week 5: chapter 9 & 10, Week 6: Chapters 11 & 12
determinants of aggregate supply
Factors such as input prices, productivity, and the legal-institutional environment that, if they change, shift the aggregate supply curve.
average propensity to save (APS)
Fraction (or percentage) of disposable income that households save; saving divided by disposable income.
average propensity to consume (APC)
Fraction (or percentage) of disposable income that households spend on consumer goods; consumption divided by disposable income.
equilibrium real output
GDP at which the total quantity of final goods and final services purchased (aggregate expenditures) is equal to the total quantity of final goods and services produced (the real domestic output); the real domestic output at which the aggregate demand curve intersects the aggregate supply curve.
What did Keynes offer as the explanation for cyclical unemployment and recessions?
General Theory of Employment, Interest, and Money: income does not have to spent within the same period it is received
net exports
Xn --> exports minus imports which can either be negative or positive
real income
amount of goods and services that can be purchased with nominal income during some period of time; nominal income adjusted for inflation.
what will happen if expected rate of return on investment rises/real interest rates fall?
an upward shift in the investment schedule
multiplier effect
any initial change in a component of total spending can lead to a larger change in GDP
cost of living adjustments (COLAs)
automatic increase in the incomes (wages) of workers when inflation occurs; often included in collective bargaining agreements between firms and unions. Cost-of-living adjustments are also guaranteed by law for Social Security benefits and certain other government transfer payments.
The type of inflation that is more likely to be associated with positive GDP gap is
demand-pull inflation
A difficult aspect of measuring the unemployment rate is
determining who is eligible and available to work
how to calculate rate of inflation
difference between CPI of current year and last/the previous year 100 --> 278.8-260.5/260.5 x100 = 7%
wealth
dollar amount of all assets owned minus amount of liabilities (debt)
If a $50 billion initial increase in spending leads to a $250 billion change in real GDP, how big is the multiplier?
5.0 (multiplier= change in real GDP/initial change in spending)
consumer price index
measures the prices of fixed market basket of some 300 goods and services bought by a "typical" consumer
The nominal interest rate is:
minus the inflation rate is the real interest rate
seasonal variation and long-term trends complicate the measurement of the business cycle because
normal seasonal variations do not signal boom or recession
multiplier
number by which a change in any such component must be multiplied to find the resulting change in equilibrium GDP.
nominal income
number of dollars received by an individual or group for its resources during some period of time.
productivity
output per unit of input
what causes disequilibrium?
overproduction (excess inventory) & excess total spending (draws down inventory)
in sequential order, the four phases of the business cycle are
peak, recession, trough, and expansion
nominal interest rate
percent increase in money borrower pays lender including the built in expectation of inflation
unemployment rate
percentage of the labor force unemployed at any time.
recession
period of declining real GDP, accompanied by lower real income and higher unemployment.
how to calculate per unit production cost
total input cost/ units of output
how to calculate productivity?
total output/total inputs
Which of the following will shift the aggregate supply curve to the right?
- business taxes fall (reduction in business taxes is likely to encourage investment and production, leading to an increase in aggregate supply) - a new networking tech increases productivity all over the economy (ntroduction of new networking technology, generally enhance productivity and increase aggregate supply)
what is the difference between frictional and structural unemployment?
- frictional have the skills and location to find jobs but are still having trouble - structural have a hard time finding new jobs due to a LACK of skills, education, or area in need of employment - frictional is short term and structural is long term
what was keynes' solution for the recessionary expenditures gap (negative GDP gap)?
- increase government spending - lower taxes
Which of the following will shift the aggregate demand curve to the left?
- interest rates rise (higher interest rates could lead to reduced consumer spending and business investment, contributing to a leftward shift in the aggregate demand curve) - the government raises corporate profit taxes (an increase in corporate profit taxes may decrease business investment and potentially reduce consumer spending, leading to a leftward shift in the aggregate demand curve)
In year 1, Anita earns $1,000 and saves $100. In year 2, Anita gets a $500 raise so that she earns a total of $1,500. Out of that $1,500, she saves $200. What is Anita's MPC out of her $500 raise?
0.80 (mpc= change in consumption or savings/ change in income)
With a marginal propensity to save of 0.4, the marginal propensity to consume will be
1.0 minut 0.4
labor force
16 years of age and older who are not in institutions and who are employed or are unemployed and seeking work.
investment schedule
shows the amount of investment forthcoming at each level of GDP
investment demand curve
A curve that shows the amounts of investment demanded by an economy at a series of real interest rates.
productivity
A measure of average output or real output per unit of input. For example, the productivity of labor is determined by dividing real output by hours of work.
