basic econ test #3: main ideas
calculating labor-force participation
% of the adult civilian population that is in the labor force *participation rate = 100 x (labor force / adult civilian population)*
calculating unemployment rate
% of the labor force that is unemployed *u-rate = 100 x (# of unemployed / labor force)*
what happens to the AD curve in each of the following scenarios? (a.) a 10 year old investment tax credit expires (b.) the US exchange rate falls (c.) a fall in prices increases the real value of consumer's wealth (d.) state governments replace their sales taxes with new taxes on interest, dividends, and capital gains
(a.) I falls; AD curve shifts left (b.) NS rises, AD curve shifts right (c.) move down along AD curve (wealth-effect) (d.) C rises, AD shifts right
in each of the following cases, determine how much GDP and each of its components is affected (if at all): (a.) debbie spends $300 to buy her husband dinner at the finest restaurant in Boston. (b.) sarah spends $1200 on a new laptop to use in her publishing business. The laptop was built in China. (c.) jane spends $800 on a computer to use in her editing business. She got last year's model on sale for a great price from a local manufacturer. (d.) general motors builds $500 million worth of cars, but consumers only buy $470 million worth of them.
(a.) consumption & GDP rise by $300 (b.) investment rises by $1200, net exports fall by $1200 (subtract imports), GDP is unchanged (c.) current GDP & investment do not change b/c the computer was built last year (d.) consumption rises by $470 million, inventory investment rises by $30 million, and GDP rises by $500 million
calculating CIT: steps
*1. fix the basket* - the bureau of labor statistics (BLS) surveys consumers to determine what's in the typical consumer's shopping basket *2. find the prices* - the BLS collects data on the prices of all the goods in the basket *3. compute the basket's cost* - use the prices to compute the total cost of the basket *4. choose a base year and compute the CPI* - CPI = 100 x (cost of basket and goods & services in current year / by cost of basket in base year) *5. compute the inflation rate* - the percentage change in the CPI from the preceding period - inflation rate = 100 x ([CPI this year-CPI last year] / CPI last year)
contrasting CPI & GDP deflator
*CPI:* - includes consumer goods - excludes capital goods - uses fixed basket *GDP deflator:* - includes capital goods (if produced domestically) - excludes consumer goods - uses basket of currently produced goods & services - capital goods → any good deployed to help increase future production (property, equipment, etc.) - consumer goods → goods used by consumers and have no future productive use
national saving (S)
*S = Y - C - G* or *S = (Y - T - C) + (T - G)* total income in the economy that remains after paying for consumption and government purchases - saving (S) = investment (I) for a closed economy
budget deficit
*T - G < 0* - shortfall of tax revenue from government spending = -(public saving) = G - T
budget surplus
*T - G > 0* excess of tax revenue over government spending = public saving (T-G)
public saving
*T - G* tax revenue that the government has left after paying for its spending
private saving
*Y - T - C* income that households have left after paying for taxes & consumption
the production function
*Y = A F(L, K, H, N)* a graph or equation showing the relation b/w outputs & inputs - F( ) → a function that shows how inputs are combined to produce output - "A" → the level of technology - "A" manipulates the function F( ), so improvements in technology (increases in "A" allow more output (Y) to be produced from any given combination of inputs
2 types of money
*commodity money*→ has intrinsic value - ex: gold coins *fiat money* → does not have intrinsic value, used as money b.c of government decree - ex: the US dollar
3 types of price indexes: economists measure inflation using different price indexes that are based on different bundles of goods
*consumer price index (CPI)* → measures the average price for a basket of goods & services bought by a typical american consumer - index covers some 80,000 goods & is weighed so that an increase in the price of a major item such as housing counts for more than an increase in the price of a minor item like kitty litter *GDP deflator* → the ratio of nominal to real GDP multiplied by 100 - covers all final goods *producer price indexes (PPI)* → measure the average price received by producers - unlike SPI and GDP deflator, PPI measure prices of intermediate as well as final goods - PPI for different industries are often used to calculate changes in the cost of input
tools of the fed: summary
*increase the money supply* - buy government securities - lower reserve ratio - lower discount rate *decrease the money supply* - sell government securities - raise reserve ratio - raise discount ratio
3 functions money serves
*medium of exchange* → item that buyers give to sellers when they want to purchase goods & services *unit of account* → yardstick people use to post prices and record debts *store of value* → item that people can use to transfer purchasing power from the present to the future
real vs. nominal interest rates
