Macroeconomics exam 2

What two key factors cause labor productivity to increase over time?

labor productivity: the quantity of capital per hour worked and the level of technology.

What is potential GDP? Does potential GDP remain constant over time?

level of GDP attained when all firms are producing at capacity. Potential GDP increases over time as the labor force grows, new factories and office buildings are built, new machinery and equipment are installed, and technological change takes place.

Why in microeconomics do we measure production in terms of quantity, but in macroeconomics we measure production in terms of market value?

macroeconomics—which studies the economy as a whole. GDP is the market value of all final goods and services produced in a country during a period of time, typically one year and is measured in terms of market value.

What is protectionism? Who benefits and who loses from protectionist policies? What are the main arguments peo- ple use to justify protectionism?

protectionism, which is the use of trade barriers to shield domestic firms from foreign competition. Protectionism is usually justified on the basis on saving jobs, protecting high wages, protecting infant industries, and protecting national security.

What is a tariff? What is a quota? Give an example, other than a quota, of a nontariff barrier to trade.

tariff is a tax imposed by a government on imports. A quota is a numerical limit imposed by a government on the quantity of a good that can be imported into the country. A voluntary export re- straint (VER) is an agreement negotiated between two countries that places a numerical limit on the quantity of a good that can be imported by one country from the other country.

What are the main reasons many poor countries have experienced slow growth?

wars and revo- lutions, poor public education and health, failure to enforce the rule of law, and low rates of saving and investment. The rule of law refers to the ability of a government to enforce the laws of the country, particularly with respect to protecting property rights and enforcing contracts.

What are the names of the following events that occur during a business a. The high point of economic activity B. The low point of economic activity C. The period between the high point of economic activ- ity and the following low point D. The period between the low point and following the high point

A. Peak B. Through C. Expansion D. Recession

Assuming that inflation has occurred over time, what is the relationship between nominal GDP and real GDP in each of the following situations? a: In the years after the base year B: In the base year C: In the years before the base year.

A: real GDP is greater than nominal GDP in years before the base year B: real GDP equals nominal in base year C: less than nominal GDP for years after the base year.

Can economic analysis arrive at the conclusion that eco- nomic growth will always improve economic well-being? Briefly explain.

Although we didn't state so explicitly, in this chapter we have assumed that economic growth is desirable and that governments should undertake policies that will increase growth rates. It seems undeniable that increasing the growth rates of very low-income countries would help relieve the daily suffering that many people in those countries endure. But some people are unconvinced that, at least in the high-income countries, further economic growth is desirable for reasons like possible pollution and depletion of natural resources.

Why do nominal incomes generally increase with inflation? If nominal incomes increase with inflation, does inflation reduce the purchasing power of an average consumer? Briefly explain.

An expected inflation rate of 10 percent will raise the average price of goods and services by 10 percent, but it will also raise average incomes by 10 percent. Goods and services will be as affordable to an average consumer as they would be if there were no inflation.

Why are firms likely to underinvest in research and development? Briefly discuss three ways in which govern- ment policy can increase the accumulation of knowledge capital.

Because knowledge capital is nonrival and nonexcludable, firms can free ride on the research and development of other firms. Firms free ride when they benefit from the results of research and development they did not pay for. Romer points out that firms are unlikely to invest in research and development up to the point where the marginal cost of the research equals the marginal return from the knowledge gained because other firms gain much of the marginal return. Therefore, there is likely to be an inefficiently small amount of research and development, slowing the accumulation of knowledge capital and economic growth. Government policy can help increase the accumulation of knowledge capital in three ways: 1. Protecting intellectual property with patents and copyrights 2. Supporting research and development. 3. Subsidizing education

What is the underground economy? Why do some coun- tries have larger underground economies than other countries?

Buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal. The underground economy is much larger in many developing countries—perhaps 50 percent or more of measured GDP. In developing countries, the underground economy is often referred to as the informal sector, as opposed to the formal sector, in which out- put of goods and services is measured.

What events led to the General Agreement on Tariffs and Trade (GATT)? Why did the WTO eventually replace the GATT?

