AP MACROECONOMICS

Assume the economy of Country A is in long-run equilibrium. Which of the following will happen in the short run in Country A if one of its major trading partners, Country B, experiences a recession?

. A recession in Country B will result in a decrease in income and a decrease in imports. Since Country B is a major trading partner of Country A, a decrease in imports in Country B will result in a decrease in Country A's exports. Therefore, aggregate demand in Country A will decrease and the price level will decrease.

3 economic systems

1. Centrally-Planned (Command) Economy 2. Free Market Economy 3. Mixed Economy

Three Shifters of PPC

1. Change in resource quantity or quality 2. Change in Technology Change in Trade (Doesn't change the amount they can produce, but it does change the amount they can consume)

Contractionary Fiscal Policy

Decreases Aggregate demand

Unemployment

Definition Types of Unemployment Natural Rate of unemployment

Types if Inflation

Demand Pull Inflation Cost Push Inflation

The Law of Supply

Direct relationship between price and quantity supplied P↓ Qs _↓__ P↑ Qs _↑__

Who is unaffected by inflation

Flexible Income Recievers - COLAS (Cost of living adjustment= adjusted to wage inflation) - Social Security recipients Debtors - Helped - pay back the loans with cheaper dollars

Types of Unemployment

Frictional Structural Seasonal Cyclical

GDP Gap

GDP Gap= actual gdp= potential gdp negative gdp= contraction positive gdp= inflation

Nominal GDP

GDP measured in current prices. It does not account for inflation from year to year

Unemployed Math

Number of Unemployed/ Labor Force The Labor Force: is the total of employed and unemployed workers US unemployment should be about 5 %

Seasonal

Occurs when industries slow or shut down for a reason hiring patterns due to time of year

Natural resources and land

any productive resource existing in nature, including wild plants, mineral deposits, wind, and water

Capitalism

individuals and private firms own the resources in society private individuals control the factors of production and operate them in pursuit of profit wages are negotiated between managers and employees or their union the market forces of supply and demand largely determined the allocation of scare resources Government may regulate businesses and provide tax supported social benefits

Galloping Inflation

inflation that exceeds 10 percent per year and grows month after month

Creeping Inflation

inflation that remains steady for a long period of time at a low rate

Difficulty in correcting a negative supply shock

ni government policies that can counteract the changes in production costs that shifts the SRAS. Policy responses can not simply aim to push the SRAS back to its original position

sticky wages

nominal wages that are slow to fall even in the face of high unemployment and slow to rise even in the face of labor shortages

division of labor

permits people to develop expertise in the task they concentrate

Disposable Income

personal income minus personal income taxes

Specialization

specialize in what they are relatively good at enhances productivity more efficient than having each person contribute equally to every task

Socialism

system where the government maintains control of specific resources or markets in society, such as energy, education or healthcare. goal of fair distribution and the pitfall of inadequate incentives wages are negotiated between trade unions and managers a single political party does not rule the economy

Output Gap

the percentage difference between actual GDP output and potential GDP

Labor or Human Capital

the physical and mental efforts of people, including human capital, the knowledge and skills acquired through training and experience

Absolute Advantage

the production of a good when it can produce using fewer resources per unit of output than any other country

Economics

the study of how to allocate scare resources amount competing ends

National Income

the sum of income earned by the factors of production owned by a country's citizens wages, salaries, fringe benefits paid for labor services, rent paid for the use of land and buildings, interest paid for the use of money, and profit received for the use of capital resources

Normative Economics

the ways things should be the fed should lower the federal funds rate

Equilibrium in a competitive market

when the quantity demanded is equal to the quantity supplied of that good

Demand Pull Inflation

"Too much money chasing too few goods" - AD Curve will shift to the right, resulting in a higher Price Level and greater output (until reaching Y)

Mixed Economies

Almost all economies are a mixture of the above systems.

Increase in government spending multiply as a component of GDP

- Any changes in government purchases of goods and services will lead to a greater change in the real GDp, the chain reaction will cause the initial change in the government to multiply throughout the economy, resulting in an even larger change in the RGDP An increase in total spending will indirectly increase the production of firms, people's disposable income, and consumer spending

Note!!

- Assume that there is only two determinants that simultaneously affect both short term aggregate supply and aggregate demand Ex. Business tax changes and foreign currency changes - A change in business taxes shift AD and AS in the same direction - A change in FX< sends both curve sin the opposite direction

Circular Flow Of economic Activity

- Households supply resources (land, labor, capital, and entpreneurial ability) to the resource market . Households demand goods and services from businesses - Businesses demand household resources and supply goods and services too the product (factor) market

GDP: Overstated

- Includes damage to the environment - Includes more spending on healthcare= Americans are unhealthy - Includes money spent to fight crime= more police officers, more jail, etc.

