Macro exam 2

Growth Rate

( (X2 - X1) / (X1) ) ×100% GDP (X2) is the GDP in the later year (e.g., the current year). GDP (X1) is the GDP in the earlier year (e.g., the previous year). (Subtract the GDP of the earlier year (X1) from the GDP of the later year (X2). Divide the result by the GDP of the earlier year (X1). Multiply the quotient by 100 to express the growth rate as a percentage.)

Inflation Rate formula

((CPI in Current Year - CPI in Previous Year) / CPI in Previous Year) × 100

Ø Durable vs. Nondurable goods and how consumption is affected when we are in a recession?

(Durable goods are long-lasting items like cars and appliances, while nondurable goods are consumable items like food and clothing. During a recession, consumers tend to cut back on spending, especially on durable goods. They may delay purchases of items like cars and appliances, prioritizing essential nondurable goods instead. This behavior can lead to a decline in durable goods consumption and can contribute to the overall economic downturn.)

Labor Force Participation Rate

(Labor Force / Working-Age Population) x 100

Contraction (Recession): Characteristics

- Declining GDP: Economic output starts to shrink, and the economy contracts. - Rising Unemployment: Job losses and layoffs lead to higher unemployment rates. - Reduced Consumer and Business Confidence: Pessimism grows, leading to decreased spending and investment. - Declining Industrial Production: Manufacturing and production activities decrease. - Falling Investment: Businesses may delay or cancel investment projects. - Monetary Policy Response: Central banks may reduce interest rates and implement stimulus measures. - Budget Deficits: Government budgets may face shortfalls due to reduced tax revenue.

Trough: Characteristics

- Lowest Economic Activity: The economy reaches its bottom point before starting to recover. - Stabilization: Economic indicators start to level off, signaling a transition. - High Unemployment: Unemployment remains elevated but may stabilize. - Increased Caution: Consumers and businesses become cautious but anticipate future improvement. - Opportunities for Bargain Investments: Asset prices may be at their lowest, presenting investment opportunities. - Monetary and Fiscal Stimulus: Policymakers continue to support the economy with measures like low interest rates and government spending.

Peak: Characteristics

- Maximum Economic Activity: The economy is operating at or near full capacity. - Inflationary Pressures: As demand outpaces supply, inflation may begin to rise. - Tight Labor Markets: The labor market is tight, with very low unemployment. - High Consumer and Business Confidence: Confidence remains high but may start to show signs of hesitation. - Potential for Asset Bubbles: Asset prices, such as real estate and stocks, can be overvalued.

Expansion (Boom):Characteristics...

- Rising GDP: Economic output is increasing, and the economy is generally growing. - Low Unemployment: Job opportunities are abundant, and unemployment rates are low. - Increased Consumer and Business Confidence: Both consumers and businesses are optimistic about the future, leading to higher spending and investment. - High Industrial Production: Manufacturing and production activities are at their peak. - Growing Investment: Businesses are expanding and making investments in capital and labor. - Low Interest Rates: Central banks may keep interest rates relatively low to encourage borrowing and investment. - Moderate Inflation: Price increases are generally under control.

Elements of Okun's Law

- Unemployment Rate: The law focuses on the unemployment rate, which is a measure of the proportion of the labor force that is unemployed and actively seeking employment. - GDP Growth: It relates changes in real GDP...changes in the unemployment rate. When GDP grows, unemployment tends to decrease, and when GDP contracts, unemployment tends to increase.

peak

- business activity has reached a temporary maximum - economy is near or at full employment, and the level of real output is at or very close to the economy's capacity. The price level is likely to rise during this time.

consumer spending is what percent of all GDP

70%

expansion (sticky prices)

: During an economic expansion, when demand for goods and services increases, firms with sticky prices may not raise their prices immediately to match the higher demand. This can lead to increased sales and higher output for these firms, as they can sell more at the existing prices. However, they may experience bottlenecks and supply constraints as they struggle to meet the increased demand without raising prices.

frictional unemployment

: Frictional unemployment is the temporary period of unemployment that occurs when individuals are transitioning between jobs or entering the labor market for the first time. Examples: Job Seekers, Career Changers, Seasonal Workers

structural unemployment

: Structural unemployment occurs when there is a mismatch between the skills or location of job seekers and the requirements or location of available jobs. It often arises due to changes in the economy, technology, or shifts in demand for certain skills. Examples: Technological Advancements, Geographical Mismatch, Lack of Necessary Skills...

unemployment rate

= (Number of Unemployed Individuals / Labor Force) x 100

Ø What is a price index?

