ECON 203 Exam 2 #MAIN

Use the table below to answer the following questions.

Argentina has the highest level of income in 2010 at $15,854 per person.China has had the highest income growth over the past 5 years. Growth = (New GDP - Old GDP)/Old GDP, and calculations are shown below for each country.Convergence is the theory that countries starting at low levels of income will grow at a faster rate than those starting at higher levels. Based on this sample of countries, convergence does not appear to have been occurring. The two poorest countries in 2005, Bolivia and Ghana, also had the lowest levels of GDP growth between 2005 and 2010, and they have not been catching up to the richer countries in the sample.

Labor Force Participation Rate

(Labor Force/Working age pop.) X 100

Factors that affect consumption

- Current income - Wealth - Expected future income - Interest rates on saving and borrowing

The main source of information on unemployment in the US is a household survey called the...

-Current Population Survey, conducted by the US Census Bureau and Bureau of Labor Statistic -Collected year around; seasonally adjusted

Compounding and the rule of 70

-Even a small annual growth rate can add up to a large change in an economy over time -US average annual growth in real GDP Per Capita was 2% during the last century -2010 real GDP Per Capita is 7 times larger than in 1910

BLS defines unemployment as people who...

-Persons aged 16 years and older who had no employment during the reference week -Were available for work -Had made specific efforts to find employment sometime during the 4-week period ending with the reference week (are NOT counted in labor force)

Sticky Wages

-Wages that are slow to respond to shifts in the economy

SRAS and LRAS curves

-everything that shifts the LRAS also shifts the SRAS -not everything that shifts the SRAS also shifts the LRAS

Not in the Labor Force

-homemakers -full-time students -retirees who choose or cannot work -those who cannot work due to disability -those who choose not to work

AD curve: movement vs. shift

-if the overall price level changes there would be a movement along the AD curve -If a non-price factor changes there would be a shift of the AD curve

Diminishing marginal returns

As physical capital increases the resulting increases in GDP are getting smaller and smaller (countries that start with very little physical capital will get a higher return from adding a unit of capital than a country that starts at a higher initial level will.

planned aggregate expenditure components

Can be decomposed into two parts: depending on income (b (mpc) *Y (national income) autonomous expenditure (A); depends on all other factors

frictional unemployment

Caused by workers who are changing locations, jobs, or careers

A relatively small but steady economic growth rate can create a large change in economic prosperity in a fairly short period of time due to a phenomenon known as compounding Using the rule of 70, if a person lived to be 70 years old in a country with an average annual growth rate in real GDP per capita of 2 percent, the average income during this person's lifetime would increase by approximately 4 times.

Compounding is the term used to describe the phenomenon where the growth from the previous period is added to the base amount and multiplied by the rate of increase for the next period. For example, a country with a GDP of $100 billion and a real growth rate of 2 percent would add $2 billion to its GDP the first year. The next year it would add $2.04 billion to its GDP because the increase of 2 percent is from a base amount of $102 billion, not the original $100 billion. The next annual increase would be 2 percent of the new base of $104.04 billion, and so on. Although this may seem like a small increase at first, compounding causes large increases fairly quickly. Using the rule of 70 we can quickly approximate how many years it takes for a given amount to double with a given annual real growth rate. The calculation is simply 70 divided by the real growth rate in percentage terms. For our example with a real annual growth of 2 percent, the years until income doubles = 70/2 = 35 years. In 70 years the income would double twice, so it would increase by approximately 4 times over this person's life span (2 x 2 = 4 times).

Employed

Everyone currently working, including part-time workers and temporary absentees

Aggregate expenditure equilibrium and the Keynesian cross:

Firms do not always produce the most they can at a given price. Firms produce what they can sell at a given price. -When demand is weak, firms produce only what is demanded -The economy could be producing more if prices adjusted

cyclical unemployment

Fluctuations from natural unemployment

Factors that affect unemployment:

Government policies, job search technologies, minimum wage laws, unemployment insurance, taxes and worker rights, professional training programs, gov. run employment agencies

Discouraged Workers

Marginally attached workers who are not currently looking for a job, because they believe there are no jobs available or there are none for which they qualify

Keynasian Equilibrium

PAE = Y (planned inventories = actual inventories)