GDP: What does not count

- Intermediate Goods (steel or lumber that goes into making other goods like homes or cars), includes only final goods - Used Goods or financial transaction/Non-production transactions/ Home production (ex. stocks, real estate, shares, sister's birthday party, old house, social security) - Non-Market Activities (Illegal, Underground) - Transfer Payments (Social Security) - Stock/ Bonds Transactions - Foreign Products - Private and public transfer payments

Net Export Effect & Contractionary Fiscal Policy

-A decrease in government spending has led to a decrease in real interest rates. -At lower interest rates, foreigners demand less U.S. dollars to invest in bonds. -This leads to a depreciation of the U.S. dollar. -This leads to an increase in Net Exports, as foreigners now have to exchange less of their currency for the U.S. dollar to buy exports. -This increase in Net Exports will increase AD and further strengthen the contractionary fiscal policy.

Crowding- Out Effects

-An Expansionary Fiscal Policy as previously diagrammed will lead to higher interest rates. -At higher interest rates, businesses will take out fewer loans and there will be a decrease in INVESTMENT (I) -At the same time there will be a decrease in CONSUMER SPENDING (C) as they will take out fewer loans as well. -This CROWDING OUT EFFECT will reduce the gain made by the expansionary fiscal policy.

Effects of a Tight Money Policy

-At the higher interest rates, INVESTMENT SPENDING, and CONSUMPTION will decrease. -At higher interest rates, the U.S. dollar will APPRECIATE (foreigners demand more U.S. securities). This will lead to a DECREASE in NET EXPORTS. -Again, the Monetary Policy is STRENGTHENED as a result, unlike the effects of a contractionary fiscal policy.

The Federal Reserve System (FED)

-Control Monetary Policy -Headquartered in Washington D.C. 12 Federal Reserve Districts -Board of Governors (7 members) is the central authority -Members are appointed by the President and confirmed by the Senate

GDP : What Counts

-Goods produced but not sold (I) -Goods produced by a foreign Company (Japan) in the U.S. (Honda and Toyota) Increases with expenditures on natural disaster, deadly epidemics, war, crime, and other detriments of society

Net Export Effect & Expansionary Fiscal Policy

-Government spending has led to an increase in interest rates. -At higher interest rates, foreigners demand more U.S. dollars to invest in bonds. -This leads to an appreciation of the U.S. dollar. -This leads to a decrease in Net Exports, as foreigners now have to exchange more of their currency for the U.S. dollar to buy exports. -This decrease in Net Exports will reduce AD and counter to some extent the expansionary fiscal policy.

Criticism of Unemployment

-Involuntary part-time workers counted as full time workers - Discourage workers are not counted as unemployed -Unequal Burden ( we give a number that does not represent everyone)

Effects of an Easy Money Policy

-LOWER INTEREST rates which will lead to an INCREASE in -INVESTMENT and CONSUMPTION. -The U.S. dollar will DEPRECIATE, leading to an increase in NET EXPORTS as well. -These effects STRENGTHEN the overall monetary policy (opposite of fiscal policy's crowding-out and net export effect

Federal Open Market Committee (FOMC)

-Made up of 12 people: Board of Governors + New York FED President + 4 other regional presidents (who rotate) -Meets regularly to direct OPEN MARKET OPERATIONS (buying or selling of bonds) to maintain or change interest rates

Unemployed

-Must be looking for work (at least 1 attempt in the past 4 weeks) -Are reporting to a job within 30 days -Are temporarily laid off from their job

Tax Multiplier

-Remember, if the government decreases taxes, the result is not as great as a spending increase, since households will save a portion (MPS) of the tax cut. -The Tax Multiplier = -MPC /MPS Example: If the MPC is .8 and the MPS is .2 Spending Multiplier = 1/.2 or 5 Tax Multiplier = -.8 /.2 or -4

Fiscal Policy

-Using Taxes and Government spending to stabilize the economy. -Controlled by the President and Congress -Discretionary Fiscal Policy: Congress must take action (change the tax rates) in order for the action to be implemented. -Automatic Stabilizers: Unemployment benefits, Progressive Tax System, these changes are implemented automatically to help the economy FISCAL POLICY CHANGES AD .... EXCEPT when the question specifically states there is a change in business taxes.

