week 5: chapter 9 & 10, Week 6: Chapters 11 & 12

determinants of aggregate supply

Factors such as input prices, productivity, and the legal-institutional environment that, if they change, shift the aggregate supply curve.

average propensity to save (APS)

Fraction (or percentage) of disposable income that households save; saving divided by disposable income.

average propensity to consume (APC)

Fraction (or percentage) of disposable income that households spend on consumer goods; consumption divided by disposable income.

equilibrium real output

GDP at which the total quantity of final goods and final services purchased (aggregate expenditures) is equal to the total quantity of final goods and services produced (the real domestic output); the real domestic output at which the aggregate demand curve intersects the aggregate supply curve.

What did Keynes offer as the explanation for cyclical unemployment and recessions?

General Theory of Employment, Interest, and Money: income does not have to spent within the same period it is received

net exports

Xn --> exports minus imports which can either be negative or positive

real income

amount of goods and services that can be purchased with nominal income during some period of time; nominal income adjusted for inflation.

what will happen if expected rate of return on investment rises/real interest rates fall?

an upward shift in the investment schedule

multiplier effect

any initial change in a component of total spending can lead to a larger change in GDP

cost of living adjustments (COLAs)

automatic increase in the incomes (wages) of workers when inflation occurs; often included in collective bargaining agreements between firms and unions. Cost-of-living adjustments are also guaranteed by law for Social Security benefits and certain other government transfer payments.

The type of inflation that is more likely to be associated with positive GDP gap is

demand-pull inflation

A difficult aspect of measuring the unemployment rate is

determining who is eligible and available to work

how to calculate rate of inflation

difference between CPI of current year and last/the previous year 100 --> 278.8-260.5/260.5 x100 = 7%

wealth

dollar amount of all assets owned minus amount of liabilities (debt)

If a $50 billion initial increase in spending leads to a $250 billion change in real GDP, how big is the multiplier?

5.0 (multiplier= change in real GDP/initial change in spending)

consumer price index

measures the prices of fixed market basket of some 300 goods and services bought by a "typical" consumer

The nominal interest rate is:

minus the inflation rate is the real interest rate

seasonal variation and long-term trends complicate the measurement of the business cycle because

normal seasonal variations do not signal boom or recession

multiplier

number by which a change in any such component must be multiplied to find the resulting change in equilibrium GDP.

nominal income

number of dollars received by an individual or group for its resources during some period of time.

productivity

output per unit of input

what causes disequilibrium?

overproduction (excess inventory) & excess total spending (draws down inventory)

in sequential order, the four phases of the business cycle are

peak, recession, trough, and expansion

nominal interest rate

percent increase in money borrower pays lender including the built in expectation of inflation

unemployment rate

percentage of the labor force unemployed at any time.

recession

period of declining real GDP, accompanied by lower real income and higher unemployment.

how to calculate per unit production cost

total input cost/ units of output

how to calculate productivity?

total output/total inputs

Which of the following will shift the aggregate supply curve to the right?

- business taxes fall (reduction in business taxes is likely to encourage investment and production, leading to an increase in aggregate supply) - a new networking tech increases productivity all over the economy (ntroduction of new networking technology, generally enhance productivity and increase aggregate supply)

what is the difference between frictional and structural unemployment?

- frictional have the skills and location to find jobs but are still having trouble - structural have a hard time finding new jobs due to a LACK of skills, education, or area in need of employment - frictional is short term and structural is long term

what was keynes' solution for the recessionary expenditures gap (negative GDP gap)?

- increase government spending - lower taxes

Which of the following will shift the aggregate demand curve to the left?

- interest rates rise (higher interest rates could lead to reduced consumer spending and business investment, contributing to a leftward shift in the aggregate demand curve) - the government raises corporate profit taxes (an increase in corporate profit taxes may decrease business investment and potentially reduce consumer spending, leading to a leftward shift in the aggregate demand curve)

In year 1, Anita earns $1,000 and saves $100. In year 2, Anita gets a $500 raise so that she earns a total of $1,500. Out of that $1,500, she saves $200. What is Anita's MPC out of her $500 raise?

0.80 (mpc= change in consumption or savings/ change in income)

With a marginal propensity to save of 0.4, the marginal propensity to consume will be

1.0 minut 0.4

labor force

16 years of age and older who are not in institutions and who are employed or are unemployed and seeking work.

investment schedule

shows the amount of investment forthcoming at each level of GDP

investment demand curve

A curve that shows the amounts of investment demanded by an economy at a series of real interest rates.

productivity

A measure of average output or real output per unit of input. For example, the productivity of labor is determined by dividing real output by hours of work.

