MacroEconomics Test 2

NNP (net national product)

(GNP - depreciation) Net national product (NNP) is the total income of a nation's residents (GNP) minus losses from depreciation. Depreciation

CPI

(consumer price index) a measure of the overall cost of the goods and services bought by a typical consumer The consumer price index (CPI) shows the cost of a basket of goods and services relative to the cost of the same basket in the base year. The index is used to measure the overall level of prices in the economy. The percentage change in the CPI measures the inflation rate.

How is CPI calculated?

1. Fix the basket 2. Find the prices 3. Compute the basket's cost 4. Choose a base year and compute the index 5. Compute the inflation rate Price of basket of goods and services in current year/ price of basket in base year x 100

Know the three other benefits of international trade.

1. Increased variety of goods, lower costs through economies of scale, increased competition, increased productivity, enhanced flow of ideas Other benefits of international trade · Increase variety of goods for consumers · Allows firms to take advantage of economies of scale · Makes markets more competitive · Makes the economy more productive · Facilitates the spread of technology

GDp measures total spending on goods and services. IF total spending rises

1. the economy is producing a larger output of goods and services, or 2. goods and services are being sold at higher prices.

US GDP per capita

63,543.58 = 63,000

Nominal GDP

: is measured using then (current) prices · Change reflects both prices and quantity. · Values output using current prices · Not corrected for inflation

Interpret the results of a tariff on trade

A tariff—a tax on imports—moves a market closer to the equilibrium that would exist without trade and, therefore, reduces the gains from trade. Domestic producers are better off and the government raises revenue, but the losses to consumers exceed these gains.

Describe how a tax affects market participants

A tax · Drives a wedge between the price buyers pay and the price sellers receive · Raises the price buyers pay · Lower the price sellers receive · Reduces the quantity bought and sold These effects are the same weather the tax is imposed on buyers or sellers

How does a tax distort incentives

A tax has a deadweight loss because it induces buyers and sellers to change their behavior. The tax raises the price paid by buyers, so they consume less. At the same time, the tax lowers the price received by sellers, so they produce less. Because of these changes in behavior, the equilibrium quantity in the market shrinks below the optimal quantity. The more responsive buyers and sellers are to changes in the price, the more the equilibrium quantity shrinks. Hence, the greater the elasticities of supply and demand, the larger the deadweight loss of a tax.

Absolute vs. Comparative (Relative) Advantage

Absolute advantage from Adam smith who was the father of market capitalism- does not account for relative advantage aka we actually do import toyotas from japan because the toyotas we make are not sufficient enough to handle demand of the whole united states so we make some and get some. Takes no consideration for relative trade or comparative advantage. Absolutely advantage is not a valid theory: it states the country that produces the goods the best should trade with our countries. One country shouldnt trade because the other country beats it. In economics, the principle of absolute advantage is the ability of a party to produce a good or service more efficiently than its competitor. II. III. Absolute advantage refers to the ability to produce more or better goods and services than somebody else. Comparative advantage refers to the ability to produce goods and services at a lower opportunity cost, not necessarily at a greater volume or quality. IV. V. Comparative advantage countries should trade the products where they receive a relative advantage. VI. Countries should trade products they have a relative advantage with another country but not if there ratios are the same Absolute Advantage pg 49-50, 53 · The ability to produce a good using fewer inputs than another producer · Measures the cost of good in terms of the inputs required to produce · Another measure of cost= opportunity cost Comparative advantage The ability to produce a goods at a lower opportunity cost than another producer Principle of comparative advantage · Each good should be produced by the individual/ individual firm that has the smaller 0pportunity cost of producing that good Specialize according to comparative advantage Comparative advantage and Trade Gains from trade · Arise from comparative advantage (Differences in opportunity cost) (where there's no difference in opportunity cost no country should trade with each other) When each country specialize in the foods in which it has a comparative advantage · Total production in countries is higher · The world economic pie is bigger · All countries gain from trade

Goverment Purchases

All spending on the goods and services purchased by the government At federal, state, and local levels Excludes transfer payments Such as Social Security or unemployment insurance benefits They are not purchases of goods and service.