By the end of World War II in 1945, government officials in the United States and Europe were looking for a way to reduce tariffs and revive international trade. To help achieve this goal, they set up the General Agreement on Tariffs and Trade (GATT) in 1948. Countries that joined the GATT agreed not to impose new tariffs or import quo- tas. In addition, a series of multilateral negotiations, called trade rounds, took place, in which countries agreed to reduce tariffs from the very high levels of the 1930s.

Briefly explain how international trade increases a country's consumption.

By trading, countries are able to consume more than they could without trade. This outcome is possible because world production of both goods increases after trade.

What are the main sources of comparative advantage?

Climate and natural resources, rela- tive abundance of labor and capital, technology, and external economies. External economies are reductions in a firm's costs that result from an increase in the size of an industry.

What is the difference between absolute advantage and comparative advantage? Will a country always be an exporter of a good in the production of which it has an absolute advantage? Briefly explain.

Comparative advantage is the ability of an individual, a firm, or a country to produce a good or service at the lowest opportu- nity cost. Absolute advantage is the ability to produce more of a good or service than competitors when using the same amount of resources. Countries trade on the basis of comparative advan- tage, not on the basis of absolute advantage.

A World Trade Organization (WTO) publication calls comparative advantage "arguably the single most pow- erful insight in economics." What is comparative advantage? What makes it such a powerful insight?

Comparative advantage is the ability of an individual, a firm, or a country to produce a good or service at the lowest opportunity cost.

Which groups tend to have above-average unemploy- ment rates, and which groups tend to have below-average unemployment rates?

Different groups in the population can have very different unemployment rates. Figure 9.4 shows unemployment rates in August 2015 for different ethnic groups and for groups with different levels of education. While the overall unemployment rate was 5.1 percent, Asians had an unemployment rate of 3.5 percent, and African Americans had an unemployment rate of 9.5 percent. The unemployment rate for people over age 25 without a high school degree was 7.7 percent, while the unemployment rate for college graduates was only 2.5 percent.

Briefly describe the debate among economists over how high U.S. productivity growth rates are likely to be in the future.

Economists have not reached a consensus in explaining the swings in U.S. productivity growth since the mid-1970s. Broadly speaking, economists' views fall into two camps: • The optimistic view. Some economists argue that although productivity has be- come more difficult to measure, the United States is likely to experience high rates of productivity growth in the long run, which will significantly increase the stan- dard of living of the average person in the decades ahead. • The pessimistic view. Other economists believe that productivity growth en- tered a long-run decline in the mid-1970s that was overcome for only a brief pe- riod of time by the initial effects of the revolution in information technology. These economists argue that future productivity growth rates are likely to remain low and, therefore, the standard of living of the average person in the United States will increase only slowly. (Hubbard)

In the circular flow of income, why must the value of total production in an economy equal the value of total income?

Every penny must end up as someone's income. (Note, though, that any sales tax on the shoes will be collected by the store and sent to the government, without ending up as anyone's income.) There- fore, if we add up the values of every good and service sold in the economy, we must get a total that is exactly equal to the value of all the income in the economy.

Does everyone gain from international trade? If not, explain which groups lose.

Example: In a world with trade, there would be only Japanese smartwatch firms and U.S. tab- let firms. Japanese tablet firms and U.S. smartwatch firms would close. Overall, total employment would not change, and production would increase as a result of trade. Nevertheless, the owners of Japanese tablet firms, the owners of U.S. smartwatch firms, and the people who work for them are worse off as a result of trade. The losers from trade are likely to do their best to convince the Japanese and U.S. governments to interfere with trade by barring imports of the competing products from the other country or by imposing high tariffs on them.

Briefly explain whether you agree with the following statement: "International trade is more important to the U.S. economy than it is to most other economies."

False, imports and exports in the US are a lower percentage of GDP than in many other countries.

Why is a country's financial system important for long- run economic growth?

Financial markets and financial intermediaries together comprise the financial system. With- out a well-functioning financial system, economic growth is impossible because firms will be unable to expand and adopt new technologies.

What is the relationship between frictional unemploy- ment and job search?

