Macroeconomics Final Exam Study Guide PDF

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Macroeconomics Final Exam Study Guide – Professor Paul Ratka Created by Emily Welch Ruth

Concepts: Chapter 7 Productivity - The average quantity of goods and services produced per unit of labor input. *Note:  

When a nation’s workers are very productive, real GDP is large and incomes are high. When productivity grows rapidly, so do living standards.

Physical Capital - The stock of equipment and structures used to produce goods and services *Note: An increase in Capital Per Worker (K/L) can cause an increase in Productivity (Y/L). Human Capital - The knowledge and skills workers acquire through education, training, and experience. *Note: An increase in worker human capital (H/L) causes an increase in Productivity (Y/L). Natural Resources = The inputs into production that nature provides. Ex. land, mineral deposits *Note: An increase in natural resources per worker (N/L) causes an increase in Productivity (Y/L). Technological Knowledge - Society’s understanding of the best ways to produce goods and services; any advance in knowledge that boosts productivity (allows society to get more output from its resources). *Note: Technological Knowledge vs. Human Capital: • • •

Technological knowledge refers to society’s understanding of how to produce goods and services. Human capital results from the effort people expend to acquire this knowledge. Both are important for productivity.

Investment - We can boost productivity by increasing capital (K), which requires investment. *Note: Increasing saving rates should increase the rate of capital creation in the economy. Returns to Capital – When given the same amount of capital, a poor country will see a larger return in terms of productivity growth than a wealthy country.

Catch-up Effect (Convergence) - Where the poor country can grow more rapidly than the wealth country and therefore can “catch-up.” Diminishing Returns - The decrease in the marginal output of a production process as the amount of a single factor of production is incrementally increased, while the amounts of all other factors of production stay constant. *Note: As Capital (K) rises, the extra output from an additional unit of Capital (K) falls. Foreign Direct Investment – When a capital investment (factory) is owned & operated by a foreign entity. Foreign Portfolio Investment – When a capital investment financed with foreign money but operated by domestic residents. Inward-Oriented Policies - Aim to raise living standards by avoiding interaction with other countries. (Ex. tariffs, limits on investment from abroad) Outward-Oriented Policies - Promote integration with the world economy. (Ex. the elimination of restrictions on trade or foreign investment) Education - Government can increase productivity by promoting education–investment in human capital (H). Ex. Public schools, subsidized loans for college. *Note: In the U.S., each year of schooling raises a worker’s wage by 10%. Education creates a trade-off between current income and future income for a country. Health and Nutrition - Health care expenditure is a type of investment in human capital healthier workers are more productive. Political Stability - Markets require the protection of property rights in order to function. Research and Development - Technological progress is one of the main reasons why living standards rise over the long run. Population Growth - May affect living standards in 3 different ways:   

May stretch natural resources thin Dilute the capital stock (both K/H) Promoting tech.

*Note: Are natural resources a limit to growth? Not necessarily. As a resource becomes scarcer, its market price rises, which increases the incentive to conserve it and develop alternatives.

Chapter 10 Labor Force Statistics – Produced by the Bureau of Labor Statistics (BLS) in the U.S Department of Labor. Based on a regular survey of 60,000 households including adult population (16-up) Employed - Paid employees, self-employed, and unpaid workers in a family business. Unemployed - People not working who have looked for work during previous 4 weeks. Not In The Labor Force - Everyone else. Unemployment Rate - Percent of the labor force that is unemployed. *Note: Not a perfect indicator of joblessness or the health of the labor market.   

It excludes discouraged workers. It does not distinguish between full-time and part-time work, or people working part time because full-time jobs are not available. Some people misreport their work status

Labor-force Participation Rate - Percent of the adult population that is in the labor force. Discouraged Workers – Would like to work but have given up looking for jobs. Classified as “not in the labor force”. Natural Rate Of Unemployment - Normal rate of unemployment around which the actual unemployment rate fluctuates. Cyclical Unemployment - Deviation of unemployment from its natural rate. Frictional Unemployment - Occurs when workers spend time searching for the jobs that best suit their skills and tastes. Usually short-term. Structural Unemployment - Occurs when there are fewer jobs than workers. *Note: Occurs when wage is kept above equilibrium – there are three reasons for this:   

Minimum Wage: May exceed the equilibrium wage for the least skilled or experienced workers, causing structural unemployment. Unions: Unions raise the wage above equilibrium. Thus, quantity of labor demanded falls and unemployment results. Efficiency Wage: Firms voluntarily pay above-equilibrium wages to boost worker productivity. Why? 1. Worker Health - Paying higher wages allows workers to eat better, makes them healthier, more productive. 2. Worker Turnover - Paying high wages gives workers more incentive to stay, reduces turnover. 3. Worker Quality - Offering higher wages attracts better job applicants, increases quality of the firm’s workforce.

4. Worker Effort - If market wage is above equilibrium wage, there aren’t enough jobs to go around, so workers have more incentive to work not shirk. Job Search - Process of matching workers with appropriate jobs. Sectoral Shifts - Changes in the composition of demand across industries or regions of the country. Displace some workers, who must search for new jobs appropriate for their skills & tastes. Government Employment Rates - Provide information about job vacancies to speed up the matching of workers with jobs. Public Train Programs - Aim to equip workers displaced from declining industries with the skills needed in growing industries. Unemployment Insurance - A government program that partially protects workers’ incomes when they become unemployed. Increases frictional unemployment. (no incentive to job search) Benefits of Unemployment Insurance - Reduces uncertainty over incomes. Gives the unemployed more time to search, resulting in better job matches and thus higher productivity.

