and 2010. Calculate real GDP in 2010 using 2009 prices. b. Why would an assessment of growth using nominal GDP be misguided?

a. In 2009 nominal GDP was (1,000,000 X $0.40) + ($800,000 X $0.60) = $880,000. the price of french fries rose to $0.50 and the servings sold rose to 840,000 In 2010 nominal GDP was (1,000,000 X $0.50) + ($840,000 X $0.60) = $788,000. In 2010 real GDP was (1,000,000 X $0.40) + ($840,000 X $0.60) = $688,000. b. Because the increase in price would increase the value of GDP as well

FRQ #1 - The economy of Britannica produces three goods; computers, DVDs, and pizza. The accompanying table shows the prices and output of the three goods for the years 2008, 2009, and 2010. a. What is the percent change in computer production from 2008 to 2009? b. What is the percent change in the price of pizza from 2009 to 2010? c. Calculate nominal GDP in Britannica for 2008. d. Calculate real GDP in Britannica for 2008 using 2008 as the base year. e. Calculate real GDP in Britannica for 2010 using 2008 as the base year.

a. 0.5/10 X 100 = 5% b. $1/$16 X 10 = 6.25% c. ($900 X 10) + ($10 X 100) + ($15 X 2) + $9,000 + $1,000 + $30 + $10,030 d. Real GDP equals nominal GDP in the base year, so this answer is the same as in part c. e. (900 X 12) + ($10 X 110) + ($15 X 3) = $10,800 + $1,100 + $45 = $11,945

FRQ #2 - Use the information in the table below (on page 117) to answer the following questions. a. Calculate the percent increase in nominal GDP between 2005 and 2010 for each country. b. What happened to the price level in each country between 2005 and 2010? c. Calculated real GDP in each country in 2010, using 2005 as the base year. d. Calculate the percent increase in real GDP between 2005 and 2010 for each country. e. Compare the two countries' real GDP per capita in 2010 using 2005 as the base year.

a. Country A: (4,000 - 2,000/2,000) x 100 = 100% Country B: (6,000 - 2,000/2,000) x 100 = 200% b. Country A - It stayed the same Country B - It doubled. c. Country A - 4,000 (there was no price increase so it stayed the same - Country B - $6000/2 = $3000 (priced doubled) d. Country A: (4,000 - 2,000/2,000) x 100 = 100% Country B: (3,000 - 2,000/2,000) x 100 = 50% e. Country A: 4000/20 = $200 vs. Country B: $3000/15 = $200. It is the same.

Explain the following. a. Frictional unemployment is higher when the pace of technological advance quickens. b. Structural unemployment is higher when the pace of technological advance quickens. c. Frictional unemployment accounts for a larger share of total unemployment when the unemployment rate is low.

a. When the pace of technological advance quickens, there will be higher rates of job creation and destruction as old industries disappear and new ones emerge. As a result, frictional unemployment will be higher as workers leave jobs in declining industries in search of jobs in expanding industries. b. When the pace of technological advance quickens, there will be greater mismatch between the skills employees have and the skills employers are looking for, leading to higher structural unemployment. c. When the unemployment rate is low, frictional unemployment will account for a larger share of total unemployment because other sources of unemployment will be diminished. So the share of total unemployment composed of the frictionally unemployed will rise.

firm

an organization that produces goods and services for sale

unit-of-account costs

arise from the way inflation makes money a less reliable unit of measurement (is the role of the dollar as a basis for contracts and calculation)

US statistics on real GDP are always expressed in...

chained dollars (splits the difference between using early and late base years)

Inflation and the level of prices (respectively)...

does not make everyone poorer and does not matter

private savings

equal to disposable income minus consumer spending, is disposable income that is not spent on consumption

disposable income

equal to income plus government transfers minus taxes, is the total amount of household income available to spend on consumption and to save

Labor Force

equal to the sum of the employed and the unemployed

The "churning" of the modern economy leads to....

frictional unemployment

intermediate goods and services

goods and services bought from one firm by another firm to be used as inputs into into the production of final goods and services

imports

goods and services purchased from other countries

exports

goods and services sold to other countries

final goods and services

goods and services sold to the final, or end, user

consumer spending

household spending on goods and services

In factor markets...