Know the role of elasticities in determining the extent to which a tax results in DWL.

As the tax increases Deadweight loss increases · Even more rapidly than the size of the tax. Price elasticities of supply and demand · More elastic supply curve o Larger deadweight loss · More elastic demand curve o Larger deadweight loss The greater the elasticities of supply and demand · The greater the deadweight loss of a tax · When supply is inelastic relative to demand A change in price leads to a small change in Quantity supplied · DWL is small · The more elastic is the supply · The greater the change in Quantity Supplied due to a change in price... · The greater the DWL · Fewer players generally who have more control of the market so you can tax more · The more elasticity you have the greater the deadweight loss for a tax · · When demand is inelastic · A change in price leads to a small change in quantity demand · DWL is small · The more elastic is demand · The greater the change in quantity demanded due to a change in price · And the greater the DWL

Leading indicator vs lagging indicator

CPI is lagging - tells you what happened PPI is leading- tells you what is going to happen

What is the difference between the GDP deflator and the CPI in terms of what they measure?

CPI: fixed basket, prices of all goods and services bought by consumers GDP deflator: prices of all goods and services currently produced domestically If it's made abroad counted in that GDP but consumed here computed in CP The GDP deflator differs from the CPI because it reflects the prices of goods and services produced domestically rather than of goods and services bought by consumers. As a result, imported goods affect the CPI but not the GDP deflator. In addition, while the CPI uses a fixed basket of goods, the group of goods and services reflected in the GDP deflator automatically changes over time as the composition of GDP changes.

CS,PS,GS,TS Graph Portions before Tariff, and After Tariff

D = consumer gains never realized. Overproduction F= producer gains never realized. Under consumption.

Additional Notes

Dumping = selling below cost Predatory price- is dumping activity. Attempt to drive out your competition Lumean learning · MFN = status of countries who participate in fair trade World Trade Organization purpose is to Facilitate fair trade practices (164 members) Free movement of goods and services across borders Need to know dumping; selling below costs purpose is trying to get rid of competition- knock the competitor out- Walmart and Kmart MFN has to apply and has to follow fair trade. Requires a country to act fairly with all WTO member countries, extending the same privileges and immunities granted to one country to all members MFN advocates for non-discriminatory trade policy ensuring equal trading among WTO members Cuba and north korea suspended from MFN are considered unfair players' Protectionism refers to government policies that restrict international trade to help domestic industries. Protectionist policies are usually implemented with the goal to improve economic activity within a domestic economy but can also be implemented for safety or quality concerns. Critics argue that over the long term, protectionism often hurts the people and entities it is intended to protect by slowing economic growth and increasing price inflation, making free trade a better alternative. Proponents of protectionism argue that the policies can help to create domestic jobs, increase gross domestic product (GDP), and make a domestic economy more competitive globally. · Size of tax is calculated by LxW. · Deadweight loss - takes a piece of market activity and makes it disappear · Highly elastic supply curve - small DWL but more elasticity of supply creates more of a gap in the market · If you are going to tax on the industry. Know if its highly competitive, exitor of people's effects. · Governments want to tax a more inelastic industry · When demand is inelastic a tax reduces q a little and DWL is smaller. When demand is more elastic greater DWL · DWL and size of tax. If you double the tax DWL more than doubles. Triple the tax you more than triple DWL · GDP does not measure the work of households and educating them limitation is also housing. Not included in C: purchases of new house but renters C includes rent payment. For homeowners C includes the imputed rental value of the house, but not the purchase price · Investments, Intellectual property, building, equipment. Inventory accumulations: goods produced not yet sold yet. It is not the purchases of financial assets like stocks or bonds · G-consists of anything the government spends money on- at the federal state and local levels. Excludes transfer payments like social security or unemployment benefits · Net exports = exports-imports.Export = forging spending on the economies goods and services. Imports= are the portions of C<I<G that are spent on goods and service produced abroad. · Know the different between nominal GDp and real GDP. Real gdp is adjusted for inflation and is a truer figure. Inflation separates the numbers by 5-6% difference

What are durable vs. nondurable goods?

