Macro Exam 2

Financial Institutions tell consumers about...

1. Risk sharing 2. Liquidity 3. Information

Problems with CPI

1. Substitution bias: Consumers may change their purchasing habits away from goods that have increased in price. 2. Increase in quality bias: Difficult to separate improvement in quality from increase in price, say in cars or computers. 3. New product bias: The basket of goods used to change only every 10 years. (Now it updates every 2 years.) There is a delay to including new goods like cell phones. 4. Outlet bias: CPI used to only survey prices at traditional retail outlets. Now it tries to minimize this bias by surveying people about where they actually buy products

Low income countries grow slowly because...

1. They fail to enforce the Rule of the Law 2. Wars and revolutions cant build an infrastructure 3. Poor education and poor health care 4. Low Rates of saving and investment

In a recession...

1. Unemployments goes up 2. Decreases in spending on durable goods - Durable good: Good not for immediate consumption and able to be kept for a period of time. 3. Inflation rate decreases

New growth theory

1. technological change is endogenous to economy 2. human capital important

Mercantilism

16th century till about the 18th century, serfs left their walled in manners and left to trade in cities, kings and queens became powerful, trading became important

What time period in the United States had the highest growth rate?

1950-1973

Rule of 70 formula

70/growth rate

By how many times are we wealthier today than in 1900 in terms of real GDP per capita?

8 times The average American can buy more than eight times as many goods and services now as in 1900

Loanable funds market

Borrowers and lenders determining the market interest rate and the quantity of loanable funds exchanged.

Who calculates CPI and PPP

Bureau of labor

CPI formula

CPI=expedentitures in current year/expenditures in base year x 100

Investment formula

I=Y-C-G income-consumption-govpurchasess

Consumer price index (CPI)

Is a measure of the average of the prices a typical urban family of four pays for the goods and services they purchase

Inflation rate

It is the percentage increase in price levels from one time period to anoth

Glorious Revolution (1688)

James II beheaded, British parliament gained power, repeal of the corn laws, repeal of the combination laws, progressive tax system put in place (wealthier you are the higher taxes you pay), public education for the poor

Gross National Product (GNP):

Market value of all final goods and services made by a country's citizens within a time frame

Who is left out of labor force?

Military employees, people incapable of working, people under 16 years of age (14 in Iowa), the disabled, homemakers and retirees.

What does NX=

Net Exports = Exports - Imports American NX are negative since the value of our imports exceeds the value of our exports

Will this add to GDP? Stock market transactions

No

Will this add to GDP? Welfare Benefits

No

will this add to GDP: used car sales

No

GDP deflator equation

Nominal GDP/Real GDP x 100

How do you calculate current real GDP

Previous GDP (1 + g)^t (g=growth rate)

How do you calculate real GDP

Quantity of a good in the current year and price of that good in a base year =base year x current quantity

Frictional unemployment

Short-term unemployment that arises from the process of matching workers with jobs

Natural rate of unemployment=

Structural unemployment + frictional unemployment

Labor force

Sum of employed and unemployed workers in the economy

S public =

T - G - TR taxes - gov purchases - transfer payments might be negative

Deficit in Gov saving

T < G+Tr

Economic Growth

The ability of an economy to produce increasing quantities of goods and services

How do we know when the economy is in a recession?

The federal government does not define when a recession starts or ends. - The typical media definition of a recession is "two consecutive quarters of declining real GDP."

Unemployment

The number of the labor force that is unemployed

Expansion

The period of a business cycle during which the total production and total employment are increasing. - To have a healthy economy, we should have 50,000+ new jobs

What period of recession was the longest and most severe since the Great Depression of the 1930s, prompting some to refer to it as the Great Recession.

The period of recession starting in late 2007 and ending in mid-2009 - The recession brought large decreases in spending on durable goods, including motor vehicles - Led economists to think if we would return to the previous pattern of long expansions and short, mild recessions

Production Function

The relationship between quantity of inputs used to make a good and the quantity of output of that good

True or False: Stagflation has occurred repeatedly in the developed world since the 1970s

True

Structured unemployment

UE due to your job is no longer needed (ex: phone operator)

Cyclical unemployment

Unemployment caused by a business cycle recession.

Structural unemployment

Unemployment that arises from a persistent mismatch between the skills or attributes of workers and the requirements of jobs.

How do you use price indexes to adjust to the effect of Inflation?

Value in year 2 $ = Value in Year 1 $ x CPI yr 2/ CPI year 1 Example. Year in 2016 = value in 1991 x CPI 2016/CPI 1991 $44,118 = $25,000 x 240/136

What are nominal variables?

Values like wages in current-year dollars

Balanced budget

When Public Savings is zero, the government spends as much as it brings in

Surplus in Gov saving

When T > G+Tr

Closed Economy GDP formula

Y (GDP) = C + I + G (no exports or imports)

S private =

Y + TR − C − T Y=household income includes payments for factors of production TR = transfer payments C = households consume T = taxes

Will this add to GDP? Bought a brand new house

Yes

Will this add to GDP: Owner purchases a new door to replace the old on

Yes, it is a final good

GDP deflator

a measure of the average price of goods and services in the economy

Price levels

a measure of the average prices of goods and services in the economy

Feudalism

an economic system where traditions rule (8th-15th century)

what are the three types of research

basic (public good), applied (public or private good), market private

Foreign portfolio investment

buying stocks and bonds

What does C=

consumption (Services, consumer undurable, durables, actual rental payments on apartments, and houses) - largest component of GDP

