Test 2 Macro Study Guide

He was targeting consumption. If people do substantially increase spending, it would be possible to shift AD enough that the recession could end. However, this doesn't usually tend to happen on its own.

. After September 11th, President Bush told American's to go shopping. What component of aggregate demand was he targeting? Can increased spending bring a country out of a recession?

In the short-run, this is an increase in AD since investment is a component of AD. In the long-run, LRAS will shift since investment is the purchase of capital.

. Explain how an increase in investment affects the AS/AD model in the short-run. How would it be affected in the long-run?

The majority of companies are not publicly traded, only around ½ of households own any stock, and the majority of stock is owned by a small share of the population (see chapter 10 for more information that you could include here). Changes in the stock market affect the wealth of households, so it can affect the AD curve. For example, if people take a big hit to their retirement portfolio, they are going to spend less now and save more to try to make up for this decrease in wealth.

. Explain why the stock market is not a good measure of the economy. How can fluctuations in the stock market lead to real changes in the economy?

AD will decrease today. Consumers will have greater incentive to save, lowering consumption. Firms will have a lesser incentive to invest believing that the cost of borrowing will be lower in the future. 4. AD will increase

. If consumers and firms believe that interest rates will soon decrease, what will happen to AD today?

It will decrease since people are spending more of their lives in school

. If more people decide to pursue graduate and professional degrees, how will the labor force participation rate be affected?

AD will increase

. If there is a wave of immigration, what will happen to aggregate demand?

This is not necessarily true since the population has also increased. The labor force participation rate could have increased, stayed the same, or even decreased.

. Suppose that a politician states that there are more people working now than ever before. Does this mean that the labor force participation rate has increased?

AD will increase as consumers will buy fewer Chinese imports and the US exports to China will increase

. Suppose that the dollar depreciates against the Chinese yuan, so that a dollar is now worth less yuan. What will happen to the AD curve?

No. Nominal GDP will increase if prices increase or if output increases. Therefore, it is possible that output stayed the same and the observed increase in nominal GDP is driven solely by prices.

. Suppose that the nominal GDP in Canada increased compared to last year. Does this mean that production has increased?

Innovation increases technological knowledge. Answers to the second part will vary. Be sure to support your argument for either fishing out or standing on the shoulders of giants.

. Why is innovation important for economic growth? What do you think the future of innovation is (will it continue or have we reached a plateau?)? Support your argument

Natural resources are not necessary for growth. They are a part of the productivity function and can be helpful for growth. However, a country that does not have abundant natural resources can trade to get the needed inputs for production.

Although abundant natural resources can benefit a country, are they necessary to ensure economic growth? If a country does not have a large amount of natural resources, what policy would you recommend?

real

An increase in ________ GDP guarantees that more goods and services are being produced by an economy a. Nominal b. Real

This makes trading with other countries around the world easier.

Countries that have ocean boarders have historically tended to grow faster than landlocked nations. Why do you think this is?

happy planet index. This measure surveys people in the country to gauge measured well-being. It also increases with life expectancy and decreases with the country's environmental impact. GDP does not capture the environment, people's health, or their reported happiness.

Describe the happy planet index, gross national happiness, or another measure that experts have proposed to improve upon GDP as a measure of well-being in a country. Explain why the measure improves upon GDP.

No. An efficiency wage is above the market wage. For example, if an engineer usually earns $80,000/year, an efficiency wage would have to be above that wage.

Do all workers who earn above minimum wage earn an efficiency wage? Explain.

No. There is not a fixed number of jobs in an economy. Though some jobs will be replaced by automation, other jobs will be created.

Does increasing automation mean that there will be fewer jobs in the future? Explain.

. falls, rises, could increase or decrease

During a recession, RGDP ________, unemployment _________, and the price level _________.

Deflation tends to be a symptom of deeper economic problems. Also, deflation can lead to a spiral of falling demand and rising unemployment. When there is deflation, firms layoff workers, lowering demand for goods and services throughout the economy. Now with even lower demand, there would be further layoffs, which would decrease demand again. This process would repeat, spiraling to lower and lower demand and output.

Economists would rather see low, predictable inflation than deflation. Explain why this is.