Personal Income

the money income received by households before personal income taxes

Problems with Fiscal Policy

1. Deficit Spending-if the government increases spending without increasing taxes they will increase the annual deficit and the national debt 2. Time Lags-Congress takes time to write, debate, pass, and implement legislation 3. Crowding out-Government spending might cause unintended effects that weaken the impact of the policy. Ex: deficit spending to increase AD would increase interest rates and decrease investment

Aggregate Demand

1. Determinants of aggregate demand 2. Multiplier and the crowding-out effect the total demand of goods and services in the economy The aggregate demand curve describes the relationship between the price level and quantity of goods and services demanded by households, firms, the government, and the rest of the world.

Short vs. Long Run Aggregate Supply

1. In the short run, wages and resource prices will NOT increase as price levels increase 2. In the long run, wages and resource prices will increase____as price levels increase -In the long run, wages and other input prices will adjust in accordance with output prices. This eliminates the incentive to produce more or less output at higher or lower price level will Yf and the LAS shift to the right as a result of improvement in skills due to education, training, increased capital levels thanks to investment in previous periods, improved technology resulting from research and development, or increased resource availability due to new discoveries or population increase

Macroeconomic Equilibrium

1. Real Output and price level 2. Short and Long run 3. Actual versus Full-employment output 4. Economic Fluctuations

Aggregate Supply

1. Short-run and Long-run Analyses 2. Sticky vs. Flexible wages and prices 3. Determinants of aggregate supply the total value of output that producers are willing and able to supply at an alternative price level in a given time period Depression and Keynesian: - firms have large inventories and excess capacity, would be glad to sell more output in the existing price level. workers and other factors of production are plentiful and the economy can increase its output without upward pressure on prices or wages. Horizontal segment= changes in aggregate demand affect real GDP but not the price level Intermediate-range of the AS Curve: - economy operates normally - no excessive inventories and firms are closer to their productive capacities - expansion in output requires firms to hire additional inputs and work their plants and equipment at a faster pace, actions that require a profit - While firms demand higher prices for increased output, wages, and other input prices are relatively slow to adjust due to long term contract - Output prices increase faster than input prices, real factor prices decrease (the buying power of payment to factor of production) , the profit per unit output increases - this gives firms incentives to increase employment and produce more goods and services Classical Stage -As the economy reaches full employment, it becomes difficult for firms to find new workers at the existing wage rate, and firms msut increase wages (amoung other factor prices) in order to hire more imput and increase output - The price level required to induceadditional output then escalates until the economy reaches its physical limit for output -Factories cannot run any faster and workers can not work any more ovetiem

Why a policy is desirable in the short run when the economy self corrects in the long run

1. Temporary falls in aggregate output, without policy intervention, can lead to high unemployment 2. Price stability is generally a desirable goal, preventing deflation, a fall in aggregate price level, is a good thing

Three Causes of Inflation

1. The Government prints money to pay citizens and pay off debts (see the Quantity Theory of money) Usually causes hyperinflation. Examples: Germany after WWI, Zimbabwe in 2008, 2. Demand-Pull Inflation- An overheated economy with excessive spending but same amount of goods. 3. Cost-Push Inflation- The result of a "negative supply shock" that increases the costs of production and forces producers to increase prices. Example: A significant increase in the price of oil would lead to higher costs for firms and higher prices.

Unemployment and Full Employment

100% of the people will never be employed, so the government considers 4-6% unemployment to be "full employment" We can never be at full employment if there is any percentage of cynically unemployed

Disinflation

A decrease in the rate of inflation. Prices are going up, but not as fast as before lowdown in the rate of increase in the consumer price index or inflation.

Government purchases are different than government transfers

A Change in government transfers or taxes shifts the AD curve les than an equal size shift in government purchases, resulting in a smaller GDP because people tend to spend a certain amount of money and keep a certain amount of money

What is the difference between a change in quanity demanded and a change in demand?

A change in quantity demanded is movement along the curve due to a change in price. A change in demand is when the entire demand curve shifts left or right due to a change in one of the shifters

Deflation

A decrease in the general price level. The opposite of inflation

Comparative Advantage

A nation should specialize in producing goods in which it has a comparative advantage: ability to produce the good at a lower opportunity cost (a smaller loss in terms of the production of another good)

One dollar change

A one-dollar change in autonomous expenditure leads to a greater-than-one-dollar increase in aggregate demand for goods and services.

