Econ Exam 2

Problems with GDP

-Illegal or underground-market transactions are omitted from GDP. -Underground transactions are especially significant in countries with higher levels of corruption and taxes. -GDP does not count non priced production, when valuable goods and services are produces but no monetary payment is made (housework, volunteering) -GDP does not count leisure, although people value it. -GDP does not count economic "bads" such as pollution, crime, or the extinction of species.

Reasons for Inefficient Organization

-Inefficient and unnecessary regulations. -Red tape, or the time and cost to do tasks such as starting a business or enforcing a contract in a court of law -Barriers to free trade

Bad News of Economic Growth

-Most of the world is poor -More than 1 billion live on incomes of less than $2 per day -These people have greatly reduces prospects for health, happiness, and peace

Ultimate Causes of Wealth

-Natural resources may help explain why a country is able to accumulate physical and human capital -Transport is cheaper over water than over land, so countries with access to water are more open to trade -Landlocked countries have lower per capita GDP than countries with access to a coast -History, ideas, geography, and luck are also important to economic growth

Factor Income Approach

One of the two common ways that economists split the production of goods and services. Splits GDP into different classes of income receiving. Add up the income generated by producing goods and services: Y = Wages + Rent + Interest + Profit When a consumer spends money, the money is received by workers, landlords, owners of capital, and businesses. We can therefore calculate GDP by adding up all of the incomes received. When using this approach, we need to make adjustments for things like sales taxes.

Which of the following splits GDP according to the national spending approach? a. C + I + G + NX b. Revenues - Expenses c. Employee compensation + rent + interest + profit

A

Something of value that becomes the property of the lender if the borrower defaults is called: a. Collateral b. Interest c. A bond

A - collateral

The risk that a borrower will not pay the loan back is called: a. Default risk b. Interest rate risk c. Crowding out

A - default risk

If there is a shortage of loanable funds, the interest rate will: a. Increase b. Decrease c. Stay the same

A - increase; if there is a shortage, borrowers will bid the rate up.

Knowledge that is used to produce goods and services is called: a. Technological knowledge b. Human capital c. Factors of production

A - technological knowledge

According to the rule of 70, a sum of money invested at 12.5% would double in: a. 5.6 years b. 17.86 years c. 56 years

A - the money would double in 70 / 12.5 = 5.6 years

Stock

A certificate of ownership in a corporation.

Dependable Legal System

A good __ __ facilitates contracts and protects private parties from expropriating one another. Poorly protected property rights can stem from either too much or too little government. Some legal systems are of such low quality that no one knows for certain who owns that. It is difficult to borrow money if lenders can't get their money back.

GDP Deflator

A price index that can be used to measure inflation. The ratio of nominal to real GDP: ___ = (Nominal GDP / Real GDP) x 100

Recession

A significant, widespread decline in real GDP and employment. Unemployment is one of the last things to recover after a recession.

Competitive and Open Markets

About half the differences in per capita income across countries are explained by differences in the amount of physical and human capital. Half the differences are explained by a failure to use capital efficiently. Competitive and open markets are one of the best ways to encourage the efficient organization of resources.

Bonds & Default Risk

All bonds involve default risk. A risky company has to pay higher interest to compensate for a greater risk of default.

The Rule of 70

Approximates the length of time necessary for a growing variable to double: Doubling time = 70 / Growth rate in % Small changes in growth rate lead to large changes over time.

Environmental Kuznets Curve

As Per Capita Income increases over time, Environmental Decay goes up -> Turning Point Income hits -> Environmental Improvement occurs. Proves that there doesn't have to be conflict between economic growth and the environment.

Borrowers Less Optimistic

As investors become less optimistic, there is declines in borrowers (demand to borrow shifts left).

People Become More Thrifty

As people become more thrifty, their time preference decreases, savings will be shifted right and interest rates will fall.

Rules, regulations, and customs that structure incentives are called: a. Human capital b. Institutions c. Investment

B - institutions

Which of the following is a major factor in determining the supply of savings? a. GDP b. Patience c. Investment

B - patience is one of the major factors along with consumption smoothing, interest rates, and marketing & psychological factors.

Real GDP per capita was $22,000 in Year 1 and $23,000 in Year 2. The growth rate was: a. 4.35% b. 4.55% c. 4.75%

B - the growth rate was [(23,000-22,000) /22,000] x 100 = 4.55%

Persistent Poverty

Becoming part of the world economy means fast growth. Many countries are opening up to trade. Hunger and child labor decreasing. Life expectancy going up and infant mortality down.