Countries that are poorer tend to grow more quickly than rich countries. Due to the diminishing returns to capital, adding more capital produces a greater increase in output when countries start off at a lower level of capital than those who have a greater amount of capital. High income countries must focus on increasing technological knowledge in order to grow, which is a lot more difficult than simply adding capital and adopting existing technology.

Explain the catch-up effect

Even when inflation is anticipated there are transaction costs as consumers try to keep their money in interest bearing accounts as long as possible. There are menu costs to firms, which is the cost of changing prices. Resources are misallocated when some prices change faster than others, consumers may substitute to less desirable goods and services. Also, inflation causes consumers confusion and inconvenience of having to constantly be calculating inflation when shopping for goods and services.When inflation is unexpected there are also arbitrary redistributions of wealth along with all of the costs associated with expected inflation.

Explain the costs of expected inflation. How do these compare to the costs when inflation is unexpected?

Substitution bias - the market basket remains fixed even while consumers may choose to substitute when the price of one item increases Outlet bias - consumers may shop only when items are on sale, buy in bulk, or use other discounts that aren't considered in the CPI Increase in quality bias - if an item's price increases but so does it's quality, consumers may be better off - or if the price of an item stays the same but quality increases, consumers are definitely better off but the CPI cannot capture this. New product bias - it takes time for a new product to be added to the market basket. During this time, the price of the item is generally falling. Adding a product too late causes the CPI to fail to measure this cost savings for consumers. All of these will cause the CPI to understate the true amount of inflation.

Explain the reasons that CPI may not be accurate. Do each of these cause the true amount of inflation to be overstated or understated?

Money that firms earn in exchange for providing goods and services is paid to the resource suppliers (input suppliers, workers, etc.). Any profit also goes to a person, whether that is the CEO, an owner, or shareholders. The higher the market value that firms earn then, the higher is total income.

Explain why an economy's output, in essence, is also its income

GDP is correlated with things that do directly affect the happiness of a country's citizens. Higher income countries are better able to provide infrastructure and services like a free education, roads, police protection etc. Also, a higher GDP will tend to mean that households have a higher income and are better able to afford to buy the things that will increase their quality of life, like air conditioning, books, healthy food, and medicine

Explain why having a higher real GDP will mean that a country's citizens are better off, on average.

Protecting property rights is essential in order to provide the incentive for firms to produce. They must know that they will have a right to ownership of their production or else they will not make anything in the first place.

Explain why protecting property rights is important for economic growth.

They argue that needing to rebuild will increase GDP and create jobs since people are forced to increase spending.

Explain why some people believe that natural disasters could be beneficial for an economy?

There is not a fixed number of jobs in an economy. The immigrants had also increased demand for goods and services, creating jobs for native workers. When they left, it stands to reason that demand would fall back to the original level and some of these jobs would be lost.

From 1929 - 1934, the US undertook a campaign to repatriate around 400,000 Mexicans who had been working in the United States. Following this effort, the employment of native US workers fell. Explain how this happened.

These could include a war, a pandemic

Give an example of something that would raise real GDP and yet be undesirable.

They can both be used to measure inflation. The CPI measures the prices of goods and services that matter the most to consumers' daily lives, whereas GDP will include all goods made in the country. The CPI is able to include imports, which GDP does not. CPI has a fixed market basket, whereas the goods in the GDP price index would change yearly

How are the CPI and GDP price index similar? How are they different?

Some people may claim to be looking for work but actually are not. They should not be counted as unemployed or in the labor force. Also, people who are employed in illegal activities might report themselves as not in the labor force or as unemployed, when they are actually working, just not in a legal capacity. Unlike with the reasons that unemployment may be understated, there is not a way to correct for this. Doing so would require people to be more truthful, which is not something that the BLS is able to do/measure.

How does the official unemployment rate overestimate the problem of joblessness? Is there a way to correct for this?

AD will increase today as consumers take advantage of relatively low prices and consume more.

If consumers believe that prices will soon increase, what will happen to AD today?

If borrowers and lenders expect that inflation will increase, they will increase the nominal interest rate in order to ensure that the lender gets the same real interest rate as before.

If inflation is expected to increase, what will happen to the nominal interest rate? Explain.