Chapter 11 Barter - The exchange of one good or service for another. Double Coincidence Of Wants - The unlikely occurrence that two people each have a good the other wants. Money - The set of assets that people regularly use to buy goods and services from other people. Medium of Exchange - An item that buyers give to sellers when they want to purchase goods and services. Unit of Account - The yardstick people use to post prices and record debts. Store of Value - An item people can use to transfer purchasing power from the present to the future. Commodity Money - Takes the form of a commodity with intrinsic value. Fiat Money - Money without intrinsic value, used as money because of government decree.\ Money Supply (Money Stock) - The quantity of money available in the economy. *Two assets considered part of the money supply. 1. Currency - The paper bills and coins in the hands of the (non-bank) public. 2. Demand Deposits - Balances in bank accounts that depositors can access on demand by writing a check.

Categories of Money:  

M1 - currency, demand deposits, traveler’s checks, and other checkable deposits. M2 - everything in M1 plus savings deposits, small time deposits, money market mutual funds, and a few minor categories.

Central Bank - An institution that oversees the banking system and regulates the money supply. Monetary Policy - The setting of the money supply by policymakers in the central bank. Federal Reserve (Fed) - The central bank of the U.S. Fractional Reserve Banking System - Banks keep a fraction of deposits as reserves and use the rest to make loans. *Note: A fractional reserve banking system creates money, but not wealth. Reserve Requirements - Regulations the Fed puts on the minimum amount of reserves that banks must hold against deposits. The Reserve Ratio (R) - fraction of deposits that banks hold as reserves and total reserves as a percentage of total deposits. T-account - A simplified accounting statement that shows a bank’s assets & liabilities. Open-Market Operations (OMO) - The purchase and sale of U.S. government bonds by the Fed. *Note: To decrease bank reserves and the money supply, the Fed sells government bonds. Discount Rate - The interest rate on loans the Fed makes to banks - to influence the amount of reserves banks borrow. Auction Facility - The Fed chooses the quantity of reserves it will loan, then banks bid against each other for these loans. *Note: The more banks borrow, the more reserves they have for funding new loans and increasing the money supply. Run on Banks - When people suspect their banks are in trouble, they may “run” to the bank to withdraw their funds, holding more currency and less deposits. Federal Funds Rate - Banks with insufficient reserves can borrow from banks with excess reserves. The interest rate on these loans is called the Federal Funds Rate. *Note: Changes in the Federal Funds Rate cause changes in other rates and have a big impact on the economy. *Note: To raise the Federal Funds Rate, the Fed sells government bonds (OMO).

Chapter 12 Price Level (P) - The price of a basket of goods, measured in money. The Quantity Theory of Money –   

Developed by 18th century philosopher David Hume and the classical economists. Advocated more recently by Nobel Prize Laureate Milton Friedman. Asserts that the quantity of money determines the value of money

Nominal Variables - Are measured in monetary units. Ex. Nominal GDP, nominal interest rate. Real Variables - Are measured in physical units. Corrected for inflation. Ex. Real GDP, real interest rate. *Note: Prices are normally measured in terms of money. Relative Price - The price of one good relative to (divided by) another. Real Wage - The price of labor relative to the price of output Classical Dichotomy - Theoretical separation of nominal and real variables. *Note: Classical economists believe that monetary developments affect nominal variables but not real variables. Money Neutrality - The proposition that changes in the money supply do not affect real variables. *Note: Doubling money supply causes all nominal prices to double; however, relative price, real wage, and employment of capital remains unchanged. *Note: Most economist believe the classical dichotomy and neutrality of money describe the economy in the long run. Hyperinflation - Inflation exceeding 50% per month. Inflation occurs when the government prints to much money. Inflation Tax - Revenue the government raises by creating (printing) money. Principle of Money Neutrality - An increase in the rate of money growth raises the rate of inflation but does not affect any real variable. Fisher Effect - In the long run, money is neutral: a change in the money growth rate affects the inflation rate but not the real interest rate. So, the nominal interest rate adjusts one-for-one with changes in the inflation rate. Inflation Fallacy - “Inflation robs people of the purchasing power of his hard-earned dollars”

*Note: Inflation does not in itself reduce people’s real purchasing power. In the long run, real incomes are determined by real variables, not the inflation rate. Costs of Inflation:     

Shoeleather Costs - Resources wasted when inflation encourages people to reduce their money holdings. Menu Costs - Costs of changing prices. Misallocation of Resources from Relative-Price Variability - Firms don’t all raise prices at the same time, so relative prices can vary. Confusion and Inconvenience - Inflation changes the yardstick we use to measure transactions Tax Distortions - Inflation makes nominal income grow faster than real income. So, inflation causes people to pay more taxes even when their real incomes don’t increase.

Unexpected Inflation - Redistributes wealth among the population. *Note: High inflation is more variable and less predictable than low inflation

Calculations: Productivity = Y/L Y = Real GDP = Quantity of output produced L = Quantity of labor K = Physical Capital H = Human Capital N = Natural Resources K = Capital Capital Per Worker = K/L Average Worker’s Human Capital = H/L Natural Resources Per Worker = N/L Labor Force = Employed + Unemployed Unemployment Rate (U-Rate) = 100 * Number of unemployed Labor Force Labor Force Participation Rate = 100 *

Labor Force Adult Population

Money Supply = Currency + Deposits Reserve Ratio = Reserves Deposits Real Wage = Price of Labor (W) Price of Output (P) Real Interest Rate = Nominal Interest Rate – Inflation Rate Nominal Interest Rate = Real Interest Rate + Inflation Rate...