Frictional unemployment is short-term unemploy- ment that arises from the process of matching workers with jobs. One type of frictional unemployment is seasonal unemployment, which refers to unemployment due to factors such as weather, variations in tourism, and other calendar-related events.

What are the three types of unemployment? Which type of unemployment do you consider most likely to result in hardship for people who are unemployed? Briefly explain.

Frictional unemployment is short-term unemploy- ment that arises from the process of matching workers with jobs. Struc- tural unemployment arises from a persistent mismatch be- tween the job skills or attributes of workers and the requirements of jobs. Cyclical unemployment is caused by a business cycle recession. (Hardest)

What is gross domestic income? Which component of gross domestic income is the largest?

GDP calculated as the sum of income payments to households is sometimes called gross domestic income. Figure 8.5 shows the division of total income among wages, interest, rent, profit, and certain non-income items. The non-income items are included in gross domestic income because sales taxes, depreciation, and a few other items are included in the value of goods and services produced but are not directly received by households as income. Wages include all compensation received by employees, including fringe bene- fits such as health insurance. Interest is net interest received by households, or the differ- ence between the interest received on savings accounts, government bonds, and other investments and the interest paid on car loans, home mortgages, and other debts. Rent is rent received by households. Profits include the profits of sole proprietorships, which are usually small businesses, and the profits of corporations. Figure 8.5 shows that the largest component of gross domestic income is wages, which are about three times as large as profits.

Why is GDP an imperfect measure of economic well- being? What types of production does GDP not measure? If GDP included these types of production, would it still be an imperfect measure of economic well-being?

GDP does not include household production, which refers to goods and services people produce for themselves, nor does it in- clude production in the underground economy, therefore it is not a perfect measure. Even if it did, it does not include the value of leisure, it is not adjusted for pollution or other negative effects of production, and it is not adjusted for changes in crime and other social problems.

Describe the four major components of expenditures in GDP and write the equation that represents the relation- ship between GDP and the four expenditure components.

GDP is divided into four major categories of expen- ditures: consumption, investment, government purchases, and net exports. Consumption is spending by households on goods and services, not including spending on new houses. Investment is spending by firms on new factories, office buildings, machin- ery, research and development, and additions to inventories, plus spending by households and firms on new houses. Net exports are equal to exports minus imports. Government purchases is spending by federal, state, and local governments on goods and services. GDP = C + I + G + NX

Why does the size of a country's GDP matter? How does it affect the quality of life of the country's people?

GDP is sometimes used as a measure of well-being. Although it is generally true that the more goods and services people have, the better off they are, we will see that GDP provides only a rough measure of well-being.

What does globalization mean? How have developing countries benefited from globalization?

Globalization has aided countries that have opened their economies to foreign trade and investment. Foreign direct investment (FDI) is the purchase or building by a corporation of a facility in a foreign country. Foreign portfolio investment is the purchase by an individual or firm of stocks or bonds issued in another country.

Why has the unemployment rate in the United States typi- cally been lower than the unemployment rates in Canada and the countries in Western Europe?

Government policies have caused the unemployment rates in most other high- income countries typically to be higher than in the United States because US policies are less generous.

Discuss the effect of each of the following on the unemployment rate. a. The federal minimum wage law B.Labor unions C. Efficiency wages

Government policies have caused the unemployment rates in most other high- income countries typically to be higher than in the United States. Wages above market levels can also increase unemployment. Wages may be above market levels because of the minimum wage, labor unions, and efficiency wages. An efficiency wage is a higher-than- market wage that a firm pays to increase workers' productivity.

Briefly describe three government policies that can increase economic growth

Governments can attempt to increase economic growth through policies that enhance property rights and the rule of law, improve health and education, subsidize research and development, and provide incentives for saving and investment.

Why does a country's economic growth rate matter?

Growth rates matter because an economy that grows too slowly fails to raise living standards.

If inflation is expected to increase, what will happen to the nominal interest rate? Briefly explain.

If inflation is expected to increase then nominal interest rates can be expected to increase as well because the nominal interest rates are the real interest rates plus the expected inflation.

What is the difference between the household survey and the establishment survey? Which survey do many economists prefer for measuring changes in employment? Why?

