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Gross Domestic Product (GDP)
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A measurement of the total goods and services produced within a country.
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The circular flow diagram
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a visual model of the economy that shows how dollars flow through markets among households and firms
-Total production = total expenditure = total income
-Total production = total expenditure = total income
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The Product Approach
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The approach to GDP measurement that determines GDP as the sum of value added to goods and services in production across all productive units in the economy.
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What is included and excluded in GDP
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Excludes: household production, underground production, intermediate goods or services, used products, financial transactions, transfer payments o Includes: inventories o Regardless of ownership
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The expenditure approach
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What is included in consumption (nondurables, durables, services), investment (business fixed investment, residential fixed investment, changes in inventory), government spending, and net exports (exports minus imports).
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Nominal GDP
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the production of goods and services valued at current prices
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Nominal GDP equation
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units of output x price per unit
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Real GDP
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the production of goods and services valued at constant prices
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Real GDP formula
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(Nominal GDP/Price Index) x 100
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GDP deflator
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a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100
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GDP deflator equation
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Nominal GDP/Real GDP x 100
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Use of GDP
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A measure of the size of the economy providing a scale against which to compare the economic performance of various nations.
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Limitations of GDP
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- Nonmarket Activities
- Underground Economy
- Negative externalities
- Quality of life
- Underground Economy
- Negative externalities
- Quality of life
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The consumer price index
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an index of the cost of all goods and services to a typical consumer
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What is included in the CPI
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...
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CPI equation (consumer price index)
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cost of market basket in a given year/cost of market basket at base x100
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Inflation Rate Formula
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(Current year CPI ) - (Earlier Year CPI) / (Earlier Year CPI) x100
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CPI
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prices are changing, and the basket is fixed
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Inflation
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a general increase in prices and fall in the purchasing value of money.
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Deflation
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a decrease in the general level of prices (NEGATIVE)
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Disinflation
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a reduction in the rate of inflation
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Disinflation vs. Deflation
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Disinflation is an inflation rate that is decreasing but still >0. Deflation is a negative inflation rate
ex) A slowing in the rate of price inflation
ex) A slowing in the rate of price inflation
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Hyperinflation
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A very rapid rise in the price level; an extremely high rate of inflation.
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core inflation
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the underlying increases in the price level after volatile food and energy prices are removed
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core inflation rate
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the rate of inflation excluding the effects of food and energy prices
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Limitations of GDP
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- Nonmarket Activities
- Underground Economy
- Negative externalities
- Quality of life
- Underground Economy
- Negative externalities
- Quality of life
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with real GDP
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quantities are changing but prices are fixed at base-year prices
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with nominal gdp
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both quantities and prices are changing
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Real value for year t (in base-year dollars)=
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Nominal value for year t (CPIbaseyear/CPIt)
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nominal interest rate equation
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real interest rate + inflation rate
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Indexing
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Providing automatic increases to compensate for inflation.
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Wage contracts
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firms rarely profit from cutting their product prices if they cannot also cut their wage rates
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Government outlays consist of
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government purchases, transfer payments, and interest on the national debt
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indexing taxes
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Specific numbers such as the personal exemption, the standard deduction, and the tax brackets are automatically adjusted for increases in the Consumer Price Index, the measure used in the U.S. to measure inflation.
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Shortcomings of CPI
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New goods bias, quality change bias, commodity substitution bias, outlet substitution bias (Overstates cost of living b/c it doesn't reflect increase in quality, or allowance for substitution of goods). UPWards bias(overestimates the change in cost of living)
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consequences of shortcomings of CPI
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distort wage and loan contracts, increase government outlays, and decrease tax revenue
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Current Population Survey
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a monthly survey of a sample of US households done by the US Census Bureau; it measures employment, unemployment, the labor force, and other characteristics of the US population
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labor force
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the total number of workers, including both the employed and the unemployed
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employed person
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a person who works at least one hour per week and is over 16
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unemployed person
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a member of the labor force available for work who has actively sought employment during the previous 4 weeks
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Non-Labor Force
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Those who are not working, but also are not looking for work. i.e.: discouraged workers, stay at home parents, retirees, full time students
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Adult population (working age population)
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all adults working age excluding those under 16, the incarcerated, institutionalized, and the military
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marginally attached to the labor force
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persons who would like to work and have searched actively for a job in the past 12 months
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discouraged workers
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people who are available for work but have not looked for a job during the previous four weeks because they believe no jobs are available for them
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Part-time workers
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people who usually work less than 35 hours a week
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shortcomings of the current population survey
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treatment of part-time worker for economic reasons and discouraged workers, short-term vs. long-term unemployment
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short-term vs long-term unemployment
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Short-term unemployment is running at levels consistent with the rate of job openings, but long-term unemployment remains elevated and suggests that for some workers, unemployment is a structural issue.
