Macro Exam 2
Financial Institutions tell consumers about...
1. Risk sharing 2. Liquidity 3. Information
Problems with CPI
1. Substitution bias: Consumers may change their purchasing habits away from goods that have increased in price. 2. Increase in quality bias: Difficult to separate improvement in quality from increase in price, say in cars or computers. 3. New product bias: The basket of goods used to change only every 10 years. (Now it updates every 2 years.) There is a delay to including new goods like cell phones. 4. Outlet bias: CPI used to only survey prices at traditional retail outlets. Now it tries to minimize this bias by surveying people about where they actually buy products
Low income countries grow slowly because...
1. They fail to enforce the Rule of the Law 2. Wars and revolutions cant build an infrastructure 3. Poor education and poor health care 4. Low Rates of saving and investment
In a recession...
1. Unemployments goes up 2. Decreases in spending on durable goods - Durable good: Good not for immediate consumption and able to be kept for a period of time. 3. Inflation rate decreases
New growth theory
1. technological change is endogenous to economy 2. human capital important
Mercantilism
16th century till about the 18th century, serfs left their walled in manners and left to trade in cities, kings and queens became powerful, trading became important
What time period in the United States had the highest growth rate?
1950-1973
Rule of 70 formula
70/growth rate
By how many times are we wealthier today than in 1900 in terms of real GDP per capita?
8 times The average American can buy more than eight times as many goods and services now as in 1900
Loanable funds market
Borrowers and lenders determining the market interest rate and the quantity of loanable funds exchanged.
Who calculates CPI and PPP
Bureau of labor
CPI formula
CPI=expedentitures in current year/expenditures in base year x 100
Investment formula
I=Y-C-G income-consumption-govpurchasess
Consumer price index (CPI)
Is a measure of the average of the prices a typical urban family of four pays for the goods and services they purchase
Inflation rate
It is the percentage increase in price levels from one time period to anoth
Glorious Revolution (1688)
James II beheaded, British parliament gained power, repeal of the corn laws, repeal of the combination laws, progressive tax system put in place (wealthier you are the higher taxes you pay), public education for the poor
Gross National Product (GNP):
Market value of all final goods and services made by a country's citizens within a time frame
Who is left out of labor force?
Military employees, people incapable of working, people under 16 years of age (14 in Iowa), the disabled, homemakers and retirees.
What does NX=
Net Exports = Exports - Imports American NX are negative since the value of our imports exceeds the value of our exports
Will this add to GDP? Stock market transactions
No
Will this add to GDP? Welfare Benefits
No
will this add to GDP: used car sales
No
GDP deflator equation
Nominal GDP/Real GDP x 100
How do you calculate current real GDP
Previous GDP (1 + g)^t (g=growth rate)
How do you calculate real GDP
Quantity of a good in the current year and price of that good in a base year =base year x current quantity
Frictional unemployment
Short-term unemployment that arises from the process of matching workers with jobs
Natural rate of unemployment=
Structural unemployment + frictional unemployment
Labor force
Sum of employed and unemployed workers in the economy
S public =
T - G - TR taxes - gov purchases - transfer payments might be negative
Deficit in Gov saving
T < G+Tr
Economic Growth
The ability of an economy to produce increasing quantities of goods and services
How do we know when the economy is in a recession?
The federal government does not define when a recession starts or ends. - The typical media definition of a recession is "two consecutive quarters of declining real GDP."
Unemployment
The number of the labor force that is unemployed
Expansion
The period of a business cycle during which the total production and total employment are increasing. - To have a healthy economy, we should have 50,000+ new jobs
What period of recession was the longest and most severe since the Great Depression of the 1930s, prompting some to refer to it as the Great Recession.
The period of recession starting in late 2007 and ending in mid-2009 - The recession brought large decreases in spending on durable goods, including motor vehicles - Led economists to think if we would return to the previous pattern of long expansions and short, mild recessions
Production Function
The relationship between quantity of inputs used to make a good and the quantity of output of that good
True or False: Stagflation has occurred repeatedly in the developed world since the 1970s
True
Structured unemployment
UE due to your job is no longer needed (ex: phone operator)
Cyclical unemployment
Unemployment caused by a business cycle recession.
Structural unemployment
Unemployment that arises from a persistent mismatch between the skills or attributes of workers and the requirements of jobs.
How do you use price indexes to adjust to the effect of Inflation?
Value in year 2 $ = Value in Year 1 $ x CPI yr 2/ CPI year 1 Example. Year in 2016 = value in 1991 x CPI 2016/CPI 1991 $44,118 = $25,000 x 240/136
What are nominal variables?
Values like wages in current-year dollars
Balanced budget
When Public Savings is zero, the government spends as much as it brings in
Surplus in Gov saving
When T > G+Tr
Closed Economy GDP formula
Y (GDP) = C + I + G (no exports or imports)
S private =
Y + TR − C − T Y=household income includes payments for factors of production TR = transfer payments C = households consume T = taxes
Will this add to GDP? Bought a brand new house
Yes
Will this add to GDP: Owner purchases a new door to replace the old on
Yes, it is a final good
GDP deflator
a measure of the average price of goods and services in the economy
Price levels
a measure of the average prices of goods and services in the economy
Feudalism
an economic system where traditions rule (8th-15th century)
what are the three types of research
basic (public good), applied (public or private good), market private
Foreign portfolio investment
buying stocks and bonds
What does C=
consumption (Services, consumer undurable, durables, actual rental payments on apartments, and houses) - largest component of GDP
Joseph Schumpeter idea of creative destruction
deliberate dismantling of established processes to make way for improved methods (entrepreneurship) ex: horse drawn carriage to cars
Capitalism
economic system based on private property and the market, in which individuals ask how, what and for when do you produce
What is responsible for implementing technological change
entrepreneurship
what are indirect funds
financial intermediaries, banks, mutual funds, pensions
Rule 70
finds the number of years it will take to double investments
what determines the rate of long run growth?
