Macro Econ

In the Romer model, how does an increase in total population affect the growth rate of per-capita output over time?

A rise in population at first leads to a decline in​ per-capita output, but the growth rate of​ per-capita output will rise permanently.

Economic Theory

A statement or set of related statements about cause and effect, action and reaction.

When applying the Romer model, what do the results yield?

Applying the Romer model yields the following results: When R&D becomes more productive, output per capita grows at a more rapid rate. When more resources are devoted to R&D, the level of per-capita output at first falls, but the growth rate of per-capita output will rise permanently. A rise in population at first leads to a decline in per-capita output, but the growth rate of per-capita output will rise permanently. A higher saving rate results in a higher level of output per capita, but not in a higher sustained growth rate.

Final Goods and Sercives

Are the end goods in the production process

What would happen to the trade balance and the net capital outflows of China should Chinese domestic savings fall?

If domestic savings fall, ceteris paribus domestic investment is higher than domestic savings. Since (Savings - Investment) equals Trade balance (= Exports - Imports), lower domestic savings will lower (Savings - Investment), therefore decreasing trade balance in China. Also, savings being the supply of loanable funds, the loanable funds supply curve shifts leftward, increasing interest rate. At higher domestic interest rate, global investors will increase their investment in China, so capital inflow will rise and capital outflow will fall as a result of higher domestic interest rate. There will be an upward movement along the Net Capital Outflow schedule, which means there will be a fall in net capital outflow in China.

What is the effect of a fall in domestic saving on the trade surplus, investment, and interest rates in both the domestic and foreign economies?

The excess of investment over savings will be financed by savings from abroad.

What is a government budget deficit? Why are macroeconomists concerned with budget deficits?

The federal budget deficit is found by: subtracting government tax revenues from government spending in a particular year.

Government Investment

I_G which is spending on capital goods like highways and schools that add to the capital stock and promote economic growth

What happens in a small open economy if there is an increase in domestic saving

If domestic savings increases it leads to an increase in the trade surplus or shrinkage of a deficit.

Endogenous Growth Theory

Models of economic growth that try to explain the rate of technological change.

How do property rights affect economic growth; in both developing and developed countries

More generally, the stronger the set of property rights, the stronger the incentive to work, save, and invest, and the more effective the operation of the economy. The more effectively an economy operates, the more growth it will produce for any set of resources.

What is National Income Divided into?

National income is divided between payments to capital and payments to labor, with the sizes of these payments determined by the marginal products of capital and labor. Capital and labor income shares of national income do not change even as the level of income grows over time

Suppose that you work at the statistical office of a given country. The graph plots estimates of the labor and capital income shares for that country over time. Your boss suggests that a Cobb-Douglas production function could be a good representation of that country's income. Is your boss right?

No, Boss is not right because if it were a Cobb-Douglas production function , the income share would be constant over time. But here in the diagram factor shares are fluctuating or changing would be changing over time.

One of the most well-known population control policies is the one-child policy implemented by China since the late 1970s. Comment on the side effects of such a policy. This policy has been dubbed a success, since fertility rates dropped by a considerable amount. Do you agree with this type of population control?

The lower growth rate of population definitely causes higher incomes per capita. So in an economical context, yes you would support this decision

Supply Shock

a change in the output an economy can produce from the same amount of capital and labor. In other words, a supply shock involves a change in A, total factor productivity

Net Foreign Assets

a country's foreign assets minus its foreign liabilities

National Wealth

a country's holdings of assets minus its liabilities at a particular point in time

Price Level

a measure of the average prices of goods and services in the economy

GDP Deflator

a measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100 GDP deflator for year y = 100 * (Nominal GDP in year y) / (Real GDP in year y)

Balance of Payment Accounts

a national bookkeeping account that tracks both payments to and receipts from foreigners between a nation and with foreign countries

Supply shocks have what type of impact?

a negative supply shock causes the aggregate production function to shift downward and also causes the marginal products of capital and labor to fall. Reversing the reasoning, we have the following: a positive supply shock causes the aggregate production to shift upward and raises the marginal products of capital and labor.

Wealth

a person's holdings of assets (such as bonds, stocks, houses, and fine art) minus his or her liabilities, the amount he or she owes (such as mortgages, car loans, and credit card balances

Use the accompanying table to calculate the following statistics for Brazil: a) Labor force b) Labor-force participation rate c) Unemployment rate Adult Population (millions): 140 Unemployed (millions): 7 Employed (millions): 88

a) 95 million b) 62% c) 7.3% (7 / (88+7)

Ratio Scale

e (also called a logarithmic scale) in which equal distances reflect the same percentage change. When we plot a variable in a ratio scale against time, if it is growing at a constant rate per year, then it will appear as a straight line, with the slope representing the rate of growth.

Government Savings

equals net government income less government consumption. For all practical purposes, we can think of net government income as taxes net of transfers, T, so we can write government saving as follows: S_G = T - C_G

In the Solow growth model, which variables are exogenous and which are endogenous?

exogenous: Total factor productivity. endogenous: Output-per-worker

Inventories

firms' holdings of raw materials, unfinished goods, and unsold finished goods—are another type of good that is not used up in the current period

Depreciation rate

fraction of capital that wears out each year For example, if on average a unit of capital lasts twenty years, then the economy's depreciation rate is 5% per year and δ is 0.05. Because we assume the amount of depreciation is a constant fraction of the capital stock, depreciation per worker equals δk_t. When we plot depreciation per worker against capital per worker, k_t, it is a straight line with a slope of δ

The United States has been experiencing very low or even negative savings rates during the recent past. If this situation persists, what does it means for future generations?

future generations may have to pay higher taxes to repay debt issued to fund these deficits

Growth Accounting Equation

g_Y = g_A + 0.3 _gK + 0.7_gL g_Y= ΔY/Y = growth rate input g_A= ΔA/A = growth rate of technology (total factor productivity) g_K = ΔK/K = growth rate of capital g_L = ΔL/L = growth rate of labor

Patents

give inventors the sole right to use, make, or sell licensing rights to others for a set period of time, typically around twenty years. For example, a drug company that earns a patent on a cholesterol-lowering medicine can sue anyone who tries to produce that drug without permission for decades. These property rights help businesses earn higher profits and recoup the investments they make in research and development, and encourage others to invest in R&D

Logarithmic Scale (ratio scale)

in which equal distances reflect the same percentage change. When we plot a variable in a ratio scale against time, if it is growing at a constant rate per year, then it will appear as a straight line, with the slope representing the rate of growth

Common Law

in which the law is continually reinterpreted by judges, originated in England. The common-law legal system is in use in the United Kingdom and its former colonies, including the United States, Canada, Australia, and New Zealand, as well as in India and many countries in Africa

Government Purchases

is spending by the government—whether federal, state, or local—on currently produced goods and services

Investment (3 categories)

is spending on currently produced capital goods that are used to produce goods and services over an extended period of time. Investment was 15.2% of GDP in 2012. We can break it down into three basic categories 1. Fixed Investments: , also referred to as business fixed investment, is spending by businesses on equipment (machines, computers, 2. Inventory Investment: is the change in inventories held by firms. If inventories are increasing, inventory investment is positive, but if they are decreasing, inventory investment is negative. 3. Residential Investment: is household purchases of new houses and apartments. (We do not include purchases of existing housing in GDP because it was produced in earlier periods.) Houses and apartments are capital goods for households because they produce a service (a roof over our heads) over an extended period of time. Indeed, for most of us, housing is the most important purchase we ever make in our lives

Depreciaiton

is the loss of capital from the wearing out of machines and factories over time.

Real Rental (cost) of Capital

is the price paid to rent the capital, often referred to as the rental price of capital, R, times the amount of capital, K, that is, RK

Investment

is the purchase of new factories and machines that adds to the capital stock.

Capital

is the quantity of structures and equipment—such as factories, trucks, and computers—that workers use to produce goods and services, which we will denote by K. It is measured by the value of the capital stock in real terms, that is, in constant dollars. For now, we will overlook other factors of production—raw materials, energy, and land—so that we can first establish a basic framework

National Saving Rate

is the share of national income saved by the government and households, or s= S / Y

Negative (adverse) Supply Shock

lead to a decline in the quantity of output produced from given quantities of capital and labor. Negative shocks are less common, but can occur if, for example, burdensome government regulations make the economy less productive.

Adverse Supply Shock

leadz to a decline in the quantity of output produced from given quantities of capital and labor. Negative shocks are less common, but can occur if, for example, burdensome government regulations make the economy less productive

Private Disposable Income

measures the amount of income the private sector has available to spend Private Disposable Income = GDP + net factor income + transfer payments received from the government + interest payments on government debt - taxes

Real Gross Domestic Product

measures the output of actual goods and services produced in an economy over a fixed period, usually a year.

Unemployment Rate

measures the percentage of workers s looking for work, but who do not have jobs, at a particular point in time. When unemployment is high, households suffer a loss of income and may even find themselves unable to meet basic needs for food and shelter

Gross National Product (GNP)

measures the total income earned by U.S. residents

Implicit Price Deflator for GDP

measures the total income earned by U.S. residents. Nominal GDP/Real GDP * 100

Positive Supply Shock

result in an increase in the quantity of output produced for given combinations of capital and labor

Favorable Supply Shock

result in an increase in the quantity of output produced for given combinations of capital and labor. reduces unemployment and the inflation rate.

Solow Residual

shows the unexplained (residual) part of the production function and was first used in growth accounting by Robert Solow. A_t = Y_t / (K_t^0.3 L_t^0.7)

Trade Surplus

situation in which a country exports more than it imports

Trade Deficit

situation in which a country imports more than it exports

Government Investment

spending for capital goods like buildings and computers represents

Labor

summing the numbers of hours people work, or per son-hours, which we will denote by L. The effort that people devote to a task for which they are paid

Production Approach

the current market value of all final goods and services newly produced in the economy during a fixed period of time

Private Saving

the income that households have left after paying for taxes and consumption YD = Y - T YD, as GDP Y, minus net taxes, T (taxes minus government transfers minus interest payments on the debt -------- Thus we can write private saving, SP, as disposable income, Y - T, minus consumption expenditure, C: SP = Y - T - C

Marginal Product

the increase in output that arises from an additional unit of input

Real Interest Rate

the interest rate corrected for the effects of inflation nominal interest rate - inflation rate

Autonomous Investment

the level of investment determined by investment demand. It is autonomous because it is assumed to be constant at all levels of GDP. I = I + I(r) - where I is autonomous investment (investment unrelated to the real interest rate) and the minus sign below r indicates that as the real interest rate increases, investment falls

Value Added

the market value a firm adds to a product In our Mac example, the value added for the producer of microprocessors is $400, while the value added for the shipping firm is $50 (assuming that it did not use any intermediate goods). The value added for Apple is the final price of the Mac minus the cost of the intermediate inputs: $1,500 minus the $400 cost of the microprocessors and the $50 cost of shipping, that is, $1,050. The sum of the value-added items for each of these firms—$1,050 plus $400 plus $50—is $1,500, the same value as the final good, the Mac. Now imagine adding up all the value added in the economy to determine the total value of final goods and services in the economy. This approach is likely to include all final goods and services in the economy, but appropriately excludes intermediate goods and services

Inflation Rate

the percentage increase in the price level from one year to the next. Inflation or the inflation rate tells us how rapidly the overall level of prices is rising.

Labor-Force Participation rate

the percentage of the adult population that is in the labor force Labor-Force Participation Rate = Labor Force / Adult Population

Diminishing Returns to Scale

the property whereby each additional increase in inputs results in a smaller increase in the quantity produced

Saving Rate

the proportion of disposable income that is saved y_t - c_t = sy_t

Private saving Rate

the proportion of private disposable income that is saved SP / YD.

GDP Deflator Example: nominal GDP in 2015 is $15 trillion and real GDP in 2005 dollars is $12 trillion

then the GDP deflator for 2015 is 100 * ($15 trillion>$12 trillion) = 125, which means that the price level as measured by the GDP deflator has risen 25% from 2005 to 2015

National Income

total income earned by everyone in the economy

Nominal Variables

variables measured in monetary units

Excess Demand

when quantity demanded is more than quantity supplied

Excess Supply

when quantity supplied is more than quantity demanded

Rival

when they are used in one activity, they cannot be used in another.

