Macro ch.5-7

Labor force

those in the adult population who are either working or looking for work

What is gross about gross domestic product? Could an economy enjoy a constant—or growing—GDP while not replacing worn-out capital?

Gross domestic product ignores depreciation. Depreciation measures the value of the capital stock that is used up or grows obsolete in the production process. GDP could grow without replacing worn-out capital, but it would imply a falling net domestic product (NDP). NDP is equal to GDP minus depreciation.

Stock

amount measured at a particular point in time

Structural unemployment

arises because of a mismatch of skills or geographic location

Recession

mild contraction, a decline in total output traditionally defined as lasting at least two consecutive quarters

Expansion

economy grows; rising output, employment, and income

Cyclical unemployment

fluctuates with the business cycle, increasing during recessions and decreasing during expansion

Inflation

increase in the economy's average price level

Aggregated demand

is the relationship between the economy's price level and aggregated output demanded

Aggregate output

is the total amount of final goods and services produced in the economy during a period of time, real GDP

Gross domestic product

measures the market value of all final goods and services produced during a year by resources located in the US regardless of who owns the resources

Intermediate goods and services

purchased by firms for further reprocessing and resale

Income approach

adds up earning during the year by those who produce all that output

Why is a relatively constant and predictable inflation rate less harmful to an economy than a rate that fluctuates unpredictably?

A constant inflation rate means less uncertainty about real dollar flows (e.g., incomes, rents, interest of payments) compared with a variable rate. Consequently, there is less risk associated with lending and less unintended redistribution of real output because of unanticipated inflation.

Describe the relationship illustrated by the aggregate demand curve. Why does this relationship exist?

Aggregate demand describes an inverse relationship between the average price level of all goods and services and the total quantities of goods and services demanded throughout the entire economy. The quantity of aggregate output demanded depends in part on household wealth. An increase in the price level decreases the purchasing power of bank accounts and currency. Thus, households are poorer when the price level increases, so they decrease the quantity of aggregate output demanded.

Disposable income

Aggregated - (Taxes + Transfers)

What is the relationship between demand-side economics and the federal budget deficit?

Demand-side economics focuses on the ability of the government to affect aggregate demand and thus promote full employment. During periods of unemployment, demand-side economics recommends that the federal government expand aggregate demand by employing expansionary fiscal policy, by increasing government spending and/or cutting taxes. This is likely to result in budget deficits, when government expenditures exceed government tax revenues.

E-readers and HDTVs have not been part of the U.S. economy for very long. Both goods have been decreasing in price and improving in quality. What problems does this pose for people who are responsible for calculating a price index?

During the base year, HDTVs may not have been an important part of the budget of the average household or an important good in the economy as a whole. Thus, their share of the current market basket will be understated. Because of this, a fall in the price of HDTVs will not affect the index very much. Today, a fall in the price of HDTVs may affect people's standard of living greatly. In this sense, the index may be biased. Another problem has been the changing quality of HDTVs and e-readers. If HDTVs become more expensive but have twice as much capacity to entertain, who is to say that the actual price has risen? Such changes in quality introduce a different type of bias into the index.

Why do economists pay more attention to national economies (for example, the U.S. or Canadian economies) than to state or provincial economies (such as California or Ontario)?

Each national economy has its own rules of the game, that is, its own laws, regulations, customs, and conventions for conducting economic activity. U.S. gross domestic product provides a measure of the performance of the national economy and of how it interacts with the rest of the world.

In national income accounting, one component of investment is net changes in inventories. Last year's inventories are subtracted from this year's inventories to obtain the net change. Explain why net inventory increases are counted as part of GDP. Also, discuss why it is not sufficient to measure the level of inventories only for the current year. (Remember the difference between stocks and flows.)

First, inventories are a stock, not a flow. Some of the inventories now existing were produced in earlier years and have nothing to do with this year's production. To obtain only this year's production of inventories, we need to subtract the total amount of inventories this year from that of the previous year. Second, inventories should be considered a type of investment good, because they are produced with the understanding that they will yield revenue over time, just as plants and equipment do. The time frame over which they do this is usually very short. Finally, inventory changes should be considered part of national income because they are current production and are not sold to other firms. The final sale in this case is to the firm itself.

The health expenditure component of the GDP price index has been rising steadily. How might this index be biased by quality and substitution effects? Are there any substitutes for health care?

For some time now, health care costs have been rising steadily. However, the rise in some types of health care prices has been caused partly by the rising costs associated with better quality care. For example, a CAT scan procedure is relatively recent. There are many other examples of quality rising along with prices. As prices of health care rise, people find substitutes. For example, they may take better care of themselves (e.g., smoking less, eating well, and exercising). They may not consult a doctor when illness is not severe, preferring home or nonprescription remedies instead.