Which of the following illustrates the difficulty of distinguishing among frictional, structural, and cyclical unemployment?
A person quits his job in search of a better one, but the former job is in a declining industry and disappears completely.
aggregate demand (AD)
A schedule or curve that shows the total quantity of goods and services that would be demanded (purchased) at various price levels.
Effect of: A widespread fear by consumers of an impending economic depression
AD will decrease
Effect of: A 10 percent across-the-board reduction in personal income tax rates
AD will increase
Effect of: A major increase in spending for health care by the federal government
AD will increase
Effect of: An increase in exports that exceeds an increase in imports (not due to tariffs)
AD will increase
Effect of: The general expectation of coming rapid inflation
AD will increase
Effect of: a reduction in interest rates
AD will increase
Effect of: A 12 percent increase in nominal wages (with no change in productivity)
AS will decrease
Effect of: A new national tax on producers based on the value added between the costs of the inputs and the revenue received from their output
AS will decrease
Effect of: A sizable increase in labor productivity (with no change in nominal wages)
AS will increase
Effect of: The complete disintegration of the Organization of the Petroleum Exporting Countries (OPEC), causing oil prices to fall by one-half
AS will increase
GDP gap
Actual gross domestic product minus potential output
how to calculate aggregate expenditures in a private closed economy?
C + Ig (consumption + investment)
how to calculate aggregate expenditures in private open economy?
C + Ig + Xn (consumption + investment + net exports)
unplanned changes in inventories
Changes in inventories that firms did not anticipate; changes in inventories that occur because of unexpected increases or decreases of aggregate spending (or of aggregate expenditures).
discouraged workers
Employees who have left the labor force because they have not been able to find employment.
Can the economy achieve and maintain an equilibrium real GDP that is substantially above the full-employment output level?
No!d There is not enough labor for the economy to produce at much more than potential output for an extended period of time
Explain how an increase in your nominal income and a decrease in your real income might occur simultaneously. Who loses from inflation? Who gains?
Nominal income is calculated through sources like wages, rent, interest, and profit. Whereas, real income is measured through a person's purchasing power and reflects inflation. An increase in nominal income and a decrease in real income could occur at the same time if prices rise faster than nominal income and if real income increases at the same level as the cost of living increases. Typically, those who are hurt by inflation are fixed-income receivers, savers, and creditors. On the other hand, the people who gain from inflation are flexible income receivers like social security recipients and debtors.
What is Say's law?
Say's law was used by classical economists and states that supply creates its own demand.
Who measures the labor force, and how is it defined?
The U.S. Bureau of Labor Statistics (BLS) measures the labor force as people over 16 years of age who are employed and those who are actively seeking work.
injection
The act of investing (purchasing capital goods) is an injection; addition of spending into the income-expenditure stream: any increment to consumption, investment, government purchases, or net exports.
leakage
The act of saving is a leakage; (1) A withdrawal of potential spending from the income-expenditures stream via saving, tax payments, or imports; (2) a withdrawal that reduces the lending potential of the banking system.
what will happen if expected rate of return declines/real interest rates rise?
a downward shift in the investment schedule
aggregate demand- aggregate supply model (AD-AS model)
a model that explains short-run fluctuations in real GDP and the price level
The noneconomic effects of unemployment include:
a sense of failure created in parents and in their children
Unemployment is an economic problem becuase:
a unit of labor resource that could be engaged in production is sitting idle.
determinants of aggregate demand
aggregate demand shifters; Factors such as consumption spending, investment, government spending, and net exports that, if they change, shift the aggregate demand curve.
what will happen if there is a tax increase?
aggregate expenditures schedule will decrease and the equilibrium GDP also lowers
what will happen if there is a tax decrease?
aggregate expenditures schedule will increase and GDP will also raise
The 45-degree line on a graph relating consumption and income shows
all the points at which consumption and income are equal.
peaks
business activity has reached a temporary maximum; the point at which an expansion ends and a recession begins. At the peak, the economy is near or at full employment and the level of real output is at or very close to the economy's capacity.
trough
business activity has reached a temporary minimum; the point at which a recession ends and an expansion (recovery) begins. At the trough, the economy experiences substantial unemployment and real GDP is less than potential output.
cyclical unemployment
caused by insufficient total spending (insufficient aggregate demand) and which typically begins in the recession phase of the business cycle
how to calculate the multiplier?