Excludability

y is the ability of the owner of a piece of property to deny its use to others unless they pay for it. Owners of capital earn a rate of return by renting out excludable items, so investments in them can have high payoffs. On the other hand, it is hard to keep unauthorized users from using a technology, reducing the potential benefits you can reap from producing it. This non-excludability may discourage investment in technology, which has important implications for policy, as we shall see next

Use the following table to find the steady-state values of the capital-labor ratio and output per worker (i.e., complete the table) if the per-worker production function is y_t = 2k_t^0.3 : s Saving rate 0.3 δ Depreciation rate 0.05 n Population growth rate 0.02 A Technology 2 k* Steady state capital-labor ratio y* Steady state output

y= 2k^0.3 Capital accumulation equation: ∆k = sy - (n+δ)k not steady state ∆k = 0 0= sy -(n+δ)k 0= s 2k^0.3 - (n+δ) k (n+δ)k = 2sk^0.3 k/k^0.3 = 2s/ n+δ k^0.7 = (2s/(n+δ) k* = (2s/ n+δ)^(1/0.7) ^steady state capital- labor ratio) and y = 2k^0.3 y= 2[(2s/n+δ)^(1/0.7)]^0.3 y* = 2(2s/n+δ)^0.3/0.7 ^^ steady state output put s= 0.3, n=.02, δ=0.05 k* = (2s/n+δ) ^(1/0.7) k* = [(2(.3)/ (.02+.05)]^(1/0.7) k* = (.6/.07)^(1/0.7) k* = (8.57)^(1/0.7) k* = 21.52

Is perfect competition a reasonable assumption both for developed and less developed countries?

yes. But for less developed natures usually the first player can get a monopoly.

Stabilization Policy

policies that the government can use to minimize fluctuations in economic activity 1. fiscal 2. monetary 3. international 4. structural

Solow Growth Model

A model showing how saving, population growth, and technological progress determine the level of and growth in the standard of living.

What is a patent? Why do governments grant them?

A patent is a right granted to an inventor by the federal government that permits the inventor to exclude others from making, selling or using the invention for a period of time. The patent system is designed to encourage inventions that are unique and useful to society

Deflation

A situation in which prices are declining. The inflation rate is zero.

What does the production approach measure?

GDP by adding up the market value of all final goods and services that are newly produced in the economy over a fixed period of time.

Economic Profits

are the revenue from selling goods and services, minus the costs of inputs. Key components of economic profit include the following 1. The revenue from selling goods and services: is the average level of the prices of goods and services, P, times the amount of goods and services sold, Y: using the production function, the revenue P * Y is P * F(K, L). 2. The cost of using capital: is the price paid to rent the capital, often referred to as the rental price of capital, R, times the amount of capital, K, that is, RK. 3. The cost of labor: is the price of labor, the wage rate, W, times the amount of labor, L, that is, WL

During the 1970s, most Latin American countries ran huge budget deficits. As their governments resorted to printing money (increasing the money supply) to pay for these deficits, very high inflation rates resulted. As a consequence, real GDP declined or remained constant during the 1980s. Comment on the relationship between budget deficits, inflation, and real GDP grow

budget deficits tend to lead to increased inflation and reduced real GDP growth.

Large Open Economy

changes in the demand and supply for loanable funds that are large enough to affect the world real interest rate

Explain the two characteristics of the Cobb-Douglas production function that make it particularly useful to macroeconomists.

constant returns to scale (output increases proportionately in inputs) and diminishing marginal product (increasing one input, then the increment in output declines)

GDP and its components

consumption expenditure (C): Consumer durables, nondurable goods, Services Investment (I): Fixed investment, inventory investment, residential investment Government Purchases (G): Federal, State and local Net Exports (NX): Exports, - Imports Total = GDP (Y)

Convergence

countries with different initial levels of per capita income gravitate to a similar level of per capita income. The two European countries that started with the highest level of real GDP per person—France and the United Kingdom—have been catching up to the United States. This phenomenon is referred to as convergence,

During the late 1960s, Chinese authorities imposed the precepts of the "Cultural Revolution" on their people. As a result, almost all scholars and researchers were sent to the fields to perform manual agricultural tasks. Comment on the effect this had on the per-person output growth rate, according to the Romer model

decrease in cx, resulting in a decrease in the growth rate of output per worker

Twin Deficits

deficits that occur when a country is running both a trade and a budget deficit

Financial Crisis

a large-scale disruption in financial markets characterized by sharp declines in the prices of assets (property that includes bonds, stocks, art, land, etc.) and business failures.

Macroeconomics

is the study of economic activity and prices in the overall economy of a nation or a region.

Value-added tax

which is a tax that is paid by a producer on the difference between what it receives for its goods and services minus the costs.

Microeconomics

which looks at the behavior of individual firms, households, or markets

Assets

(property that includes bonds, stocks, art, land, etc.) and business failures

Income Approach Components

1. Compensation of employees: includes both the wages and salaries of employees (excluding the self-employed) and employee benefits, which include payments for health insurance and retirement benefits. As Table 2.2 indicates, employee compensation is the largest category of income, 53.2% of GDP in 2012. Although wages and salaries have been declining relative to GDP, total compensation relative to GDP has stayed nearly constant over time because the declining share of wages and salaries has been offset by increasing employee benefits 2. Other income: includes income of the self-employed, income that individuals receive from renting their properties (which includes royalty income on books and music), and the net interest earned by individuals from businesses and foreign sources (interest income minus the interest that they pay) In addition, the other income category includes indirect business taxes like the sales tax because these taxes need to be added to net income of business to yield their total income. Other income was 20.4% of GDP in 2012. 3. Corporate Profits: s is made up of the profits of corporations. It was 12.4% of GDP in 2012 4. Depreciation: is the loss of value of capital from wear and tear or because capital has been scrapped because it is obsolete. To obtain the net income of businesses, depreciation was subtracted out, so in order to compute gross income, we have to add it back into GDP. If we do not add depreciation back into GDP, then we call the measure net domestic product. Depreciation was 15.6% of GDP in 2012. 5. Net Factor income: equals wages, profits, and rent (called factor income) paid to U.S. residents by foreigners minus factor income paid by U.S. residents to foreigners. When U.S. residents get more factor payments from abroad than they pay out, their overall income goes up. Net factor income is typically very small. In 2012, it was a negative number, -1.6% of GDP, indicating that U.S. residents received less income from foreigners than they paid out to foreigners, and so made a negative contribution to GDP

In the Romer model, what three factors determine an economy's growth rate?

1. The productiveness of labor used in R&D 2. The fraction of the population that is engaged in R&D 3. The total population of the eonomy

Refer to the previous exercise for data and assume that three million unemployed individuals become "discouraged" and decide not to look for a job anymore. Calculate the new unemployment rate for Brazil.

10.2% (10/(10+88)

Constant Returns to Scale

: if you increase all the factor inputs by the same percentage, then output increases by exactly the same percentage. Put simply, doubling the inputs doubles the output, which makes intuitive sense. If a company can build 1,000 vehicles a month with one fully staffed factory, it should be able to produce 2,000 vehicles a month with two identical fully staffed factories

What would be the effect on the Golden Rule capital-labor ratio of a decrease in the depreciation rate?

A decrease in the depreciation rate will increase the Golden Rule​ capital-labor ratio.

Solow Diagram

A diagram based on the Solow growth model showing the steady-state level of investment and capital-labor ratio graphically. when the capital stock per worker is in its steady state, investment and depreciation are identical. We show this relationship graphically by plotting the investment function and depreciation line. At the point of intersection, capital per worker is at its steady state. We label this point k * in Figure 6.3, which is also known as the Solow diagram

Nonrival

A good, service, or resource is nonrival if its use by one person does not decrease the quantity available for someone else.

Saving-Investment Diagram

A graphical analysis of the equilibrium in the goods market

According to Michael Kremer's research, the Chinese one-child policy may hamper technological progress. Explain why

A higher population puts more pressure on limited available​ resources, thereby increasing incentives to spur technological change.

What is the impact of an increase in saving in the Romer model?

A higher saving rate results in a higher level of output per​ capita, but not a higher sustained growth rate.

What is a large open economy a mix of?

A large open economy is a mix of a small open economy and a closed economy: the effects of shifts in saving and investment on the trade balance and net capital flows are the same as in a small open economy, while the effects on the domestic real interest rate and the actual amounts of saving and investment are the same as in a closed economy.

Romer Model

A model of sustained economic growth that is driven by the discovery of new ideas

What would a tour of economic growth around the world indicate?

A tour of economic growth around the world indicates that almost all countries have experienced positive economic growth from 1960 to 2010, with France, the United Kingdom, Japan, South Korea, and India displaying convergence to the U.S. level of real GDP per capita. Other countries have not experienced convergence, with some, such as Kenya, Nigeria, and particularly Haiti, experiencing growth disasters in which their real income per capita has fallen relative to that of the United States.

What would be the effect on the Golden Rule capital-labor ratio of an increase in the population growth rate?

An increase in the population growth rate will decrease the Golden Rule​ capital-labor ratio.

One of the goals of the Obama administration is to develop and encourage the use of new technologies, in particular within the energy industry. What would be the effect of an increase in technology on the Golden Rule capital-labor ratio?

An increase in technology will increase the Golden Rule​ capital-labor ratio.

Do you tend to agree more with Sachs (foreign aid should be increased) or with Easterly (foreign aid can do more harm than good) in the foreign aid debate? Explain your arguments

According to the economist Jeffrey Sachs If rich countries would increase their foreign aid budgets over the next decade, they could help eliminate extreme global poverty. Increasing foreign aid may lead to dramatic improvements in health and life expectancy in developing countries. Increasing foreign aid can break down the poverty cycle and allow individuals to escape their poverty traps. According to the economist William Easterly, the political elites that run these governments often use foreign aid funds to line their own or their friends' pockets. With access to increased resources, bad governments are even more likely to stay in power. Foreign aid removes incentives for countries to develop policies that promote economic growth.

Which are the four expenditure components of national income identity? What are your thoughts about those components when comparing Indian and Chinese data (Figure

According to the national income identity, GDP (Y) can be measured by summing consumption expenditure (C), investment expenditure (I), government purchases of goods and services (G), and net exports (NX). Consumption expenditure includes consumer durable goods, nondurable goods, and services. Investment expenditure includes business fixed investment (capital goods), inventory investment, and residential investment. Government purchases include spending on currently produced goods and services by federal, state, and local governments but do not include transfers such as payments for Social Security and unemployment insurance benefits. Net exports equal exports minus imports, so goods and services that domestic households, business firms, and governments purchase that are produced elsewhere are subtracted from GDP and not counted as domestic production.

In the per-worker production function, what factors determine the level of output per worker? Which one of these factors does the Solow growth model consider to be exogenous?

According to the per-worker production function, derived from the aggregate production function, output per worker Y/L depends on two things: total factor productivity A and the amount of capital per worker, the capital-labor ratio K/L. The Solow growth model considers total factor productivity to be an exogenous variable and provides no explanation for changes in its value.

What happens when saving increases on a graph?

An increase in saving (from a decrease in autonomous consumption, a decrease in government purchases, or an increase in taxes) shifts the saving curve to the right and leads to a lower real interest rate and higher saving and investment. An increase in autonomous investment shifts the investment curve to the right and leads to a rise in investment, saving, and the real interest rate.

What happens when there is an increase in saving in a small open economy?

An increase in saving in a small open economy leads to a higher trade balance and an increase in net capital outflows. An increase in desired investment causes a decline in the trade balance and lowers net capital outflows

What determines the distribution of national income between payments to labor and payments to capital?

Assuming that labor and capital inputs are hired in perfectly competitive factor markets, national income is divided between labor and capital with the payments to each input determined by the input's marginal product. Support for the Cobb-Douglas production function comes from evidence that the shares of national income going to labor and capital remain constant over time, as it predicts, regardless of the level of national income.