Not in the Labor Force

A person who is not looking for work: - Full-time Students - Stay at home parents Discouraged workers those who have given up hope of finding a job - Retirees

Inflation, Unemployment, and Stabilization Policies

A. Fiscal and monetary policies 1. Demand-side effects 2. Supply-side effects 3. Policy mix 4. Government deficits and debt B. Inflation and unemployment 1. Types of inflation a. Demand-pull inflation b. Cost-push inflation 2. The Phillips curve: short run versus long run 3. Role of expectations

Economic Growth and Productivity

A. Investment in Human Capital B. Investment in Physical Capital C. Research and development, and technological progress D. Growth Policy

Financial Sector (Money and Banking )

A. Money, banking, and financial markets 1. Definition of financial assets: money, stocks, bonds 2. Time value of money (present and future value) 3. Measures of money supply 4. Banks and creation of money 5. Money demand 6. Money market 7. Loanable funds market B. Central bank and control of the money supply 1. Tools of central bank policy 2. Quantity theory of money 3. Real versus nominal interest rates

Trade Offs

ALL possible options given up when you make a choice

Recessionary Gap

Aggregate Output is below potential output

Inflationary Output

Aggregate output is above potential output

Centrally Planned Economics

An economic system where the government owns the resources and decides what to make, how to make it, and who gets it. Total government control of the economy

Country X is currently in long-run macroeconomic equilibrium. If the country's economy experiences a significant increase in the price of energy, a major input in production, which of the following will occur in the short run?

An increase in energy prices increases the cost of production and causes the short-run aggregate supply curve to shift to the left. This will cause the actual rate of unemployment to go below the natural rate of unemployment.

Negative Supply Shock

An unexpected decrease in the availability of a key resource that temporarily decreases productivity

Positive Supply Shock

An unexpected increase in the availability of a key resource that temporarily increases productivity

Product Price Index (PPI)

Applies to the price of wholesale goods such as lumber and steel good predictor of future inflation because producers often pass their cost increases on to consumers

Consumption and Saving

As income increases, both consumption and savings will increase The determinants of overall consumption and savings are: - More money or a positive outlook will increase consumption and reduce savings - Less money or a negative outlook will increase savings and reduce consumption - Wealth (financial assets) - Expectations about future prices and income - Real Interest Rates - Household Debt -Taxes

Consumer Price Index (CPI)

CPI is an index number that shows how prices change over time for a fixed basket of consumer goods Consumer Price Index (CPI) Equation: Price of Market Basket/Price of market basket in case year x 100 the CPI may overestimate the inflation rate, due to its inflexible dependency on the base year market. substitutions of less expensive goods and services are not accounted for in its measure of inflation. Quality improvements and price changes in new products that were not in the base year basket are also excluded from CPI inflation estimates

Capital Stock

Capital stock is the amount of capital businesses have. The more capital stock, the more output they can make

National Income Account

Circular Flow Gross Domestic Product Component of gross domestic product Real versus nominal gross domestic product

Economic Philosophies

Classical: Believes that the government SHOULD NOT interfere in the economy. And believes in self-correction of economic problems. Keynesian: Believes that GOVERNMENT SHOULD interfere in the economy (taxes, government spending). Most "mainstream" economists are Keynesians Rational Expectations: Believes that monetary and fiscal policy have certain effects on the economy and take action to make these policies ineffective.

Consumer Goods vs. Capital Goods ( physical capital)

Consumer goods- (ex: pizza) goods made for direct consumption Capital goods- (ex: restaurant oven) goods made for indirect consumption. Goods that make consumer goods _ manufactured goods that an be used in the production process, including tools, equipment, buildings, and machinery ( this is often referred to physical capital)

Aggregate Demand Determinants

Consumption - Wealth - Expectations - Debt -Taxes Investment - Interest Rates -Expected Returns Technology, Inventories, Taxes Government -Change in Gov. Spending Net Exports - National Income Abroad - Exchange Rates Increases: Right Decreases: Left

Which of the following will happen when the actual inflation rate exceeds the expected inflation rate?

Correct. When the actual inflation rate exceeds the expected inflation rate, lenders will receive lower real interest rates than expected. Therefore, this will harm lenders with fixed-interest rate loans.