*nominal interest rate* - interest rate not corrected for inflation - rate of growth in the dollar value of a deposit or debt *real interest rate* - corrected for inflation - rate of growth in the purchasing power of a deposit or debt - computed by subtracting the inflation rate from the nominal interest rate
3 tools of the Fed
*required reserve ratio (R)* → affects the amount of money banks can lead *discount rate* → affects the borrowing of banks from the Fed *open market operations* → affects the borrowing & lending between banks
consumption (C)
*total spending by households on goods & services* - mostly, the term "consumption" refers to total consumer spending, but housing costs are an exception note on housing costs: - for renters, C includes rent payments - for homeowners, C includes the imputed rental value of the house, but not the purchase price or mortgage payments - NOT included in C: purchases of new housing
investment (I)
*total spending on goods that will be used in the future to produce more goods* - business capital → business structures, equipment, & intellectual property products - residential capital → landlord's apartment building; a homeowner's personal residence (purchases on new housing) - inventory accumulations → goods produced but not yet sold "investment" does NOT mean the purchase of financial assets like stocks and bonds
unemployed
- are available for work - are currently out of work - are also currently looking for work
short-run economic fluctuations around long-run trends ...
- are irregular and largely unpredictable - when recessions occur, real GDP and other measures of income, spending, and production fall, while unemployment rises
policies to boost productivity
- encourage saving & investment; international trade, to raise K/L - encourage international investment, to raise K/L - provide education, health, & nutrition, to raise H/L - property rights & political stability - patent laws or grants, to increase A - research & development - population growth
the reserve ratio, R
- fraction of deposits that banks hold as reserves - total reserves as a percentage of total deposits
why the slope of SRAS matter
- if AS is vertical, fluctuations in AD do not cause fluctuations in output or employment - if AS slopes up, then shifts in AD do affect output and employment
problems with CPI: unmeasured quality change
- improvements in the quality of goods in the basket increase the value of each dollar - the BLS tries to account for quality changes but probably misses some, as quality is hard to measure - this, the CPI overstates increases in the cost of living
why is productivity important?
- it is the main determinant of living standards in the long run; when productivity grows rapidly, so do living standards - an economy's income is the economy's output
factors affecting frictional unemployment
- job search - sectoral shifts (changes in the composition of demand across industries) - public policies affecting the above 2
problems with CPI: substitution bias
- over time, prices rise faster than others - consumers substitute toward goods that become relatively cheaper, mitigating the effects of price increases - the CPI misses this substitution b/c it uses a fixed basket of goods - thus, CPI overstates increases in the cost of living
determinants of productivity
- physical capital, K - human capital, H - natural resources, N - technological knowledge
problems with CPI: introduction of new goods
- the introduction of new goods increases variety, allows consumers to find products that more closely meet their needs - in effect, dollars become more valuable - the CPI misses this effect b/c it uses a fixed basket of goods - thus, CPI overstates increases in the cost of living
labor force
- you are in the labor force if you are either employed or unemployed - not in labor force: retirees, full-time students, homeless people
compute *real GDP* in each year: 2014: pizza → P = $10, Q = 400 latte → P = $2, Q = 1000 2015: pizza → P = $11, Q = 500 latte → P = $2.50, Q = 1100 2016: pizza → P = $12, Q = 600 latte → P = $3, Q = 1200
2014: ($10x400) + ($2x1000) = *$6000* 2015: ($10x500) + ($2x1100) = *$7200* 2016: ($10x600) + ($2x1200) = *$8400* growth rate of real GDP: 2014 → 2015: *20.0%* increase 2015 → 2016: *16.7%* increase - this example shows that real GDP in every year is constructed using the prices of the base year & that base year doesn't change - the *change in real GDP* is the amount that GDP would change if prices were contsant (i.e. if zero inflation) - thus, *real GDP is corrected for inflation*
compute *nominal GDP* in each year: 2014: pizza → P = $10, Q = 400 latte → P = $2, Q = 1000 2015: pizza → P = $11, Q = 500 latte → P = $2.50, Q = 1100 2016: pizza → P = $12, Q = 600 latte → P = $3, Q = 1200
2014: ($10x400) + ($2x1000) = *$6000* 2015: ($11x500) + ($2.50x1100) = *$8250* 2016: ($12x600) + ($3x1200) = *$10800* growth rate of nominal GDP: 2014 → 2015: *37.5%* increase 2015 → 2016: *30.9%* increase - in this example, nominal GDP increases for 2 reasons: prices are rising, and the economy is producing a larger quantity of goods - the *change in nominal GDP* reflects both prices & quantities
if real GDP per capita is growing at an annual growth rate of 3.5%, when will it double?