What distinguishes the Golden Rule capital-labor ratio from other possible capital-labor ratios? What determines whether the economy will operate at the Golden Rule capital-labor ratio?

At the Golden Rule​ capital-labor ratio, the value of consumption per worker is maximized. The saving rate

Why may private R&D expenditures be too low?

Because of the non-excludable nature of technology, many of the benefits of new technology will be external. This means that private businesses who invest in R&D will not get the full benefits of the new technology they create and therefore may not expect to earn enough profits to justify the R&D investment necessary to develop the new technology.

Discuss the validity of the following statement: "Unlike Solow's model, Romer's model concludes that changes in the saving rate do not affect the sustained per-capita output growth rate."

Because the non-rivalrous nature of technology means that additions of technology from​ R&D are not subject to diminishing returns.

Why is sustained per-capita growth possible in the Romer model but not in the Solow model?

Because the non-rivalrous nature of technology means that additions of technology from​ R&D are not subject to diminishing returns.

Income Approach to GDP Factors

Compensation of employees, Other Income, Corporate Profits = National Income + Depreciation = GNP - Net factor income =Gross Domestic Product

Calculating CPI Example: let's assume that the basket of goods for the average consumer consists of ten gallons of gas and two apples. The calculation of the CPI for 2014 with a base year of 2005 would then be...

CPI for 2014 = 100 * (10 * price of gas per gallon in 2014) + (2 * price of apples in 2014) / (10 * price of gas per gallon in 2005) + (2 * price of apples in 2005)

Government Consumption

C_G which is government spending on current needs. In other words, G = C_G + I_G

Why are capital goods and inventories treated differently from intermediate goods in the production approach to measuring GDP?

Capital goods and inventories represent economic activity that is not counted elsewhere.

How are the effects of changes in domestic saving and investment for large open economies similar to those for small open economies and closed economies?

Changes in domestic saving/investment for large open economies has the same effect in small open and closed economies.

What does the endogenous growth theory using the Romer model tell us?

Endogenous growth theory using the Romer model explains endogenously how technology advances and leads economies to sustained economic growth. Its key equations are the fraction of the population devoted to R&D, L_A = αN; the production function for the growth of technology, ∆At / At = g_A = χαN; and the production function in terms of output per person, y*_t = (1 - α)A_tk_P*^ 0.3. The Romer model produces a balanced growth path in which output per person grows at a steady rate.

Describe the GDP deflator and the personal consumption expenditure deflator.

Deflator: measures changes in the prices of goods and services produced in the United States, including those exported to other countries. Prices of imports are excluded. Consumption expenditure Deflator: measure of inflation based on changes in personal consumption.

College Premium

Extra money earned by those with a college degree. a higher wage over their lifetime for college graduates relative to high-school graduates

What would be the consequences for future generations of a saving rate that is lower than the Golden Rule level of the saving rate?

Future generations will not have as much consumption as possible.

Define GDP and then answer the following question. How is it possible to compare the GDP of 2 different countries, for example Spain and France, given that they produce not only different quantities of the same goods and services (e.g. haircuts), but also different goods and services (e.g. bullfights only happen in Spain)?

GDP measures the value of the final goods and services produced in the United States One way to compare different countries' GDPs is with an exchange rate, the price of one country's currency in terms of another. Since GDP is measured in a country's currency, in order to compare different countries' GDPs, we need to convert them to a common currency.

Underground Economy

Goods and services produced in the underground economy are also not counted in GDP. goods and services produced are hidden from the government, either because they are illegal (drugs or prostitution) or because the person producing the goods and services is avoiding paying taxes on the income he or she receives (the carpenter who is paid in cash and does not declare it on his or her tax return). In some countries, the underground economy (also sometimes referred to as the "black market economy") is very large, and as a percentage of the total economy it differs substantially among countries. Italy, an example among rich countries, is notorious for tax avoidance, so its GDP is likely to be understated relative to other countries because of the large size of its underground economy

Considering the world as two large open economies, a domestic economy and the rest of the world, what condition is required for goods market equilibrium? How is this condition achieved?

Goods market equilibrium requires that world saving equal world investment, which means that a trade surplus (or deficit) in the domestic economy must equal the trade deficit (or surplus) in the rest of the world, so that net capital outflows from one economy match net capital inflows to the other economy. This is brought about by adjustments in the world real interest rate. If the trade surplus in the domestic economy is greater than the trade deficit in the rest of the world, the world real interest rate will fall until the two magnitudes match. If the domestic economy's trade surplus is smaller than the rest of the world's trade deficit, the world real interest rate will rise until equilibrium is attained.

Explain why building infrastructure could be a good policy for governmental agencies to promote productivity growth

Government can promote productivity growth by designing policies that lead to more spending on infrastructure, human capital, and research and development. These policies might take the form of increased government spending in these areas or instead provide greater incentives for private individuals and investors to undertake the increased expenditures.

Transfers

Government payments for Social Security, Medicare, and unemployment insurance benefits are transfers from one segment of society—healthy, working people—to another segment—the elderly, sick, and jobless. Because they are not payments in exchange for currently produced goods and services, they are not included in government purchases, G, or GDP. Interest payments on government debt are also not made in exchange for goods and services, so we exclude them from government purchases, G, and GDP.

What does growth Accounting Demonstrate?

Growth accounting demonstrates that productivity growth is a more important source of variation in growth rates across countries than factor accumulation.

What is growth accounting based on?

Growth accounting is based on the growth version of the production function. It indicates that there are three contributions that add up to growth in GDP: the contribution from productivity growth, ∆A . A; the contribution from capital growth, 0.3∆K / K; and the contribution from labor growth, 0.7∆ L /L. The growth accounting equation is g_Y = g_A + 0.3g_K + 0.7g_L, where g_Y = ∆ Y / Y, g_A = ∆ A / A, gK = ∆ K / K, and g_L = ∆L / L

Which are the different sources of economic growth according to the growth accounting method?

Growth in capital, Growth in labor, Growth in productivity

What determines whether a small open economy will have a trade surplus or a trade deficit?

If world real interest rate is < equilibrium there is a trade deficit and if it's > equilibrium there's a surplus.

How does the goods market equilibrium in an open economy differ from that in a closed economy? Which two countries may be labeled as open and closed economies, respectively?

In a closed economy equilibrium occurs when saving = investment. In an open economy it happens when desired saving- desired investment= NX

When are goods in a market in equilibrium in a closed economy?

In a closed economy, the goods market is in equilibrium when saving equals investment, S = I, at the intersection of the saving and investment curves

What does the domestic real interest rate equal to in an open economy?

In an open economy, the domestic real interest rate equals the world real interest rate. Goods market equilibrium occurs when net exports equals saving minus investment: NX = S - I

What are the 4 things that happens when there is a rise in domestic savings in large open economies?

In large open economies, a rise in domestic saving 1) raises the trade surplus and net capital outflows in the domestic economy 2) raises the trade deficit and capital inflows in the rest of the world 3) raises investment in both the domestic economy and the rest of the world, and 4) lowers world interest rates.

What are the 4 things that happen when there is an increase in domestic desired investment in large open economies?

In large open economies, an increase in domestic desired investment 1) lowers the trade surplus and net capital outflows in the domestic country 2) lowers the trade deficit and capital inflows in the rest of the world 3) raises world interest rates, and 4) lowers investment in the rest of the world.

How does an increase in total factor productivity affect output per worker? Summing Up the Solow Mode

In the Solow growth model, an increase in total factor productivity increases capital per worker, increases output per worker, and increases consumption per worker. Capital and labor are the factors of production. Total factor productivity increase means that the per worker capital increases. As per worker capital increases hence the per worker output level increases. As per worker output level increases hence per worker get more money to spend. As a result, the consumption per worker increases.

What dies a higher saving rate mean in regards to the solow model?

In the Solow model, a higher saving rate, and hence a higher level of investment relative to income, leads to higher steady-state levels of capital and output per worker, but does not affect the long-run growth rates of these variables.

What can population growth mean in the Solow Model?

In the Solow model, population growth can explain why economies have sustained growth in output, but it does not explain why output per person grows at a sustained pace. Higher population growth lowers the level of output per person.

What shortcoming of the Solow growth model does the Romer model attempt to remedy?

In the Solow​ model, output per person eventually reaches a steady state​, from which it grows no further. while Romer model shows how growth can be sustained)

What happens to the domestic real interest rate when world savings increase or decrease?

Increases in world saving or decreases in world investment cause the domestic real interest rate to fall, domestic investment to rise, and net capital outflows (net exports) to fall

Explain the differences between nominal and real interest rates and between ex ante and ex post real interest rates

It's the difference between the expected (inflation-adjusted) interest rate that you plan to get, and the real (inflation-adjusted) interest that you actually get. Suppose you buy a 10-year government bond that gives you a nominal interest rate (yield) of say 5% per annum over the next ten years and presume that inflation will run at a rate of say 2% per annum over the next 10 years Then, the real interest rate you're planning to ex-ante (before the event) is about 3 percent per annum over the next ten years. Now presume that the truth of the ex-post (after the event) turns out to be that while you get the nominal interest rate of 5% per annum on the government bond, the average inflation rate over the ten years turns out to be 3%. Instead, the real ex-post interest rate you'll actually earn over the ten years turns out to be about 2 percent per annum. Ex-post yield varies from ex-ante yield because it reflects actual values, simply what investors receive and not expected values. Investors base their decisions on expected returns versus actual returns, which is a key aspect of a risk analysis of an investment. Ex-post is the current market price, minus the amount owed by the buyer. It shows an asset's performance; however, it does exclude projections and probabilities.

Unemployment in the Adult Population Example: Not in labor force (36.0%), 88.5 million Unemployed: (7.8%), 12.3 million Employed: (58.9), 144.8 million Find: 1. Labor Force 2. Unemployment Rate 3. Labor-Force Participation Rate 4. Employment Ratio

Labor Force = 144.8 + 12.3 = 157.1 million Unemployment Rate = 12.3 / 157.1 = 7.8% Labor-Force Participation Rate = 157.1 / 245.6 = 64.0% Employment Ratio = 144.8 / 245.6 = 59.0%

Factors of Production

Land, labor, and capital; the three groups of resources that are used to make all goods and services

A snack food factory in the Tuas area of Singapore employs 100 workers and 20 machines. Currently the marginal product of labor is $6 and that of capital is $15. Assuming that the market prices for labor and capital are $3 and $25 respectively; answer the following: a) Is the firm maximizing its profits? b) Should the firm change its use of labor and capital? If yes, how?

MP_L = $6 MP_k = $15 Market price of labor: $3 Market price of capital: $25 Let P be price of product from producers. A profit maximizing firm will employ labor until MP_L = w/p $6 > 3/p ^^ the firm should employ more labor as MP_L us greater than wage MP_K = δ / p $15 = 25 / p If 15 > 25/p the firm should employ more capital to maximize profit and it should do this until MP_K = w/p a) No, the firm is not maximizing its profits because it is not employing labor and capital optimally. Profit can be increase by employing more labor and capital. b) The firm should employ more labor and more capital. The firm can do this by employing labor and capital until their marginal product equals the real wage and the real rental rate

Consider the following production function: Y = F(K, L) = AK^0.4L^1.0 a) Calculate the marginal product of labor. b) Does this production function exhibit diminishing marginal product of labor?

MP_L = d(Y)/dL = d (AK^0.4 L^1.0) / dL = AK^0.4 L^1-1 = AK^0.4 L^0 =AK^0.4 *1 MP_L= AK^0.4 ^^ that is the marginal product of labor No this production function does not exhibit marginal product of labor because we can see, MP_L does not have an L term, so it is constant and the graph will be positive.

The Consumer Price Index (CPI) is constructed using a basket of goods consumed by a typical urban consumer. Do you think that the basket is the same in every country? Explain

No. Different countries citizens have different basket of goods that they regularly purchase.