A price index is a numerical measure that reflects changes in the average prices of a basket of goods and services over time. It is used to track inflation or deflation and to compare the purchasing power of money across different time periods. Common examples include the Consumer Price Index (CPI) and the Producer Price Index (PPI).

GDP

C + I + G +NX Consumer Spending + Investments + Government Spending + Net Exports

What are "Sticky Prices" and how do they affect the business cycle?

Change in Output when price remains the same. "Sticky prices" refer to prices of goods and services that do not adjust immediately or frequently in response to changes in supply and demand. Instead, they remain relatively constant for a period of time, even when there are shifts in the overall economic conditions. This phenomenon is a crucial concept in macroeconomics and has important implications for the business cycle and overall economic stability.

How is GDP understated?

Changes in quality is unread by GDP... UNACCOUNTED work or sales that lead to economic growth.

Research and Development (R&D) Investment

Companies and governments invest in research and development activities to create new products and technologies.

how to measure inflation

Consumer Price Index (CPI) = (price of the most recent market basket in the particular year / price estimate of the market basket in 1982-1984) * 100

What is the components of the expenditure model for GDP

Consumption (C): This represents consumer spending on goods and services. It includes purchases of items like food, clothing, housing, healthcare, entertainment, and other consumer goods and services. Consumption is often the largest component of GDP in many economies. Investment (I): Investment refers to spending by businesses and individuals on capital goods and assets used in production. It includes expenditures on machinery, equipment, factories, buildings, and residential housing. Investment is a key driver of economic growth. Government Spending (G): This component accounts for government expenditures at the federal, state, and local levels. It includes spending on public services, infrastructure, education, defense, and other government programs and activities. Net Exports (NX):Exports represent goods and services produced domestically and sold abroad, while imports represent goods and services produced abroad and purchased domestically. A positive value indicates that a country is exporting more than it is importing, contributing to GDP, while a negative value indicates a trade deficit

CPI formula

Cost of Basket in Current Year / Cost of Basket in Base Year) × 100

Cost-Push Inflation:

Cost-push inflation results from increases in the production costs of goods and services. These cost increases can be triggered by factors such as rising energy prices, increases in labor wages, or disruptions in the supply chain. When businesses face higher production costs, they may pass these costs on to consumers by raising prices. Cost-push inflation can be a challenge for both businesses and consumers, as it erodes profit margins and decreases purchasing power. It can also be driven by external factors, such as natural disasters or geopolitical events that disrupt the supply of critical resources.

Cyclical Unemployment

Cyclical unemployment is associated with fluctuations in the business cycle. It occurs when there is a decrease in overall economic activity, leading to reduced demand for labor, and thus job losses. Examples: Recession: cyclical unemployment, Economic Downturns: financial crises or external shocks, can lead to cyclical unemployment.

What are demand and supply shocks and can you give examples

Demand shocks are sudden and unexpected changes in the quantity of a good or service that consumers are willing to buy at a given price. These changes can be caused by various factors, such as changes in consumer preferences, income, or expectations Supply shocks are unforeseen events that disrupt the production or supply of goods and services, leading to changes in the quantity available in the market. Supply shocks can result from natural disasters, labor strikes, or changes in input costs.

How can the unemployment rate be understated?

Discouraged Workers: People who have given up on finding a job and are no longer actively seeking employment are not counted as unemployed. This means that the official unemployment rate may not fully capture the number of people who are jobless and would like to work. Underemployment: The unemployment rate typically focuses on those who are completely jobless. It may not account for individuals who have part-time jobs but want full-time employment. This underemployment can lead to an understated unemployment rate. Informal Economy: People who work in the informal or underground economy, often in off-the-books jobs, may not be included in official unemployment statistics. This can result in an understated unemployment rate. Measurement Issues: Errors or limitations in data collection and measurement methods can result in an inaccurate representation of the true unemployment rate. For example, misclassification of workers or sampling errors can lead to an understated unemployment rate.