What were some of the causes of the stagflations of 1973 and 1979? In what ways were these episodes of stagflation different from the Great Depression of the 1930s?

In 1973, crop failures around the world caused grain prices to rise substantially. At the same time, OPEC raised oil prices sharply. These two events combined to reduce aggregate supply, causing the price level to rise while output and employment fell. In 1979, oil prices again rose sharply, and aggregate supply dropped.

If actual inflation exceeds anticipated inflation, who will lose purchasing power and who will gain?

In the case described, those who have borrowed at fixed nominal rates will gain purchasing power, and those who have lent at such rates will lose. Also, workers whose wages are not tied directly to the price level will lose.

Why do people dislike inflation?

Inflation distorts purchasing power and, especially if variable and unanticipated, causes other problems including the arbitrary redistribution of income and wealth from one group to another, a reduction in the ability to make long-term plans, and an increase in transaction costs due to less transparent relative price changes that force buyers and sellers to pay more attention to prices.

Explain why intermediate goods and services usually are not included directly in GDP.

Intermediate goods and services are further processed and resold to become part of the value of final goods and services. The market value of final goods and services already includes the value of intermediate goods and services used up in the production of the final good or service. If the intermediate goods and services were also counted directly, they would be counted twice in GDP, once as themselves and again as part of the price of the final good or service. However, intermediate goods and services that are produced in a given year—but not yet processed and resold to become part of a final good or service—must be included directly in GDP. These intermediate goods and services become part of the firms' inventories and, thus, part of the investment component of GDP.

Define leading economic indicators and give some examples.

Leading economic indicators are economic statistics that change prior to a change in the overall economy. That is, they turn downward before a recession and upward before an expansion, thus pointing to the future direction of the overall economy. Examples include orders for machinery and equipment, the stock market index, consumer confidence, and household spending on durable goods.

What are the leakages from and injections into the circular flow? How are leakages and injections related in the circular flow?

Leakages include net taxes (taxes minus transfer payments), saving, and imports. Injections consist of investment spending, government purchases, and exports. In equilibrium, leakages from the circular flow equal injections into the circular flow.

How are economic fluctuations linked across national economies? How could a recession in the United States trigger a recession abroad or vice-versa?

Major economies around the world often fluctuate together. Economies are related through international trade, finance, and migration, and ties grow stronger each year. A recession in the U.S. increases unemployment and decreases production in the U.S. The U.S. will export fewer goods and services (since total production declined) and will import fewer goods and services (since income declined). Foreign production goes unsold and foreign firms eventually cut back production and lay off workers. Foreign countries experience lower output and higher unemployment, a recession.

When the economy is at full employment, is the unemployment rate at zero percent? Why or why not? How would a more generous unemployment insurance system affect the full employment figure?

No, even at "full employment," frictional, seasonal, and structural unemployment still exist. Full employment implies that only cyclical unemployment is zero. A more generous unemployment insurance system might lead to more unemployment because incentives to work would be lower and more people could qualify for benefits for, perhaps, a longer period of time.

Does the overall unemployment rate offer an accurate picture of the impact of unemployment on each U.S. population group?

No, the overall unemployment rate does not show the wide differences that occur across age, race, and gender categories. For example, blacks have a higher unemployment rate than whites. Teenagers also have higher unemployment rates than adults, while women have higher rates than men do. Wide disparities also exist across geographical regions in the country. For example, unemployment in Midwestern industrial states substantially exceeds the overall unemployment rate. The unemployment rate also does not indicate the duration of unemployment. This is important, because the longer an individual is unemployed, the greater is its impact.

Differentiate between stock and flow variables. Give an example of each.

Stock variables are measures at a given point in time such as height, weight, checking account balance. Flow variables measure something over an interval such as annual income, monthly budget.

One form of the CPI that has been advocated by lobbying groups is a "CPI for the elderly." The Bureau of Labor Statistics currently produces only indexes for "all urban households" and "urban wage earners and clerical workers." Should the BLS produce such an index for the elderly?

The CPI is based on the cost of a set of goods purchased by the typical urban wage earner. If the elderly purchase a different set of goods (more medical care, for example), a CPI for the elderly could change in a manner very different from that of the official CPI indexes. This could be important to the elderly because the CPI is used to index changes in Social Security, Medicare, and programs. Whether such an index is worth producing depends on how the costs of producing such an index compared with the benefits that would accrue to the users of the index.

What does the consumer price index measure? Does the index measure changes in relative prices? Why, or why not?