Depreciation

Currency is decreasing in demand (weaker dollar) Being SUPPLIED in exchange for other currency - US currency will depreciate when fewer foreigners: travel to the US, buy fewer US goods or services, or sell US dollar to invest in thier own bonds

Appreciation

Currency is increasing in demand (stronger dollar) - U.S. Currency will appreciate when more foreigners: travel to the US, buy more US goods or services, or buy the US dollars to invest in bonds

Free Market Economics

Economic system where individual citizens own the resources and decides what to make, how to make it, and who gets it. Little or no government involvement in the economy

Types of Fiscal Policy

Expansionary: LAWS TO INCREASE OUTPUT Used to Fight a Recession LOWER TAXES ( Increases disposable income) INCREASE GOVERNMENT SPENDING Contractionary Used to fight Inflation RAISE TAXES (decrease disposable income) DECREASE GOVERNMENT SPENDING

Interest Rate- Investment

Expected Rate of Return: Amount of Profit (expressed as a percentage) a business expects to gain on a project/investment. This rate must be greater than the interest in order to be profitable. The Real Rate of Return is most important. An expected profit of 10%, that costs 5% in interest = The real rate of return: 5%.

Economic Growth

Five Factors connected to long run economic growth. Supply Factors: Increase in natural resources (quantity and quality) Increase in human resources (quantity and quality) Increase in capital goods Improvements in technology Demand Factors: Increase in consumption by households, businesses, and government

Who is hurt by inflation?

Fixed Income Receivers - real income falls' Savers - value of accumated savings deteriorates - purchasing power decreases Creditors - Lenders get paid back in "cheap dollars" - decreases purchasing power when inflation goes back down

GDP

Gross Domestic Product: The total dollar (market) value of all final goods and services produced in a country's borders in one year. "final goods and services" Aggregate Income: Aggregate expenditure Expenditure Approach: The expenditure approach adds up to all spending done in the economy by households, businesses, the government, and other countries GDP= C+I+G+X(n)

Assume inflation is 2% but actual inflation turns out to be 5%. Who is helped and hurt by inflation?

Helped: - Borrowers Hurt: - Lenders -Savers - People on fixed Incomes

Marginal Propensity to Save ( MPS)

How much people Dave rather than consume when there is a change in income

Marginal Propensity to Consume (MPC)

How much people consume rather than save when there is a change in income

Nominal/ Real Tips

If nominal rates INCREASE and Price Level INCREASE, the CHANGE in Real is "indeterminable." If nominal Wage rates do NOT change and Price Level fall. REAL WAGES increase. NOMINAL RATES "PIGGY-BACK" REAL RATES & NOT VICE VERSA.

What happens to aggregate supply when people expect inflation?

If people expect inflation, workers will seek higher wages and costs for businesses will increase. This causes the aggregate supply to decrease

Supply Changes when

Imputes prices change (resources and wages) Government tariffs, quotas, and subsidies) Technology Number of sellers (producers) changes Expectations (about price and product profitability change) Disasters (weather, strikes, etc)

The increase in the price level results in an upward movement along the short-run aggregate supply curve to a higher real output level.

In an economy where wages and prices are sticky, which of the following will happen as a result of an increase in the price level?

Assume an economy is currently at full employment. Which of the following best describes the long-run adjustments that will occur in the economy following a negative aggregate demand shock with no government intervention?

In the long run, wages and prices are flexible and will adjust to restore full employment. In this situation, the negative demand shock with no government intervention decreases aggregate demand, moving the economy to below full employment. Unemployment will impose downward pressure on nominal wages and prices, which will increase short-run aggregate supply until full employment is restored.

Demand Changes when

Income Changes Related Products, complements, substitutes, (price and quantity) Future Expectations (Future price change) Number of Consumers (more or less added ) Tastes, fads, preferences change

Expansionary Fiscal Policy

Increases Aggregate demand

Scarcity

Individuals, businesses, and governments have unlimited wants but limited resources. imputs or factors of production

The two big problems that plague the economy are

Inflation Unemployment people generally prefer steady, stable growth to large "ups" and "downs". Therefore, government policies, both fiscal and monetary, are aimed at flattening the business cycle C the government wants not only to stimulate the economy when it's slow, but also to slow it down when it is growing too quickly

The Law of Demand

Inverse relationship between priceand quantity demanded P↓ Qd __↑_ P↑ Qd __↓_

Investment

Investment is business spending on capital (tools and machinery) that makes businesses more productive

Criticism of unemployment

Involuntary part time workers counted as full time (underemployed) Discourage Workers are not counted as unemployed Unequal burden ( we do not give a # that repersents every sub group

Money Supply Terms

M1= Checkable Deposits and Currency M2= M1 + Savings deposits, money market accounts, small time deposits (less than $100,000) Velocity of Money Equation: MV = PQ ( GDP) (M= Money Supply and V = Velocity (number of times per year the average dollar is spent on goods and services.