In addition to the household survey, the BLS uses the establishment survey, sometimes called the payroll survey, to measure total employment in the economy. This monthly survey samples about 300,000 business establishments. The establishment survey has four drawbacks: 1. The survey does not provide information on the number of self-employed persons because they are not on a company payroll. 2. The survey may fail to count some persons employed at newly opened firms that are not included in the survey. 3. The survey provides no information on unemployment. 4. The values for employment that the BLS initially announces can be significantly revised as data from additional establishments become available. Notice that the household survey, because it includes the self- employed, gives a larger total for employment than does the establishment survey. The household survey provides information on the number of persons unemployed and on the number of persons in the labor force. This information is not available in the establishment survey.

show the effect on real GDP per hour worked of an increase in capital per hour worked, holding technology constant. Now, again using the per-worker production function graph, show the effect on real GDP per hour worked of an increase in technology, holding constant the quantity of capital per hour worked.

Increases in capital per hour worked increase output per hour worked but at a diminishing rate. Technological change shifts up the production function graph and allows more output per hour worked with the same amount of capital per hour worked.

Why does knowledge capital experience increasing returns at the economy level while physical capital experiences decreasing returns?

Increasing physical capital eventually begins to lower GDP, where as technological change will always lead to increasing GDP

The chapter states that it is impossible to know whether a particular nominal interest rate is "high" or "low." Briefly explain why.

It all depends on inflation rate.

If the U.S. Bureau of Economic Analysis added up the values of every good and service sold during the year, would the total be larger, smaller, or equal to GDP? Briefly explain

Larger, because some goods and services (ex: used goods) are not included in GDP.

Are imports and exports now a smaller or larger fraction of GDP than they were 40 years ago?

Larger.

If the economy is experiencing deflation, will the nominal interest rate be higher or lower than the real interest rate?

Lower

What are loanable funds? Why do businesses demand loanable funds? Why do households supply loanable funds?

Market for loanable funds: interaction of borrowers and lenders that determines the market interest rate and the quantity of loanable funds exchanged. The demand for loanable funds is determined by the willingness of firms to borrow money to engage in new investment projects. In determining whether to borrow funds, firms compare the return they expect to make on an investment with the interest rate they must pay to borrow the necessary funds. The supply of loanable funds is determined by the willingness of households to save and by the extent of government saving or dissaving. The willingness of households to save rather than consume their incomes today will be determined in part by the interest rate they receive when they lend their sav- ings.

By how much did real GDP per capita increase in the United States between 1900 and 2014? Discuss whether the increase in real GDP per capita is likely to be greater or smaller than the true increase in living standards.

Measured in 2009 dollars, real GDP per capita in the United States grew from about $6,000 in 1900 to about $50,010 in 2014. An average American in 2014 could buy more than eight times as many goods and services as an average American in 1900. Large as it is, this increase in real GDP per capita actually understates the true increase in the stan- dard of living of Americans in 2014 compared with 1900. A per- son's happiness also depends on education, health, spiritual well-being, and many other factors ignored in calculating GDP.

What are menu costs? What effect has the Internet had on the size of menu costs

Menu costs , The costs to firms of changing prices, increased them.

What is the new growth theory? How does the new growth theory differ from the growth theory developed by Robert Solow?

New growth theory is a model of long-run economic growth that emphasizes that technological change is influenced by how individuals and firms respond to economic incentives. The economic growth model we have been using was first developed in the 1950s by Nobel Laureate Robert Solow of MIT. According to this model, productivity growth is the key factor in explaining long-run growth in real GDP per capita.

Why does inflation make nominal GDP a poor measure of the increase in total production from one year to the next? How does the U.S. Bureau of Economic Analysis deal with this drawback?

Nominal GDP is not adjusted for inflation, so we also measure real GDP. Real GDP holds prices constant, which makes it a better measure than nominal GDP.

What is the difference between a nominal variable and a real variable?

Nominal variables are current year prices not adjusted for inflation, The real variable will be measured in dollars of the base year for the price index.