The consumer price index measures the price level as the cost of a fixed "market basket" of consumer goods and services. Percentage changes in the cost of this basket are used as a measure of inflation. Because it looks at the overall cost of that basket, it masks changes in relative prices. Within the basket, prices of some goods may be falling, some may be rising more slowly than the overall basket's cost, and others may be rising more rapidly. Goods whose prices are rising more rapidly have an increased relative price compared to goods whose prices are rising more slowly.

Explain as carefully as you can why borrowers would be willing to pay a higher rate of interest if they expected the inflation rate to increase in the future

The cost of borrowing is the opportunity cost today of purchasing power given up in the future. Thus, an increase in the expected inflation rate means that borrowers can increase their nominal repayment rate without increasing the lost future purchasing power. The real rate of interest falls for the initial lower nominal rate

In countries such as Zimbabwe, which had problems with high inflation, the increased use of another country's currency (such as the U.S. dollar) became common. Why do you suppose this occurred?

The desire to replace one's currency with some other currency having stable value is the reason. If successful, you don't have to worry about a reduction in purchasing power due to your country's unstable currency because you have moved your cash into a more stable currency.

Why doesn't the National Bureau of Economic Research identify the turning points in economic activity until months or even a year after they occur?

The economy does not move smoothly through recessions and expansions. Throughout each year, the economy goes through seasonal fluctuations, for example, the tourist industry in Colorado expands during the winter months. In addition, the economy experiences random disturbances, such as the impact due to hurricanes or earthquakes. The NBER must wait to determine whether a change in the direction of the economy is sustained in order to distinguish the impact of seasonal fluctuations and random disturbances and the movement into a recession or expansion.

Expenditure approach

adds up spending on all final goods and services produced in the US during the year

Describe fluctuations in economy activity over time. Because economic activity fluctuates, how is long-term growth possible?

The economy moves through periods of expansion and periods of contraction. Contractions include recessions in which total output and employment decline over a six-month period and more serious depressions in which sharp reductions occur in output and employment that last more than a year. The end of a contraction is marked by the trough, or lowest point. After the trough, the economy enters an expansion period in which total output increases until the economy reaches its peak. The economy grows over time. This is possible because the growth during expansions more than offsets the decline during recessions. In fact, expansions and contractions are measured as movements above and below the long-term trend line.

Explain why most experts believe that official U.S. data underestimate the actual rate of unemployment. What factors could make the official rate overstate the actual unemployment rate?

The official unemployment rate does not include discouraged workers—those who have given up searching for work in the belief that it is futile. In addition, the official rate does not account for underemployment. Because unemployment insurance and most welfare programs require recipients to seek employment, some people may act as if they are looking for work just to qualify for such programs. If these people do not in fact want to find a job, their inclusion among the unemployed tends to overstate the official unemployment figures.

If people dropped out of the labor force because they could not find work, what would this do to the unemployment rate? Why?

The unemployment rate would decrease. The unemployment rate is calculated as the number of people unemployed divided by the labor force, and when discouraged workers drop out of labor force, both the number of unemployed and the labor force decrease by the number of discouraged workers, which decreases the unemployment rate.

Leading economic indicators

Variables that predict, or lead to, a recession or recovery; examples include consumer confidence, stock market prices, business investment, and big-ticket purchases, such as automobiles and homes

Coincident economic indicators

Variables that reflect peaks and troughs in economic activity as they occur; examples include employment, personal income, and industrial production

Why does a decrease of the aggregate demand curve result in less employment, given an aggregate supply curve?

When aggregate demand decreases along a fixed aggregate supply curve, both the price level and the output level drop. As aggregate output declines, fewer workers are needed and unemployment rises.

Is it possible for the price level to fall while production and employment both rise? If it is possible, how could this happen? If it is not possible, explain why not.

Yes, this could occur if aggregate supply and aggregate demand increased. Both curves would shift to the right, but the aggregate supply curve would shift more than the aggregate demand curve. This would force down the price level while increasing production. Increased production and a lower price level would also occur if aggregate supply increased along a fixed aggregate demand curve.

Flow

a measure of an amount per unit of time

Seasonal unemployment

caused by seasonal changes in labor demand during the year

Contraction

economy declines; falling output, employment and income

Price level

is the average price of aggregated output

Frictional unemployment

reflects the time required to bring together employers and job seekers

Depression

severe contraction or reduction in the nation's total production lasting more than a year and accompanied by high unemployment

Aggregated demand curve

shows the inverse relationship between the economy's price level and real GDP demanded, downward sloping

Aggregated supply curve

shows the positive relationship between the price level and the quantity of real GDP supplied, upward sloping

Great Depression

stock market crashed because people were in so much debt > aggregated demand quantity shifted left because price and quantity dropped

Net taxes

taxes - transfer payments

Labor force participation rate

the number in the labor force divided by the adult population

Aggregate income

the sum of all the income earned by resource suppliers in the economy during the year