In France at the beginning of 2008 the nominal long-term interest rate was 4%, and inflation was 3%; higher than the European Central bank target of 2% but expected to remain at that level. If you took a loan at BNP Paribas at that interest rate, calculate the bank's ex ante real interest rate. What was the bank's ex post real interest rate, given that inflation went to 0% at the end of 2009? And did the fall in inflation benefit you as a borrower?

Nominal interest rate in the beginning of 2008 = 4% Prevailing inflation rate = 3% (expected to remain at that level) European central bank target= 2% inflation at the end of 2009 = 0% ---------- real interest rate= nominal interest rate - inflation rate .. So bank's ex ante real interest rate = nominal interest rate - inflation rate that we expect = 4% -3% = 1% .. So bank's ex post real interest rate = nominal interest rate - inflation rate that we actually get = 4% -0% = 4% .. No fall in inflation from 3% to 0% did not benefit me as a borrower. Borrowers are hurt by deflation because they have to pay back their debts with money worth more than the money they borrowed in the first place. As my purchasing power is unaltered because of 0% inflation and i am paying back money which is worth more.

What are some polices that can stimulate productivity?

Policies to stimulate productivity include building infrastructure, increasing human capital, government spending on R&D, tax incentives for R&D, and patents

What does Profit Maximization indicate?

Profit maximization indicates that firms demand a quantity of each factor of production (labor and capital) up until the marginal product of that factor falls to its real factor price, that is, MPK = R/P = r_c and MPL = W / P = w. Hence, the marginal product curves for each factor are also the demand curves for each factor. Factor prices are determined at the intersection of the demand and supply curves for each factor.

What type of right is the most fundamental institutions required for economic growth? What are the 4 properties of this?

Property rights are the most fundamental institution required for economic growth and require 1) an effective legal system that can enforce contracts with adequate resources and plenty of lawyers; 2) an absence of corruption; 3) a low cost of establishing legal businesses; and 4) an absence of the "grabbing hand" by the government.

Suppose that the following Cobb-Douglas production function represents the economy of Chile: Y = F(K, L) = AK^0.4L^0.6 . Assuming Chile's national income equals $170 billion, calculate real labor income and real capital income

Real Capital income = Share of capital in national income * national income 0.4 * 170bn = $68 billion Real labor income: Share of labor in national income * national income 0.6 * $170bn = $102 billion The real labor income is $102 billion and the real capital income is $68 billion

Which part of the business cycle is of particular concern to macroeconomists? Why?

Recession because it affects employment and income.

Investment Funtion

Reveals the relationship between per-worker investment and the per-worker capital stock when investment equals saving i_t = sAk_t^0.3

Net Capital Outflow Identity

S - I = NX Net Capital Outflow = Trade Balance If saving is greater than investment, then the excess saving is invested abroad and so constitutes a net capital outflow, that is, more capital flows from the domestic economy to foreigners than flows into the domestic economy from abroad. If, on the other hand, investment is greater than saving, the excess of investment over saving is financed by borrowing abroad. We can say that net capital outflow is negative, or that there is a capital inflow

Uses-of-savings identity

S = (C + I + G + NX) - C - G = I + NX tells us that saving either goes into investment—acquiring capital goods and boosting the capital stock—or, alternatively, into net exports—selling goods to foreigners in exchange for foreign currency assets. In other words, a nation that saves can invest in its capital stock or acquire assets from foreigners.

What causes desired saving to increase? What effects will an increase in desired saving have in a closed economy

Savings are stimulated through tax consumption, tax incentives, increased return on saving, and reducing budget deficits. If autonomous consumption and real interest rates decrease savings and investments increases.

Suppose Japan has a GDP of $5 trillion, and that its national savings rate is 25%. Assuming Japan is an open economy, a) calculate Japan's investment if net exports are 1% of GDP. b) calculate Japan's exports if imports are valued at $650 billion

Since Japan has a GDP of $5 trillion, and that its national savings rate is 25%. and Japan is an open economy. a) National Saving= 25% of $5 trillion =0.25*$5 trillion =$1.25 trillion Since National saving is equal to the Investment. Hence the investment is $1.25 trillions. a pt.2) Net exports are 1% of GDP Net export= 1% of $5 trillion Net export=0.01*$5 trillion =$0.05 trillions Since 1 trillions = 1000 billions Hence Net export is = 0.05*1000 billion =$50 billion b) Japan's exports if imports are valued at $650 billion Net export= Export - import $50 billion= Export - $650 billion Export=50+650 =$700 billions.

Budget Surplus

T - G. an excess of tax revenue over government spending. This amount is identical to government saving. When government outlays are greater than government receipts, we say the government budget is in deficit

How to increase savings

Tax policy is one way to increase the returns to saving a) governments can lower income taxes for households that put money into saving vehicles such as 401(k)s. b) Governments can make consumption more costly through national sales taxes, or give tax breaks to businesses that contribute to employee pensions.

Why are technological ideas that are put into production nonrivalrous?

Technological ideas are an input into production and are non-rivalrous, that is, they can be used over and over again without limit. However, they often have a low level of excludability because it is hard to keep others from using them without permission. As a result, there may not be sufficient incentives to invest in technology

As an input to production, how does technology differ from labor and capital inputs

Technological ideas are non-rivalrous inputs and they often have a low level of​ excludability, whereas capital and labor are fundamentally excludable rival inputs.

Types of Supply shocks

Technology Shocks: Technological advances, such as the development of a faster computer chip, can raise total factor productivity so that the A parameter in the production function rises Natural Environment Shocks: Blizzards, droughts, floods, earthquakes, and hurricanes can slow construction activity to a grind, reducing output for a given level of capital and labor. An unusually warm winter may have the opposite effect Energy Shocks: Energy is an important factor of production separate from capital or labor. When energy supplies are disrupted—for example, when OPEC cuts back on the production of oil to raise prices—firms use less energy, causing the amount of output the economy produces to fall for a given quantity of capital and labor

new generation of iPhones that can ascertain whether your interlocutor is lying. Assuming that the price of this good will be higher than that of the currently marketed iPhone, comment on the CPI's capability to correctly measure the corresponding change in the cost of living

The CPI will overstate the change in the cost of living because the new iPhone is an improved product.

What is the Golden Level rule of the Capital-Labor Ratio?

The Golden Rule level of the capital-labor ratio is the level of the capital-labor ratio that maximizes consumption per worker in the steady state.

When does the Golden Rule level of Capital-labor ratio occur?

The Golden Rule level of the capital-labor ratio occurs when MPK = δ + n, that is, when the marginal product of capital equals the depreciation rate plus the population growth rate

What part of the olden Rule Level causes the investment function?

The Golden Rule level of the saving rate, s_G, is the one that causes the investment function, s_GAk_t^0.3 , to intersect with the depreciation plus capital dilution line, (δ + n)k_t, at the Golden Rule level of the capital-labor ratio, k*_G

Consider the world economy and comment on the effect of the Industrial Revolution on the world growth rate of output per person, according to the assumptions of the Romer model.

The Industrial Revolution increased productivity of ​R&D. The fraction of the population engaged in ​R&D thereby increasing the balanced growth paths of many countries.

Technological Spillover

The Romer model's optimistic view of population growth may not apply well to individual countries. Suppose India, a country with a fast-growing population, develops a new process for growing wheat that helps farmers produce more wheat in less time. The process will improve living standards in India. However, the nonrivalry of ideas will lead the technology to spread to India's neighbors and eventually around the world. This phenomenon of technological spillover might explain why countries with high rates of population growth don't have higher per-capita income (see Figure 6.11 in the last chapter). If the productivity frontier At is similar across countries, then the Solow result still holds and rising population will be associated with lower per-capita income

What does the Solow Growth Method focus on?

The Solow growth model focuses on explaining how capital accumulation occurs and the role that it plays in producing economic growth. It shows that an economy reaches a steady state in the long run at the level of the capital-labor ratio at which investment equals depreciation plus capital dilution, that is, where ∆k_t = 0 = sAk_t^0.3 - (δ + n)k_t. An important implication of the Solow model is that there is convergence: countries with different levels of per capita income will gravitate to a similar level. Economies that have low initial per capita income will have higher growth rates, while those with high initial per capita income will have lower growth rate

What are the four basic results of the Solow growth model? What is the model's chief weakness?

The Solow model provides these insights into economic growth: (1)if different economies have the same aggregate production function they will converge to similar levels of output-per-worker and per-capita income (2) a higher saving rate increases the levels of capital-per-worker and output-per-worker but does not affect their long-run growth rates; (3) a higher rate of labor force growth reduces the level of output-per-person; and (4) increases in productivity directly increase output-per-person and also increase it indirectly by causing the capital-to-labor ratio to rise. The Solow model's chief deficiency is that it does not explain sustained increases in output-per-worker and per-capita income. This is so because productivity growth, which in the Solow model is the only source of continuous growth, is determined by factors outside the model, i.e., productivity growth is an exogenous variable.

The nominal GDP of Italy increased by roughly 1% between 2011 and 2012. Is this information sufficient to conclude that the economy grew in that period of time? Given that the inflation rate was 3%, what can we conclude on the growth of the economy? Did standards of living improve between 2011 and 2012 in Italy?

The above statement is not significant to conclude that the economy grew because nominal gdp can increase if the price increase (inflation) and with no change in quantity of goods and services. growth of real gdp: 1% - 3% = -2% so growth has reduced in italy. The standard of living in italy has fallen from 2011 anf 2012 in italy

What relationship does the aggregate production function portray? Which of the production function's variables are endogenous and which are exogenous?

The aggregate production function represents the relationship between the quantities of inputs that go into the production process and the output that is produced with those inputs. In the production function Y = F(K,L), output (Y) is an endogenous variable whose value is explained by the production function while the capital (K) and labor (L) inputs used in production are the exogenous variables that determine or explain the level of output produced.

What does the Aggregate Production Function Tell us?

The aggregate production function tells us how much output an economy produces for given amounts of factor inputs, capital and labor. The Cobb-Douglas production function, Y = F(K, L) = AK^0.3L^0.7, displays constant returns to scale: when all the factor inputs increase by the same percentage, aggregate output increases by exactly the same percentage. The Cobb-Douglas production function also displays diminishing marginal product: as the amount of a specific factor input increases, holding other inputs constant, its marginal product decreases. Positive supply shocks result in an increase in the quantity of output and marginal products of factors for any given combination of capital and labor, while negative supply shocks do the opposite.

Capital-Labor Ratio

The amount of capital per worker, k_t = K_t / L_t

What determines the amount of investment per worker and capital accumulation in the Solow growth model?

The amount of investment-per-worker is based on the equality of saving and investment in the long-run. The Solow model assumes workers save a given proportion s of their output-per-worker Y/L so sY/L is available to finance investment-per-worker I/L. To avoid capital dilution and a decline in the capital-to-labor ratio, a fraction of this investment must be used to replace old capital that has worn out (depreciated). This fraction is the depreciation rate . Capital accumulation—increases in capital-per-worker—occur only if the amount of investment is greater than K/L. The change in capital-per-worker, then, equals investment-per-worker minus depreciation-per-worker.

Wage Rate

The cost of labor is the price of labor, the wage rate, W, times the amount of labor, L, that is, WL.

Real Wage Rate

The cost of labor is the price of labor, the wage rate, W, times the amount of labor, L, that is, WL. the average hourly wage rate measured in the dollars of a given reference base year. is the wage in term of goods and services, which can be written as the nominal wage rate divided by the price level, w = (W / P)Hence the expression for real economic profits can be written as: Π = F(K, L) - r_cK - wL

According to the growth accounting equation, what are the three sources that contribute to economic growth?

The growth accounting equation primarily looks at three factors: labor, capital, and technology

What does the Income approach measure?

The income approach measures GDP by adding up all the incomes received by households and firms in the economy, including profits and tax revenue to the government. In this approach, there are eight categories of income: compensation of employees, self-employment income, rental income, net interest income, indirect business taxes, corporate profits, depreciation, and net factor income.

What are the main types of income included in national income? Why doesn't national income equal GDP?