Underemployed Workers

People who are either working less than they would like or in jobs below their skill level

Marginally Attached Workers

Persons not in the labor force who want and are available for jobs, and who have looked for a job in the prior 12 months, but not in the 4 weeks preceding the survey. (not counted in labor force)

Actual versus planned expenditure

Planned investment: the amount that firms decide to put in formation of new capital and inventory accumulation Actual investment: the amount of new capital investment and actual inventory changes

Show what happens to the planned aggregate expenditure curve in each of the following scenarios. Instructions: Drag the PAE curve in the appropriate direction to illustrate the impact of the stated change.

a. An increase in government spending will shift the PAE curve upwards. Equilibrium output will increase. b. An increase in business taxes will reduce planned investment spending and the PAE curve will shift downwards. Equilibrium output will decrease. c. A decrease in aggregate income causes a downward movement along the PAE curve and not a shift of the curve. A shift is caused by a change in autonomous expenditure.

Factors that affect investment:

expected profitability, interest rates, business taxes

autonomous expenditure

expenditure that is not affected by the current income (y)

Use the AS-AD model below to answer the following questions. In each case assume the economy starts in long- and short-run equilibrium.

a. A stock market crash reduces AD, shifting the AD curve to the left. Output falls, and there is downward pressure on prices. b. Eventually SRAS shifts to the right to move the economy back to long-run equilibrium at the previous level of output but lower prices.

Impact of minimum wage on the labor market

if MW is set above equilibrium wage the quantity of labor supplied is higher than quantity of labor demanded, resulting in unemployment

Government investments come from:

tax revenue and borrowing

convergence theory is also called:

the catch-up effect

Empirical Approach

the growth of an economy can be decomposed into the various components that caused it

Physical Capital

the stock of equipment and structures used to produce goods and services As physical capital increases workers become more productive

planned aggregate expenditure

total planned spending on final goods and services

Wealth

value of savings and checking accounts, stocks, bonds, and mutual funds, value of house, debts and loans

Classical unemployment

wage is higher than equilibrium wage

Efficiency wages

wages that employers set above the equilibrium wage rate as an incentive for better employee performance

AD curve slopes downward because of

wealth effect, interest rate effect, foreign purchases effect

Unemployment occurs:

when the wage rate is higher than the equilibrium rate

Productivity

A measure of the output per worker and is what drives growth output per worker = GDP Per Capita

Rapid Economic Growth

A modern phenomenon

Which of the following defines the investment trade off?

A reduction in current consumption to pay for investment capital

Calculate the implied growth rate of technology in each scenario. Assume labor's share of output is 42% and capital's share of output is 58%.

A. 0.03 - (0.42 × 0.02) - (0.58 × 0.02) = 0.01, or 1% B. 0.042 - (0.42 × 0.03) - (0.58 × 0.03) = 0.012, or 1.2% C. 0.03 - (0.42 × 0.02) - (0.58 × 0.01) = 0.016, or 1.58% D. 0.042 - (0.42 × 0.01) - (0.58 × 0.04) = 0.015, or 1.46%

Look at the following list of observed phenomena and select the probable cause of the phenomena:

In order for both prices and output to decrease in the short-run, the aggregate demand (AD) curve must shift to the left. In other words, a negative demand-side shock must occur. A long-run increase in prices with no change in output is caused by a positive demand-side shock. When the AD curve shifts right initially, both prices and output increase. However, it is expected that after the increase in prices that workers will demand higher wages and providers of other inputs to producers will increase their prices. These increases will increase producers' costs, which will cause the SRAS curve to shift to the left. Thus, the long-term result is higher prices at the same level of output. A short-run increase in output with reductions in prices can only be caused by a rightward shift in the SRAS, or (in the terminology we are using) a positive supply-side shock. The reason we know that this is a temporary shock is that in the long-run, price and output levels will adjust back to the original equilibrium level. A positive or negative temporary supply-side shock will cause no change to either price or output in the long-run, because after the initial shock market forces will eventually push prices and output back to their original levels. (Of course, no shock at all could also cause this observation, but that was not one of the answer choices listed.) If price increases with reduced output are observed in the long run, this must be caused by a leftward shift of the LRAS curve. In other words, this is a negative permanent supply-side shock. If it were a temporary supply-side shock, market forces would eventually push prices and output back to their original levels.