Biases in GDP Statistics

Biases over time and biases across nations. -As more women in the US entered the workforce, housework shifted from unpaid to paid. -Women's participation in the workforce varies across countries, changing the proportion of work included in GDP.

Economic Growth

Brings wealth > increases societal well-being. Wealthier nations have: -higher infant survival rates, life expectancy, and nutrition -more educational opportunities, leisure, and entertainment -fewer conflicts such as civil wars and riots -more material goods

The Stock Market

Businesses can fund their activities by issuing stock. Stocks are traded on organized markets called stock exchanges. These markets encourage investment and growth.

If GDP in 1990 was $5,803 billion and GDP in 1991 was $5,995 billion, what was the growth rate of GDP? a. 1.92% b. 3.20% c. 3.31%

C - The growth rate was [(5995 - 5803) / 5803] x 100 = 3.31%

The main function of financial intermediaries is to: a. Make capital investments b. Provide investment advice c. Mobilize savings towards productive uses

C - financial intermediaries reduce the costs of moving savings to investors and mobilize the savings towards productive uses.

Which of the following is a final good: a. A book in Amazon's inventory. b. Tires purchased by a Toyota plant. c. Tires purchased by you for your car.

C - tires purchased by you are a final good because they are for your own use (consumption), not for resale.

Child Labor

Caused by poverty, so economic growth means less child labor. Boycotting companies that use it lead to more problems for the children and their families. The children may turn to agricultural work which pays less and is more dangerous for the children. Many turn to prostitution too.

Honest Government

Corruption is like a tax that bleeds resources away from productive entrepreneurs. Resources "invested" in bribing cannot be invested in machinery and equipment. Corruption makes it more profitable to be a corrupt politician or bureaucrat. Few people want to be entrepreneurs because they know that their wealth will be stolen.

Splitting GDP

Economists split the production of goods and services in many different ways. Two common ways are: national spending approach and factor income approach

2. Everyone Used to be Poor

For most of recorded human history, there was no long-run growth in real per capita GDP. Today, GDP per capita is 50 times larger in the richest countries than in the poorest.

Growth Miracles

From 1950 to 1970, Japan grew 8.5% per year. Today, Japan is one of the richest countries in the world. In 1950, South Korea had GDP per capita about the same as that of Nigeria. Between 1970 and 1990, it grew at a rate of 7.2% per year. Today, South Korea is on a par with many European economies.

Real GDP

GDP after counting for inflation. Only counts final goods, not intermediate ones. Includes machinery and equipment used to produce other goods.

Nominal GDP

GDP before counting inflation. Calculated using prices at the time of sale.

Cyclical & Short Run Changes

GDP is used to measure short-run fluctuations in an economy such as recessions.

Market Values

GDP uses these to determine how much each good or service is worth and then sums the total.

Intermediate Goods

Goods that are sold to firms and then bundled or processed with other goods or services for sale at a later stage.

Final Goods and Services

Goods what are sold to final users and then consumed or help in personal inventories. Only these are counted in real GDP.

Real GDP per Capita

Growth in this is usually the best reflection of changing living standards. Growth in real GDP does not account for changes in population. For example, the US and Guatemala had the same growth rate, but the US standard of living grew much faster.

Saving

Income that is not spent on consumption goods. ___s are necessary for capital accumulation. Builds a cushion for unemployment or unexpected health problems.

Marketing and Psychological Features

Individuals save more if saving is presented as the natural or default alternative. The retirement savings plan participation rate was 25% higher in businesses that used automatic enrollment rather than opt in. The default also mattered for how much was saved. Simple _____ changes, combined with _____, can change how much people save.

The Bond Market

Investors can more easily find information about large, well-known corporations. They are therefore more willing to bypass banks and lend to these companies directly. A corporation acknowledges its debt to a member of the public by issuing a bond, or a corporate IOU. Bonds are a way to raise a large sum of money for long-lived assets, and pay it back over a long period of time.

Technological Knowledge

Knowledge about how the world works, that is used to produce goods and services. This improved increases productivity, and it potentially boundless. Better this has allowed US farms to increase their output two and half times since 1950, while using less land. Increases through research and development.

T-bills

Maturities of a few days to 26 weeks; pay only at maturity.

T-notes

Maturities ranging from 2 to 10 years; pay interest every 6 months.

Ecnomic Growth Rates

Measured as the growth rate of real GDP per capita. Even slow growth, sustained over time, produces big differences in wealth. Growth builds on top of growth through "compounding" or "exponential growth." The causes of growth in GDP per capita include factors of production, incentives, and institutions.