70/3.5 = 20 years
determine the effects on the CPI and GDP deflator: armani raises the price of the italian jeans it sells in the US
CPI rises; GDP deflator does not why? - italian jeans appear in the US consumer's shopping basket, and hence the increase in their price causes the CPI to rise - the GDP deflator is unchanged b/c it only includes prices of domestically produce goods and excludes the prices of imports
determine the effects on the CPI and GDP deflator: starbucks raises the price of frappuccinos
CPI rises; GDP deflator rises why? - fraps are made in the US, so their prices are part of the GDP deflator - they are purchased by consumers, so their prices are part of the CPI
compute the GDP deflator in each year: 2014: - nominal GDP = $6000 - real GDP = $6000 2015: - nominal GDP = $8250 - real GDP = $7200 2016: - nominal GDP = $10800 - real GDP = $8400
GDP deflator = 100 x (nominal GDP/real GDP) 2014: 100 x (6000/6000) = *100* 2015: 100 x (8250/7200) = *114.6* 2016: 100 x (10800/8400) = *128.6* growth rate of GDP deflator: 2014 → 2015: *14.6%* increase 2015 → 2016: *12.2%* increase
determine the effects on the CPI and GDP deflator: caterpillar raises the price of the industrial tractors it manufactures at its Illinois factory
GDP deflator rises; CPI does not why? - since the tractors are produced in the US, the price increase can cause the GDP deflator to rise - however, industrial tractors are a capital good, so the CPI is unaffected
breaking down the definition of GDP: the market value of *all* final goods & services produced within a country in a given period of time
GDP includes: - all items produced in the economy and sold legally in markets GDP excludes: - most items produced and sold illicitly - most items that are produced and consumed at home
breaking down the definition of GDP: the market value of all final goods & services *produced* within a country in a given period of time
GDP includes: - currently produced goods, not goods produced in the past GDP excludes: - used goods
breaking down the definition of GDP: the market value of all final *goods & services* produced within a country in a given period of time
GDP includes: - tangible goods (DVDs, mountain bikes, beer) - intangible services (dry cleaning, concerts, cell phone service)
what is the main indicator of a country's well-being?
GDP is the main indicator of a country's economic well-being, even though it is not perfect
breaking down the definition of GDP: the market value of all final goods & services produced *within a country* in a given period of time
GDP measures the value of production that occurs within a country's borders, whether done by its own citizens or by foreigners located there - ex: honda cars produced in the US are counted toward US GDP - ex: ford cars produced in japan are counted toward the japanese GDP
what does GDP measure?
GDP measures: - a country's total income of everyone in the economy (national income) - a country's total expenditure on the economy's output of goods & services
breaking down the definition of GDP: the market value of all *final* goods & services produced within a country in a given period of time
GDP only includes final goods ... they already embody the value of the intermediate goods used in their production - *final goods* → intended for the end user - *intermediate goods* → used as components or ingredients in the production of other goods
short run aggregate supply
SRAS curve is upward-sloping over the period of 1-2 years, an increase in P causes an increase in the quantity of goods and services supplies
why is long run AS vertical?