The major income items in national income are employee compensation, proprietors' income, rental income of persons, corporate profits, net interest, and some other minor income components.The total of these income categories does not equal the GDP because depreciation, which is treated as an expense and therefore reduces proprietors' income and corporate profits, is not income for anyone else.Furthermore, a country's national income includes income its residents earn from productive activities in other countries, which do not contribute to the country's GDP and excludes income nonresidents earn from their productive activities in the country that do contribute to its GDP.Adjusting national income by adding in depreciation and factor income paid to the rest of the world, subtracting factor income received from the rest of the world, and adjusting for the (relatively small) statistical discrepancy that arises from measuring GDP in two different ways—the production approach and the income approach—reconciles the two approaches.

Why does the per-worker production function have its particular shape and slope?

The per-worker production function slopes upward because an increase in capital-per-worker increases output-per-worker. However, as capital-per-worker rises, the additional output-per-worker that can be produced with each unit addition to the capital-to-labor ratio declines because the per-worker production function, like the aggregate production function on which it is based, exhibits diminishing marginal product of capital. Thus the per-worker production function becomes flatter as the capital-to-labor ratio increases.

Consider the following production function: Y = F(K, L) = A(2K + 3L). Does this production function exhibit constant returns to scale? (Hint: Replace K and L by 2K and 2L, respectively, and check if F(2K, 2L) = 2F(K, L).)

This function exhibits constant returns to scale. By substituting 2k and 2L, Y' = A (4K+6L) = 2A(2K+3L) = 2 Y.

What is crowding out?

The rise in government spending causes private investment to fall as government spending increases

What does the unemployment rate measure, who calculates it, and how is it calculated?

The unemployment rate measures the share of workers in the labor force who do not currently have a job but are actively looking for work. the unemployment rate in the United States is obtained by dividing the number of unemployed persons by the number of persons in the labor force (employed or unemployed) and multiplying that figure by 100.

What determines the world real interest rate? Why must the domestic real interest rate be the same as the world rate?

The world real interest rate is determined by flows on capital between domestic and foreign residents. It must be the same because of perfect capital mobility.

How does the Chinese one-child policy affect steady-state levels of capital and output per worker according to the Solow Model

There are many consequences that arise from a coercive population control method as the one implemented by China. First, the drop in fertility rates has been so big that the Chinese labor force might be smaller in the future than what it is today. Second, it means that young workers in the future will have to work extra hard to support their parents. This is a phenomenon shared by many aging populations, even when there is not population control, but clearly the one-child policy makes this worse. Finally, and most importantly, Chinese families that are allowed to have only one child usually prefer to have a baby boy. This has resulted in ratios of baby boys to baby girls of around 120 to 100, when the usual ratio is around 103 to 105 baby boys per 100 baby girls. An interesting corollary is that in the future there will be more Chinese young boys trying to marry fewer Chinese girls than in previous years

According to many observers, low wages in China are due to excess supply of labor. Explain how the equilibrium factor price is reached in a market with excess supply of the factor.

They will decrease the price that they pay which will make individuals leave the labor force.

Why do the factor demand and supply curves have their particular slopes?

They're both downward sloping because of diminishing marginal product.

The Spanish unemployment rate was less than 10% before the 2007 crisis. At the end of 2012 it moved to about 25%. Comment on the economic and social consequences of such a dramatic change.

This means people were not able to work, and the economy was not as productive.

What are the 3 savings measures prominently used in macroeconomics?

Three saving measures figure prominently in macroeconomics: private saving: (S_P = Y - T - C) government saving: (S_G = T - G) national saving (S = Y - C - G = S_P + S)G), which is the sum of the other two. The uses-of-saving identity indicates that saving is linked to wealth because it either goes into investment, which adds to physical capital, or into net capital outflow, which adds to a country's net foreign assets. The net capital outflow identity says that net capital outflow, the difference between saving and investment, equals net exports: S - I = NX

How does total factor productivity differ from labor productivity?

Total factor productivity tells us how productive capital and labor are, whereas labor productivity tells us how productive labor is. total factor productivity" (TFP), which tries to capture the efficiency with which inputs of capital as well as labor are used. labor productivity, which is usually calculated by dividing total output by the number of workers, or the number of hours worked.

Suppose total population is 100 million and 25% is devoted to the production of research and development. Using the simplified version of the Romer model outlined in the chapter, calculate the following: a) The change in technology (∆ At), if χ = 0.0005 and A_t = 20 b) The growth rate of technology c) The per-person output growth rate

Total population: 100 million Production: 25% x= .0005 A_t = 20 a) Change in tech: .0005*20*25 (x*A_t*p) = .25% b) Growth Rate = X * P * population = .0005 *.25*100 =1.25% c) per person output growth rate: = growth rate * 1.43g =1.25% * 1.43 = .0170 =1.7095

What is the fundamental identity of national income accounting? What is its significance?

Total production = Total expenditure = Total income. The national income accounts measure economic activity. Any way it's measured, it's the same thing: economic activity. Each specific activity is a good or service that has been produced, has a market value (actual or imputed), and generates income for someone. An individual who produces ten dollars of market value does so in order to receive ten dollars of income, which arrives as the customer's ten dollar expenditure.

Describe the two components of national saving and explain how saving affects national wealth.

Two major components of national saving are private saving and public saving. Private saving is the mount of the private sector's after tax income that is not spent on current consumption expenditures.

How do macroeconomists distinguish between nominal and real values of variables? Does nominal GDP or real GDP provide a better picture of changes in economic activity and economic well-being? Why?

Variables measured in terms of dollars or other monetary units, such as GDP and its various income and expenditure components, can be measured using either current market prices or the prices of a base year. The nominal value of a variable is measured using current market prices and will change when either current market price or quantity changes. Therefore, a change in a variable's nominal value gives no information about whether or how much market price or quantity has changed. The measure of a real value, however, always uses the prices of a base year. Thus a variable's real value changes only when quantity changes and is unaffected by changes in current market prices. For that reason, real GDP rises only when the output of final goods and services rises and falls only when output falls and thus is a better measure of changes in economic activity and well-being.

The International Property Rights Index (IPRI) ranks countries according to the significance and protection of both intellectual and physical property rights. What correlation between income per capita growth and the IPRI ranking might you expect? Why?

We should expect that countries that have better designed and enforced property rights are the ones with better standards of living. Properly enforcing property rights increases individuals' and firms' ability to recover their investment needed to advance technology. After the period from which the innovation is made excludable by patents laws (or the enforcement of some other property right), technology spills over and benefits the whole society, even the world. Countries in which individuals and firms have the incentives to engage in R&D will benefit the most from this innovation process. As predicted, the IPRI ranking and per capita income growth are strongly correlated.

Small open Economy

We will now look at a small open economy, an economy that is open to trade and to flows of capital across its borders and that is "small" relative to the world economy, so that whatever happens in this economy has no effect on the world real interest rate. For a small open economy, we can take the world real interest rate, denoted by r^w, as given

Which are the obstacles to effective property rights? Explain.

When property rights do not satisfy all of the three necessary conditions, market allocations will be inefficient; most significant problem.

Suppose the economy of India can be represented by the following production function: Y = AK^1/3 L^2/3 . Assume that during 2014, India's technological growth (Solow residual) is 4%, and the growth rates of both the capital and labor input stocks are 3% a) Calculate India's output growth for 2014. b) What is the contribution of productivity growth to total output growth (in percentage terms)?

Y = A K^1/3 L^2/3 Y is output; A is total factor productivity; K is capital; L is labor Solow residual is a measure of total factor productivity. Solow residual is 4% i.e., % change in A = 4% and Growth rates of the capital and labor input stocks were 3% in both cases. i.e., % change in capital = % change in labor = 3% ----------------- a) Growth accounting equation: % change in Y = % change in A + (1/3)* (% change in K) + (2/3)* (% change in L) => % change in Y = 4% + (1/3)*3% + (2/3)*3% => % change in Y = 4% + 1% + 2% => % change in Y = 7% Hence, the output growth was 7% b) Productivity growth = 4% Total output growth = 7% Contribution of productivity growth to total output growth = (4% / 7%) = 0.5714 => Contribution of productivity growth to total output growth = 57.14%

Cobb-Douglass Production Function

Y = F(K, L) = AK^0.3 L^0.7 First, an efficient, developed economy will generally produce more with the same quantity of capital and labor than an inefficient, primitive economy. Second, the shares of labor and capital income in the U.S. economy have remained relatively constant over time at about 70% labor and 30% capital

Productivity

Y = F(K, L) = AK^0.3 L^0.7 The A variable describes productivity or, more precisely, total factor productivity, telling us how productive capital and labor are. In other words, it tells us how much output an economy can produce given one unit of capital and one unit of labor. If total factor productivity, A, goes up by 5%, then for the same amount of labor and capital, the total amount of goods and services produced in the economy increases by 5% under the Cobb-Douglas function

National Income Identity Formula Pieces Y = C + I + G + NX

Y = GDP = total production (output) C = consumption expenditure I = investment G = government purchases of goods and services NX = net exports = exports - imports

Explain each symbol or term in the Cobb-Douglas production function. Which element in the production function cannot be measured directly? How is it measured?

Y(output),=F(function) (K,L) (capital,labor)=A(total factor productivity)K^.03L^.7. We can't directly measure total factor productivity so we measure by: A=Y/(K^.3L^.7).

Is it correct to assume that total income equals total expenditure for a household? What about for the whole economy?

Yes, because there is a buyer and a seller for every good or service produced in the economy.

Inflation

a general increase in prices and fall in the purchasing value of money.

Aggregate Production Function

a hypothetical function that shows how productivity (real GDP per worker) depends on the quantities of physical capital per worker and human capital per worker as well as the state of technology which is a description of how much output, Y, is produced for any given amounts of factor inputs, such as K and L. We present the production function as follows: Y = F(K, L)

Compare the following factors of production in terms of their rivalry and excludability: a) A robot that welds car frames and the idea of building a car in an assembly line b) A recipe to make pancakes and the recipe to manufacture a soda drink

a) A robot that welds care frames is rivalrous and excludable, and the idea of building a car in an assembly line is non-rivalrous and nonexcludable (b) A recipe to make pancakes is non-rivalrous and nonexcludable, and the recipe to manufacture a soda drink is non-rivalrous and highly excludable

The British Office of National Statistics decides about the CPI basket of goods and assumes that alcohol and tobacco account for almost 5% of total consumer expenditure in the UK. a) With everything else the same, if the prices of alcohol and tobacco increase by 20%, by how much would the CPI increase? b) Does the CPI correctly measure the true change in the cost of living of a British citizen who neither drinks alcohol nor smokes?

a) An average consumer spends 5 pounds out of every 100 pounds on purchasing tobacco and alcohol. Now, 20% increase in 5 pounds is equal to 1 pound. Therefore, if everything else remains the same in the CPI basket, the CPI would increase by 1 from earlier 100 pounds to the new CPI 101 pounds. Thus, CPI increases by 1%. b) We can not say that CPI truly measures the true change in the cost of living of a British. Critics of CPI say that it overstates inflation by at least 1%. They say that CPI measures cost of living index, whereas earlier the CPI was used to measure inflation at different periods of time.

Comment on the effect of a decrease in autonomous investment on wealth when the economy can be considered a a) closed economy. b) small open economy.

a) In a closed economy, it will intersect the saving line at a point left than before, therefore reducing interest rate and income. As interest rate decreases, return from savings also decrease (since savers now receive lower interest on their savings). This will decrease their wealth. b) In a small open economy, however, interest rate is fixed at the level of world interest rate, which is usually at a level higher than the domestic equilibrium interest raye of a closed economy. Therefore, shift in investment function causes no impact on the interest rate and only income falls. The fall in income, however, reduces savings and indirectly decreases wealth.