Extended AD-AS and Cost-Push Inflation

Mainstream economists must decide whether to target the Price Level or Unemployment, before taking any action. Classical economists would argue to DO NOTHING. Eventually, wages and resource prices must decrease and when they do the SRAS curve will shift back to the right, restoring the economy to its full-employment output level and the original Price Level.

Extended AD/AS and Cost Push (Supply-Side) Inflation

Mainstream economists will fight a recession as previously discussed: with either an easy money policy or an expansionary fiscal policy. The goal would be to move the aggregate demand curve to the right. Classical economists would argue to DO NOTHING. The decrease in wages and resource prices will shift the SRAS curve to the right, restoring the economy to its full-employment output level, but with a LOWER price. (SELF-CORRECTION) A decrease in supply ( shortage or high cost in producing goods) Due to a raise in per unit input costs supply shocks minimum= harder for employers to hire workers

Extended AD-AS and Demand-Pull Inflation

Mainstream economists will fight inflation as previously discussed: with either a tight monetary policy or a contractionary fiscal policy. The goal would be to move the aggregate demand curve to the left. Classical economists would argue to DO NOTHING. As nominal wages rise, the SHORT-RUN AS curve will shift to the left (resources and wages are becoming more expensive), restoring the economy to its full-employment output level, but with a higher Price Level.

Cost-Push Inflation

Major cause is a supply shock-OPEC cutting back on oil production AS Curve will shift to the left, resulting in a higher price level and decrease in Real GDP

Competitive market

Many buyers and sellers Identical goods or services

Marginal Propensities

Marginal Propensity to Consume: MPC Marginal Propensity to Save: MPS MPS+MPC=1 Spending Multiplier: 1/MPS

Real GDP per Capita

Most commonly used to compare and measure each country's standard of living and overall economic growth Real GDP/ Nation's Population

Last year, Myron purchased a $10,000 certificate of deposit with a 3% rate of interest from his bank. The government reported that prices, on average, have fallen by 5% during the current year. Which of the following can be concluded as a result of this transaction?

Myron gains, while the bank loses. Correct. Prices have fallen by 5% on average, which results in an increase in the real interest rate (real interest rate = nominal interest rate - inflation). Myron is better off because the dollars that Myron will receive back from the bank when the certificate of deposit matures will buy more goods and services than when Myron purchased the certificate of deposit. And conversely, the money that the bank pays back to Myron when the certificate of deposit matures is worth more than that money was worth during the time the bank had this money.

Interest Rate (I)

NOMINAL I%: interest rate expressed in terms of annual amounts currently charged for interest; not adjusted for inflation REAL I%: interest rate expressed in dollars of constant value (adjusted for Inflation) and equal to the NOMINAL I% minus the EXPECTED RATE OF INFLATION

Trends of Inferior and Normal Goods

Normal Goods: Income ↑ Demand ___↑_ Income ↓ Demand ___↓_ ex. Inferior Goods: Income ↑ Demand ___↓_ Income ↓ Demand ___↑_ ex.

Income (Nominal/ Real)

NOMINAL INCOME: number of dollars received by an individual or group for its resources during some period of time REAL INCOME: amount of goods and services which can be purchased with nominal income during some period of time; nominal income adjusted for inflation

Wages ( Nominal/ Real)

NOMINAL WAGES: amount of money received by a worker per unit of time (hour, day, etc.); Money Wage REAL WAGES: amount of goods and sevices a worker can purchase with their NOMINAL WAGE; purchasing power of the nominal wage. (Real = Nominal - Inflation rate)

Real GDP

Nominal GDP adjusted for inflation GDP adjusted for inflation and expressed in constant, or unchanging, dollars RGDP: Nominal / Price Index in Hundredths (deflator)

GDP ( Nominal and Real GDP)

Nominal GDP: GDP measured in terms of current Price Level at the time of measurement. (Unadjusted for inflation) Real GDP: GDP adjusted for inflation; GDP in a year divided by a GDP deflator (Price Index) for that year

Short Coming of GDP: Leading to GDP being understated

Nonmarket Activities: (services of homemakers) do not count Leisure: Does not include the value of leisure Does not include improvements in product quality Underground economy GDP understates the value of output since it only counts market transactions and doesn't count non-market transactions such mowing your neighbor's lawn.

What are discouraged job seekers

People that are no longer looking for a job because they gave up. Since these people are not counted in the labor force, the unemployment rate may be too low.

