Test 1 Macroeconomics - Midterm Exam Review PDF

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Test 1 MacroeconomicsUnit 1: Learning Goals Define economics and distinguish between macro and micro Explain the three big questions of economics Explain the key ideas that define the economic way of thinking Explain the concepts of scarcity and opportunity cost Differentiate between positive econom...

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Test 1 Macroeconomics Unit 1: Learning Goals -

Define economics and distinguish between macro and micro Explain the three big questions of economics Explain the key ideas that define the economic way of thinking Explain the concepts of scarcity and opportunity cost Differentiate between positive economics and normative economics Describe economic models Use the PPF to analyze opportunity cost and economic growth Use the concepts of comparative and absolute advantage to demonstrate how specialization and trade can expand production possibilities Compare different types of economic systems, including strengths and weaknesses Apply the circular flow model of the economy

Economics – a social science that studies how people use scarce resources to satisfy unlimited human wants Economic Periods in History -

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Agricultural revolution o 7500-10000 years ago o People moved from being lawless nomads in search of food to farmers with specific laws and economic exchange Industrial Revolution o Mid-1700’s o New technologies allowed for manufacturing on a larger scale o People migrated to large cities, bringing new forms of economic organization and change o The first two revolutions provided people with better ways of obtaining goods and services needed to live – enhancing standard of living Digital Revolution o We are currently in the midst of this o Everything we are doing and how we are doing it is changing rapidly o Bringing immense change to our lives

Scarcity -

The worlds population had grown to nearly 7.5 billion in the last 5 decades All people strive daily to achieve an economic livelihood Scarcity is the key underpinning of economics and why it exists

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If there was no scarcity, there would be no economic problem Scarcity forces people to make choices among competing alternatives

Opportunity Cost -

The choices we make depend on incentives, a reward that encourages a choice or a penalty that discourages one The highest-valued alternative that we give up to get something is the opportunity cost

Microeconomics – a subfield of economics that deals with the individual decision making units of the economy Macroeconomics – subfield of economics that studies the economy as a whole and deals with the national or global economy Positive Economics – a positive analysis deals with what is supported by data and is not in dispute – tested by checking it against facts Normative Economics – a statement that cannot be tested, is about what ought to be or should be Economic Models -

Economists perform studies regarding positive statements where there is a cause and effect Economists use models to help make better business decisions Effective when dealing with positive economic analysis

The Three Big Economic Questions -

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What? o What goods and services will we produce and in what quantities How? o How will goods and services be produced? o Four Factors of production  Land – earns rent  Labour – earns wages  Capital – earns interest  Entrepreneurship – earns profit For whom? o For whom are goods and services produced?

Self interest vs. Social Interest -

Self-interest – people make decisions that they feel are best for their own welfare Social interest – people make decisions that are best for society

Circular Flow Model of Economics -

Demonstrates how money moves through society Money flows from producers to workers as wages and flows back to producers as payment for products The four main players are households, product markets, factor markets, and firms

Production Possibilities Frontier -

Positive economic tool that allows us to analyze the opportunity costs and trade-offs that individuals, firms and nations face when confronted with scarcity

Sources of Economic Growth -

Increase in the quantity of resources available Increase in the quality of resources like labour Better technology

Specialization and Trade -

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We take place in trade because we believe it benefits us o Absolute Advantage – trading for a good or service in greater quantity for the same cost or at a same quantity but lower cost o Comparative Advantage – trading goods and services at a lower opportunity cost than that of trade partners  Sources of comparative advantage between countries  Natural Endowment – climate and natural resources  Relative abundance of labour and capital  Technology Globalization and movement towards freer trade o Over the past 50 years international trade has grown because  Lower costs of shipping products internationally  Greatly improved technologies  Government and international trade agreements have facilitated freer trade

Different Types of Economic Systems -

Capitalistic Economy o Economic problem of scarcity is dealt with by the interactions and decisions of households and firms in various product and factor markets o There is individual ownership and control of resources and freedom of choice o The what question in this market – consumers determine what will be produced o The how question is determined by privately owned firms deciding which factors of production to utilize o The for whom question is determined by the ability of consumers to purchase goods and services o Advantages  There is freedom of choice since all economic decision makers make choices that best suit their needs

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o Disadvantages  Economic instability  Limited production of public goods  Limited protection of the environment Command Economy o An economy where the government or some authority co-ordinates the allocation of resources o The government deals with scarcity by deeming what is to be produced, how and for whom o Advantages  The government ensures all people get work and resources fully utilized o Disadvantages  Limits individual economic freedom  Inefficient production  Insufficient quantity and quality of goods and services Mixed Economy o Buyers and sellers interact but the government plays an important role in the allocation of resources o Advantages  Stabilize economic growth  Improve the distribution of income  Prevent worker exploitation  Enhanced access to education and health care  Protection for the environment o Disadvantages  Inefficiency

Unit 2: Learning Goals -

Explain GDP as a macroeconomic indicator Use the circular flow model of expenditure and income to demonstrate how GDP is measured Apply the expenditure and income approaches to measure GDP Differentiate between nominal and real GDP Use real GDP to measure economic growth and the SOL Discuss business cycles and fluctuations in economic growth in Canada Discuss the limitations of real GDP as a measure of the SOL Explain the relationship between productivity growth and the SOL Compare long-term growth trends in Canada and internationally using various macroeconomic indicators

Gross Domestic Product – the market value of all of the final goods and services produced within a country during a given period of time Final Goods and Services -