Y(n), the natural rate of output, is determined by the economy's stocks of labor, capital, and natural resources, and on the level of technology an increase in P does not affect any of these, so it does not affect Y(n)
underemployment rate
a bureau of labor statistics measure that includes part-time workers who would rather have a full-time position & people who would like to work but have given up looking for a job
unemployment insurance
a government program that partially protects workers' incomes when they become unemployed - increases frictional unemployment b/c gives workers less incentive to find jobs
consumption & investment in the treatment of owner-occupied housing
a house is considered a piece of capital that is used to produce a flow of services - housing services when a consumer (as a tenant) rents a house/apt., the consumer is buying housing services - these services are considered *consumption*, so the price paid for these services (rent) is counted in the consumption component of GDP when someone buys a new house to live in, she is both a producer & a consumer - as a producer, she has made an *investment* (the purchase of the house) that will produce a service - she is also a *consumer* of this service, which is valued at the market rental rate for that type of house
consumer price index (CPI)
a measure of the cost of living - tracks the cost of the typical consumer's "basket" of goods & services - used to make cost of living adjustments and to correct economic variables for the effects of inflation
GDP deflator
a measure of the overall level of prices - measures the current level of prices relative to the level of prices in the base year *100 x (nominal GDP/real GDP)*
real price
a price that has been corrected for inflation
bank t-account
a simplified accounting statement that shows a bank's assets and liabilites
government purchases (G)
all spending on the goods & services purchased by the government - at the federal, state, & local levels - excludes transfer payments such as social security or unemployment insurance benefits (these are not purchases of goods & services)
money multiplier
amount of money the banking system generates with each dollar of reserves
slope of the AD curve
an increase in P reduced the quantity of goods and services demanded b/c: - the wealth effect → C falls - the interest-rate effect → I falls - the exchange-rate effect → NX falls
inflation
an increase in the average level of prices
why the AD curve might shift
any event that changes C, I, G, or NX (except a change in P) will shift the AD curve changes in C: - stock market crash - tax hikes/cuts changes in I: - forms buy new capital - expectations - interest rates - monetary policy changes in G: - federal spending - state & local spending changes in NX: - booms. recession in countries that buy our exports - appreciation/depreciation resulting from international speculation in foreign exchange market
why the long run AS might shift?
any event that changes any of the determinants of Y(n) will shift LRAS changes in L or natural rate of unemployment: - immigration - baby-boomers retire changes in K (capital) or H (human capital): - investment in factories, equipment - more people get college degress - factories destroyed by a hurricane changes in natural resources - discovery of new mineral desposits - reduction in the supply of imported oil changes in technology: - productivity improvements from technological progress
the rule of 70
approximates the length of time necessary for a growing variable to double *doubling time = 70 / growth rate %*
demand deposits
balances in bank accounts that depositors can access on demand by writing a check
tools of the fed: open-market operations
buying or selling US government securities in the "open market" - govn't securities are govn't bonds, bills, notes - affects the money supply through the federal funds rate - to *increase* money supply → fed will *buy govn't bonds* (securities) from the banks (buying securities from the public pumps cash into the economy)
how to find the economy's inflation rate
compute the percentage increase in the GDP deflator from one year to the next
why the SRAS curve might shift?
everything that shifts LRAS shifts SRAS too
what type of money does the US use?
fiat money, which includes currency and various types of bank deposits
the expenditure approach to GDP:
four components of GDP: 1. consumption (C) 2. investment (I) 3. government purchases (G) 4. net exports (NX) these concepts add up to GDP (denoted Y): Y = C + I + G + NX
the (factor) income approach to GDP:
four components of GDP: 1. wages 2. rents 3. interests 4. profits these components add up to GDP (denoted Y): Y = wages + rents + interests + profits
breaking down the definition of GDP: the *market value* of all final goods & services produced within a country in a given period of time
goods are valued at their market prices, so: - all goods measured in the same units (e.g. dollars in US) - things that don't have market value are excluded (e.g. housework you do for yourself)
financial system
group of institutions in the economy that help match the saving of one person with the investment of another
example of calculating economic growth: 2008 → real GDP per capita = $15,000 billion 2009 → real GDP per captia = $15,500 billion
growth = ($15,500-$15,000) / $15,000 = 0.033 0.033 x 100 = *3.3%*
why is GDP important?