Inflation Measurement and Adjustment

Price Indicies Nominal and real value Cost of inflation

Circular Flow Matrix ( Model)

Product Market- Places where individuals buy goods and services from businesses Factor (Resource) Market- Places where businesses buy the factors (land, labor, capital) from individuals Factor Payments- Payments made by businesses. Rent for land, wages for labor, interest for capital Transfer Payments-Payments made by the government to meet a specific goal rather than pay for goods and services (ex: welfare)

Cyclical

Results from a decline in the business cycle Unemployment that results from economic downturns (recessions). As demand for goods and services falls, demand for labor falls, and workers are fired During a recession or depression, firms are likely to hire fewer works or let existing workers go. When the economy recovers, many of these cyclical employees will find work again

Structural

Results from changes in technology or a business restructure (ex. Merger) Changes in the structure of the labor force make some skills obsolete. Workers NO NOT have transferable skills and these jobs will never come back lack marketable skills

Inflation

Rise in the general level of prices Reduces the purchasing power of money Measured with the consumer price index (CPI) - Reports the price of a market basket, more than 300 goods that are typically purchased by an urban household

Quantity Theory of Money Equation:

Quantity Theory of Money Equation: __M__ x__V__=__P__x__Q__ __M__= Money Supply __P___= Price Level __V__= Velocity of Money __Q___= Quantity/Output Assume the amount of money is $5 and it is being used to buy 10 products with a price of $2 each.

Aggregate Supply Factors

R: Resource or Commodity Prices ( The cell/ wages and materials, and as well as oil) E: Environment (Legal-institutional), Taxes, Subsidies, and more regulations P: Productivity (Better Technoloy)

Constant Opportunity Cost

Resources are easily adaptable between both products.

Increasing Opportunity Cost

Resources are not easily adaptable between both products

What are underemployed (part-time) workers?

Someone who wants more hours but can't get them is still considered fully employed. The unemployment rate ignores the plight of such workers.

Trends with Substitutes and Complements

Substitutes: Price of A↑ Demand for B __↑_ Price of A↓ Demand for B __↓_ Ex. Complements: Price of A↑ Demand for B __↓_ Price of A↓ Demand for B __↑_ Ex.

Money Illusion coming from nominal salary

Ted's nominal salary (the actual number of dollars) has increased, but his real salary ( the purchasing power of dollars) has remained the same If ted notes the increase in his salary but not the increase in products around him, it will lead to excessive spending and money illusion

Frictional

Temporary and unavoidable Temporarily unemployed or being between jobs. Individuals are not qualified workers with transferable skills but they aren't working new labor force entrants looking for their first job and worker show temporarily between jobs because they are moving to a new location or occupation in which they will be more productive

Business Cycle

The Increase and decreases in Real GDP consisting of four phases Peak: Highest point of Real GDP Recession: Real GDP declining for 6 months Through: lowest point of real GDP Recovery GDP increasing (trough to peak)

Opportunity Cost

The ONE best option given up when you make a choice including the money, time, and forgone opportunities Most desirable Alternative .

What is the natural rate of employment?

The amount of unemployment that exists when the economy is healthy. The economy is at full employment when there is no cyclical unemployment 5% structural plus frictional Actual unemployment can be above or below NRU

Classical Economic Theory

The belief that the economy self corrects and the government intervention will do more harm than good

Keynesian Economic Theory

The belief that the government should actively manipulate the economy to reach full employment

GDP Deflator

The deflator is an index number that measures all prices and is used to convert nominal GDP into real alternative general price index that reflects the importance of products in current market baskets, rather than in base year market baskets, which becomes less relevant over time. GDP Deflator: Nominal GDP/ Real GDP x100

Suppose that the economy is in a recession. In the absence of government policy action to restore the economy to full employment, how will the economy adjust in the long run?

The economy is in recession. Therefore in the provided graph, the short-run macroeconomic equilibrium occurs where the SRAS2 curve intersects the AD1 curve. In the absence of policy action, the economy will self-correct in the long run. Nominal wages will fall and the SRAS2 curve will shift rightward until it restores the economy to full employment in the long run.

Rationale for Stabilization Policy

The government should not wait for the economy to correct itself, government should use fiscal policy ti get the economy back to potential output in the aftermath of a shift in the aggregate demand Active Stabilization policy: use of the government to reduce the severity of recessions and rein inexcessively strong expansions automatic Stabilizers: Automatic stabilizers are changes in taxes and government spending that occur automatically to stimulate aggregate demand in a recession and curb aggregate demand in a potentially inflationary boom. During a recession, income taxes fall and transfer payments rise, which will shift the aggregate demand curve to the right and increase real output. lessen the blunt of extreme business cycles

Multiplier Effect

The idea that an initial change in spending will set off a spending chain that is magnified in the economy. The strength of multiplier depends on the amount that consumers spend of new income.