Labor Force.

Employed + Unemployed

Ø What is our natural rate of unemployment? What type of unemployment occurs when we are ABOVE the natural rate compared to when we are at or below our natural rate?

Frictional Unemployment: This type of unemployment is considered voluntary and occurs when individuals are transitioning between jobs or entering the labor market for the first time. It is a temporary and natural part of the labor market as people search for new job opportunities or better matches for their skills and preferences. Structural Unemployment: Structural unemployment is associated with a mismatch between the skills, location, or qualifications of job seekers and the requirements or location of available jobs. This type of unemployment can persist over time and is often caused by changes in the economy, technological shifts, or skills gaps. Seasonal Unemployment: Seasonal unemployment is temporary and occurs due to fluctuations in demand for certain jobs during specific times of the year. Examples include agricultural labor during planting and harvesting seasons or retail employment during holiday periods. (When an economy is operating with an unemployment rate that is above its natural rate, it experiences cyclical unemployment. Cyclical unemployment is a result of fluctuations in the business cycle and is associated with periods of economic downturn, such as recessions. During these times, demand for goods and services decreases, leading to reduced business activity, layoffs, and higher unemployment rates)

Production Approach

GDP is calculated by summing the value-added at each stage of production. Value-added is the difference between the value of a firm's output and the value of its intermediate inputs (materials, components, etc.). This method avoids double counting by focusing on the additional value created at each stage rather than the total output.

Expenditure Approach

GDP measures the total spending in an economy. It categorizes spending into different components, such as consumption, investment, government spending, and net exports. By summing these components, it ensures that the total value of economic activity is counted without duplicating transactions.

What is GDP?

GDP stands for Gross Domestic Product, and it is a fundamental economic indicator used to measure the economic performance and size of a country or region. GDP represents the total monetary value of all goods and services produced within a specific geographic area (usually a country) during a given period, typically a year or a quarter

Public Investment

Governments invest in public infrastructure, such as roads, bridges, schools, and healthcare facilities. These investments are made to improve the overall economic environment and promote long-term economic development.

Nominal Income Increase > Inflation:

If your nominal income (your income in current dollars) is rising at a faster rate than inflation, your real income is increasing. This means you have more purchasing power, and your standard of living can improve. You can buy the same goods and services as before and still have money left over for additional expenses or savings

Nominal Income Increase = Inflation:

If your nominal income is increasing at the same rate as inflation, your real income remains constant. In this case, your purchasing power remains unchanged. You can still afford the same goods and services as before but may not have additional funds for extra expenses or savings.

contraction (sticky prices)

In a downturn or recession, when demand decreases, firms with sticky prices may be hesitant to lower their prices quickly to stimulate demand. This can result in excess inventory, reduced sales, and a decline in output. Firms may cut production or reduce their workforce to adapt to the lower demand.

Ø What do we mean when we refer to "investment"?

In economics, "investment" refers to the allocation of resources. It involves the purchase or creation of assets, such as stocks, bonds, real estate, machinery, or research and development, with the aim of achieving a return on the invested capital. Investment plays a fundamental role in economic growth and development, and it can be categorized into several forms. investment in economics refers to the allocation of resources with the expectation of generating future benefits, whether in the form of financial returns, increased production capacity, human capital development, or technological advancement

Ø Why are strong property rights essential for economic growth?

Incentive for Investment: When individuals and businesses have confidence that their property rights are protected, they are more likely to invest in and develop their assets. This includes physical assets like land and buildings, intellectual property, and financial assets. The prospect of reaping the benefits from their investments encourages people to save, innovate, and take risks. Efficient Resource Allocation: Property rights help in the efficient allocation of resources. When property is privately owned, owners have a vested interest in maximizing its value and putting it to its highest valued use. Innovation and Creativity: Strong property rights protect intellectual property such as patents and copyrights. This protection is crucial to incentivize innovation.

· Describe inflation and what are 2 main types of inflation?

Inflation is an increase in the overall level of prices. - Demand-Pull Inflation - Cost-Push Inflation

What relationship do unemployment and inflation have?