change in real GDP/initial change in spending
The Consumer Price Index (CPI) is determined each month by:
comparing the value of a "market basket" of goods that consumers typically purchase to the value of the basket in a base year.
substitutions effect
consumers will want to buy more of the individual product because it becomes less expensive relative to other goods (NOT AN EXPLANATION FOR THE AD DOWN SLOPE)
The type of inflation that is more likely to be associated with negative GDP gap is
cost-push inflation
If there is an increase in the unemployment rate, the size of the labor force:
could increase or decrease
deflation
decline in the general level of prices in the economy
Which of the following statements is true?
deflation means the the price level is falling, whereas the inflation overall prices are rising
interest-rate effect
explains AD downward slope: tendency for increases in the price level to increase the demand for money, raise interest rates, and, as a result, reduce total spending and real output in the economy (and the reverse for price-level decreases).
real-balances effect
explains AD downward slope: tendency for increases in the price level to lower the real value (or purchasing power) of financial assets with fixed money value and, as a result, to reduce total spending and real output, and conversely for decreases in the price level.
hyperinflation
extremely high rate of inflation, usually defined as an inflation rate in excess of 50 percent per month
If the MPS rises, then the MPC will:
fall (1-MPC = MPS)
expansion
followed by recession where real GDP, income, and employment begin to rise (may lead to inflation)
Okun's Law
for every 1% point by which the actual unemployment rate exceeds the natural rate, a GDP gap of about -2% happens
marginal propensity to consume (MPC)
fraction of any change in disposable income spent for consumer goods; equal to the change in consumption divided by the change in disposable income.
marginal propensity to save (MPS)
fraction of any change in disposable income that households save; equal to the change in saving divided by the change in disposable income.
natural rate of unemployment (NRU)
full-employment rate of unemployment; the unemployment rate occurring when there is no cyclical unemployment and the economy is achieving its potential output; the unemployment rate at which actual inflation equals expected inflation.
intermediate-short-run aggregate supply curve
horizontal aggregate supply curve that applies to time periods over which both input prices and output prices are fixed; an aggregate supply curve for which real output, but not the price level, changes when the aggregate demand curve shifts.
anticipated inflation
increase in price level/inflation at the expected rate
expected rate of return
increase in profit a firm anticipates it will obtain by purchasing capital or engaging in research and development (R&D); expressed as a percentage of the total cost of the investment (or R&D) activity.
supply-push inflation
increase of inflation from an increase in resource costs and hence per unit production costs; inflation caused by reduction in total supply
unanticipated inflation
increase of the price level/ inflation at a rate greater than expected
demand-pull inflation
increases in the price level (inflation) resulting from an excess of demand over output at the existing price level, caused by an increase in aggregate demand
what do injections and leakages look like during equilibrium GDP?
injections into the income expenditures stream = leakage from income stream AKA equilibrium GDP ---> leakages = injections
what kind of relationship does a the aggregate demand curve have?
inverse relation: when price levels rise, real GDP demanded decreases
foreign purchases effect
inverse relationship between the net exports of an economy and its price level relative to foreign price levels. (increase in the price level means decrease in net exports)
planned investment
investment schedule showing the amounts business firms collectively intend to invest at each possible GDP
offshoring
jobs that occurs when the demand for a particular type of labor shifts from domestic to foreign firms
break-even income
level of disposable income at which households plan to consume (spend) all their income and to save none of it.
paradox of thrift
possibility that households trying to protect themselves against a recession by saving more may inadvertently worsen the recession and hurt themselves by reducing overall consumption and economic activity.
equilibrium price level
price level at which aggregate demand equals aggregate supply; the price level at which the aggregate demand curve intersects the aggregate supply curve.
how to calculate CPI
price of the most recent market basket in the particular year/ price estimate of the market basket in 1982-1984 x 100
how did the Great Depression begin?
prices did not fall and economy sank below its output level - GDP declined by 27% and unemployment rose to 25%
Demand-pull inflation occurs when:
prices rise because of an increase in aggregate spending not fully matched by an increase in aggregate output.
potential output
real output (GDP) an economy can produce when it fully employs its available resources.
business cycle
recurring increases and decreases in the level of economic activity over periods of years consists of: -peak -recession -trough -expansion
What does inflation do?
reduces the purchasing power of the dollar
45 degree line
reference line in a two-dimensional graph that shows equality between the variable measured on the horizontal axis and the variable measured on the vertical axis - line along the value of output (horizontal) and value of aggregate expenditures (vertical)
what does movement on the aggregate demand curve mean?
represent changes in the amount of real GDP demanded in response to changing price levels
Because real GDP kept growing in 2021, we know that AD must have shifted _________
rightward, leftward
inflation
rise of general level of prices -- increase in economy's price level
saving schedule
saving function; table of numbers that shows the amounts households plan to save (plan not to spend for consumer goods), at different levels of disposable income.
aggregate supply
schedule or curve showing the total quantity of goods and services that would be supplied (produced) at various price levels.