What are the problems in measuring the unemployment rate? In what ways does the official BLS measure of the unemployment rate understate the true degree of unem- ployment? In what ways does the official BLS measure overstate the true degree of unemployment?

One problem that the BLS confronts is distinguishing between the unemployed and people who are not in the labor force. The BLS also counts people as being employed if they hold part-time jobs even though they would prefer to hold full-time jobs. There are other measurement problems, however, that cause the measured unem- ployment rate to overstate the true extent of joblessness. These problems arise because the BLS does not verify the responses of people included in the survey. These inaccurate responses to the survey bias the unem- ployment rate as measured by the BLS toward overstating the true extent of joblessness.

How can inflation affect the distribution of income?

People on fixed incomes are particularly likely to be hurt by inflation. If a retired worker receives a pension fixed at $3,000 per month, over time, inflation will reduce the purchasing power of that pay- ment. In that way, inflation can change the distribution of income in a manner that seems unfair to many people.

During a period of deflation, which is likely to increase faster: nominal average hourly earnings or real average hourly earnings? Briefly explain

Real average earning are likely to increase faster than nominal average hourly earnings.

How does the financial system—both financial markets and financial intermediaries—provide risk sharing, liquidity, and information to savers and borrowers?

Risk is the chance that the value of a financial security will change relative to what you expect. The financial system provides risk sharing by allowing savers to spread their money among many financial investments. Liquidity is the ease with which a financial security can be exchanged for money. The financial system provides the service of liquidity by offering savers markets where they can sell their holdings of financial securities. financial system provides savers is the collection and com- munication of information, or facts about borrowers and expectations about returns on financial securities.

Briefly explain whether the value of U.S. exports is typi- cally larger or smaller than the value of U.S. imports.

Smaller. In 2014, exports were about 13 percent of GDP, and imports were about 17 percent. Not all sectors of the U.S. economy are affected equally by international trade. For example, although it's difficult to import or export some services, such as haircuts and appendectomies, a large percentage of U.S. agricultural production is exported.

What potential biases exist in calculating the CPI? What steps has the Bureau of Labor Statistics taken to reduce the size of the biases?

Substitution bias. In constructing the CPI, the BLS assumes that each month, consumers purchase the same amount of each product in the market basket. In fact, consumers are likely to buy fewer of those products that increase most in price and more of those products that increase least in price (or fall the most in price) Increase in quality bias. The BLS attempts to make adjustments so that only the pure infla- tion part of price increases is included in the CPI. These adjustments are difficult to make, however, so the recorded price increases overstate the pure inflation in some products. New product bias. For many years, the BLS updated the market basket of goods used in computing the CPI only every 10 years. So, new products introduced between updates were not included in the market basket. Outlet bias. During the mid-1990s, many consumers began to increase their purchases from discount stores such as Sam's Club and Costco. By the late 1990s, the Internet began to account for a significant fraction of sales of some products. Because the BLS continued to collect price statistics from traditional full-price retail stores, the CPI did not reflect the prices some consumers actually paid. The BLS continues to take steps to reduce the size of the bias. For example, the BLS has reduced the size of the substitution and new product biases by updating the market basket every 2 years rather than every 10 years. The BLS has reduced the size of the out- let bias by conducting a point-of-purchase survey to track where consumers actually make their purchases. Finally, the BLS has used statistical methods to reduce the size of the quality bias. Prior to these changes, the size of the total bias in the CPI was probably greater than 1 percentage point.

What is the GDP deflator, and how is it calculated?

The GDP deflator is a measure of the price level and is calculated by dividing nominal GDP by real GDP and multiplying by 100.

What is the difference between the CPI and the PPI?

The consumer price index (CPI) is a measure of the average change over time in the prices a typical urban fam- ily of four pays for the goods and services purchases. The producer price index (PPI) is an average of prices received by producers of goods and services at all stages of production.

Which price index does the government use to measure changes in the cost of living?

The consumer price index (CPI) is a measure of the average change over time in the prices a typical urban family of four pays for the goods and services they purchase. Changes in the CPI are the best measure of changes in the cost of living as experienced by a typical household.

Why does the economic growth model predict that poor countries should catch up to rich countries in real GDP per capita? Have poor countries been catching up to rich countries?