Which of the following illustrates the difficulty of distinguishing among frictional, structural, and cyclical unemployment?

A person quits his job in search of a better one, but the former job is in a declining industry and disappears completely.

aggregate demand (AD)

A schedule or curve that shows the total quantity of goods and services that would be demanded (purchased) at various price levels.

Effect of: A widespread fear by consumers of an impending economic depression

AD will decrease

Effect of: A 10 percent across-the-board reduction in personal income tax rates

AD will increase

Effect of: A major increase in spending for health care by the federal government

AD will increase

Effect of: An increase in exports that exceeds an increase in imports (not due to tariffs)

AD will increase

Effect of: The general expectation of coming rapid inflation

AD will increase

Effect of: a reduction in interest rates

AD will increase

Effect of: A 12 percent increase in nominal wages (with no change in productivity)

AS will decrease

Effect of: A new national tax on producers based on the value added between the costs of the inputs and the revenue received from their output

AS will decrease

Effect of: A sizable increase in labor productivity (with no change in nominal wages)

AS will increase

Effect of: The complete disintegration of the Organization of the Petroleum Exporting Countries (OPEC), causing oil prices to fall by one-half

AS will increase

GDP gap

Actual gross domestic product minus potential output

how to calculate aggregate expenditures in a private closed economy?

C + Ig (consumption + investment)

how to calculate aggregate expenditures in private open economy?

C + Ig + Xn (consumption + investment + net exports)

unplanned changes in inventories

Changes in inventories that firms did not anticipate; changes in inventories that occur because of unexpected increases or decreases of aggregate spending (or of aggregate expenditures).

discouraged workers

Employees who have left the labor force because they have not been able to find employment.

Can the economy achieve and maintain an equilibrium real GDP that is substantially above the full-employment output level?

No!d There is not enough labor for the economy to produce at much more than potential output for an extended period of time

Explain how an increase in your nominal income and a decrease in your real income might occur simultaneously. Who loses from inflation? Who gains?

Nominal income is calculated through sources like wages, rent, interest, and profit. Whereas, real income is measured through a person's purchasing power and reflects inflation. An increase in nominal income and a decrease in real income could occur at the same time if prices rise faster than nominal income and if real income increases at the same level as the cost of living increases. Typically, those who are hurt by inflation are fixed-income receivers, savers, and creditors. On the other hand, the people who gain from inflation are flexible income receivers like social security recipients and debtors.

What is Say's law?

Say's law was used by classical economists and states that supply creates its own demand.

Who measures the labor force, and how is it defined?

The U.S. Bureau of Labor Statistics (BLS) measures the labor force as people over 16 years of age who are employed and those who are actively seeking work.

injection

The act of investing (purchasing capital goods) is an injection; addition of spending into the income-expenditure stream: any increment to consumption, investment, government purchases, or net exports.

leakage

The act of saving is a leakage; (1) A withdrawal of potential spending from the income-expenditures stream via saving, tax payments, or imports; (2) a withdrawal that reduces the lending potential of the banking system.

what will happen if expected rate of return declines/real interest rates rise?

a downward shift in the investment schedule

aggregate demand- aggregate supply model (AD-AS model)

a model that explains short-run fluctuations in real GDP and the price level

The noneconomic effects of unemployment include:

a sense of failure created in parents and in their children

Unemployment is an economic problem becuase:

a unit of labor resource that could be engaged in production is sitting idle.

determinants of aggregate demand

aggregate demand shifters; Factors such as consumption spending, investment, government spending, and net exports that, if they change, shift the aggregate demand curve.

what will happen if there is a tax increase?

aggregate expenditures schedule will decrease and the equilibrium GDP also lowers

what will happen if there is a tax decrease?

aggregate expenditures schedule will increase and GDP will also raise

The 45-degree line on a graph relating consumption and income shows

all the points at which consumption and income are equal.

peaks

business activity has reached a temporary maximum; the point at which an expansion ends and a recession begins. At the peak, the economy is near or at full employment and the level of real output is at or very close to the economy's capacity.

trough

business activity has reached a temporary minimum; the point at which a recession ends and an expansion (recovery) begins. At the trough, the economy experiences substantial unemployment and real GDP is less than potential output.

cyclical unemployment

caused by insufficient total spending (insufficient aggregate demand) and which typically begins in the recession phase of the business cycle

how to calculate the multiplier?

