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Gross Domestic Product (GDP)
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the market value of all final goods and services produced within a country in a given period of time
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Microeconomics
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The study of how households and firms make choices, how they interact in markets.
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Macroeconomics
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The study of the economy as a whole
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Final goods
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intended for the end user
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Intermediate goods
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used as components or ingredients in the production of other goods
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GDP includes...
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tangible goods and intangible services
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GPD incudes...
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Currently produced goods, not good created in the past.
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GDP within a country
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GDP measures the value of production that occurs within a country's borders, whether done by its own citizens or by foreigners located there
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GDP in a given period of time
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Usually a year or a quarter (3 months) by the U.S. Department of Commerce: Bureau of Economic Analysis
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income equals expenditure
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every dollar a buyer spends is a dollar of income for the seller
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Components of GDP
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consumption (C) , investment (I) , government purchases(G) , and net exports (NX)
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formula for gpd
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GPD or Y = C + I + G + NX
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Consumption
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spending by households on goods and services, with the exception of purchases of new housing
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Investment
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total spending on goods that will be used in the future to produce more goods
ie. machines, structures, inventories
ie. machines, structures, inventories
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Government purchases
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all spending on the goods and services purchased by government at the federal, state, and local levels. excludes transfer payments, such as social security or unemployment insurance benefits.
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Net exports
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exports - imports
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Exports
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represent foreign spending on the economy goods and services
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Imports
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goods and services purchased from other countries
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Debbie spends $300 to buy her husband dinner at the finest restaurant in Boston.
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Consumption and GDP rise by $300
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Sarah spends $1800 on a new laptop to use in her publishing business. The laptop was built in China.
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Investment rises by $1800, net exports fall by $1800, GDP is unchanged
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Jane spends $800 on a computer to use in her editing business. She got last year's model on sale for a great price from a local manufacturer
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Current GDP and investment do not change, because the computer was built last year.
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General Motor builds $500 million worth of cars, but consumers only buy $470 million of them
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Consumption rises by $470 million, inventory investment rises by $30 million, and GDP rises by $500 million
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Inflation
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the increase of prices in an economy associated with the fall of the purchasing power of money
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Nominal GDP
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values output using current prices, not corrected for inflation
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Nominal GDP grows for two reasons
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Prices are rising and the economy is producing a larger quantity of goods
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Real GDP
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values output using the prices of a base year
is corrected for inflation
is corrected for inflation
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GPD does not value..
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quality of environment, leisure time, non-market activity, an equitable distribution of income
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Consumer Price Index (CPI)
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measures the typical consumer's cost of living and the basis of cost of living in many contacts and social security
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How to measure CPI
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1. fix the basket (Shopping cart)
2. find the prices (of items in cart)
3. compute the baskets cost (total cost)
4. choose a base year and compute the index
5. Compute the inflation rate
2. find the prices (of items in cart)
3. compute the baskets cost (total cost)
4. choose a base year and compute the index
5. Compute the inflation rate
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The CPI in any year equals
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100 x (cost of basket in current year/cost of basket in base year)
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Inflation rate
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(CPI this year - CPI last year / CPI last year) x 100 (new-old/old)
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problems with CPI: substiution bias
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Over time, some prices rise faster than others. Consumers substitute goods that become cheaper, mitigating price increases. CPI overstates increases in cost of living.
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Problems with CPI: Introduction of new goods
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The introduction of new goods increases variety, allows consumers to find products that more closely meet their needs.
In effect, dollars become more valuable.
The CPI misses this effect because it uses a fixed basket of goods.
Thus, the CPI overstates increases in the cost of living.
In effect, dollars become more valuable.
The CPI misses this effect because it uses a fixed basket of goods.
Thus, the CPI overstates increases in the cost of living.
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Problems with CPI: Unmeasured quality change
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Improvements in the quality of goods in the basket increase the value of each dollar.
The BLS tries to account for quality changes
but probably misses some, as quality is hard to measure.
Thus, the CPI overstates increases in the cost of living.
The BLS tries to account for quality changes
but probably misses some, as quality is hard to measure.
Thus, the CPI overstates increases in the cost of living.
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How much does CPI overstate inflation?
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0.5% per year
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Why is it important if CPI overstates inflation?
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This is important because Social Security payments and many contracts have COLAs tied to the CPI.
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Comparing dollar figures formula
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amount in todays dollars = amount in year X dollars X price level today/price level in year x
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nominal interest rate
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the interest rate not corrected for inflation, the rate of growth in the dollar value of a deposit or debt
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real interest rate
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corrected for inflation, the rate of growth in the purchasing power of a deposit or debt
Real interest rate = (nominal interest rate) - (inflation rate)
Real interest rate = (nominal interest rate) - (inflation rate)
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