Impatience

Most individuals prefer to consume now rather than later. The stronger the preference for present rather than future consumption, the higher that person's time preference. The more ____a person, the more likely that person's savings rate will be low. _____ is reflected in any economic situation where people must compare costs and benefits over time. Criminals, addicts, alcoholics, and smokers all tend to discount the future more heavily.

1. GDP Growth Varies

Most of the world's population is poor relative to the US. About a billion people have incomes of less than $2 per day.

Growth Disasters

Nigeria has barely grown since 1950. It was poorer in 2005 than in 1972 when high oil prices briefly bumped up its per capita GDP. In 1900, Argentina was one of the richest countries in the world. By 1950, Argentina's per capita GDP had fallen to half that of the US. By 2000, Argentina's per capita GDP was less than 1/3 of that of the US.

Market for Loanable Funds

Occurs when suppliers of _____ ___ (savers) trade with demanders of ____ ___ (borrowers). Trading in the ____ __ ____ ___ determines the equilibrium interest rate.

National Spending Approach

One of the two common ways that economists split the production of goods and services. Splits GDP according to different classes of income spending. Add up the components of spending: Y = C + I + G + NX

The Demand to Borrow

One reason people _____ is to smooth consumption. Many young people ____ to invest in their education. Businesses ____ to finance large projects. Often the people with the best business ideas are not the people with the most savings. The ability to ____ greatly increases the ability to invest and the rate of economic growth.

Zero-coupon Bonds

Pay only at maturity.

Personal Savings Rates

Personal income minus taxes is disposable personal income. Disposable personal income minus personal outlays (spending, gifts) is personal saving. These rates have dropped in the US substantially but have leveled off.

Factors of Production

Physical capital, human capital, and technological knowledge. The organization of ___ __ ___ depends on incentives and institutions.

Controls on Interest Rates

Price controls on interest rates cause the loanable funds market to malfunction. They lead to 1) shortage of savings, 2) less savings and investments, and 3) slower econoimc growth. *All because the controlled interest rate is below the market equilibrium. Usury laws impose a maximum ceiling on the interest rate that can be charged on a loan.

Institutions of Economic Growth Include

Property rights, honest government, political stability, a dependable legal system, and competitive and open markets.

2009 Congress Bill

Protected credit card users from "unfair" lending practices in the credit card industry such as raising interest rates and late fees. This made getting credit much harder for consumers. Relates to the affect of Usury laws.

The Lifecycle Theory of Savings

Puts the demand to borrow and save together. Borrowing up while in college, saving while prime working years, and dissaving during retirement. All up and down along the consumption path as time moves on.

Banks

Receive savings from many individuals and pay them interest. They loan these funds to borrowers, charging them interest. They earn profit by providing services such as evaluating investments and spreading risk. They pose less risk than borrowing from non-professionals. By specializing in loan evaluation, they are better able to decide which business ideas make sense.

Business Cycles

Short-run movements in real GDP around its long-term trend.

Insecure Property Rights

Some gov'ts do not offer secure property rights to savers. Savings may be confiscated. This negativity affects savings and investment.

Free Rider

Someone who consumes a resource without working or contributing to the resource's upkeep.

Collateral

Something of value that by agreement becomes the property of the lender if the borrower defaults.

Three Types of Government Bonds

T-bonds, T-notes, T-bills, Zero-coupon bonds, and TIPS

GDP Growth Rate

Tells us how rapidly the country's production is rising or falling. (GDP2013 - GDP2012 / GDP2012) x 100 = ___ ______ ____ for 2013. *we have not yet counted for inflation*

Institutions

The "rules of the game" that structure economic incentives. Include laws and regulations but also customs, practices, organizations, and social mores. These promote growth by creating incentives that align self-interest with the social interest. Wealthy countries use these to make it in people's self-interest to invest in physical capital, human capital, and technological knowledge.

Output

The ______ of an economy includes both goods and services. Haircuts, transportation, and medical care provide a benefit to individuals without a tangible output. US's GDP created by services has doubled since 1950.

Economies of Scale

The advantages of large-scale production that reduce average cost as quantity increases.

Bottom Billion

The billion people who live on less than $2 per day.

When Intermediation Fails

The bridge between savers and borrowers can be broken in many ways: insecure property rights, politicized lending, government banks, interest rate controls, inflation, and bank failures and panics.

Arbitrage Principle

The buying and selling of equally risky assets; ____ensures that equally risky assets earn equal returns.

Crowding Out

The decrease in private consumption and investment that occurs when government borrows more. An increase in government borrowing ____ out private consumption and investment. Interest rates up, private quantity demanded down, increase supply of savings.

Time Preference

The desire to have goods and services sooner rather than later (all else being equal).

Initial Public Offering (IPO)

The first time a corporation sells stock to the public in order to raise capital.