Inverse

Nominal GDP - Definition

Nominal GDP is the total value of all goods and services produced in an economy, measured in current market prices and without any adjustments for inflation. Use: Nominal GDP is used to assess the absolute size of an economy and to compare economic output from one year to the next without considering changes in price levels. Doesn't account for changes in the price level, making it less suitable for comparing economic performance over time. Can be influenced by inflation, making it hard to determine if economic growth is due to increased production or rising prices

Human Capital Investment

People invest in education, training, and skills development with the expectation of improving their earning potential and career prospects over time.

How do you avoid double counting when measuring GDP (3)

Production approach income approach expenditure approach

Real GDP: Definition

Real GDP is the total value of all goods and services produced in an economy, adjusted for changes in the price level (inflation or deflation) so that it represents the economy's output in constant, base-year prices. Use: Real GDP is used to provide a more accurate measure of economic growth because it accounts for the effects of changing prices over time. It, however, is more complex to calculate than nominal GDP because it requires a price index (such as the Consumer Price Index) to adjust for inflation

What are ways we have become more productive over the last 100 years?

Technological Advancements: Technological innovations, such as the development of the internet, automation, and artificial intelligence, have transformed various industries. These technologies have streamlined processes, improved communication, and increased the efficiency of production. Industrialization and Automation: The shift from labor-intensive, manual processes to automated and mechanized production methods has significantly increased productivity. Factories and manufacturing facilities have become more efficient and capable of producing more with fewer workers. Specialization and Division of Labor: The division of labor, as theorized by Adam Smith, has become more pronounced. Specialization allows workers to become experts in their specific tasks, leading to higher productivity and efficiency. Improved Transportation and Logistics: Advances in transportation and logistics have made it easier to move goods and people quickly and cost-effectively. This has reduced supply chain inefficiencies and lowered the cost of production. Energy Efficiency: Improved energy technologies and the shift towards cleaner and more efficient energy sources have reduced the cost of energy and increased the productivity of energy-intensive industries. Education and Skill Development: Increased access to education and skill development programs has created a more skilled and adaptable workforce. A more educated and trained workforce is generally more productive. Globalization: The ability to access global markets, trade goods and services internationally, and outsource certain tasks to other countries has allowed firms to tap into cost-effective resources and expand their markets, boosting productivity. Innovations in Agriculture: Technological advancements in agriculture have greatly increased crop yields and reduced the labor required for farming. This has freed up labor for other industries and contributed to overall economic productivity. Infrastructure Development: The construction and maintenance of modern infrastructure, such as roads, bridges, and communication networks, have enhanced the efficiency of transportation and communication, facilitating economic growth. Lean Production and Quality Management: T

The Okun's Coefficient

The 2% to 3% coefficient is often used to quantify the relationship between unemployment and GDP growth. In other words, if the unemployment rate increases by 1%, GDP is expected to decrease by approximately 2% to 3%.

difference between nominal and real GDP

The key difference between nominal and real GDP lies in the adjustment for price changes. Real GDP adjusts for inflation or deflation, allowing for a more meaningful comparison of economic output over time. It helps to answer the question, "How much did the economy actually produce, accounting for changes in the price level?" Nominal GDP, on the other hand, reflects the current market prices and can be affected by changes in price levels.

Labor Force:

The labor force is the sum of employed individuals and unemployed individuals who are actively seeking employment. It does not include individuals who are not in the labor force (e.g., retirees, students, homemakers).

Natural Rate of Unemployment:

The law assumes the existence of a "natural rate of unemployment" or "full employment" rate, which is the level of unemployment that exists even in a healthy economy due to factors like job turnover, people transitioning between jobs, and changes in labor force composition.

Ø What is the leader/follower theory?

The leader-follower theory, often applied in business and management contexts, is a concept where a leader sets a direction or trend, and others (followers) in the industry or market imitate or follow the leader's strategies, decisions, or innovations. It's a theory about how market leaders can influence the behavior and choices of their competitors or peers.

Financial Investment

This includes the purchase of financial assets like stocks, bonds, and other securities. Investors expect to earn returns through dividends, interest, or capital gains as the value of these assets appreciates over time.

