Test 2 Cheat Sheet - Test 2 study guide PDF

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Economics Test 2 Cheat Sheet Chapter 5 - Macroeconomic analysis explains past patterns in aggregate economic activity and tries to predict future one - Unemployed if… 1. Does not have a job 2. Has actively looked for work in the prior 4 weeks 3. Is currently available for work - GDP: the market value of the final goods and services produced in a given year o GDP per capita and life satisfaction have positive correlation - National income accounts: Production (how much they produced) = Expenditure (everything the nation bought) = Income (everything people were payed) o Production: Measure each firm’s value added (firm’s revenue from sales – its purchases of intermediate goods). Adding up the value added by all firms in the US will sum to the US GDP. o Expenditure: Y = C + I + G + X – M (national income accounting identity) o Income: Labor income—income paid for people’s work. Capital income—income realized by owners of physical or financial capital. - Factors of production: capital and labor

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Not included in GDP: o Physical Capital Depreciation: reduction of the value of physical capital due to wear and tear o Home Production o The Underground Economy: cash, illegal drug sales o Negative Externalities: a spillover cost that does not affect those directly engaged (electric plant breaks—cost of pollution effects is not counted) o Leisure (cannot measure happiness) GDP vs. GNP (can be very different, most commonly they are similar)

o GDP: everything within the borders of a country (country’s residents and it’s visitors) o GNP: includes only the output of factors of production owned by residents of a country. To calculate… begin with GDP, then add the production of US within foreign borders, then subtract the production of foreign production in US - Nominal GDP: normal GDP (not adjusted for inflation) - Real GDP: adjusts for inflation—uses prices from a base year to compare. To figure out... use the quantity of the year your looking at with the prices of the base year o Real GDP growth in year B= Real GDP in year B – Real GDP in year A (100) Real GDP in year A o Real GDP growth lets us look at how much the economy is producing at different points in time - GDP Deflator: a measure of how prices of goods and services produced in a country have risen since the base year (*is always going to be 100 for the base year) o GDP deflator = Nominal GDP (100) Real GDP o Percent change in GDP deflator = GDP deflator in year B – Deflator in year A(100) GDP deflator in year A - CPI: studies a basket of consumer goods. Includes things that households purchase that are not counted in GDP. Has a more personal relevance for the consumer o CPI (of target year) = Cost of goods with target year price (100) Cost of goods with base year price - Inflation rate: the rate of increase in prices o Inflation Rate of B = Price index in B - Price Index in A Price index in A Chapter 6 - GDP per capita: GDP/Total population. Fails to account for the fact that prices vary in some countries… so the PPP helps with that (standard of living) - Purchasing Power Parity (PPP): makes a “basket” on commodities in each country and adjusts GDP so that a dollar in each country can purchase this basket (doesn’t use exchange rate—but rather how much a USD can actually buy in that country) - GDP per worker: GDP/ # of people in employment (always higher than per capita) (Very closely related to productivity) - Productivity Differences—each play a role in determining how productive X is… 1. Human Capital: person’s stock of skills to produce value (degrees) 2. Physical Capital: any good used for production 3. Technology: determines how efficiently an economy uses its labor/capital/land - Aggregate production function: relationship between a nation’s GDP and its factors of production (follows the Law of Diminishing Marginal Product) o Total efficiency units of labor (H) = L (total number of workers in the economy) X h (the average efficiency or human capital of workers) o Physical Capital and land (K)—more K, then faster work, more GDP

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o Technology (A)—summarizes the relationship between factors of production and GDP. More technology  increase productivity o Y (GDP) = A x F(K, H) (aggregate production function) Law of Diminishing Marginal Product: the marginal contribution of a factor of production to GDP diminishes when we increase the quantity used of that factor

Technology—either knowledge, new advancements on what we have learned, or efficiency of production

Chapter 7 - Economic growth—the increase in real GDP per capita - Growth ratet, t+1= Yt+1 – Yt Yt - Exponential growth—quantity grows at a constant rate. Results because current growth builds on past growth. One of the big reasons from large differences in GDP per capita. - Catch-up growth—catching up with the wealthiest in world—do so by technology, increasing saving, and efficiency of labor and production - Sustained growth—steady growth over long periods of time - Y = C + I (no government, closed economy), I = Saving (banks will take money deposited by homes and then it for investment). A national with a high savings rate will accumulate physical capital rapidly and increase GDP - High interest rates  more saving - Saving Rate = Total Saving … designates the fraction of income that is saved GDP - Physical capital does not generate sustained growth because of the diminishing marginal product of physical capital o Because of this… we cannot guarantee a steady increase in real GDP per capita by just increasing the work force and education of work force

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Technology—achieve sustained growth—new technologies enabling the economy to achieve a higher level of real GDP for capita. Is exponential. Plays central role in differences of nations GDP Cultural Trends o Subsistence level: minimum level of income per person is generally enough to survive—very poor o Malthusian cycle: increase in income  population growth  reduces income per capita

Chapter 8 - Proximate causes: physical capital, human capital, and technology—link high levels of prosperity of high level of inputs - Fundamental causes of prosperity: factors are the roots of the differences in the proximate causes of prosperity

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Fundamental causes: o Geography: the differences in geography, climate, and ecology are ultimately responsible for the differences in prosperity o Culture: different values and beliefs cause the differences around the world (some nations have superstition of new technologies) o Institutions: the formal and informal rules governing the organization of a society (determined by individuals as members of a society, place constraints on behavior, shape behavior by determining incentives). Institution hypothesis: different societies = different institutions  different types of incentives  determines the degree wot which societies accumulate the factors of production and adopt new technology Economic institutions: the aspects of society’s rules that concern economic transactions o Private property rights: individuals can own their own assets (what you generate is yours)

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o Inclusive economic institutions: encourage participation of the general majority so they can make use of their talents. Protect private property, uphold law and order, private contracts, free entry into businesses and occupations o Inclusive economic institutions foster economic activity, promote growth, and economic prosperity o Extractive economic institutions: shaped by those who control political power to extract resources from the rest of society. Erect significant entry barriers into businesses and jobs. Communist, monarch, dictators, and juntas (supported by political institutions that hands power to the elite). By creating insecure property rights  entrepreneurship is less profitable. By having entry barriers  entry to economy is costlier (shift opportunity cost schedule upward)  If these nations open up their economy… there will be room for new leaders. Fear PCD and CD keeps rulers blocking adoption of new technologies and economic development (Political creative destruction: economic growth destabilizes existing regimes and reduces political power of rulers) (Creative destruction: new technologies, skills, and businesses replace old ones) Economists believe that foreign acid has been ineffective in alleviating poverty o GDP grows from physical capital, human capital, and technology… foreign aid is not large enough to lead to a big enough increase in these o Much of foreign aid doesn’t not get invested in new technology or education o Root of poverty is extractive institutions then no amount of money is going to help...