Final Good or service – a good or service that is produced for its final user and not as a component of another good or service Intermediate good or service – a good or service that is produced by one firm, bought by another firm and used as a component of a final good or service

GDP: Expenditures NOT included -

Used or second-hand goods Purchase of financial assets Household production Expenditure on illegal goods or payment under the table

Circular Flow Model of Expenditure and Income

The blue directions (Y) represents the total income paid by firms to households. -

Firms sell and households buy consumer goods and services in the goods market

Consumption expenditure © is the total payment for consumer goods and services -

Firms buy and sell new capital equipment in the goods market and put unsold output into inventory

The purchase of new plant, equipment and buildings and the additions to inventories are investment (I) Governments buy goods and services from firms and their expenditure on goods and services – government expenditure

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Government expenditure is shown as (G) Governments finance their expenditure with taxes and pay financial transfers to households, such as unemployment benefits and pay subsidies to firms

Firms in Canada sell goods and services to the rest of the world – exports – and buy goods and services from the rest of the world – imports -

The value of exports (X) minus the imports (M) is called net exports o If net exports are positive, the net flow of goods and services is from Canadian firms to the rest of the world o If net exports are negative, the net flow of goods and services is from the rest of the world to Canadian firms

The blue and red flows are the circular flow of expenditure and income The sum of the red flows equals the blue flow Aggregate income equals the total amount paid for the use of factors of production: wages, interest, rent profit. Firms pay out all their receipts from the sale of final goods, so income equals expenditure Expenditure Approach: Y = C + I + G + (X – M)

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Four groups buy the final goods and services produced: firms, households, government and the rest of the world

Total expenditure on final goods and services equals GDP Income Approach: GDP = C + I + G + (X – M)

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The income approach measures GDP by first adding all the incomes paid to households by firms for the use of the resources firms enjoy The national income and expenditure accounts divide income into various income components

Gross vs Net Investment -

Gross Investment – total amount spent buying new capital and replacing depreciated capital Net investment (NI) is gross investment (I) minus depreciation (D)

NI = I – D Nominal vs Real GDP -

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Nominal – value of goods and services produced during a given year valued at the prices that prevailed the same year o To obtain this, we value the products produced at the current price and then sum these values o Nominal GDP = (Real GDP * PL) / 100 Real – the value of final goods and services produced in a given year when valued at constant prices of a reference base year o Real GDP = (Nominal GDP/PL) x 100

o Currently expressed in millions of chained dollars o Measuring the GDP Deflator  The average level of priced is called the price level (PL)  GDP Deflator is an average of the prices of the goods in GDP in the current year expressed as a percentage of the base year prices  PL = GDP Deflator = (Nominal GDP/Real GDP) x 100 How do we measure economic growth? -

The economic growth rate is the percentage change in the quantity of goods and services produced from one year to the next o Growth rate of real GDP = (real GDP in current year – real GDP in previous year) / (Real GDP in previous year) x 100

The rule of 70 -

States that the number of years it takes for the level of any variable to double is approximately 70 divided by the annual percentage growth rate of the variable

How do we measure changed in standard of living? -

The SOL depends on real GDP per person, which is real GDP, divided by population o Real GDP per capita = Real GDP/Population Calculating the rate of growth in real GDP per capita and the SOL o (Read GDP/population current year – Real GDP/population previous year) / (Real GDP/population previous year) x 100

Business Cycles -

The use of real GDP to determine if there has been economic growth and to assess economic performance Two business cycle phases o Expansion, recession, growth recession Two business cycle turning points o Peak, trough

Predicting Business Cycles and Business Decision-Making -

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Economists use indicators which provide signals to economic decision makers Leading indicators o Consist of measures of economic activity which signal the onset of a business cycle  Examples include:  Average weekly work hours in manufacturing  Factory orders for goods  Stock prices Lagging indicators o Confirm trends and consist of measures that change after an economy has entered an economic fluctuation  Examples include  Average length of unemployment  Labour cost per unit of manufacturing output Coincident indicators o Consist of aggregate measures of economic activity that change as the business cycles progress  Examples include  Unemployment rate  Personal income levels The yield curve

o A measure of how long-term investment rates for government bonds compare to short term Limitations of Real GDP per capita as a measure of economic well being These 6 limitations state why real GDP is over or under estimated -

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Household production – under estimated GDP o Real GDP does not include household production, that is, productive activities done in and around the house by household members Underground economy – under estimated GDP o Production that is hidden from view of the government for the purpose of avoiding taxes and regulations or illegal goods and services Health and life expectancy – under estimated GDP o Better health and long life are not directly included in real GDP Political freedom and social justice – under estimated GDP o Not measured by real GDP but can have a big impact on quality of life Leisure time – under estimated GDP o The want to enjoy the money we earn, and it is not included in GDP Environmental quality – over estimated GDP o Out SOL is adversely affected by pollution but real GDP does not show this

The Human Development Index (HDI) -

The HDI provides a composite measure of three dimensions of human development o Living a long and healthy life – life expectancy o Being educated – adult literacy and gross enrolment in education o Having a decent SOL – purchasing power parity and income

Labour Productivity -

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What is it and why is it important o Economic growth occurs when real GDP increases and is sustained by increases in potential GDP o The factors that influence this growth can be divided into those that increase aggregate hours and labour productivity o Labour productivity = real GDP / aggregate hours Benefits and sources of labour productivity

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Sources of growth in labour productivity o Investment in physical capital o Discovery of new technologies o Expansion of human capital...