The bout of inflation the United States experienced in 2021 was unusual in that it was caused by _________
shifts in BOTH AD and AS
The Bureau of Labor Statistics (BLS) calculates the inflation rate from one year to the next by
subtracting the CPI of the previous year from the CPI of the most recent year, and then dividing by the CPI of the previous year.
consumption schedule
table of numbers showing the amounts households plan to spend for consumer goods at different levels of disposable income
aggregate expenditures schedule
table of numbers showing the total amount spent on final goods and final services at different levels of real gross domestic product (real GDP)
lump sum tax
tax that collects a constant amount (the tax revenue of government is the same) at all levels of GDP.
wealth effect
tendency for people to increase their consumption spending when the value of their financial and real assets rises and to decrease their consumption spending when the value of those assets falls
what will happen if there is an increase in government spending (publicly or privately)?
the aggregate expenditures schedule will shift upward and produce a higher equilibrium GDP
inflationary expenditures gap
the amount (vertical distance) by which aggregate expenditures at the full-employment GDP level exceed those just sufficient to achieve employment --> amount by which aggregate schedule would have to shift downward to realize equilibrium at the full employment level of GDP
recessionary expenditures gap
the amount (vertical distance) from which aggregate expenditures at the full-employment GDP level fall short of those needed to achieve full-employment --> insufficient spending contracts or depresses the economy
This economic concept is a key driving force behind _________
the business cycle
The central economic idea humorously illustrated in the Last Word "Toppling Dominoes" is _________
the multiplier effect
The unemployment rate is defined as:
the number of unemployed persons divided by the labor force.
real interest rate
the percentage increase in purchasing power that the borrower pays the lender
The business cycle affects output and employment in capital goods industries and consumer durable goods industries more severely than in industries producing consumer nondurables because:
these goods last, so that purchases can be postponed
frictional unemployment
type of unemployment caused by workers voluntarily changing jobs and by temporary layoffs; unemployed workers between jobs. - called frictional because the labor market does not operate perfectly - this can be a good thing as people can search for better paying jobs and therefore have better allocation of labor resources and real GDP for the economy
core inflation
underlying increases in the price level after volatile food and energy prices are removed
A positive unemployment rate—more than zero percent—is fully compatible with full employment because at full employment,
unemployment includes frictional unemployment, which is always positive because people are transitioning to new jobs
full-employment rate of unemployment
unemployment rate at which there is no cyclical unemployment of the labor force; equal to around 4 percent (rather than zero percent) in the United States because frictional and structural unemployment are unavoidable.
short-run aggregate supply curve
upward sloping aggregate supply curve relevant to time periods over which input prices are fixed but output prices are flexible; an aggregate supply curve for which real output and the price level both change when the aggregate demand curve shifts.
the length of a complete business cycle
varies greatly in duration and intensity
long-run aggregate supply curve
vertical aggregate supply curve relevant to time periods over which input prices and output prices are both fully flexible; an aggregate supply curve for which the price level, but not real output, changes when the aggregate demand curve shifts; a vertical aggregate supply curve that implies fully flexible prices.
A consequence of a negative GDP gap is that:
what is not produced is lost forever and future economic growth will be less.
when does an increase in AD and demand pull inflation occur?
when economy is operating at full employment output, but firms or government decide to increase spending creating an inflationary gap (actual GDP > potential GDP)
below equilibrium GDP
when investments (injections) are greater than savings (leakage), the aggregate expenditures will be more than GDP and drive it up
above equilibrium GDP
when savings (leakage) are greater than investments (injections), the aggregate expenditures will be less than GDP *spending deficiency reduces GDP*
income effect
when the price of an individual product falls, the consumers (constant) nominal income allows a larger purchase of the product; (NOT AN EXPLANATION FOR THE AD DOWN SLOPE)
equilibrium GDP
when the total spending (aggregate expenditures) equals the total output. produced (GDP) --> C + Ig = GDP
structural unemployment
workers whose skills are not demanded by employers, who lack sufficient skill to obtain employment, or who cannot easily move to locations where jobs are available