Durable goods are consumer goods that have a long-life span (e.g. 3+ years) and are used over time. Examples include bicycles and refrigerators. Nondurable goods are consumed in less than three years and have short lifespans.

What are the three limitations to measuring the cost of living

First, it does not take into account consumers' ability to substitute toward goods that become relatively cheaper over time. Second, it does not take into account increases in the purchasing power of the dollar that result from the introduction of new goods. Third, it is distorted by unmeasured changes in the quality of goods and services. Because of these measurement problems, the CPI overstates true inflation.

What are three ways GDP can be measured?

GDP can be measured in three different ways: the value added approach, the income approach (how much is earned as income on resources used to make stuff), and the expenditures approach (how much is spent on stuff).

GDP per capita

GDP divided by population Gross Domestic Product (GDP) per capita shows a country's GDP divided by its total population.

Components of GDP

GDP is divided into four components: consumption , investment , government purchases , and net exports : Y = C + I + G + NX

Definintion of GDP

Gross domestic product (GDP) The market value of all final goods and services produced within a country in a given period of time.

A quota, which is a NTB, is especially deleterious to trade. Why?

I. Import quotas are much like tariffs. Both tariffs and import quotas reduce the quantity of imports, raise the domestic price of the good, decrease the welfare of domestic consumers, increase the welfare of domestic producers, and cause deadweight losses. II. There is only one difference between these two types of trade restriction: A tariff raises revenue for the government, whereas an import quota generates surplus for those who obtain the permits to import. The profit for the holder of an import permit is the difference between the domestic price (at which she sells the imported good) and the world price (at which she buys it).

Does GDP measure the quality of life

If a large GDP leads to a higher standard of living, then we should observe GDP to be strongly correlated with various measures of the quality of life. And, in fact, we do. Countries with low GDP per person tend to have more infants with low birth weight, higher rates of infant mortality, higher rates of maternal mortality, and higher rates of child malnutrition. They also have lower rates of access to electricity, paved roads, and clean drinking water. In these countries, fewer school-age children are actually in school, those who are in school must learn with fewer teachers per student, and illiteracy among adults is more common. The citizens of these nations tend to have fewer televisions, fewer telephones, and fewer opportunities to access the Internet. International data leave no doubt that a nation's GDP per person is closely associated with its population's standard of living.

Import quotas: another way to restrict trade

Important Quota Quantitative limit on imports of a good Mostly has the same effect as a tariff Raises price, reduce quantity of imports Reduces buyer welfare Increases sellers welfare A tariff raises revenue for the government An import quota generates surplus for those who obtain the permits to import A tariff bends the market mechanism- separates buy and sellers. A quota breaks it. Are illegal unless they protect national security. Quota puts a hole in the market because it shuts down trade completely reduces the ability for buyers and sellers to meet.

Inflation between years form base year

Inflation in year 2 = CPI in year 2 - CPI in year 1/ CPI in year 1 x 100

GDP Inflatation Rate Calculation

Inflation rate in year 2 = GDP deflator in year 2 - GDP Deflator in year 1/ GDP deflator in year1 x 100

Introduciton of new goods

Introduction of new goods The introduction of new goods increases variety allows consumers to find products that more closely meet their needs IN effect dollars become more valuable The CPI misses this effect because it uses a fixed basket of goods Thus the CPI overstates increases in the cost of living

Investment

Investment Total spending on goods that will be used in the future to produce more goods Business capital: business structures, equipment, and intellectual property products Residential capital- landlords apartment building; a homeowners personal residence Inventory accumulations: goods produced but not sold yet Investment does not mean the purchase of financial assets like stocks and bonds Investment includes spending on business capital, residential capital, and inventories.