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unemployment rate formula
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number of unemployed/labor force x 100
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labor force participation rate formula
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labor force/adult population x 100
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Potential GDP
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The value of real GDP when all the economy's factors of production—labor, capital, land, and entrepreneurial ability—are fully employed.
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determinants of potential gdp
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supply side variables: Factors of production such as labor hours (L), (physical) capital (K), human capital (H), land and natural resources (N) and
§ technological knowledge/total factor productivity (A)
§ technological knowledge/total factor productivity (A)
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full employment
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the level of employment reached when there is no cyclical unemployment
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natural rate of unemployment
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the unemployment rate that arises from the effects of frictional plus structural unemployment (excludes cyclical)
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(flexible) adjustment of real factor prices...
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ensures full employment.
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frictional unemployment
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A type of unemployment caused by workers voluntarily changing jobs and by temporary layoffs; unemployed workers between jobs. SHORT TERM
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causes of frictional unemployment
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job search, sectoral shifts, unemployment insurance
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policies that shorten time spent in job search
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training program, employment agencies, tax incentives for finding jobs
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policies that lengthen time spent in job search
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ex: unemployment insurance
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structural unemployment
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unemployment that results because the number of jobs available in some labor markets is insufficient to provide a job for everyone who wants one
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Structural unemployment is caused by:
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o minimum wage
o labor unions (and its impact on non-union sector)
o efficiency wages (definition and rationale)
o labor unions (and its impact on non-union sector)
o efficiency wages (definition and rationale)
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cyclical unemployment
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Fluctuations of unemployment over the business cycle (recession and expansion)
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financial system
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the system that allows the transfer of money between savers and borrowers
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Direct Financing
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The provision of own funds by a lender to a borrower without going through another organization, typically used in terms of governments, foundations and non-profits. See indirect financing.
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Stocks
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shares of ownership in a company
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Bonds
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A certificate issued by a government or private company which promises to pay back with interest the money borrowed from the buyer of the certificate: The city issued bonds to raise money for putting in new sewers.
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relationship between bonds and interest rates
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inversely related
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characteristics of bonds
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Bonds pay fixed coupon (interest) payments at fixed intervals (usually every 6 months) and pay the par value at maturity.
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characteristics of interest rates
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Demand for and supply of money, government borrowing, inflation, Central Bank's monetary policy objectives affect the interest rates.
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Indirect Financing
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The provision of funds from a lender to a borrower through another entity, process or incentives. Examples of indirect financing include banks, mutual funds, pension funds, insurance companies)
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the market for loanable funds
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the market in which those who want to save supply funds and those who want to borrow to invest demand funds
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suppy of labor force=
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national saving
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Public Saving Equation
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T-G(independent of real interest rate)
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Private Saving Equation
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Y-T-C
Income that households have left after paying for taxes and consumption
(when disposable income goes up->C and Sp goes up; when r goes up->C goes down and Sp goes up)
Income that households have left after paying for taxes and consumption
(when disposable income goes up->C and Sp goes up; when r goes up->C goes down and Sp goes up)
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demand for labor force
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if demand for a firm's output increases, the firm will demand more labor, thus hiring more staff.
investment (when r goes up->I goes down)
investment (when r goes up->I goes down)
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Increase in budget deficit
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leads to increase in unemployment rate
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crowding-out effect
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the offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending
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Know 1) what shifts the S or D curve; 2) whether it increases it or decreases it; 3) what happen to r and the quantity of LF in equilibrium; and 4) what happen to Sp, C, Sg, I (both in terms of direction and magnitude)
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...
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Fisher Equation
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real interest rate = nominal interest rate - inflation rate
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