Unemployment Rate

Number of unemployed/labor force X 100

Absolute Convergence (catch up-effect)

Poor countries will grow faster than rich ones, until they "catch up" and all counties converge to the same growth rate and income level.

Classify each of the following situations as either frictional, structural, or cyclical unemployment.

Remember, frictional unemployment is unemployment caused by a worker changing his or her location, job, or career. Structural employment occurs due to a mismatch between the skills workers can offer and the skills in demand in the economy. Cyclical unemployment occurs when people become temporarily unemployed due to an economic downturn. a. Frictional unemployment: Returning from work after childbirth is a natural life change. b. Structural unemployment: Juan skills are not demanded today. c. Cyclical unemployment: The financial crisis is a temporary economic downturn. d. Frictional unemployment: Changing cities is a natural life change. e. Classical unemployment: Wage is above equilibrium wage because of unions. f. Cyclical unemployment: Her job was lost due to a temporary economic downturn.

Human Capital

Set of skills, knowledge, experience, and talent that determines the productivity of workers

Fill in the blanks in the table below.

The equation used in the text to calculate the real GDP per capita growth rate is: Real GDP per capita growth rate = Nominal GDP growth rate - Inflation rate - Population growth rate

For each of the following examples, state whether this activity would likely hinder or promote economic growth, and name a component of productivity each produces or reduces.

The factors that influence labor productivity are physical capital, human capital, technology, and natural resources. a. Not requiring students to attend school will hinder growth by reducing the accumulation of human capital. b. Granting patents on new inventions will likely increase growth by encouraging the invention of new technology. c. Building a solid infrastructure system will increase growth by increasing physical capital. d. Allowing local rivers and streams to become polluted will reduce growth by reducing natural resources.

Suppose the National Bureau of Economic Research (NBER) comes out with a report suggesting that the economy will soon dip into recession. You can expect that:

The labor force participation rate is likely to fall. Potential workers facing a bad job market are more likely to stay in school, stay at home, or retire early rather than look for a job. The cyclical unemployment will rise. Frictional unemployment may rise as new graduates or other people losing their jobs for normal "course of life" reasons will find it harder to find new jobs. On the other hand, given a bad job market, people may stay in school or their existing jobs longer, reducing frictional unemployment. Structural unemployment is likely to rise as workers who have been cyclically unemployed for a long period of time begin to see their skills deteriorate.

For each growth rate below, use the rule of 70 to calculate how long it will take incomes to double.

To find the time to double, simply take 70 and divide by the growth rate to find the number of years to double.

Working age population

Total Population - Young, Military, and Institutionalized

Foreign direct investment

When a firm runs parts of its operation abroad or invests in another company abroad

Components of aggregate expenditure

Y=C+I+G+NX Consumption, Investment, government spending, and net exports

Assume that initially economy is in the long-run equilibrium. For each of the following scenarios, say what will happen in the long run.

a. In the long-run input prices fell and SRAS shifts to the right.b. In the long-run input prices fell and SRAS shifts to the right.c. In the long-run input prices rise and SRAS shifts to the left. d. In the long-run input prices rise and SRAS shifts to the left. e. LRAS shifts to the right, potential output increases and new long run equilibrium will be at a higher output level. f. LRAS shifts to the left, potential output decreases and new long run equilibrium will be at a lower output level.

For each of the following shocks, say which type of shock is it.

a. Negative demand-side shock: Consumers spend less today if they become less confident in their future income. b. Positive demand-side shock: Government spending is one of the four components of AD, as one of its components increases, AD increases too. c. Positive demand-side shock: Foreign goods become more expensive for US consumers and Imports decreases, as a result NX increases, and it is one of the components of AD. d. Negative supply-side shock: Oil is an input to production, as inputs become more expensive the short-run supply decreases. e. Negative supply-side shock: Manufacturing plants represent capital, a component of LRAS.