Physical Investment:

This involves the acquisition of tangible assets like machinery, equipment, real estate, and infrastructure. Businesses

Unemployed Individuals

This represents the total number of people who are actively seeking employment and are willing and able to work but do not have a job

Inflation and Deflation (sticky prices)

When prices are sticky, it can lead to inflation or deflation. Inflation occurs when prices are slow to adjust upward in response to increased demand. Deflation occurs when prices remain elevated even as demand falls. Both situations can have adverse effects on the business cycle. Inflation erodes purchasing power, while deflation can lead to reduced consumer spending as people postpone purchases in anticipation of lower prices.

Negative GDP Gap (Recessionary Gap):

When the actual GDP falls below the potential GDP, it results in a negative GDP gap or a recessionary gap. A negative GDP gap implies that the economy is not operating at its full potential and is underutilizing its productive capacity. It typically corresponds to periods of economic downturn, high unemployment, and underutilization of resources.

Positive GDP Gap (Inflationary Gap):

When the actual GDP is higher than the potential GDP, it is referred to as a positive GDP gap. This situation typically indicates that the economy is operating beyond its full productive capacity, which can lead to inflationary pressures because there may be excessive demand for goods and services relative to the economy's ability to supply them.

Nominal Income Increase < Inflation:

When your nominal income is rising at a slower rate than inflation, your real income decreases. In this situation, you have less purchasing power. Even though you are earning more money in current dollars, the increased cost of goods and services means you can buy less than you could before. This can lead to a lower standard of living and financial challenges.

recession

a period of decline in total output, income, and employment, that lasts at least 6 months. recessions generate a widespread contraction of business activity in many sectors of the economy. Along with a decline in real GDP, unemployement increases significantly

expansion

a recession is usually followed by a recovery and expansion, a period in which real GDP, income, and employment rise. At some point, the economy again approaches full employment. If spending then expands faster than production capacity, the prices of nearly all goods and services will rise, thereby generating a bout of inflation.

A Production Possibilities Curve (PPC)

also known as a Production Possibility Frontier (PPF) is a graphical representation that illustrates the various combinations of two or more goods or services that an economy can produce with its available resources and technology. Economic growth on the PPC is depicted by an outward shift or expansion of the curve.

Income Approach

calculates GDP by summing all the incomes earned within an economy. This includes wages, salaries, rents, interest, and profits. By measuring income flows, this approach ensures that each factor of production (labor, capital, land, and entrepreneurship) is only counted once.

3 types of unemployment

frictional, structural, cyclical

trough

in the trough of the recession or depression, output and employement "bottom out" at their lowest levels. The trough phase may be either short lived or quite long.

demand-pull inflation

inflation occurs when the aggregate demand for goods and services in an economy exceeds the aggregate supply. This can happen due to various reasons, such as increased consumer spending, business investment, or government expenditure. When demand outpaces supply, businesses may raise their prices to take advantage of the increased consumer interest, leading to overall price level increases. Demand-pull inflation is often associated with economic growth and can be a sign of a healthy economy, but if it becomes excessive, it can reduce the purchasing power of consumers and lead to economic instability.

Rule of 70 formula

number of years to double = 70 / growth rate in %

Business cycle phases

peak, recession, trough, expansion

inflation

rise in the general level of prices. reduces purchasing power of money

What is the Rule of 70

tells us how long it will take for something to double in size if it grows at a constant rate

Inflation is typically calculated using

the Consumer Price Index

Two primary concerns of Macroeconomics

unexpected changes in output and prices and long run growth

What is Okun's Law?

Ø Okun's Law is an empirical relationship that describes the relationship between changes in a country's unemployment rate and its GDP growth. ( The fundamental principle of Okun's Law is that there is a negative relationship between changes in the unemployment rate and changes in real GDP. Specifically, the law states that for every 1% increase in the unemployment rate above its natural or "full employment" level, there is a corresponding 2% to 3% decrease in real GDP. )

What is the deal with real income when you have increases in nominal income and inflations both rising at different levels?

Ø Real income will change... If nominal income rises faster than inflation real income goes up. If inflation is rises faster than nominal income, then real income goes down.

Under what type of prices (sticky or flexible) would a firm hold inventory if there was a demand shock?

Ø Sticky prices are when they don't move in the short run...Prices that don't change in the short run when demand gets times get better or worse. Flexible is more like gas... changing daily.