. In the short-run, saving money means that there is less for current consumption. So, AD would fall. However, savings makes more money available for investment, increasing AD. The overall effect on AD in the short-run depends on the magnitude of these shifts. In the long-run as this capital begins to be used in production, LRAS and SRAS will increase. *you are not responsible for graphing this

If people suddenly decide to save more, how will the economy be affected in the short-run? In the long-run?

The price of imports from Denmark would increase, so the US would decrease imports. Exports would increase as people in Denmark buy more US goods now that they are relatively cheaper. The overall effect would be an increase in AD

If prices in Denmark increase, will US aggregate demand be affected? If so, how?

North Korea due to the catch-up effect

If the United States and North Korea both increase investment this year by the same amount per person, which country do you expect to grow faster and why?

Now some of those who were previously employed in illegal activities will be counted as employed and in the labor force. This would increase the labor force participation rate and decrease the unemployment rate.

If the United States legalized the sale of all drugs, how do you predict that the unemployment rate and labor force participation rate would be affected?

If there was deflation, the nominal interest rate would be lower than the real interest rate.

If the economy is experiencing deflation, will the nominal interest rate be higher or lower than the real interest rate?

Having enough money so that you are able to enjoy your retirement and not work up until you die on the job is a good thing.

If the labor force participation of people over the age of 55 decreases, explain why economists might consider this to be overall positive for the economy.

Neither will be affected

If the number of people working multiple jobs increases, how will the unemployment rate be affected? How will the labor force participation rate be affected?

Governments can incentivize research and development. They can fund research through grants. They can also grant patents.

In what ways do governments help improve technological knowledge?

Discouraged workers who give up looking for work are not counted as unemployed. Some people are underemployed for their skill level, so they are counted as employed, but ideally they would like better jobs. Finally, some workers can only find part-time employment even though they would prefer to work full time. They are counted as employed even though they would prefer a better job. The BLS is able to correct for this with the U-4 - U-6 measures of labor underutilization.

In what ways does the official unemployment rate underestimate the problem of joblessness? Is there a way to correct for this?

Yes. If RGDP only increases a small amount but potential GDP has increased by more, it is possible that unemployment could increase even though RGDP is increasing.

Is it possible that RGDP increases and unemployment increases?

Globalization Patents and Copyrights The catch-up effect Differences in saving and investment Education differences Protection of property rights Less corruption Political stability R & D incentives

List reasons why some countries grow faster than others

GDP would increase if there was a better way to track the production of these goods

Many goods and services are illegally sold but not reported to the government. How would increased efforts to count those goods affect our calculation of GDP?

No, there will always be some unemployment in an economy due to frictional unemployment and structural unemployment. This is known as the natural rate of unemployment.

Should the government's goal be to make the unemployment rate zero? Explain.

Spending on education is an investment in human capital. Like physical capital, this human capital is used over and over again to produce output.

Spending on education is included in the consumption component of GDP, but it might better fit in the investment variable. Defend this statement.

10 years (using the rule of 70)

Suppose that a country is growing at an average of 7% per year. How long will it take for the GDP/person to double?

False. The US grew at around 1% per year during the industrial revolution.

T/F explain. The United States grew very quickly during the industrial revolution.

. A brain drain happens when a country's most educated workers emigrate and live abroad. This will be a problem in lower income countries.

What is the brain drain? What types of countries will be affected?

The market value includes both price and quantity of goods and services. If this number increases over time, it is not possible to tell if price increased, quantity increased, or both. We solve this with the measure of real GDP, which holds prices constant. This way, if real GDP increases it can only be that quantity has increased, so production has increased.

What makes it difficult to compare GDP over time? How is this problem addressed?

This would reduce frictional unemployment. The natural rate of unemployment would fall if frictional unemployment falls since the natural rate of unemployment will contain frictional, seasonal, and structural unemployment.

What type of unemployment is affected when online job search engines reduce the time necessary for job searches? Does this outcome affect the natural rate of unemployment? If so, how?

No, imports are not counted in GDP. When GDP is measured using the expenditure approach, they appear in C, I, G because when measuring all of consumption, for example, some items included will be imports. This is corrected by subtracting for imports in the NX component so that overall, there is no effect on GDP.

When a country imports more goods and services does its GDP decrease? Explain.

No. GDP is a summary measure. It means that the country is better off as a whole, but doesn't tell you who benefitted from this. If the increased income from the higher level of GDP went to only a few very rich people, it is possible that millions of people saw no benefit to this higher level of production.