change in real GDP/initial change in spending

The Consumer Price Index (CPI) is determined each month by:

comparing the value of a "market basket" of goods that consumers typically purchase to the value of the basket in a base year.

substitutions effect

consumers will want to buy more of the individual product because it becomes less expensive relative to other goods (NOT AN EXPLANATION FOR THE AD DOWN SLOPE)

The type of inflation that is more likely to be associated with negative GDP gap is

cost-push inflation

If there is an increase in the unemployment rate, the size of the labor force:

could increase or decrease

deflation

decline in the general level of prices in the economy

Which of the following statements is true?

deflation means the the price level is falling, whereas the inflation overall prices are rising

interest-rate effect

explains AD downward slope: tendency for increases in the price level to increase the demand for money, raise interest rates, and, as a result, reduce total spending and real output in the economy (and the reverse for price-level decreases).

real-balances effect

explains AD downward slope: tendency for increases in the price level to lower the real value (or purchasing power) of financial assets with fixed money value and, as a result, to reduce total spending and real output, and conversely for decreases in the price level.

hyperinflation

extremely high rate of inflation, usually defined as an inflation rate in excess of 50 percent per month

If the MPS rises, then the MPC will:

fall (1-MPC = MPS)

expansion

followed by recession where real GDP, income, and employment begin to rise (may lead to inflation)

Okun's Law

for every 1% point by which the actual unemployment rate exceeds the natural rate, a GDP gap of about -2% happens

marginal propensity to consume (MPC)

fraction of any change in disposable income spent for consumer goods; equal to the change in consumption divided by the change in disposable income.

marginal propensity to save (MPS)

fraction of any change in disposable income that households save; equal to the change in saving divided by the change in disposable income.

natural rate of unemployment (NRU)

full-employment rate of unemployment; the unemployment rate occurring when there is no cyclical unemployment and the economy is achieving its potential output; the unemployment rate at which actual inflation equals expected inflation.

intermediate-short-run aggregate supply curve

horizontal aggregate supply curve that applies to time periods over which both input prices and output prices are fixed; an aggregate supply curve for which real output, but not the price level, changes when the aggregate demand curve shifts.

anticipated inflation

increase in price level/inflation at the expected rate

expected rate of return

increase in profit a firm anticipates it will obtain by purchasing capital or engaging in research and development (R&D); expressed as a percentage of the total cost of the investment (or R&D) activity.

supply-push inflation

increase of inflation from an increase in resource costs and hence per unit production costs; inflation caused by reduction in total supply

unanticipated inflation

increase of the price level/ inflation at a rate greater than expected

demand-pull inflation

increases in the price level (inflation) resulting from an excess of demand over output at the existing price level, caused by an increase in aggregate demand

what do injections and leakages look like during equilibrium GDP?

injections into the income expenditures stream = leakage from income stream AKA equilibrium GDP ---> leakages = injections

what kind of relationship does a the aggregate demand curve have?

inverse relation: when price levels rise, real GDP demanded decreases

foreign purchases effect

inverse relationship between the net exports of an economy and its price level relative to foreign price levels. (increase in the price level means decrease in net exports)

planned investment

investment schedule showing the amounts business firms collectively intend to invest at each possible GDP

offshoring

jobs that occurs when the demand for a particular type of labor shifts from domestic to foreign firms

break-even income

level of disposable income at which households plan to consume (spend) all their income and to save none of it.

paradox of thrift

possibility that households trying to protect themselves against a recession by saving more may inadvertently worsen the recession and hurt themselves by reducing overall consumption and economic activity.

equilibrium price level

price level at which aggregate demand equals aggregate supply; the price level at which the aggregate demand curve intersects the aggregate supply curve.

how to calculate CPI

price of the most recent market basket in the particular year/ price estimate of the market basket in 1982-1984 x 100

how did the Great Depression begin?

prices did not fall and economy sank below its output level - GDP declined by 27% and unemployment rose to 25%

Demand-pull inflation occurs when:

prices rise because of an increase in aggregate spending not fully matched by an increase in aggregate output.

potential output

real output (GDP) an economy can produce when it fully employs its available resources.

business cycle

recurring increases and decreases in the level of economic activity over periods of years consists of: -peak -recession -trough -expansion

What does inflation do?

reduces the purchasing power of the dollar

45 degree line

reference line in a two-dimensional graph that shows equality between the variable measured on the horizontal axis and the variable measured on the vertical axis - line along the value of output (horizontal) and value of aggregate expenditures (vertical)

what does movement on the aggregate demand curve mean?

represent changes in the amount of real GDP demanded in response to changing price levels

Because real GDP kept growing in 2021, we know that AD must have shifted _________

rightward, leftward

inflation

rise of general level of prices -- increase in economy's price level

saving schedule

saving function; table of numbers that shows the amounts households plan to save (plan not to spend for consumer goods), at different levels of disposable income.

aggregate supply

schedule or curve showing the total quantity of goods and services that would be supplied (produced) at various price levels.