The economic growth model predicts that poor countries will grow faster than rich countries, resulting in catch-up. In re- cent decades, some poor countries have grown faster than rich countries, but many have not. Some poor countries have not experienced rapid growth for four main reasons: wars and revo- lutions, poor public education and health, failure to enforce the rule of law, and low rates of saving and investment.

What does the employment-population ratio measure? How does an unemployed person dropping out of the labor force affect the unemployment rate? How does it affect the employment-population ratio?

The employment-population ratio measures the percentage of the working-age population that is employed.

Which is a greater problem: anticipated inflation or unanticipated inflation? Briefly explain.

The extent to which inflation redistributes income depends in part on whether the inflation is anticipated—in which case consumers, workers, and firms can see it coming and can prepare for it—or unanticipated—in which case they do not see it coming and do not prepare for it.

Briefly describe the three major measures of the price level.

The federal government compiles statistics on three different measures of the price level: the consumer price index, the GDP price deflator, and the producer price index.

Describe the record of productivity growth in the United States from 1800 to the present

The growth rate in the United States increased from 1800 through the mid- 1970s. Then, for more than 20 years, growth slowed before increasing for a 10-year period beginning in the mid- 1990s. During the past 10 years, growth has slowed again.

Briefly describe the effect of the business cycle on the inflation rate and the unemployment rate. Why might the unemployment rate continue to rise during the early stages of an expansion?

The inflation rate usually rises near the end of a business cycle expansion and then falls during a recession. The unemploy- ment rate declines during the latter part of an expansion and increases during a recession. The unemployment rate often continues to increase even after an expansion has begun because even though employment begins to increase as a recession ends, it may be increasing more slowly than the increase in the labor force resulting from population growth. Also, some firms continue to operate well below their capacity even after a recession has ended and sales have begun to increase.

What does the labor force participation rate measure? Since 1950, how have the labor force participation rates of men and women changed?

The labor force participation rate is the percentage of the working-age population in the labor force. Since 1950, the labor force participation rate of women has been ris- ing, while the labor force participation rate of men has been falling.

What is the natural rate of unemployment? What is the relationship between the natural rate of unemployment and full employment?

The natural rate of unemployment is the normal rate of unemployment, consisting of structural unemployment and frictional unemployment. The natural rate of unemployment is also sometimes called the full-employment rate of unemployment.

What is the difference between the nominal interest rate and the real interest rate?

The stated interest rate on a loan is the nominal interest rate. The real interest rate is the nominal interest rate minus the inflation rate.

How is the unemployment rate measured? What are the three conditions someone needs to meet to be counted as unemployed?

The unemployment rate measures the percentage of the labor force that is unemployed: Number of unemployed / labor force * 100 = Unemployment rate. Unemployed: In government statistics, someone who is not currently at work but who is available for work and who has actively looked for work during the previous month.

What are the differences between national income, personal income, and disposable personal income?

The value of this worn-out machinery, equipment, and buildings is called depreciation. In the NIPA tables, depreciation is called the consump- tion of fixed capital. If we subtract this value from GDP, we are left with national income. Personal income is income received by households. Disposable personal income is equal to personal income minus personal tax payments, such as the federal personal income tax. It is the best measure of the income households actually have available to spend.

What is the rule of 70? If real GDP per capita grows at a rate of 5 percent per year, how many years will it take to double?

To calculate approximately how many years it will take real GDP per capita to double is to use the rule of 70. The formula for the rule of 70 is: Number of years to double = 70 / growth rate. 14 = 70 / 5

What effect does the payment of government unemploy- ment insurance have on the unemployment rate? On the severity of recessions?

Unemployment insurance payments can raise the unemployment rate by extending the time that unemployed workers search for jobs.

Briefly compare the severity of recessions before and after 1950. What explanations have economists offered for the period of relative macroeconomic stability from 1950 to 2007?

Until the severe recession of 2007-2009, recessions had been milder and the economy had been more stable in the period since 1950. Econo- mists debate whether the economy will return to the stability it experienced during the period of the Great Moderation. Explanations: The increasing importance of services and the declining importance of goods. The establishment of unemployment insurance and other government transfer programs that provide funds to the unemployed. Active federal government policies to stabilize the economy. The increased stability of the financial system.

