Macroeconomics Test#2 study guide PDF

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Study Guide for second test. Includes summaries and definitions for chapters 24- 27. Includes calculations of nominal and real GDP and inflation rate....

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Macroeconomics Test #2 Chapter 24 

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Production (P) increases, when there is more production happening in a country, employment (E) increases, income (I) also increases, then they also spend (expenditures increase) more or aggregate demand (AD), which flows back to production. Financial Investment- The purchase of a financial asset (such as a stock, bond, or mutual fund) or real asset (such as a house, land, or factories) or the building of such assets in the expectation of financial gain. Economic Investment- Spending for the production and accumulation of capital and additions to inventories. Investment made by firms or government in any project. The money they are using. Performance and Policy (of an economy) Business Cycle- Recession + Peak The natural rate of unemployment is that rate of unemployment occurring when the economy is at its potential output. Assuming the total population is 100 million, the civilian labor force is 50 million, and 47 million workers employed, the unemployment rate is (6 percent). Wait unemployment and Search unemployment are both types of frictional unemployment. The type of unemployment associated with recessions is called cyclical unemployment. A headline states: “Real GDP falls again as the economy slumps.” This condition is most likely to produce what type of unemployment? Cyclical. Real GDP- (Real Gross Domestic Product) Gross Domestic Product adjusted for inflation; gross domestic product in a year divided by the GDP price index for that year, the index expressed as a decimal. A measure of the value of economic output adjusted for price changes (i.e., inflation or deflation). Corrects for price changes. Real GDP refers to GDP data that have been adjusted for changes in the next price level. Nominal GDP- Gross domestic product without or before accounting for inflation. GDP measured in terms of price level at the time of measurement; GDP not adjusted for inflation. Uses current prices. The GDP deflator or price index equals: Nominal GDP divided by real GDP Nominal GDP is adjusted for price changes through the use of the GDP deflator (GDP price index). The consumer price index is used to monitor changes in the cost of living over time. If 2004 is the base year, then the inflation rate for 2005 equals CPI in 2005 – CPI in 2004/ CPI in 2004 x 100. If the consumer rice index rises from 300 to 333 in a particular year, the rate of inflation in that year is (11 percent).

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If real GDP in a particular year is $80 billion and nominal GDP is $240 billion, the GDP price index for that year is (300). If the price index is 130, this means that prices are 30 percent higher than in the base year Suppose in a small economy produces only HD TV sets. In year 1, 100,00 sets are produced and sold at a price of $1,200 each. IN year 2, 100,000 sets are produced and sold at a price pf $1,000 each. As a result, nominal GDP decreases, while real GDP stays constant. Suppose that an economy’s output does not change from one year to the next, but the price level doubles. What happens to nominal GDP? Nominal GDP doubles. Inflation- A rise in the general level of prices in an economy; an increase in an economy’s price level. An increase in the overall level of prices. Output Growth= GDP Growth Standard of living is measured by output per person No growth in living standards prior to industrial revolution The situation where output and living standards decline is referred to as a recession. Short- run fluctuations in output and employment are referred to as the business cycle. An example of an intermediate good is the purchase of baseball uniforms by a professional baseball team. Efficiency wages create a surplus of labor, and so raise unemployment.

Chapter 25 

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National Income Accounting- A term used in economics to refer to the bookkeeping system that a national government uses to measure the level of the country's economic activity in a given time period. Measures an economy’s overall performance. Is done by the Bureau of Economic Analysis. Compiles National Income and Product Accounts. Access health of economy. Track long run course. The system that measures the economy’s overall performance is formally known as National Income Accounting Gross Domestic Product- defines aggregate output as the dollar value of all final goods and services produced within the borders of a country during a specific period of time, typically a year. GDP is the total market value of all final goods and services produced in an economy in a given year. Measure of aggregate output. Monetary measure. Avoid multiple counting. Market value final goods (are products that are purchased by their end users). Ignore Intermediate goods (are products that are purchased for resale or further processing or manufacturing). Count Value added- is the difference between the sale price of a good or service and the costs associated with it. This attempts to correct the problem of double counting. It is the total value of the goods and services produced by a country in a year. The total volume of business sales in our economy is several times as large as the GDP because the GDP excludes intermediate transactions.