increase in labor productivity
Why the LFPR (Labor force participation rate)
it measures how much of our labor resource is being used
Suppose the gov shifts from taxing nominal interest to real interest? what happens to savings?
nominal - inflation = real 8% - 5% =3% (it decreases)
Recession
period of business cycle during which total production and total employment are decreasing
Growth rate formula
point 2-point 1/point 1 x100
Savings =
public saving + private saving Y - C - G
What is included in the national income
salary and wages, rents, interest and profits
The catch-up model
shows that poor countries will grow faster than wealthy countries
What are direct funds
stocks and bonds
What were some driving factors in the 1970s recession
the Vietnam war, an increase in social spending and an increase in foreign competition
Gross Domestic Product (GDP)
the market value of all final goods and services produced in a country during a period of time (usually a year)
Stagflation
the simultaneous appearance in an economy of slow growth, high unemployment, and rising prices
What are the two main conceptual ways to measure the total economic activity in an economy
total production and total income
What happened with stagflation in the 1970s/80's
- 1970s saw some of the highest rates of inflation in the US in recent history, interest rates rose to nearly 20% - Fed policy, the abandonment of the gold window, Keynesian economic policy and market psychology all contributed to the high inflation - Lower inflation would return only after a tough period of tight money and recession
Value added
- An alternative method to measure GDP -Take the value added at each stage of production, add them up, and that is what that good contributes to GDP
What's the different between PPI & CPI
- PPI is similar to the CPI, in that it uses a basket of goods, but the goods are those used by producers. PPI Includes raw materials like coal and crude petroleum, and intermediate goods like flour, yarn, steel, and lumber.
Problems with unemployment
- The discouraged worker: those who are out of work but give up looking for work and have not looked for work in the past 4 weeks. They are not part of the labor force. - The underemployed: those who work but either do not work as much as they want or are hired in a capacity that does not utilize the worker's productivity. - Overstate UE, lie about looking for work - Doesn't capture job intensity
other factors that affect UE
- UE rates -minimum wage laws - labor unions - efficiency wages
What do you need to calculate CPI in a given year
- a basket of goods - the cost to purchase the basket of goods in base year -the cost of making the same purchase of goods and services from the base year and now using prices in the current year
how do we change human capital
- education (public good = non exclusive and non rival) - learning by doing (internships) - accumulate knowledge through research
How do you increase labor productivity?
- hours of human and physical capital per hour worked - level of technology
How did mercantilist differ from classical economist
- in terms of $ mercantilist saw money as an end in itself - in terms of commerce the rich does not give up resource to the poor
main aspects of GDP:
- measurement put in $s - it is the market value of all final goods and services within a time period -excludes pure exchange transactions -includes only production that takes place during the indicated time
Inflation
- rapid inflation occurs when the prices of goods and services suddenly rise, eroding the purchasing power of savings
Adam Smith
- wrote the wealth of nations (1776), believed money was a veil, money is a medium of exchange not an end in itself
What rate do economists believe the CPI overstates true inflation by
0.5-1%
What are other things we can do with the CPI?
1. Change from nominal to real dollars - Value of point 2 = value of point 1 x ((CPI point 2) / (CPI point 1) 2. Estimate real interest rates
What did mercantilism lead to?
1. Colonization 2. High taxes for agricultural imports, food was very expensive even if on farm (Corn Laws) 3. Labor unions were outlawed: Combination Laws (wealthy wanted to keep poor poor)
Supply for loanable funds decreases (shifts left) when...
1. Crowding out in deficit with government (government is spending deficit, tos pend that they have to take out money, competing for loans with people, drive interest rates up and makes quantity loans less than) 2. Consumption increases 3. Personal taxes increases
The Great Moderation
1. Increasing important services 2. The establishment of unemployment insurance 3. Active federal government stabilization policies 4. Increased stability of the financial systems
Concerns with GDP
1. Military 2. Rural 1950-1980 urbanization - of country, selling farms to move to town, women entering workforce 3. Quality of life -lots of pollution, high GDP -happiness score (Norway happiness place to live) -Leisure time -crime 4. Underground market 5. Lags - GDP from last quarter, revising 6. Lifestyle differences
How does New Growth Theory protect new technology
1. Patents - Review the way to make the good 2. Plant rarity protection certification 3. Copyrights 4. Trade secrets 5. Government subsidies in education 6. Government subsidies in Research and development
What are other ways to identify a recession?
1. Production inputs 2. Production prices 3. New housing starts 4. Durable goods purchase (are people willing to buy?)
Demand for loanable funds increases (shift right) when....
1. Profitable opportunities 2. Technological change 3. Taxes on industry go down
Business Cycle
Alternating periods of economic expansion and economic recession
Nominal GDP
GDP in current dollars
GDP formula
GDP= C+I+G+NX C=consumption I=Investments G=Gov. Spending NX= Net exports
What does G=
Government Spending (Federal, State, and local governments)
What does I=
Gross Investment (Business fixed investment(based on savings), residential investments, and changed in business inventories)