What is meant by a firm's "value added"?

Value added refers to the additional market value a firm gives to a product and is equal to the difference between the price for which the firm sells a good and the price it paid other firms for intermediate goods.

Briefly explain why the total value of saving in the econ- omy must equal the total value of investment.

We begin with the relationship between gross domestic product, GDP (Y), and its components, consumption (C), investment (I), government purchases (G), and net exports (NX): Y = C + I + G + NX. In a closed economy, net exports are zero, so we can rewrite the relationship between GDP and its components as: Y = C + I + G. f we rearrange the equation showing the relationship between GDP and its components, we have an expression for investment in terms of the other variables: I = Y - C - G. SPrivate =Y+TR-C-T. The government also engages in saving. Public saving 1SPublic2 equals the amount of tax revenue the government retains after paying for government purchases and making transfer payments to households: SPublic =T-G-TR. So, total saving in the economy (S) is equal to the sum of private saving and public saving: S = SPrivate + SPublic, Or S = 1Y + TR - C - T2 + 1T - G - TR2 Or S = Y - C - G. The right side of this expression is identical to the expression we derived earlier for investment spending. So, we can conclude that total saving must equal total investment: S = I.

What is the difference between GDP and GNP? Briefly explain whether the difference is important for the United States.

We have seen that GDP is the value of final goods and services produced within the United States. Gross national product (GNP) is the value of final goods and services produced by residents of the United States, even if the production takes place outside the United States. For the United States, GNP is almost the same as GDP.

What is meant by a country specializing in the production of a good? Is it typical for countries to be completely specialized? Briefly explain

When a country specializes in producing goods for which it has a comparative advantage and trades for the other goods it needs, the country will have a higher level of income and consumption. We do not see complete specialization in production for three reasons: (1) Not all goods and services are traded internationally, (2) production of most goods involves increasing opportunity costs, and (3) tastes for products differ across countries.

Explain the difference between the total percentage increase in real GDP between 2005 and 2015 and the average annual growth rate in real GDP between the same years.

When economists talk about growth rates over a period of more than one year, the numbers are always average annual percentage changes and not total percentage changes. For example, in the United States, real GDP per capita was $14,398 in 1950 and $50,398 in 2014. The percent- age change in real GDP per capita between these two years is 250%. However, this is not the growth rate between the two years. The growth rate between these two years is the rate at which $14,398 in 1950 would have to grow on average each year to end up as $50,398 in 2014, which is 2.0 percent.

What problems does deflation cause?

When prices began to decline, many potential buyers postponed purchases in the expectation that prices would continue to fall. The deflation of the 1930s hurt the U.S. economy not just because it may have led some consumers to postpone purchases but also because it increased the burden on borrowers.

What are the consequences for growth of diminish- ing returns to capital? How are some economies able to maintain high growth rates despite diminishing returns to capital?

When we hold technology constant, however, equal increases in the amount of capital per hour worked lead to diminishing increases in output per hour worked. Each additional increase in capital per hour worked results in progressively smaller increases in real GDP per hour worked. In fact, at very high levels of capital per hour worked, further increases in capital per hour worked will not result in any increase in real GDP per hour worked. This effect results from the law of diminishing returns, which states that as we add more of one input—in this case, capital—to a fixed quantity of another input—in this case, labor—output increases by smaller additional amounts. If countries have continuing technological change they can maintain high growth rates.

What is dumping? Who benefits and who loses from dumping? What problems arise when anti-dumping laws are implemented?

dumping, when an imported product is sold for a price below its cost of production. Using tariffs to offset the effects of dumping is controversial despite being allowed under the WTO agreement.

What is globalization? Why are some people opposed to globalization?

globalization, the process of countries be- coming more open to foreign trade and investment. Some critics of the WTO argue that globalization has damaged local cultures around the world. Other critics oppose the WTO because they believe in protectionism, which is the use of trade barriers to shield domestic firms from foreign competition.