What is GNP (Gross National Product)?

It is the total income earned by a nation's permanent residents (called nationals). It differs from GDP in that it includes income that our citizens earn abroad and excludes income that foreigners earn here. For example, when a Canadian citizen works temporarily in the United States, her production is part of U.S. GDP, but it is not part of U.S. GNP. (It is part of Canada's GNP.)

What are some things GDP cannot measure

It omits some things that contribute to a good life, such as leisure GDP omits the value of goods and services produced at home. GDP excludes is the quality of the environment GDP also says nothing about the distribution of income.

CPI measures

Measure of the overall level of prices Measure of the overall cost of good and services

National Income

National income is the total income earned by a nation's residents in the production of goods and services. It is almost identical to net national product. These two measures differ because of the statistical discrepancy that arises from problems in data collection

Net Exports

Net Exports Net exports, NX = exports-imports Exports: foreign spending on the economies goods and services Imports are the portions of C, I and G that are spent on goods and services produced abroad. Net exports equal the value of goods and services produced domestically and sold abroad (exports) minus the value of goods and services produced abroad and sold domestically (imports).

Nominal GDP VS Real GDP

Nominal GDP uses current prices to value the economy's production of goods and services. Real GDP uses constant base-year prices to value the economy's production of goods and services

GDP deflator calculation

Nominal GDP/Real GDP x 100

Why is the PPI important?

PPI is leading- tells you what is going to happen Price indexes allow us to compare dollar figures from different points in time and, therefore, get a better sense of how the economy is changing.

Real GDP

Real GDP: measured using constant prices from base year · Change in real GDP is the amount that GDP would change if prices were constant Real GDP · Values output using the prices of a base year · Is corrected for inflation Real gdp is adjusted for inflation and is a truer figure

Subsitution Bias

Substitution Bias Over time some prices rise faster than others Consumers substitute toward goods that become relatively cheaper, mitigating the effects of price increases The CPI misses this substitution because it uses a fixed basket of goods Thus the CPI overstates increases in the cost of living Health sharing

GDP Deflator

The GDP deflator is one measure that economists use to monitor the average level of prices in the economy and thus the rate of inflation. The GDP deflator gets its name because it can be used to take inflation out of nominal GDP—that is, to "deflate" nominal GDP for the rise that is due to increases in prices. The GDP deflator—calculated from the ratio of nominal GDP to real GDP—measures the level of prices in the economy.

What is the difference between the cost of living vs. the standard of living

The cost of living is the cost that maintains a given level of living in a particular geographical area. The standard of living on the other hand is a country's indication of general comfort, necessities, and, wealth and material properties.

Nominal Interest Rates and Real Interest Rate

The interest rate that measures the change in dollar amounts is called the nominal interest rate, and the interest rate corrected for inflation is called the real interest rate. Real interest rate = nominal interst rate- inflation rate The nominal interest rate tells you how fast the number of dollars in your bank account rises over time, while the real interest rate tells you how fast the purchasing power of your bank account rises over time. Correcting for inflation is especially important when looking at data on interest rates. The nominal interest rate—the interest rate usually reported—is the rate at which the number of dollars in a savings account increases over time. By contrast, the real interest rate is the rate at which the purchasing power of a savings account increases over time. The real interest rate equals the nominal interest rate minus the rate of inflation.