having a large GDP enables a country to afford better schools, a cleaner environment, health care, etc. many indicators of the quality of life are positively correlated with GDP, for example... - GDP does not ensure health for children, but nations with larger GDP can afford better health care for children - GDP does measure the beauty of our poetry, nations with a larger GDP can afford to teach more students to read and write poetry
determinants of productivity: human capital, H
human capital, H: - knowledge and skills workers acquire through education, training, and experience human capital per worker, H/L: - productivity is higher when the average worker has more human capital (education, skills, etc.)- an increase in H/L causes an increase in Y/L
bank reserves
in a fractional reserve banking system, banks keep a fraction of deposits as *reserves* and use the rest to make loans the fed establishes reserve reuqirements - regulations on the minimum amount of reserves that banks must hold against deposits
inflation & the value of money
inflation drives up prices and drives down the value of money
correcting variables for inflation: comparing dollar figures from different times
inflation makes it harder to compare dollar amounts from different times amount in today's dollars = (amount in year T dollars) x (price level today / price level in year T) - price level = CPI
central bank
institution that oversees the banking system and regulates the money supply
financial intermediaries
institutions through which savers can *indirectly* provide funds to borrowers - banks - mutual funds → institutions that sell shares to the public and use the proceeds to buy portfolios of stocks and bonds
financial institutions
institutions through which savers can directly provide funds to borrowers - financial markets & intermediaries
income = expenditure
it must be true that income equals expenditure - for the economy as a whole - because every dollar a buyer spends is a dollar of income for the seller
how does the Fed control the money supply?
mainly through open-market operations - purchasing government bonds increases the money supply - selling government bond decreases the money supply
economic growth
measured as the growth rate of real GDP per capita calculated as: *g(t) = 100 x ([y(t)₂ - y(t)₁] / y(t)₁)*, where: - g(t) = growth rate of real GDP per capita - y(t) = real GDP per capita in time period t
calculating natural rate of unemploymeny
natural rate of unemployment... = frictional u-rate + structural u-rate = actual u-rate + cyclical u-rate
determinants of productivity: natural resources, N
natural resources, N: - inputs into production that nature provides (land, rivers, and mineral deposits) natural resources per worker, N/L: - other things equal, more N allows a country to provide more Y - an increase in N/L causes an increase in Y/L
net exports (NX)
net exports: *NX = exports - imports* - exports → foreign spending on the economy;s goods & services - imports → the portions of C, I, and G that are spent on goods & services produced abroad the subtraction of imports is important b/c imports are counted in the other components of GDP ... failing to subtract them would cause GDP to measure not just the value of goods produced domestically, but also goods produced abroad and imported.
which GDP rises faster: nominal or real?
nominal GDP rises faster b/c growth in nominal GDP is driven by growth in output AND inflation, whereas real GDP is driven only by growth in output
productivity
output per unit of labor - the quantity of goods & services produced from each unit of labor input *productivity = Y / L *, where - Y = real GDP = quantity of output produced - L = quantity of labor
using AD & AS to depict long-run growth and inflation
over the long run, technological progress shifts LRAS to the right, and growth in the money supply shifts AD to the right - result: ongoing inflation and growth in output
currency
paper bills and coins in the hands of the non-bank public
structural unemployment
persistent, long term unemployment caused by long-lasting shocks or permanent features of an economy that make it more difficult for some workers to find a job - occurs when there is not enough jobs to go around
determinants of productivity: physical capital, K
physical capital, K: - stock of equipment & structures used to produce goods and services physical capital per worker, K/L: - productivity is higher when the average worker has more capital (machines, equipment, etc.) - an increase in K/L causes an increase in Y/L
intution
printing more money cannot make a country more productive; it will only make everything appear more expensive.