What is the income approach

The income approach adds up al the income earned in the economy including wages, rent, interest, and profit National Income= W + R + I + Pr

Autonomous Consumption

The minimum amount of consumer spending when people have no income

Why is Fiscal Policy an important tool for managing economic fluctuations

The more taxation or government spending there is, the stronger effect on total aggregate spending in the economy, Changes in taxation and transfer has some impact over consumer and investment spending

Substitute

Two goods are substitutes if a fall in the price of one of the goods makes consumers willing to buy the other

Velocity of Money

The velocity of money is the average time a dollar is spent and re-spent in a specific period of time

Criticism of Fiscal Policy

Timing Problems Recognition Lag: identifying recession or inflation Administrative Lag: getting Congress/President to agree to take action Operational Lag: Time needed to see the results of the fiscal policy Political Business Cycles: Politicians may take inappropriate action to get reelected (lower taxes during an inflationary period). Plus it is difficult to raise taxes

Complements

Two good are complements if a fall in the price of one good makes people more willing to buy the other good

Inferior Good

When a rise in income decreases the demand of the good. it is inferior good

Normal Income

When a rise in income increases the demand for a good

If the natural rate of unemployment exceeds the actual rate of unemployment, which of the following will occur in the long run in the absence of government intervention?

When the natural rate of unemployment exceeds the actual rate of unemployment, the economy is in an inflationary gap. Inflation will cause nominal wages and input prices to increase, and the short-run aggregate supply curve will shift to the left.

Stagflation

When there is high inflation and a sluggish economy. Usually accompanies a negative supply shock high inflation and high unemployment.

Inflation : Winners and Losers

Winners: - Debtors who borrow money that will be repaid with "cheap dollars" -Those who have anticipated inflation - those who borrow money at a fixed interest rate pay back amounts that are worth less in real terms due to inflation Losers - Savors (especially in saving) - Creditors (Banks will be repaid with those "cheap dollars" - Fixed-Income Recipients (retirees receiving the same monthly pension_

They agreed to a 3 percent per year increase in pay over the 3 years. How would each group be affected by an actual inflation rate of 4% next year?

Workers would be better off, and the employers would be worse off. When the actual rate of inflation (4%) is greater than the expected inflation rate (3%), the real value of worker income is reduced, which means that workers are worse off and employers are better off.

Recessionary Gap

Ye<Yf, which equilibrium RGDP would have increase to reach Yf Classical theory suggests that when a recessionary gap exists, the surplus of workers and other inputs will cause wages and other inputs prices to fall, thus shifting the SRAS to the right, lowering the price level , and increase RGDP until equilibrium is at Yf.

Inflationary Gap

Ye>Yf, which equilibrium RGDP would have to decrease to reach Yf Classical Theory, an inflationary gap will be quickly be cured as production beyond Yf, necessitates high wages that lead As to shift left, the price level to increase, and real GDP to fall until Ye=Yf.

Employed

You are employed if: - You work for 1 hour as a paid employee (so part-time workers count) -You are temporally absent from work (Illness, strike, vacation) - Your work 15 hours or more as an unpaid worker (family farms are common)

Non-Discretionary Fiscal Policy

automatic stabilizers; permanent spending or taxation laws enacted to work counter cyclically to stabilize the economy

Dishonest Workers

bias the unemployment rate too high claim to be unemployed to receive unemployment benefits when in fact they do not want a job or are working for cash in an unreported job

Positive Economics

describes the way things are unemployment rate hit a three year high

hyperinflation

excess of 50 percent per year

Discretionary Fiscal Policy

fiscal policy that is the result of deliberate actions by policy makers rather than rules Congress creates a new bill that is designed to change AD through government spending or taxation.

Okun's Law

for every one percentage point increase in the unemployment rate above the natural rate, output falls by 2 to 3 percentage points

Full employment

is not 100% but the level of employment that corresponds with the natural rate of unemployment No cyclical employment= Full employment

Entrepreneurship

the ability to identify, opportunities and organizer production, the willingness to accept risk in the pursuit of reward

Macroeconomics

the branch of economics that deal with the whole economy and issues that affect most of society includes: inflation, unemployment, greoss production possibilities, national income, interest rate, exchange rates...

Communism

the government owns all the resources in society designed to minimize imbalance in wealth via the collective ownership of property divide the available wealth for equal advantage among citizens lack of incentives for extra effort, risk taking, and innovation the central government in allocating resources and setting production levels makes this system particularly vulnerable to corruption