Consider the planned aggregate expenditure diagram in the figure below.

a. Output is at its equilibrium level if planned aggregate expenditure is equal to actual aggregate expenditure. Graphically, this means the planned aggregate expenditure curve (PAE) intersects the PAE = Y line. Equilibrium output is $300 billion. b. From the PAE curve, planned aggregate expenditure is equal to $250 billion at an output level of $200 billion. Because planned expenditure is greater than actual expenditure, output in the economy will increase in the upcoming year. c. From the PAE curve, planned aggregate expenditure is equal to $350 billion at an output level of $400 billion. Because planned expenditure is less than actual expenditure, output in the economy will decrease in the upcoming year.

A firm's labor demand and labor supply equations are shown below. Labor demand equation: Ld = 80 - 2w Labor supply equation: Ls = -20 + 3w, where w is the wage per hour worked, Ld is the number of workers demanded by firms, and Ls is the number of people willing to work.

a. Set Ld = Ls. 80 - 2w = -20 + 3w. 100 = 5(w). Divide both sides by 5, leaving 20 = w. Plugging 20 into either Ld or Ls, we get the equilibrium quantity of labor employed = 40. Since Ld = Ls, there is no unemployment. At the equilibrium wage rate, the labor market exactly clears. b. Now the wage rate is increased by 40 percent from 20 to 28. At w = 28, Ld = 80 - 2(28) = 24, and Ls = -20 + 3(28) = 64. Since the quantity of labor demanded is 24 and the quantity of labor supplied is 64, there is an excess supply or surplus of labor, better known as unemployment, of 40 units.

Assume the equilibrium wage rate is $6 as shown below.

a. The government introduces a minimum wage of $5.50. Draw this on the graph. Compared to unemployment at the equilibrium wage, unemployment will stay the same. b. The government introduces a minimum wage of $6.50. Draw this on the graph. Compared to unemployment at the equilibrium wage, unemployment will increase

Suppose there are 75 million people in the labor force. The labor force participation rate is 60% and the unemployment rate is 8%.

a. The labor force participation rate equals the number in the labor force (LF) divided by the number in the working-age population (WAP); therefore, 0.60 = 75 million/WAP, so the WAP equals 125 million. b. If there are 125 million in the working-age population and only 75 million in the labor force, then there are 50 million who are part of the WAP but not part of the LF. c. The unemployment rate equals the number unemployed divided by the number in the labor force; therefore, 0.08 = number unemployed/75 million, so the number unemployed is 6 million. d. The number of employed workers equals the number in the labor force minus the number unemployed, or 69 million.

Consider the data presented in the table:

a. The marginal propensity to consume measures the amount by which consumption will increase when income increases. The marginal propensity to consume is calculated as the change in consumption divided by the change in income. From the table, observe that as income increases by 100 (560 - 460), consumption increases by 80 (340 - 260). The MPC is therefore 80/100, or 0.8. b. The aggregate expenditure model assumes that planned investment, government spending, and net exports are fixed at the given amounts. This type of spending is called autonomous spending because it is independent of changes in income. When income changes, we assume planned investment, government spending, and net exports do not change. This assumption is made to make the model easier to understand. c. Planned aggregate expenditure is equal to C + I + G + NX and these values are recorded in the table above. For example, at an income level of Y = 460: C + I + G + NX = 260 + 100 + 120 + 20 = $500 billion. If people spend $500 billion and production is only $460 billion, then unplanned inventory investment is equal to 460 - 500 = -40 billion dollars. d. The equilibrium level of aggregate expenditure is Y = $660. At this level of output, Y = C + I + G + NX and unplanned inventory investment is equal to zero. e. Inventory investment measures the change in the stock of inventory. If unplanned inventory investment is negative, then production is less than sales and firms are depleting their stock of inventory. In this case, the tendency will be to increase output. When unplanned inventory investment is negative, then production is greater than sales and firms will tend to decrease output in upcoming months. f. At the equilibrium level of output, firms have no tendency to change output and unplanned inventory investment is equal to zero.