Joseph Schumpeter idea of creative destruction

deliberate dismantling of established processes to make way for improved methods (entrepreneurship) ex: horse drawn carriage to cars

Capitalism

economic system based on private property and the market, in which individuals ask how, what and for when do you produce

What is responsible for implementing technological change

entrepreneurship

what are indirect funds

financial intermediaries, banks, mutual funds, pensions

Rule 70

finds the number of years it will take to double investments

what determines the rate of long run growth?

increase in labor productivity

Why the LFPR (Labor force participation rate)

it measures how much of our labor resource is being used

Suppose the gov shifts from taxing nominal interest to real interest? what happens to savings?

nominal - inflation = real 8% - 5% =3% (it decreases)

Recession

period of business cycle during which total production and total employment are decreasing

Growth rate formula

point 2-point 1/point 1 x100

Savings =

public saving + private saving Y - C - G

What is included in the national income

salary and wages, rents, interest and profits

The catch-up model

shows that poor countries will grow faster than wealthy countries

What are direct funds

stocks and bonds

What were some driving factors in the 1970s recession

the Vietnam war, an increase in social spending and an increase in foreign competition

Gross Domestic Product (GDP)

the market value of all final goods and services produced in a country during a period of time (usually a year)

Stagflation

the simultaneous appearance in an economy of slow growth, high unemployment, and rising prices

What are the two main conceptual ways to measure the total economic activity in an economy

total production and total income

What happened with stagflation in the 1970s/80's

- 1970s saw some of the highest rates of inflation in the US in recent history, interest rates rose to nearly 20% - Fed policy, the abandonment of the gold window, Keynesian economic policy and market psychology all contributed to the high inflation - Lower inflation would return only after a tough period of tight money and recession

Value added

- An alternative method to measure GDP -Take the value added at each stage of production, add them up, and that is what that good contributes to GDP

What's the different between PPI & CPI

- PPI is similar to the CPI, in that it uses a basket of goods, but the goods are those used by producers. PPI Includes raw materials like coal and crude petroleum, and intermediate goods like flour, yarn, steel, and lumber.

Problems with unemployment

- The discouraged worker: those who are out of work but give up looking for work and have not looked for work in the past 4 weeks. They are not part of the labor force. - The underemployed: those who work but either do not work as much as they want or are hired in a capacity that does not utilize the worker's productivity. - Overstate UE, lie about looking for work - Doesn't capture job intensity

other factors that affect UE

- UE rates -minimum wage laws - labor unions - efficiency wages

What do you need to calculate CPI in a given year

- a basket of goods - the cost to purchase the basket of goods in base year -the cost of making the same purchase of goods and services from the base year and now using prices in the current year

how do we change human capital

- education (public good = non exclusive and non rival) - learning by doing (internships) - accumulate knowledge through research

How do you increase labor productivity?

- hours of human and physical capital per hour worked - level of technology

How did mercantilist differ from classical economist

- in terms of $ mercantilist saw money as an end in itself - in terms of commerce the rich does not give up resource to the poor

main aspects of GDP:

- measurement put in $s - it is the market value of all final goods and services within a time period -excludes pure exchange transactions -includes only production that takes place during the indicated time

Inflation

- rapid inflation occurs when the prices of goods and services suddenly rise, eroding the purchasing power of savings

Adam Smith

- wrote the wealth of nations (1776), believed money was a veil, money is a medium of exchange not an end in itself

What rate do economists believe the CPI overstates true inflation by

0.5-1%

What are other things we can do with the CPI?

1. Change from nominal to real dollars - Value of point 2 = value of point 1 x ((CPI point 2) / (CPI point 1) 2. Estimate real interest rates

What did mercantilism lead to?

1. Colonization 2. High taxes for agricultural imports, food was very expensive even if on farm (Corn Laws) 3. Labor unions were outlawed: Combination Laws (wealthy wanted to keep poor poor)

Supply for loanable funds decreases (shifts left) when...

1. Crowding out in deficit with government (government is spending deficit, tos pend that they have to take out money, competing for loans with people, drive interest rates up and makes quantity loans less than) 2. Consumption increases 3. Personal taxes increases

The Great Moderation

1. Increasing important services 2. The establishment of unemployment insurance 3. Active federal government stabilization policies 4. Increased stability of the financial systems

Concerns with GDP

1. Military 2. Rural 1950-1980 urbanization - of country, selling farms to move to town, women entering workforce 3. Quality of life -lots of pollution, high GDP -happiness score (Norway happiness place to live) -Leisure time -crime 4. Underground market 5. Lags - GDP from last quarter, revising 6. Lifestyle differences

How does New Growth Theory protect new technology

1. Patents - Review the way to make the good 2. Plant rarity protection certification 3. Copyrights 4. Trade secrets 5. Government subsidies in education 6. Government subsidies in Research and development

What are other ways to identify a recession?

1. Production inputs 2. Production prices 3. New housing starts 4. Durable goods purchase (are people willing to buy?)

Demand for loanable funds increases (shift right) when....

1. Profitable opportunities 2. Technological change 3. Taxes on industry go down

Business Cycle

Alternating periods of economic expansion and economic recession

Nominal GDP

GDP in current dollars

GDP formula

GDP= C+I+G+NX C=consumption I=Investments G=Gov. Spending NX= Net exports

What does G=

Government Spending (Federal, State, and local governments)

What does I=

Gross Investment (Business fixed investment(based on savings), residential investments, and changed in business inventories)