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A nations GDP can be found by summing Y = C +Ig +G +Xn. Y = GDP. C = Personal consumption expenditures (covers all expenditures by households on goods and services. Ig = Gross private domestic Investment (all final purchases of machinery, equipment, and tools by businesses enterprises, all construction, changes in inventories). G= Government Purchases (government consumption expenditures and gross investment. Xn= Net exports (to be equal to exports minus imports). GDP in an economy is $11,050 billion. Consumer expenditures are $7,735 billion, government purchases are $1,989 billion, and gross investment is $1,410 billion. Net exports are: ($84 billion)

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Increase in real GDP or real GDP per capita over some time period Percentage rate of growth, growth as a goal Rule of 70 Given the annual rate of economic growth, the rule of 70 allows one to calculate the number of years required for real GDP to double. Determinates of growth rate: 1) quantity and quality of natural resources. 2) Quantity and quality of human resources (labor, skilled labor), 3) supply and stock of capital goods. 4) Technology. These effect the growth rate of countries (ability to produce goods and services). Additions may include education, literacy, efficient financial institutions, free trade, and a competitive market. Leader countries invent technology, follower countries adopt technology. Research and development can also promote growth. Real GDP= hours of work x labor productivity The data for GDP comes from the Bureau of Economic Analysis, which is part of the Department of Commerce. There are two possible reasons for total spending to rise from one year to the next. 1) The economy may be producing a larger output of goods and services. 2) Goods and services could be selling at higher prices. When studying GDP over time, economists would like to know if output has changed (not prices). Thus, economists measure real GDP by valuing output using a fixed set of prices. A Numerical Example 1. Two goods are being produced: hot dogs and hamburgers. Year Price of Quantity of Price of Hamburgers Hot Dogs Hot Dogs

Quantity of Hamburgers

2010

$1

100

$2

50

2011

$2

150

$3

100

2012

$3

200

$4

150

2. Definition of nominal GDP: the production of goods and services valued at current prices. Nominal GDP for 2010 = ($1 × 100) + ($2 × 50) = $200. Nominal GDP for 2011 = ($2 × 150) + ($3 × 100) = $600. Nominal GDP for 2012 = ($3 × 200) + ($4 × 150) = $1,200. 3. Definition of real GDP: the production of goods and services valued at constant prices. Let’s assume that the base year is 2008. Real GDP for 2010 = ($1 × 100) + ($2 × 50) = $200. Real GDP for 2011 = ($1 × 150) + ($2 × 100) = $350. Real GDP for 2012 = ($1 × 200) + ($2 × 150) = $500. 

Because real GDP is unaffected by changes in prices over time, changes in real GDP reflect changes in the amount of goods and services produced.  The GDP Deflator Definition of GDP deflator: a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100. GDP deflator 

Nominal GDP 100 Real GDP

2. Example Calculations GDP Deflator for 2010 = ($200 / $200) × 100 = 100. GDP Deflator for 2011 = ($600 / $350) × 100 = 171. GDP Deflator for 2012 = ($1200 / $500) × 100 = 240. Rearranging this equation gives us: Real GDP =

Nominal GDP

x100

GDP deflator 

We can also say that we are deflating the Nominal GDP for price rise by dividing by deflator to get the real GDP which is adjusted for inflation.

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We can also see that there are times when real GDP declines. These periods are called recessions. Is GDP a true measure of economic well- being or strength of an economy?  GDP measures both an economy’s total income and its total expenditure on goods and services.