Laffer curve and supply-side economics

The laffer curve shows the relationship between size of the tax and tax revenue Panel (d) shows that as the size of a tax grows larger, the deadweight loss grows larger. Panel (e) shows that tax revenue first rises and then falls. This relationship is called the Laffer curve. A basis of supply-side economics is the Laffer curve, a theoretical relationship between rates of taxation and government revenue. The Laffer curve suggests that when the tax level is too high, lower tax rates will boost government revenue through higher economic growth, though the level at which rates are deemed "too high" is disputed. ccording to supply-side economics, consumers will benefit from greater supplies of goods and services at lower prices, and employment will increase.[

Know the five most justifiable arguments for trade restrictions (protectionism)

There are various arguments for restricting trade: protecting jobs, defending national security, helping infant industries, preventing unfair competition, and responding to foreign trade restrictions.

Consumption

Total spending by households on goods and services Notes on housing cost For renters C includes rent payments For homeowners C includes the imputed rental value of the house, but not the purchase price or mortgage payments Not included in C: purchases of new housing. Consumption includes spending on goods and services by households, with the exception of purchases of new housing.

Unmeasured quality change

Unmeasured quality change Improves in the quality of goods in the basket increase the value of each dollar The BLS tries to account for quality changes but probably misses some, as quality is hard to measure Thus CPI overstates increases in cost of living

In terms of trade, what is the difference between world price and domestic price? Why does it matter?

WP = the price of a good that prevails in the world market for that good. The effects of free trade can be determined by comparing the domestic price before trade with the world price. A low domestic price indicates that the country has a comparative advantage in producing the good and that the country will become an exporter. A high domestic price indicates that the rest of the world has a comparative advantage in producing the good and that the country will become an importer.

Reaganomics, or supply-side economics, makes an interesting argument. What is it?

When Reagan ran for president in 1980, he made cutting taxes part of his platform. Reagan argued that taxes were so high that they were discouraging hard work and thereby depressing incomes. He argued that lower taxes would give people more incentive to work, which in turn would raise economic well-being. He suggested that incomes could rise by so much that tax revenue might increase, despite the lower tax rates. Because the cut in tax rates was intended to encourage people to increase the quantity of labor they supplied, the views of Laffer and Reagan became known as supply-side economics. It states that corporate tax cuts are the best way to grow the economy. When companies get more cash, they should hire new workers and expand their businesses.

Exports who gains and loses

When a country allows trade and becomes an exporter of a good, producers of the good are better off, and consumers of the good are worse off. When a country allows trade and becomes an importer of a good, consumers are better off, and producers are worse off. In both cases, the gains from trade exceed the losses.

Imports who gains and loses

When a country allows trade and becomes an importer of a good, domestic consumers of the good are better off, and domestic producers of the good are worse off.

Indexation

When some dollar amount is automatically corrected for changes in the price level by law or contract, the amount is said to be indexed for inflation.

PPI (Producer Price Index)

a measure of the cost of a basket of goods and services bought by firms

Percentages of GDP Equation (Larges to Littlests natural order)

consumption is the largest 60-70%, (70%) Investment 17%, Government Purchases 17%, Net Exports -4%

What is in the CPI basket?

fixed basket, prices of all goods and services bought by consumers

What does PPI measure?

measures the average change over time in selling prices received by domestic producers of goods and services

What does GDP Deflator measure

· A measure of the overall level of prices

Notes of Tax and DWL

· A tax on a good reduces the welfare of buyers and sellers of the good, and the reduction in consumer and producer surplus usually exceeds the revenue raised by the government. The fall in total surplus—the sum of consumer surplus, producer surplus, and tax revenue—is called the deadweight loss of the tax. · Taxes have deadweight losses because they cause buyers to consume less and sellers to produce less, and these changes in behavior shrink the size of the market below the level that maximizes total surplus. Because the elasticities of supply and demand measure how much market participants respond to market conditions, larger elasticities imply larger deadweight losses. · As a tax grows larger, it distorts incentives more, and its deadweight loss grows larger. Because a tax reduces the size of the market, however, tax revenue does not continually increase. It first rises with the size of a tax, but if the tax gets large enough, tax revenue starts to fall.