the money supply
quantity of money available in the economy money supply = currency + deposits
what is the main indicator of the average person's standard of living?
real GDP per capita - real GDP per capita = (real GDP) /(population)
calculating real interest rate
real interest rate = (nominal interest rate) - (inflation rate)
financial markets
savers can *directly* provide funds to borrowers - governed by the forces of supply & demand - help allocate the economy's scarce resources to their most efficient uses - stock & bond markets
monetary policy
setting of the money supply by policymakers in the central bank
frictional unemployment
short term unemployment cause by the ordinary difficulties of matching employee to employer
aggregate demand curve
shows the quantity of all goods and services demanded in the economy at any given price level
AD supply curve
shows the total quantity of goods and services firms produce and sell at any given price - upward-sloping in short run - vertical in long run
determinants of productivity: technological knowledge
society's understanding of the best ways to produce goods and services technological progress means: - afaster computer, a higher-definition TV, or a smaller cell phone - also, any advance in knowledge that boosts productivity: allows society to get more output from its resources e.g., Henry Ford and the assembly line.
supply & demand of loanable funds
supply of funds→ comes from saving demand for funds → comes fro investment - the interest rate adjust to balance supply & demand in the loanable funds market
the interest-rate effect (P and I)
suppose the price level, P, declines: - buying goods & services requires fewer dollars - decrease in the interest rate - increase spending on investment goods, I - increase in quantity demanded of goods & services
the exchange-rate effect (P and NX)
suppose the price level, P, declines: - decrease in the interest rate - US dollar depreciates - stimulates US net exports, NX - increase in quantity demanded of goods & services
the wealth effect (P & C)
suppose the price level, P, declines: - increase in the real value of money - customers are wealthier - increase in consumer spending, C - increase i n quantity demanded of goods and services
difference b/w technological knowledge & human capital
technological knowledge → refers to society's understanding of how to produce goods & services human capital → results from the effort people expend to acquire this knowledge
natural rate of output, Y(n)
the amount of output the economy produces when unemployment is at its natural rate - aka: potential output or full-employment output
the federal reserve
the central bank of the US - responsible for regulating the monetary system
liquidity
the ease of converting an asset to cash
federal funds rate
the interest rate that banks and other financial institutions charge one another for short-term loans
tools of the fed: discount rate
the interest rate the federal reserve charges member banks for short-term loans - used mostly as a signal from the Fed to banking industry - to *increase* money supply → the fed *lowers discount rate* (makes borrowing from fed less expensive; banks may be less selective and lend more) - to *decrease* money supply → the fed *raises discount rate* (makes borrowing from fed more expensive; banks may be more discerning and lend less)
gross domestic product (GDP)
the market value of all final goods & services produced within a country in a given period of time
inflation rate
the percentage change in the average level if prices (as measured by a price index) over a period of time
tools of the fed: reserve requirement (R)
the percentage of deposit banks are required to hold as reserves - affects money supply because R affects money multiplier - to *increase* money supply → the fed *lowers R* (this increases the power of the money multiplier; banks can lend a larger fraction of their deposits)
monetary neutrality
the proposition that changes in the money supply do not affect real variables in the long-run
seasonal unemployment
unemployment caused by seasonal changes in the demand for certain kinds of labor
cyclical unemployment
unemployment that fluctuates with the business cycle, increasing in recessions and decreasing in expansions
breaking down the definition of GDP: the market value of all final goods & services produced within a country *in a given period of time*
usually a year or a quarter (3 months) - the quarterly GDP reported usually represents GDP "at an annual rate" (multiplies the quarterly figures by 4) so it can be compared with the annual data, and are seasonally adjusted so it is robust to seasonal changes
nominal GDP
values output measured using *current prices* - not corrected for inflation
real GDP
values output measured using the *prices of a constant base year* - is corrected for inflation - for the base year: normal GDP = real GDP
in a closed economy, equilibrium occurs in the market for loanable funds where?
where saving = investment
discouraged workers
workers who want to and are available for work, and who have looked for a job sometime in the last year but not in the last month b/c they believe that no jobs are available - excluded from the u-rate