What determines the desired amounts of national saving and investment? What relationship between desired saving and desired Relationship Between Saving and Wealth 1. Suppose Japan has a GDP of $5 trillion, and that its national savings rate is 25%. a) Calculate Japan's national saving. b) Calculate Japan's government saving if private saving is $800 billion.

a) National savings: GDP * saving rate $5tr * 25% = $1.25tr b) National saving: $1.25 - $800bn = $450bn

a) Consider the effects of an immigration wave of individuals who exhibit both higher saving and fertility rates than the current population. Draw the new curves. b) Identify the new steady-state capital-labor ratio level. Is it necessarily higher or lower than the previous steady state?

a) The new wave of immigrant workers is equivalent to the rise in the population. This will lead to the forward shift of the depreciation and capital dilution curves. Also, more saving rate will lead to more investment and will move the investment curve upwards. b) The new steady state capital labor ratio level is thus higher as compared to the old one

Consider a small open economy that is currently running a trade surplus. Answer the following questions using a graphical representation of desired saving and investment in the small open economy: a) Is the world real interest rate higher or lower than the real interest rate that would prevail if this were a closed economy? b) What would be the effect of an autonomous decrease in investment on the trade balance?

a) The real interest rate that would prevail if this were a closed economy is lower than the world interest rate b) Net export will INCREASE. At world real interest rate, savings is greater than investment. So there is a trade surplus. A fall in world interest rate will lead to increase in net exports.

Suppose Equation 2 represents the production function of both Mexico and Spain. Use the following information to answer the next questions. L = Population (millions) K = Capital (trillion) Y = Output (Trillion) L K Y Mexico 105 0.18 1.0 Spain 45 0.74 1.7 a) Calculate total factor productivity for both countries using Equation 3. b) Calculate per capita income for both countries. c) Explain the difference in per capita income.

a) The total factor productivity for mexico is, A=Y/K^0.3L^0.7 = 1/(0.18)^0.3(105)^0.7 =0.64 The total factor productivity for Spain is: A= Y/K^0.3L^0.7 = 1.7/(0.74)^0.3(45)^0.7 =0.13 b) The percapita income for both the countries are PI= Y/L = AK^0.3 L^0.7/L =AK^0.3/L^0.3 The percapita income of Mexico is: PI(M) = AK^0.3/L^0.3 = 0.064(0.18)^0.3/(105)^0.3 =$ 0.0094 million/ capita The percapita income of Spain is: PI(S)= AK^0.3/L^0.3 = 0.13(0.74)^0.3/(45)^0.3 = 0.0379 c) The difference in per capita income of two countries is due to the difference in the total factor productivity in two countries. The total factor productivity is less in Mexico, the per capita income is also less in Mexico.

The inhabitants of Pandora value their natural environment (e.g., forests, springs, breathable air, etc.) twice as much as the inhabitants of Utopia. Suppose that the value added for all goods and services increases by the same amount in both countries, but has a negative effect on the environment (e.g., pollution). a) According to the production approach to the measurement of GDP, is this good or bad? b) Are both countries necessarily better off? Which country benefits more for sure? c) The inhabitants of Utopia are very concerned about income distribution, which is not that important for the inhabitants of Pandora. If the increase in value added results in further wealth concentration, how will this affect your answers to part (b)?

a) This is good because the value of GDP increases in both countries due to the increase in value added. b) Neither country is necessarily absolutely better​ off, but Utopia will be relatively better off than Pandora. c) n this alternative scenario, inhabitants of Utopia will not benefit as much from the increased economic activity if it undermines one of their fundamental values: a more equal income distribution. As before, it might even be the case that inhabitants of Pandora will suffer a lot from observing a more skewed income distribution, but they will always benefit more from this situation than their counterparts in Utopia

Uruguay has implemented the One Laptop per Child (OLPC) initiative in which one laptop is given to every child and teacher in a public primary school. Comment on the effects of this program on the following: a) Uruguay's human capital stock b) Uruguay's output per capita growth rate

a) This program is an increase in the chi ​(chiχ​) parameter—the productivity of research and development—of the​ Romer's model. b) This program increases the balanced growth path of output per capita.

Comment on the effect of an increase in the government budget surplus (or a decrease in the government budget deficit) on the real interest rate, desired saving, and net exports for a a) large open economy. b) small open economy.

a) We know that large open economy is a economy of large enough to affect world interest rate. If the government face budget deficit or surplus is explained on the basis of Interest rate, desired saving and net exports. Interest rate, desired saving and net exports We know that large open economy affects the world real interest rate. If the government faces the budget deficit then government purchases will be increased. if the government budget deficit will be increased that will shift or decreases the loanable funds. reduces of the supply of loanable funds leads to increase the interest rate of the country. When interest rate will increased it crowd out the investment from the country. When the real interest rate will be low that will increase the net exports. because more foreign income will be earned by the country. b) The small open economy is a economy that is they will be small enough compared to their trading partner. In the small open economy the increase in government budget deficit will affect the current account only if the budget deficit reduces national saving. In the small open economy the interest rate is determined by the level of investment. Also the differences between saving and investment determines the net export of the country.

Assume that the marginal product of capital is given by the following expression: MPK = 60 / K^0.7 (K is measured in trillions). a) Graph the demand curve for capital and find the equilibrium real rental rate of capital if capital supply is ten trillion. b) Suppose a positive supply shock hits the economy, and now MPK = 70 / K^0.7. Draw the new demand curve and calculate the new equilibrium real rental rate of capital

a) We would have a graph and a straight line at x=10. then a curved line that passes through (10,11.97) demand for capital= r = P*MP_K r= 60 / K^0.7 K^0.7 = 60/r K = 60^(1/0.7) / r^(1/0.7) 60^(1/0.7) / r^(1/0.7) = 10 r^(1/0.7) = 60^(1/0.7) / (10) r= 60 / 10^0.7 r* = 11.97 (new equilibrium) ------------- b) We would have a graph and a straight line at x=10. then a curved line that passes through (10,13.97) 70^(1/0.7) / r^(1/0.7) 70^(1/0.7) / r^(1/0.7) = 10 r^(1/0.7) = 70^(1/0.7) / (10) r= 70 / 10^0.7 r*= 13.97 (new equilibrium)

Based on the Solow model's conclusions about population growth, comment on the effects of immigration on a country's a) aggregate output level. b) capital-labor ratio.

a) aggregate output level to INCREASE b) DECREASING the country's capital-labor ratio

Sciences other than economics also use models to explain the behavior of endogenous variables based on assumptions about the environment and changes in exogenous variables. Suppose you have to design a model that links childhood obesity and diabetes. a) Which one would be the exogenous variable? Which one would be the endogenous variable? b) Can you think of other exogenous variables?

a) childhood obesity b) Diabetes

Consider the expenditure approach to the measurement of GDP. For each of the following situations, decide if the transaction will affect GDP and, if so, in which expenditure category will it be included. a) A household purchase of a home built in 2005. b) A household purchase of a newly built dishwasher. c) A farmer purchases a new tractor to work his or her field. d) A disabled individual receives a transfer from the U.S. government. e) The U.S. Department of Defense buys ten helicopters just built in Brazil

a) does not count toward GDP b) is counted in the consumption category. c) is counted in the investment category d) does not count toward GDP e) is counted as government spending and subtracted as imports.

Assume that the per-worker production function is y_t = 2k_t^0.5 . The saving and depreciation rates are estimated at 0.2 and 0.04, respectively. a) Calculate the capital-labor ratio steady state for this economy. b) Calculate consumption per worker at the steady state

a) Δk = 0 sy_t - δk_t = 0 sy_t = δk_t 0.2(2k_t^0.5) = 0.04k_t 0.4k_t^0.5 = 0.04k_t 0.4/ 0.04 = k_t/k_t^0.5 10 = k_t^0.5 k_t = 100 Thus, the steady-state value of the capital-labor ratio is k_t=100 b) y_t = 2k_t^0.5 2(100)^0.5 2*10 =20 Output per worker is 20. steady-state value: c=(1-s)y =(1-0.2)20 =0.8*20 =16 Consumption per worker at the steady state is 16

Assume that the marginal product of labor is given by the following expression: MPL = 52 / L^0.3 (L is measured in millions). a) What is the marginal product of labor when L = 80 million? b) Determine the equilibrium real wage if the labor supply equals 100 million workers (L = 100).

a)marginal product of labor when L = 80 million =52/(80)^0.3 (as given MPL =50/L^0.3 =13.966 =14(appx) => marginal product of labor when L = 80 million =13.966 =14(appx) b)equilibrium real wage if the labor supply equals 100 million workers => real wage = MPL in equilibrium => real wage = 52/L^0.3 =52/(100)^0.3 =13.06 => Real wage =13.06 in equilibrium

Distinguish between a flow measure and a stock measure. Which type of measure is GDP?

a. flows: represent an amount per unit of time b. stocks: represent an amount at a particular point in time since GDP is a flow concept, it must be measured during a specified period of time

Activist Economists

advocates the use of policies to eliminate excessive unemployment whenever it develops. Activists think that doing nothing will leave too many people out of work for too long.

Open Economy

an economy that interacts freely with other economies around the world

Closed Economy

an economy that is closed to international trade with zero net exports (NX = 0). . The total demand for goods and services in a closed economy is C + I + G. If the goods market is in equilibrium, this demand will equal the amount of goods and services produced, Y. Goods market equilibrium therefore occurs when Y = C + I + G

Institutions

are sets of rules, organizations, and customs that govern the behavior of individuals and firms

Nonactivist Economists

argues that the economy has a self-correcting mechanism that will quickly restore an economy in recession to a healthy condition Activist policies, nonactivists say, could kick in at the wrong time, producing undesirable fluctuations in economic activity and inflation.

The following table contains information about the marginal product of capital corresponding to each capital-labor ratio (measured as the value of the capital stock per capita). Use it to determine the Golden Rule capital-labor ratio if the depreciation rate is 5% and the population growth rate is 2% k $4.5 $5 $5.5 $6 $6.5 MPK 10% 9% 8% 7% 6%

at golden rule, MPK = n+d n+d= 1+8= 9% MPK is 9% at golden rule and it is 9% when capital labor ratio is 5000. golden rule capital labor ratio is 5000

What rule do firms follow to determine how much of each input to hire in order to maximize profits?

demand a quantity of each factor of production up until the marginal product of that factor falls to its real factor price

Investment Tax Credit

gives businesses a tax break when they make an investment in physical capital, encourage businesses to expand investment at any given real interest rate and also shift the investment curve to the right. An increase in business optimism or a change in the tax code that increases autonomous investment causes saving, investment, and the real interest rate to rise. Similar reasoning indicates that when businesses become more pessimistic or the government raises taxes on investment, lowering autonomous investment, the investment curve will shift to the left, and so saving, investment, and the real interest rate will fall

Central Banks

government banks that manage, regulate, and protect both the money supply and the banks, and keeps inflation in check

Government Consumption

government purchases for short-lived goods and services like health care and police protection

Balance Growth Path

growth at a constant rate. This constant growth rate contrasts with the Solow model, in which output per person eventually reaches a steady state from which it grows no further

Capital Dilution

growth in the labor force that leads to less capital per worker. For example, if the number of workers is growing at 1% per year, the number of machines must grow at 1% per year to keep the capital-labor ratio constant. In other words, net investment would have to be 1% of the capital stock. If net investment were zero, then the capital stock per worker would fall by 1% of the capital stock per year.

Steady State

he point at which capital per worker kt comes to rest and stops changing, occurs when ∆k_t = 0 0 = sAk_t^0.3 - δk_t

Factor Accumulation

increasing the size of capital stock or the labor force

Marginal Product of Capital (MPK)

indicates how much output increases for each additional unit of capital, holding other inputs constant. Thus another way to describe the slope of the production function is that as the capital stock increases, the marginal product of capital declines. In other words, there is diminishing marginal product of capital

Marginal Product of Labor

indicates how much output increases for each additional unit of labor

Discouraged Workers

individuals who would like to work but have given up looking for a job

Perfect Capital Mobility

no restrictions on international trade in assets

Using the Romer model, explain how economic growth responds to developments related to R&D activities

nvestment in knowledge capital generates enough output per person and savings per person to always maintain the investment required, and the savings which is generated is in excess of the amount of investment required. Thus, Romer's model intuitively identifies how companies investing in human capital continuously realize excess returns from their initial investment.