The bout of inflation the United States experienced in 2021 was unusual in that it was caused by _________

shifts in BOTH AD and AS

The Bureau of Labor Statistics (BLS) calculates the inflation rate from one year to the next by

subtracting the CPI of the previous year from the CPI of the most recent year, and then dividing by the CPI of the previous year.

consumption schedule

table of numbers showing the amounts households plan to spend for consumer goods at different levels of disposable income

aggregate expenditures schedule

table of numbers showing the total amount spent on final goods and final services at different levels of real gross domestic product (real GDP)

lump sum tax

tax that collects a constant amount (the tax revenue of government is the same) at all levels of GDP.

wealth effect

tendency for people to increase their consumption spending when the value of their financial and real assets rises and to decrease their consumption spending when the value of those assets falls

what will happen if there is an increase in government spending (publicly or privately)?

the aggregate expenditures schedule will shift upward and produce a higher equilibrium GDP

inflationary expenditures gap

the amount (vertical distance) by which aggregate expenditures at the full-employment GDP level exceed those just sufficient to achieve employment --> amount by which aggregate schedule would have to shift downward to realize equilibrium at the full employment level of GDP

recessionary expenditures gap

the amount (vertical distance) from which aggregate expenditures at the full-employment GDP level fall short of those needed to achieve full-employment --> insufficient spending contracts or depresses the economy

This economic concept is a key driving force behind _________

the business cycle

The central economic idea humorously illustrated in the Last Word "Toppling Dominoes" is _________

the multiplier effect

The unemployment rate is defined as:

the number of unemployed persons divided by the labor force.

real interest rate

the percentage increase in purchasing power that the borrower pays the lender

The business cycle affects output and employment in capital goods industries and consumer durable goods industries more severely than in industries producing consumer nondurables because:

these goods last, so that purchases can be postponed

frictional unemployment

type of unemployment caused by workers voluntarily changing jobs and by temporary layoffs; unemployed workers between jobs. - called frictional because the labor market does not operate perfectly - this can be a good thing as people can search for better paying jobs and therefore have better allocation of labor resources and real GDP for the economy

core inflation

underlying increases in the price level after volatile food and energy prices are removed

A positive unemployment rate—more than zero percent—is fully compatible with full employment because at full employment,

unemployment includes frictional unemployment, which is always positive because people are transitioning to new jobs

full-employment rate of unemployment

unemployment rate at which there is no cyclical unemployment of the labor force; equal to around 4 percent (rather than zero percent) in the United States because frictional and structural unemployment are unavoidable.

short-run aggregate supply curve

upward sloping aggregate supply curve relevant to time periods over which input prices are fixed but output prices are flexible; an aggregate supply curve for which real output and the price level both change when the aggregate demand curve shifts.

the length of a complete business cycle

varies greatly in duration and intensity

long-run aggregate supply curve

vertical aggregate supply curve relevant to time periods over which input prices and output prices are both fully flexible; an aggregate supply curve for which the price level, but not real output, changes when the aggregate demand curve shifts; a vertical aggregate supply curve that implies fully flexible prices.

A consequence of a negative GDP gap is that:

what is not produced is lost forever and future economic growth will be less.

when does an increase in AD and demand pull inflation occur?

when economy is operating at full employment output, but firms or government decide to increase spending creating an inflationary gap (actual GDP > potential GDP)

below equilibrium GDP

when investments (injections) are greater than savings (leakage), the aggregate expenditures will be more than GDP and drive it up

above equilibrium GDP

when savings (leakage) are greater than investments (injections), the aggregate expenditures will be less than GDP *spending deficiency reduces GDP*

income effect

when the price of an individual product falls, the consumers (constant) nominal income allows a larger purchase of the product; (NOT AN EXPLANATION FOR THE AD DOWN SLOPE)

equilibrium GDP

when the total spending (aggregate expenditures) equals the total output. produced (GDP) --> C + Ig = GDP

structural unemployment

workers whose skills are not demanded by employers, who lack sufficient skill to obtain employment, or who cannot easily move to locations where jobs are available