--- GDP per person tells us the income and expenditure level of the average person in the economy. ---- GDP, however, may not be a very good measure of the economic well-being of an individual. 1. GDP omits important factors in the quality of life including leisure, the quality of the environment, and the value of goods produced but not sold in formal markets. 2. GDP also says nothing about the distribution of income. 3. However, a higher GDP does help us achieve a good life. Nations with larger GDP generally have better education and better health care. --- The Underground Economy 1. The measurement of GDP misses many transactions that take place in the underground economy.  Productivity explains most of the differences in the standard of living across countries.  Alexis and Tara both mine salt. Alexis mines 400 pounds in 40 hours. Tara mines 300 pounds in 20 minutes. Which of the following is correct? Tara’s productivity is greater than Alexis’s. This difference could be explained by Tara having more physical capital than Alexis.  The traditional view of the production process is that capital is subject to diminishing returns, so that other things the same, real GDP in poor countries should grow at a slower rate than in rich countries.  The logic behind the catch-up effect is that new capital adds more to production in a country that doesn’t have much capital than in a country that already has much capital.  If a Brazilian country opens a new factory in Peru, it makes foreign direct investment. The factory will make bigger impact on Peru’s GDP than on its GNP.  If companies from foreign countries build and operate factories in China, then China’s productivity and the wages of Chinese workers increase.  “When workers have a relatively small quantity of capital to use in producing goods and services, giving them an additional unit of capital increases their productivity by a relatively large amount” this statement is consistent with the view that capital is subject to diminishing returns.  When a society decided to increase its quantity of physical capital, the society is in effect deciding to consume fewer goods and services in the present.  Other things the same, when an economy increases its saving rate consumption falls now and production rises later.  The growth rate arises from capital accumulation is not a free lunch. It requires that society sacrifices consumption goods and services now in order to enjoy more consumption in the future.  Perry accumulated a lot of mathematical skills while in high school, college, and graduate schools. Economists include these skills as part of Perry’s human capital.

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An understanding of the best ways to produce goods and services is called physical capital.

Chapter 27 

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Types/ Causes of Inflation: Cost- Push Inflation- Increases in the price level (inflation) resulting from an increase in resource costs (for example, raw-material prices) and hence in per-unit production costs; inflation caused by reductions in aggregate supply. If the price of inputs rises, the cost of the product rises, and the supply will decrease. Demand-Pull Inflation- Increases in the price level (inflation) resulting from the increases in aggregate demand. The primary effects of a cost-push inflation is it reduces real output and redistributes a decreased level of real income. A statement that is often used to describe demand-pull inflation is “too much money chasing too few goods”. Inflation- An increase in the general price level .It is to note that prices of certain commodities may be falling as well during inflation. Types of inflation: 1) Cost push inflation- When cost of producing goods goes up .It is costlier to produce so prices rise. 2) Demand pull inflation- An Increase in prices caused by an excess in total spending, beyond the economy’s capacity to produce.so prices rise as a result. Two measures of price level: 1) GDP deflator (talks about total production). 2) Consumer price index( talks about total consumption on a basket of goods) Unanticipated inflation benefits debtors at the expenses of creditors/ The Consumer Price Index- a measure of the overall cost of the goods and services bought by a typical consumer. How the Consumer Price Index Is Calculated

1. Fix the basket: b. Example: 4 hot dogs and 2 hamburgers The Bureau of Labor Statistics uses surveys to determine a representative bundle of goods and services purchased by a typical consumer. 2. Find the prices. a. Prices for each of the goods and services in the basket must be determined for each time period. b. Example: Year Price of Price of 2010 2011 2012 3. Compute the basket’s cost.

$1 $2 $3

$2 $3 $4

a. By keeping the basket the same, only prices are being allowed to change. This allows us to isolate the effects of price changes over time. b. Example: Cost in 2010 = ($1 × 4) + ($2 × 2) = $8. Cost in 2011 = ($2 × 4) + ($3 × 2) = $14. Cost in 2012 = ($3 × 4) + ($4 × 2) = $20. 4. Choose a base year and compute the index. a. The base year is the benchmark against which other years are compared. b. The formula for calculating the price index is:  cost of basket in current year  CPI   100  cost of basket in base year 

c. Example (using 2010 as the base year): CPI for 2010 = ($8)/($8) × 100 = 100. CPI for 2011 = ($14)/($8) × 100 = 175. CPI for 2012 = ($20)/($8) × 100 = 250. CPI must equal 100 in the base year. 5. Compute the inflation rate. a. Definition of inflation rate: the percentage change in the price index from the preceding period. Inflation does not mean that the prices of all goods in the economy are rising. Inflation means that prices of all goods on average are rising. In fact, the prices of many electronic goods (such as computers and DVD players) have fallen over time. b. The formula used to calculate the inflation rate is:  CPI Year 2  CPI Year 1 inflation rate   CPI Year 1 

  100% 

Inflation Rate for 2011 = (175 – 100)/100 × 100% = 75%. Inflation Rate for 2012 = (250 – 175)/175 × 100% = 43%....