households receive income in the form of wages, profit, interest, and rent via factor markets

final buyers

include consumers, firms that purchase investment goods, the government or foreign buyers

real income

income divided by the price level

GDP deflator

is 100 times the ratio of nominal GDP to real GDP in that year (for a given year)

national income and product accounts

keep track of the flows of money between different sectors of the economy

foreign lending

lending by foreigners to borrowers in the US and purchases by foreigners of shares of sock in American companies

producer price index (PPI)

measures changes in the prices of goods and services purchased by producers

price index

measures the cost of purchasing a given market basket in a given year (the index is normalized so that it is equal to 100 in the selected base year; is the basis for measuring inflation)

consumer price index (CPI)

measures the cost of the market basket of a typical urban American family (most widely used measure of the overall price level)

Discouraged Workers

nonworking people who are capable of working but have given up looking for a job due to the state of the job market

government transfers

payments that the government makes to individuals without expecting a good or service in return

Unemployed

people are actively looking for work but aren't currently employed

Employed

people are currently holding a job in the economy, either full time or part time

Underemployed

people who work part time because they cannot find full-time job

investment spending

spending on new productive physical capital and on changes in inventories

inventories

stocks of goods and raw materials held to facilitate business operations

government borrowing

the amount of funds borrowed by the government in the financial markets

financial market

the banking, stock, and bond markets, which channel private savings and foreign lending into investment spending, government borrowing, and foreign borrowing

cyclical unemployment

the deviation of the actual rate of unemployment from the natural rate (actual unemployment is natural unemployment plus cyclical unemployment)

net exports

the difference between the value of exports and the value of imports

market basket

the hypothetical set of consumer purchases of goods and services

shoe-leather costs

the increased costs of transactions caused by inflation (an allusion to the wear and tear caused by the extra running around that takes place when people are trying to avoid holding money)

nominal interest rate

the interest rate actually paid for a loan

Another contributor to unemployment is...

the leaving of jobs voluntarily by individual workers, typically for family reasons

chain-linking

the method of calculating changes in real GDP using the average between the growth rate calculated using an early base year and the growth rate calculated using a late base year

real interest rate

the nominal interest rate minus the rate of inflation

inflation rate

the percent change per year in a price index (typically the consumer price index)

interest rate

the percentage of the loan amount that the borrower must pay to the lender , typically on an annual basis, in addition to the repayment of the loan

Labor Force Participation Rate

the percentage of the population aged 16 or older that is in the labor force

Unemployment Rate

the percentage of the total number of people in the labor force who are unemployed

disinflation

the process of bringing the inflation rate down

menu costs

the real costs of changing listed prices (these are becoming less and less important with technological advances)

aggregate output

the total quantity of final goods and services the economy produces

aggregate spending

the total spending on domestically produced final goods and services in the economy (its the sum of consumer spending, investment spending, government purchases of goods and services, and exports minus imports)

An important general characteristic of the circular-flow diagram is...

the total sum of flows of money out of a given box is equal to the total sum of flows of money into that box

gross domestic product (GDP)

the total value of all final goods and services produced in the economy during a given year

real GDP

the total value of all final goods and services produced in the economy during a given year, calculated using the prices of a selected base year

nominal GDP

the total value of all final goods and services produced in the economy during a given year, calculated with the prices current in the year in which the output is produced

frictional unemployment

the unemployment due to the time workers spend in job search (is one main reason that there is a considerable amount of unemployment even when jobs are abundant)

natural rate of unemployment

the unemployment rate that arises from the effects of frictional plus structural unemployment (it is frictional unemployment plus structural unemployment); the natural rate changes over time and can be affected by economic policies

structural unemployment

the unemployment that results when there are more people seeking jobs in a labor market than there are jobs available at the current wage rate

value added

the value of its sales minus the value of its purchases on inputs

real wage

the wage rate divided by the price level

government purchases of goods and services

total expenditures on goods and services by federal, state, and local governments

efficiency wages

wages that employers set above the equilibrium wage rate as an incentive for better employee performance (when many firms pay these, the result is a pool of workers who want jobs but can't find them)

In order to avoid double-counting of spending...

we omit sales of inputs from one business to another when estimating GDP using spending

product markets

where goods and services are bought and sold

factor markets

where resources, especially capital and labor, are bought and sold

job search

workers who spend time looking for employment

Marginally Attached Workers

workers who would like to be employed and have looked for a job in the recent past but are not currently looking for work