Select the effects of the following scenarios on the listed employment statistics (assuming all other factors stay constant):

a. U3 will decrease because the lawyer was no longer considered unemployed when he took a part-time job. However, U6 will stay the same because while he is no longer considered unemployed, he is underemployed. The labor force participation rate does not change because he was already part of the labor force while looking for a job. b. U3 will stay the same because the machinist is still counted as employed. However, U6 increases since he is working not part-time by choice and therefore is considered underemployed. c. U3 will decrease. The carpenter has stopped looking for work and therefore is no longer considered unemployed because he is no longer counted as part of the labor force. U6 stays the same because the carpenter moves from being unemployed to being a discouraged worker. d. U3 decreases. Because the painter did not actively look for work last month, he is no no longer counted as part of the labor force. Therefore, he is longer considered unemployed. As a result, the labor force participation rate also decreases. U6 stays the same because the painter moves from being unemployed to being a "marginally-attached" worker. e. U3, U6, and the labor force participation rate increase because the former student has joined the labor force, but is unemployed.

Reference equation: Real GDP per capita growth rate = Nominal GDP per capita growth rate - Inflation rate - Population growth rateThis equation is an approximation of the exact rate of growth of GDP per capita, and so it results in some errors when calculating this rate. However, the simplified equation is both easy to use and results in small error terms when inflation, nominal GDP growth, and population growth are low, and so it is a useful approximation. The table below lists a fictional country's nominal GDP, real GDP, GDP deflator, and population over two years.

a. Using equation 25.4, Real GDP (2012 dollars) = Nominal GDP × GDP deflator (2012)/GDP deflator (year of nominal GDP). Real GDP in 2012 = $1000000 × 100/100 = $1000000. Real GDP in 2013 = $1050000 × 100/103 = $1019417. b. Real GDP per capita = Real GDP/population. For 2012, real GDP per capita = $1000000/1000 = $1000.0. For 2013, real GDP per capita = $1019417/1005 = $1014.3. c. The growth rate between any two numbers = (New - Old)/Old. Real per capita GDP growth = [(1014.3 - 1000.0)/1000.0] × 100 = 1.4%. d. The growth rate between any two numbers = (New - Old)/Old. Nominal GDP growth = [(1050000 - 1000000)/1000000] × 100 = 5.0%. Population growth = [(1005 - 1000)/1000] × 100 = 0.5%.

For each of the following shocks, identify what component(s) of U.S. planned aggregate expenditure are directly affected and in which direction.

a. When income tax rates increase, disposable income will fall, consumption will fall, and planned aggregate expenditure will fall. b. When China experiences an economic boom, it will buy more goods from other countries. Our net exports will rise. c. When people become more optimistic regarding their future prospects, they are likely to consume more and save less. Consumption will increase. d. When Congress decides to increase funding for education, government spending will increase. e. When German fashion designs become popular among celebrities, spending on imported clothing will rise. Net exports will decrease.

Aggregate expenditure is affected when...

any go the four components change

Equilibrium in the national economy:

at the point where AD=AS

Equilibrium in the labor market occurs:

at the wage level where workers provide the same level of labor as firms are willing to hire (no unemployment)

Factors that affect government purchases:

beliefs about what citizens need, stimulate or restrain economy

structural unemployment

caused by a mismatch between the skills workers can offer and the skills in demand

Current income

consumers spend a constant fraction of the disposable income (MPC)

limitations of unemployment rate

does not give good indication of how many people are discouraged, underemployed. marginally attached

Factors that affect Net exports:

domestic income, foreign income, exchange rate of dollar to other currencies, tastes for foreign goods, trade policies

Labor Force

employed + unemployed

Foreign portfolio investment

investment funded by foreign sources that is operated domestically

Working Age Population

labor force + not in labor force

unemployment insurance

money paid by the government to people who are unemployed.

Real GDP Per Capita growth rate

nominal GDP growth rate - inflation rate - population growth rate

natural rate of unemployment

normal level of unemployment that persists in an economy in the long run

inflationary output gap

occurs when equilibrium aggregate expenditure is above the level needed for full employment

recessionary output gap

occurs when equilibrium aggregate expenditure is below the level needed for full employment

Components of Productivity

physical capital, human capital, technological improvements, natural resources

long-run aggregate supply curve (LRAS)

represents potential output in the economy and depends on available resources and technology -SHIFTS if there is a change in productivity or quantities of factors of production

Real-wage or classical unemployment

results from wages being higher than the market-clearing level

short-run aggregate supply curve

shows the relationship between the aggregate price level and the quantity of aggregate output supplied that exists in the short run, the time period when many production costs can be taken as fixed

Aggregate demand curve

shows the relationship between the overall price level in the economy and output