When a country's Real GDP increases, does that mean that every household is better off than before? Defend your answer.

A large, educated population means that there will be more scientists, engineers etc. There is a greater likelihood that the next great innovation could come from one of these educated workers. A large population also means that capital will be spread more thinly per worker. Natural resources will also be stretched. Quality of education would also be likely to suffer as the education system is stretched with more students. There might be more students per class or newly hired teachers might be less qualified.

Whether or not a large population is beneficial or harmful for a country's economic growth is debated in the literature. Give one reason why a large population may be good for an economy. Explain three reasons why a large population can be harmful for an economy's growth.

The BLS is able to measure those working part-time who would prefer to work full-time but cannot capture people who are underemployed for their skill level.

Which type of underemployment is measured by the BLS?

According to the Fisher equation, the higher inflation is, the lower the real interest rate will be. That is, they are repaid with money that is worth less than they had expected.

Why do lenders tend to lose out in a period of unexpected inflation

Growth rates, similar to interest rates get compounded over time.

Why does a small difference in economic growth rates lead to a big difference in the standard of living over time?

Paying an efficiency wage is a business strategy. Companies pay an efficiency wage to maximize their profits but usually this strategy revolves around not needed as many workers as other companies in that industry. Trader Joe's had specifically designed their stores to be smaller and have fewer items in stock so that they do not need as many employees as a typical grocery store.

Why don't all grocery stores pay their workers as much as Trader Joe's does?

A large population is not detrimental to growth because people are both "stomachs", consumers of output and "brains", producers of output.

Why is having an aging population bad for the future of economic growth if a large population itself is not necessarily a problem?

The CPI measures the prices of goods and services that matter the most to consumers' daily lives. It doesn't measure the prices of things that are produced but aren't directly purchased by consumers. The CPI is able to include imports, which GDP does not. It has a fixed market basket, whereas the goods in the GDP price index would change yearly.

Why is the CPI preferred to the GDP deflator when measuring changes in the price level?

Stocks and bonds do not represent production, they are a way of transferring ownership. GDP measures what is produced in a country, so we would not want to include transactions that don't measure production. A used car was not produced in the current year, so we do not want to measure it in the current year's production.

Why is the value of stocks and bonds sold not included in GDP? Why is the value of used furniture not included?

Trading enables countries to specialize in producing just the goods that they are good at making. By not wasting time trying to produce the products that they are not good at, a country can use its scarce resources where they are valued the most. After trading with other countries, both nations can attain consumption outside of what they would be able to do alone.

Why would removing a trade restriction lead to higher economic growth rates?

No. There are two reasons why this could happen. This will tend to be the case for the years prior to the chosen base year for Real GDP since prices tend to increase over time. Using later year prices will then tend to result in a Real GDP that is higher than nominal GDP which uses current year prices. It is also possible that average prices may decrease from one year to the next, in which case, the real GDP will be using previous year prices that are higher than the current year prices used by nominal GDP

Will a country's nominal GDP always exceed its real GDP? Explain.

. a. No. Recessions are irregular and unpredictable. b. If a large number of consumers and/or businesses start to believe that there will soon be a recession, C & I will fall now as they look to cut back spending in anticipation of the recession. This reduces aggregate demand, which can be enough to cause a recession.

a. A reporter for the New York Times says that since there has not been a recession in over 10 years, we should expect one soon. Explain what is wrong with this statement. b. If everyone begins to believe that there will soon be a recession, why is this likely to become true?

a. GDP would increase since output will have increased due to people working more and producing more. b. People now have less leisure time, so that is not good for their well-being. However, if the additional income buys things that offset this decrease in happiness, it is possible to come out better off overall. The problem is that while GDP increased it is possible that people working themselves to exhaustion are not better off.

a. If every worker doubled their hours worked, how would GDP be affected? b. Would these workers be happier?

it takes away money that might have otherwise been spent on something else. It is not necessarily going to increase total spending/GDP. People might have still spent the money, but on things that they wanted rather than needing to replace.

explain why natural disasters might not actually increase GDP.

The price of homes will have a larger effect since a house payment takes up a larger share of a consumer's budget.

if the prices of homes go up by 5% and the price of textbooks increases by 12%, which will have the larger impact on the CPI? Why?