Fisher Equation example you have made a one-year loan with a 4% interest rate )i = 4%) and you expect the price level to rise by 6% over the course of the year (π^e = 6%).

r = 4% - 6% = -2%

World real interest rate

r^w, the real interest rate found in world markets. r = r^w If the domestic real interest rate r were above the world real interest rate rw, then with no barriers to capital flows, domestic residents (which include the government) would just borrow abroad at the world real interest rate rw. Alternatively, if the domestic real interest rate were below the world real interest rate, domestic residents would only lend to foreigners and earn the world interest rate r^w. Since borrowing or lending would only occur at the world real interest rate r^w, the domestic real interest rate would not deviate from the world real interest rate

Rental price (cost) of capital

r_c the rental price of capital in terms of goods and services, which is the nominal rental price of capital divided by the price level—that is, r_c = (R>P)

ex-post interest rate

real (inflation adjusted) interest you end up actually getting

ex-ante interest rate

real (inflation-adjusted) interest rate you expect

Perfect Competition

t firms take market prices as given because they are not large or powerful enough to charge more than the market price for their goods or services. Also, firms are not powerful enough to pay their workers less than the market wage, nor are groups of workers, such as unions, powerful enough to get wages above the market wage. By long-run equilibrium, we mean here that everyone who wants work can find it, and all factories and other capital are utilized, so that quantity of labor and capital supplied equals quantity demanded. These assumptions, of course, may not hold at every moment in every country, but they serve as useful benchmarks to understand how factor prices are determined.

Total Factor Productivity

tells us s how productive capital and labor are. In other words, it tells us how much output an economy can produce given one unit of capital and one unit of labor. If total factor productivity, A, goes up by 5%, then for the same amount of labor and capital, the total amount of goods and services produced in the economy increases by 5% under the Cobb-Douglas function.

fundamental Identity of national Income Accounting

the accounting identity that states that total production, total income, and total expenditure during a given period are equal Total Production = Total Expenditure = Total Income

Autonomous Consumption

the amount of consumption that occurs no matter the level of disposable income. In a linear consumption function, this shows up as a constant and graphically it appears as the y intercept. - C = C + C(Y - T, r) + - The plus sign below Y - T indicates that as disposable income increases, consumption expenditure rises, while the minus sign below r indicates that as real interest rates rise, consumption expenditure falls. As disposable income rises, consumers have more income to spend, increasing their desired amount of consumption expenditure. Rising real interest rates encourage consumers to save more and spend less, since they can earn a higher return on their saving

Property Rights

the protection of property from expropriation by the government or other parties. Property rights are necessary if people are to have incentives to make investments. Otherwise, the fruits of their investments (the profits) could be easily taken away. A farmer who does not have clear-cut ownership of his land, or who worries that armed marauders may take away his crops or farm equipment, is unlikely to buy enough seeds, fertilizer, and tractors to boost his farm's production. Weak property rights thus lead to low investment and low accumulation of capital

Net Capital Outflow

the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners Net Capital Outflow = Trade Balance

Labor Productivity

the quantity of goods and services that can be produced by one worker or by one hour of work

Production Function

the relationship between quantity of inputs used to make a good and the quantity of output of that good. which is a description of how much output, Y, is produced for any given amounts of factor inputs, such as K and L.

Crowding Out

the rise in government spending causes private investment to fall as government spending increases. a rise in government spending causes saving and investment to fall and the real interest rate to rise in the long run, while a decline in government spending causes saving and investment to rise and the real interest rate to fall.

National Income Accounting

the techniques used to measure the overall production of the economy and other related variables for the nation as a whole looking at expenditure, income, and production methods

National Saving

the total income in the economy that remains after paying for consumption and government purchases S = S_P + S_G = Y - C - G

The March 2011 earthquake led to the Fukushima Daiichi nuclear disaster in Japan. Can the earthquake be labeled as a supply shock? Explain

yes. Natural disasters are considered supply shocks

Capital-Accumulation Equation

∆k_t = i_t - δk_t Change in capital stock per worker = Investment per worker - Depreciation per worker

Explain each term in the profit function for a firm

𝜫 = P * F(K,L) - RK - WL. 𝜫 denotes economic profits, which are revenues earned from production minus the costs of production. Revenues are P * F(K,L), where P is the average price level and F(K,L) is the quantity of output; costs are RK for capital, the rental price of capital times the amount of capital hired, and WL for labor, the wage rate times the amount of labor hired.

Real Variable

A measure of an economic variable in terms of quantities of actual goods and services

Business Cycle

Fluctuations in economic activity, such as employment and production

Personal Consumption Expenditure (PCE) Deflator

PCE deflator for year y = 100 * (Nominal PCE in year y) / (Real PCE in year y)

The recent financial crisis led to expansionary fiscal policy responses both in the United States of America and in Europe to counteract the adverse effects on the economy. Increased budget deficits in Europe resulted in high public debts (and the so-called sovereign debt crisis). What can governments do to lower their deficits and debts? What measures have already been taken?

The deficit can only be reduced if the government raises taxes, cuts spending, or some of each.

Nominal Interest Rate

The interest rate without accounting for inflation. the interest rate as usually reported without a correction for the effects of inflation

Net Government Income

The part of GDP that is not at the disposal of the private sector. taxes - transfers - interest payments on government debt

Exogenous Variables

a set of factors not explained by the model that are used to explain the endogenous variables but are taken as given and thus are viewed as determined outside the model. endogenous variable (the unemployment rate), the macroeconomist might specify consumer optimism or government spending as exogenous variables that are taken as given. Or if he or she were interested in explaining real wage growth, the endogenous variable, the macroeconomist might choose the rate of technological progress or the power of unions as the exogenous variables

What is the distinction between endogenous variables and exogenous variables in economic models?

a. an exogenous variable is an input to the model, while an endogenous variable is an outcome of the model. An exogenous variable is an input that is allowed to change over time at a rate predeterminedby the model builder, whereas an endogenous variable is an output of the model

Government Budget Deficits

an excess of government spending relative to revenue

Net Exports

are exports minus imports: that is, the value of currently produced goods and services exported, or sold to other countries, minus the value of goods and services imported, or purchased from abroad. Exports - imports

Intermediate Goods and Services

are used up entirely in the stages of production. To illustrate, suppose that Intel produces $400 of microprocessors to go into the Mac that Apple sells for $1,500, and it costs $50 to ship the Mac to the computer store where you buy it. The $400 of microprocessors is an intermediate good, the $50 of shipping is an intermediate service, and the $1,500 Mac is a final good. Would it make sense to include all these goods and services in GDP? No. We include only the $1,500 Mac, the final good, in GDP. Otherwise, there would be double counting because the costs of the intermediate goods and services used in producing the Mac are already included in the price for the final good. That is, GDP should include only the market value of final goods and services.

Net Domestic Product

gross domestic product - minus depreciation

Interest Rate

is the cost of borrow ing, or the price paid for the rental of funds (usually expressed as a percentage of the rental of $100 per year). If, for example, you lend $100 to a friend, and he or she agrees in one year's time to pay you $105—$5 for the rental of the funds and $100 for repayment of the loan—then the interest rate is 5%

Fisher Equation

real interest rate = nominal interest rate - inflation rate defines the real interest rate in precise terms by stating that the nominal interest rate i equals the real interest rate plus the expected rate of inflation π^e :6

Nominal GDP

the production of goods and services valued at current prices Nominal GDP = Price Level * Real GDP

Labor Force

the total number of workers, including both the employed and the unemployed Labor Force = Number of Employed + Number of Unemployed

Seasonally Adjusted

which means economists adjust the data to subtract out the usual seasonal fluctuations using advanced statistical techniques. This is because if you just looked at the raw data on GDP, you might conclude that every winter the economy goes into recession, when in reality output tends to fall in cold and snowy months.

Employment Ratio

The percentage of the adult civilian population employed = Employed / Adult Population

What is the main test that an economic model should pass?

1. Identify an interesting economic question. For example, a macroeconomist might want to understand why the unemployment rate rises or falls over time, or why workers' wages in real terms (in terms of the goods and services they can actually buy) rise more rapidly during certain periods, but not others. 2. Specify the variables to be explained by the model, as well as the variables that explain them. A variable that a macroeconomist wants to explain is referred to as an endogenous variable, because it is explained inside the model he or she is building (and thus has the endo prefix). She would then identify a set of factors, called exogenous variables, that are used to explain the endogenous variable, but are taken as given and thus are viewed as determined outside the model. (This is why they have the exo prefix.) For example, in explaining the endogenous variable (the unemployment rate), the macroeconomist might specify consumer optimism or government spending as exogenous variables that are taken as given. Or if he or she were interested in explaining real wage growth, the endogenous variable, the macroeconomist might choose the rate of technological progress or the power of unions as the exogenous variables. The schematic diagram in Figure 1.1 illustrates the relationship between endogenous and exogenous variables in an economic model. 3. Posit a set of equations or graphical analysis to connect movements in the exogenous variables to the endogenous variables. For example, we might create a formula showing how, all else being equal, a 10% increase in government spending would change the unemployment rate. This formula is our model. 4. Compare the conclusions of the model with what actually happens. For example, if the model is designed to explain the unemployment rate, we would compare the model's predictions to actual unemployment data in prior years. If the conclusions do not match this historical data, return to step 2 and change the model 5. If the data are well explained, use the model to make further predictions, say on where the unemployment rate will head a year from now, and suggest policies to lower it.

Chain-Weighted Measures

A chain-weighted inflation measure takes into account changes in both price and spending patterns. What is chain weighted measures of real GDP? Essentially, a chain-weight system differs from a fixed-weight system in that it measures output using current and previous year prices—something akin to a floating base year. For example, calculating chain-type GDP for 1994 is done using prices and quantities from 1993 and 1994.

Bond

A financial security that represents a promise to repay a fixed amount of funds

According to a note in the House of Commons, United Kingdom, in June 2011, since September 2007 the Government was dealing both with specific banks in crisis and with the broader problems of the monetary and banking system. Does this statement about the economic activities of the British government reveal an activist or a non-activist policy behavior?

Activist

A financial crisis hit the British economy at the end of 2007. In the aftermath of the crisis, the Bank of England provided liquidity to the UK economy and pursued a loose monetary policy in order to favor recovery. Do these policy measures affect future inflation, and individuals' expectations about it?

After liquidity is provided, there will be times of inflation that will occur after like in Covid times.

Explain the difference between fiscal policy and monetary policy. Which of the two is in the hands of the European Central Bank?

ECBank is in charge of monetary policy. Monetary policy refers to the actions of central banks to achieve macroeconomic policy objectives such as price stability, full employment, and stable economic growth. Fiscal policy refers to the tax and spending policies of the federal government

Flow

GDP is a flow, an amount per a given unit of time If the faucet has been running for a half hour with a flow of one gallon per minute and the tub was initially empty, then the stock of water in the tub will be thirty gallons, that is, thirty minutes times the flow of one gallon per minute. The most important flow variable we have discussed in this chapter is GDP, which always has to be thought of as an amount produced per year or per quarter. Examples of stocks and flows that are related include the following: inventory investment, a flow, which accumulates into the stock of inventories saving, a flow, which accumulates into a person's wealth; and fixed investment, a flow, which accumulates into the economy's capital stock

Expenditure Approach

GDP is the total spending on currently produced final goods and services in the economy. The expenditure approach allows us to get information on the different components of spending that add up to GDP. The national income accounts divide spending into four basic categories: 1. consumption expenditure, 2. investment, 3. government purchases (spending) 4. net exports

What are global trade imbalances and why do economists focus on them?