Financial Intermediaries & Roles

The go between between savers and borrowers such as banks, bond markets, and stock markets. -equilibrium in the market for loanable funds does not come out automatically -savers move their capital to find the highest returns

The Interest Rate and what they have to account for

The higher this is, the greater the quantity saved. Account for: -cost to the lender of giving up use of funds for a while -cost of arranging the loan (ex: mortgages take forever) -The possibility that the lender might not get money back (default risk) -The risk that dollars that he gets paid back with might have lost value due to inflation (inflation risk)

Gross National Product (GNP)

The market value of all final goods and services produced by a country's permanent residents, wherever located, within a year.

What is GDP?

The market value of all final goods and services within a country in a year. Gives us a way to measure changes in economic output and the standard of living. Measures production, so sales of old houses, used goods, and financial assets do not add to GDP. Includes goods and services by labor and capital located in the United States, regardless of the nationality of the workers or property owners.

Default Risk

The possibility that the lender might not get his money back.

Human Capital

The productive knowledge and skills that workers acquire through education, training, and experience. Enables workers to take advantage of more sophisticated tools. Increased through education.

Investment

The purchase of new capital goods. The more capital an economy can __, the greater GDP per capita will be.

Inflation Risk

The risk that dollars that he gets paid back with might have lost value due to inflation.

Physical Capital

The stock of tools including machines, structures, and equipment. More and better of this make workers more productive.

Bond Prices and Interest Rates

The value of a bond at maturity is called the face value. The rate of return, or implied interest rate, on a zero-coupon bond can be calculated as: Rate of Return= [((FV-Price)/Price)x100] When interest rates go up, bond prices fall; when interest rates go down, bond prices rise

Net Exports

The value of exports minus the value of imports. Negative in the US -> people argue that this is dragging down our GDP. Even if you bring imports down, it still won't work. If we cut imports, then we reduce the ability of foreigners to buy our exports (we pay them with US dollars -> they use this $ to buy our exports)

GDP Does Not Include

The value of leisure, goods in the underground economy, the value of goods that are difficult to price, and how equally income is distributed.

Real Variables

Variables such as GDP that have been adjusted for changes in prices by using the same set of prices in all time periods.

Nominal Variables

Variables such as GDP that have not been adjusted for changes in price.

US Government Bonds

Very liquid (easy to buy and sell). Very low probability of default. Gov't can pay their debts because they can always force people to pay.

National Spending Approach Meanings

Y = nominal GDP C = consumption (largest of the 4) I = investment (new athletic building) G = government purchases (excludes social security, welfare, grants, and subsidies) NX = net exports

Measuring Growth

g^t = [(y^t - y^t-1) / y^t-1] x 100 Where: g^t = growth rate of real GDP per capita y^t = real GDP per capita in time period t Year Real GDP 2008 $15,000 2009 $15,500 g^2009 = [(15,500 - 15,000) / 15,000] x 100 = 3.3%

T-bonds

30-year bonds; pay interest every 6 months

Good News of Economic Growth

-Transformed the world -raised the standard of living of most people in developed nations many times above the historical norm -it can happen quite quickly -Understanding the wealth of nations is critical if we are to improve the human condition

Three Key Facts about the Wealth of Nations and Economic Growth

1. GDP growth varies among nations 2. Everyone used to be poor. 3. There are growth miracles and growth disasters.

Four of the Major Factors that Determine the Supply of Savings

1. Smoothing Consumption 2. Impatience (time preference) 3. Marketing and Psychological factors 4. Interest Rates

Calculate GDP in constant prices

2013 GDP in 2013 dollars: 2013 prices x 2013 quantities = $16.8 tril 2000 GDP in 2013 dollars: 2013 prices x 2000 quantities = #13.8 tril We can not find the increase in real GDP.

Equilibrium in Loanable Funds

If interest rate is below the equilibrium, there is a shortage. If interest rate is above the equilibrium, there is a surplus because the quantity of savings supplied is greater than the quantity of savings demanded --> suppliers will bid the interest rates down as the compete to lend.

Smoothing Consumption

If you consume what you earn every year, consumption is high during your working years. After retirement consumption drops quickly. You can ___ your consumption by saving during the working years and dissaving during the retirement years.

Property Rights

Important for institutions for encouraging investment in physical and human capital. Under communal property, effort is divorced from payment so there is incentive to free ride. Savers won't save and investors won't invest if they don't expect that they will receive a return for their savings and investment. Important for technological innovation because companies will not undertake research and development unless they expect to profit from it.

Usury Laws

Impose a maximum ceiling on the interest rate that can be charges on a loan. Leads to shortage of savings.