Global Imbalances refers to the situation where some countries have more assets than the other countries. In theory, when the current account is in imbalance, it has a zero value: inflows and outflows of capital will be cancelled by each other. Hence, if the current account is persistently showing deficits for certain period it is said to show an inequilibrium. Since, by definition, all current accounts and net foreign assets of the countries in the world must become zero, then other countries become indebted with the other nations.During recent years, global imbalances have been concerned in rest of world. The United States has run long term deficits, as well as many other advanced economies, while country Asia and economies, among other countries, the opposite have occurred. Although this imbalance has reached unparalleled levels, it is far from being a new situation. And often, it is a sign of unsustainable features that occur a big risk to the global economy when they loosen, especially in an abrupt manner.

Fiscal Policy

Government policy that attempts to manage the economy by controlling taxing and spending. (policymakers' decisions to raise taxes, cut government spending, or both).

Monetary Policy

Government policy that attempts to manage the economy by controlling the money supply and the interest rates.

Price Indexes

Help gauge the health of the economy by measuring the levels of inflation, disinflation, deflation, and stagflation.

What macroeconomic conditions, issues, and events can shape your future?

In thinking about the overall health of the macroeconomy, it is useful to consider three primary goals: economic growth: ultimately determines the prevailing standard of living in a country. Economic growth is measured by the percentage change in real (inflation-adjusted) gross domestic product full employment (or low unemployment): as measured by the unemployment rate, is the percentage of people in the labor force who do not have a job. When people lack jobs, the economy is wasting a precious resource-labor, and the result is lower goods and services produced. stable prices (or low inflation): nflation is a sustained increase in the overall level of prices. If many people face a situation where the prices that they pay for food, shelter, and healthcare are rising much faster than the wages they receive for their labor, there will be widespread unhappiness as their standard of living declines.

How to interpret GDP?

Interpreting GDP requires distinguishing between real and nominal GDP. Real GDP provides the most information about the level of economic activity and equals nominal GDP adjusted for changes in the price level.

What is stabilization policy? What two important debates occur among macroeconomists regarding its use, and who are the parties to these debates?

Stabilization policy is the use of fiscal and monetary policies to stabilize economic activity by reducing business cycle fluctuations. One debate concerns how active stabilization policy should be. It pits nonactivists, macroeconomists who believe that the economy has a self-correcting mechanism that works rapidly to reduce unemployment without the need for stabilization policy, against activistswho think this self-correcting mechanism is too slow and therefore call for the active use of fiscal and monetary policies to reduce unemployment when it is unacceptably high. A second debate arises between macroeconomists who advocate the use of policy rules to specify in advance precisely how policymakers must react to changes in unemployment or inflation and those who would allow policymakers greater latitude to use their discretionary judgment to formulate the policy response they believe is most appropriate in a given situation.

Inventory Investment

The change in inventories over a given period of time, say a year

What does the Expenditure Approach measure?

The expenditure approach measures GDP by adding up the total spending on currently produced final goods and services in the economy. With this approach there are four basic categories of expenditure: 1. consumption expenditure, 2. investment, 3. government purchases 4. net exports. The fundamental identity of national income accounting says that GDP equals the sum of consumption expenditure, investment, government purchases, and net exports, that is, Y = C + I + G + NX.

What is the inflation rate?

The inflation rate is the percentage rate of change of the price level, measured by a price index, over a particular period of time. The most popular price indexes are the consumer price index (CPI), the GDP deflator, and the personal consumption expenditure (PCE) deflator. There is a link between inflation, nominal GDP, and real GDP: the growth rate of nominal GDP equals the sum of the inflation rate and the growth rate of real GDP

Consumer Price Index

The key measure of inflation- the change in the cost of buying a fixed basket of goods and services. the Bureau of Labor Statistics determines what people actually buy with an expenditure survey and then compiles a "basket of goods" that the average urban consumer buys.

Credit Markets

The markets where households and businesses get funds (credit) from each other

National Income Identity and formula

The national income accounts add up these four categories (consumption expenditure, investment, government purchases (spending), and net exports) of spending to determine GDP Y = C + I + G + NX

What is a nation's savings rate? Why are the Chinese and the US savings rates so different from one another (Figure 1.9)?

The national savings rate is the GDP that is saved rather than spent in an economy

What is the real interest rate?

The real interest rate is the nominal interest rate minus the expected rate of inflation, that is, r = i - π^e . It is a better measure of the incentives to borrow, invest, and lend than the nominal interest rate, and it is a more accurate indicator of the tightness of credit market conditions than the nominal interest rate.

What is the business cycle?

The term "business cycle" refers to economy-wide fluctuations in production, trade, and general economic activity. The upward and downward movements of levels of GDP and refers to the period of expansions and contractions in the level of economic activities (business fluctuations) around a long-term growth trend.

What is the unemployment rate?

The unemployment rate is the percentage of people in the civilian population who want to work but are unemployed. The labor-force participation rate is the percentage of the adult civilian population in the labor force, and the employment ratio is the percentage of the adult civilian population that are employed.

Personal Consumption Expenditure

Total spending by consumers for durable goods, nondurable goods, and services during a specified period of time.

Depression

When the decline in real GDP is severe, a recession is classified as a depression. A long-term economic state characterized by unemployment and low prices and low levels of trade and investment

Suppose your model predicts that overweight children have an 80% higher risk of suffering from diabetes in their adult life. If data show that overweight children do not suffer from diabetes as predicted by your model (i.e., data show a lower than 80% probability), what would your next step be?

You should choose new​ variables, equations, or graphs.

Capital Good

a good that is produced in the current period to be used in the production of other goods and that is not used up in the stages of production. We classify new capital goods as final goods and thus include them in GDP because they are not included in spending on other final goods and yet their production is certainly part of economic activity Ex: Suppose a robot is manufactured to install windshields in new automobiles. Is it an intermediate good or a final good? Although the robot is used to help produce new cars, it is not used up in producing the car and will keep on installing windshields for many years, the robot is a capital good.

Income Approach

involves adding up all the incomes received by households and firms in the economy, including profits and tax revenue to the government

Gross Domestic Product (GDP)

is the total market value of all final goods and services newly produced in the economy. We measure GDP in three ways: the production approach the expenditure approach and the income approach

Consumption / Consumption expenditure / personal consumption expenditure

is the total spending for currently produced consumer goods and services. Consumption expenditure is by far the largest component of GDP and was 68.7% of GDP in 2012 (see Table 2.1). We can break it down into three basic categories: 1. Consumer durables: are goods purchased by consumers that last a long time (are durable), such as automobiles, electronic goods, and appliances. 2. Nondurable goods: are short-lived consumer goods such as food, housing services (but not purchases of houses, which are part of investment), gasoline, and clothing. 3. Services: are purchased by consumers; examples include haircuts, education, medical care, air travel, and financial services

Gross Domestic Product

the total value of goods produced and services provided in a country during one year. We add up the value of all the goods and services produced in one year—say, from cell phones, automobiles, textbooks, DVDs, computers, haircuts, and rock concerts—to determine GDP

Trade Balance

the value of a nation's exports minus the value of its imports; also called net exports

What three macroeconomic data series are of particular interest to macroeconomists? Why?

1. real GDP 2.Unemployment 3. Inflation rate

Endogenous Variables

A variable that a macroeconomist wants to explain. because it is explained inside the model he or she is building (and thus has the endo prefix endogenous variable (the unemployment rate), the macroeconomist might specify consumer optimism or government spending as exogenous variables that are taken as given. Or if he or she were interested in explaining real wage growth, the endogenous variable, the macroeconomist might choose the rate of technological progress or the power of unions as the exogenous variables

Hyperinflation

A very rapid rise in the price level; an extremely high rate of inflation. Zimbabwe (not shown in the figure) is the most recent extreme example, with its inflation rate soaring to over two million percent at an annual rate

Imputed Value

An estimate of the value of a good or service that is not sold in the marketplace and therefore does not have a market price. For example, an important component of GDP is housing services. When you rent your college apartment, there is a market price that you pay and so it is easy to include it in GDP. But what if, instead, you owned the apartment? A homeowner is getting housing services, just as a renter is. To impute the value of these services, the Department of Commerce, which computes GDP, assumes that in effect the homeowner is paying rent to him- or herself. A homeowner's imputed value is the rental price of comparable housing in the market The existence of nonmarket goods and services suggests that GDP is an imperfect measure of output produced in the economy. An especially large component of GDP that is not traded in the market is goods and services provided by the government, such as national defense, police protection, firefighting, and education. The standard practice is to value these services at the cost of providing them. The imputed value of a police officer giving out traffic tickets, for example, is the wages he or she is paid when doing traffic duty

What happens to the overall level of prices during periods of inflation and deflation?

Inflation is an increase in the general prices of goods and services in an economy. Deflation, conversely, is the general decline in prices for goods and services, indicated by an inflation rate that falls below zero percent.

Recession

a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.

Stock

a quantity at a given point in time. To see the difference between a stock and a flow, consider the classic example of a bathtub, shown in Figure 2.1. Stocks and flows are clearly related: a stock is often an accumulation of flows over time. If the faucet has been running for a half hour with a flow of one gallon per minute and the tub was initially empty, then the stock of water in the tub will be thirty gallons, that is, thirty minutes times the flow of one gallon per minute. The most important flow variable we have discussed in this chapter is GDP, which always has to be thought of as an amount produced per year or per quarter. Examples of stocks and flows that are related include the following: inventory investment, a flow, which accumulates into the stock of inventories; saving, a flow, which accumulates into a person's wealth; and fixed investment, a flow, which accumulates into the economy's capital stock

Economic Model (and the 5 steps)

a simplified representation of the economic phenomenon that takes a mathematical or graphical form. The development of an economic theory or model typically involves five steps: 1. Identify an interesting economic question. For example, a macroeconomist might want to understand why the unemployment rate rises or falls over time, or why workers' wages in real terms (in terms of the goods and services they can actually buy) rise more rapidly during certain periods, but not others. 2. Specify the variables to be explained by the model, as well as the variables that explain them. A variable that a macroeconomist wants to explain is referred to as an endogenous variable, because it is explained inside the model he or she is building (and thus has the endo prefix). She would then identify a set of factors, called exogenous variables, that are used to explain the endogenous variable, but are taken as given and thus are viewed as determined outside the model. (This is why they have the exo prefix.) For example, in explaining the endogenous variable (the unemployment rate), the macroeconomist might specify consumer optimism or government spending as exogenous variables that are taken as given. Or if he or she were interested in explaining real wage growth, the endogenous variable, the macroeconomist might choose the rate of technological progress or the power of unions as the exogenous variables. The schematic diagram in Figure 1.1 illustrates the relationship between endogenous and exogenous variables in an economic model. 3. Posit a set of equations or graphical analysis to connect movements in the exogenous variables to the endogenous variables. For example, we might create a formula showing how, all else being equal, a 10% increase in government spending would change the unemployment rate. This formula is our model. 4. Compare the conclusions of the model with what actually happens. For example, if the model is designed to explain the unemployment rate, we would compare the model's predictions to actual unemployment data in prior years. If the conclusions do not match this historical data, return to step 2 and change the model 5. If the data are well explained, use the model to make further predictions, say on where the unemployment rate will head a year from now, and suggest policies to lower it.

Consider the difficult task of raising children. One of the most widely recognized challenges of this task is to properly balance rules and ad-hoc decisions. Constantly breaking rules might send the wrong message to a kid, while strictly enforcing rules every time might result in excessive punishments. The debate about the conduct of macroeconomic policy is not significantly different from this example. a) Comment on the American Recovery and Reinvestment Act of 2009. Can this Act be characterized as discretionary policy? b) Is it possible for this set of policies to affect the incentives of financial intermediaries or other major economic agents?

a) Discretionary policy is implemented by​ decision, such as the American Recovery and Reinvestment Act of​ 2009, and usually has a much longer response lag. discretionary fiscal policy that made the cyclically-adjusted budget become more negative. increase in government spending and decreases in taxes b) These other financial intermediaries will look to receive money from the government and provide that as loans to people

Assume that a civil war erupts in a given country, creating chaos and destroying most of the economy's infrastructure (e.g., roads, businesses, and telecommunications). a) What would be the effect on economic growth? b) How do you think a civil war affects incentives to invest in that country?

a) decrease b) decrease