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ComEcon Book Notes Section 2.1 2-1 Economist as Scientist 1. Economics is a science 2. The scientific method: Observation, Theory, and more Observation a. Economists look for correlation to back claims b. However, conducting experiments is often times impossible 3. The Role of Assumptions a. Assumptions can simplify the complex world and make it easier to understandthe art of scientific thinking is deciding which assumptions to make b. Economists make the assumption that in the short run prices are fixed and in the long run completely flexible 4. Economic Models 5. First Model: The Circular Flow Diagram a. How it works i. In this model the economy is simplified to include only two types of decision makers: Firms and households. ii. Firms produce goods and services using inputs and these inputs are called factors of production iii. Households own the factors of production and consume all the goods and services the firms produce 6. The Production Possibilities Frontier- a graph that shows the various combinations of outputs a. Same as Micro 7. Micro and MacroEconomics a. Micro- study of how households and firms make decisions and how they interact in specific markets b. Macro- study of the economy wide phenomena Section 2.2 1. Positive versus Normative Analysis a. Positive Statements- descriptive, they make a claim about how the world is i. We can confirm or refute positive statements by examining evidence b. Normative Statements- prescriptive, they make a claim about how the world ought to be i. Deciding what is a good normative statement takes into consideration ethics, religion and political philosophy 2. Economists in Washington a. Tradeoffs are involved in most polic decisions b. Since 1946 the president has received guidance from the council of economic advisers which consists of three members and a saff of a few dozen economists 3. Why economists advice is not always followed a. President hears from economic advisors, communication advisers press advisors and legislate advisors and political advisors before making a decision 2-3 Why economists Dissagree 1. Differences in Scientific Judgements a. Economics is a young science and there is still much to be learned b. They disagree because they have different hunches about the validity falternative theories or about the size of important parameters that measure how economic variables are related 2. Difference in values a. Economists sometimes give conflicting advice because they have different values 3. Perception versus Reality a. Almost all economists agree that a ceiling on rent will lower the availability and quality but governers do it anyway b. Almost all economists oppose barriers to free trade but it happens anyway 2-4 Let’s get Going Chapter 5 1. 5-1 The Economy’s Income and Expenditure a. Gross Domestic Product is a good indication of how good a nations economy is b. GDP measures i. the total income of everyone in the economy ii. the total expenditure of goods and services c. For an economy as a whole income must equal total expenditure d. GDP is measured by either counting all expenditure or adding up the total income paid by firms 2. 5-2 The Measurement of Gross Domestic Product a. GDP- is the market value of all final goods and services produced within a country in a given period of time i. GDP is comprehensive, it includes all items produced and sold legally in markets ii. GDP Takes into consideration homes even if not rented and just owned, they exstimate the rent value and basically assume the buyer is renting it from himself iii. Includes goods and services iv. If a Canadian citizen comes to America and works its incluced v. EXCLUSIONS 1. GDP excludes items produce and sold illegally 2. Items that are produced and consume at home 3. Selling of used goods like a used car 4. If an Ammerican has a company in Haiti it is part of Haitis GDP b. Intermediate vs Final Product i. If a company buys a good to use as one of the ingredients to make another good which they sell, the middle good is intermediate, the final good is the final 1. When a car dealership buys paint that’s intermediate and it sells the car: Final c. GDP is yearly or quarterly, if quarterly it is adjusted x4 to be by year i. Seasonal adjustment (More sales in December) 3. 5-3 The Components of GDP a. GDP is broken down into four components i. C- Consumption 1. The spending by households on goods and services with the exeption of purchases of new housing 2. Goods and Services 3. Education ii. I- Investment 1. THe purchase of goods that will be used in the near future to produce more goods and services 2. The sum of capital equipment, inventorieas and structures iii. G- Government Purchases 1. Includes spending on goods and services by local, state and federal governmeents 2. Includes salaries of govt workers and expenditures on public works 3. Transfer payments do nnot count iv. NX- Net exports 1. Is the foreign purchases of domestically produced goods (exports) – the domestic purchases of foreign goods (imports) 2. Exports-Imports b. Y=C+I+G+NX 4. 5-4 Real verses Nominal GDP a. If GDP goes up either more goods and services are being consumed or the price is higher b. REAL GDP measures the value of the goods and services produced if we vled these goods and services at prices of a different year c. Nominal GDP- the amount of production of goods and services valued at current prices d. The GDP Deflator= Nominal/Real *100 e. This negates inflation i. Inflation is the GDP deflator in year 2-year one/Year 1 5. 5-5 Is GDP a good measure of Economic Well-Being a. Yes, the more money genaearally the better b. However it does exclude the quality of the environment, the distribution of income Chapter 6 1. 6-1 The Consumer Price Index- a measure of the overall cost of the goods and services bought by a typical consumer a. How is it calculated? i. Total revenue of year 2/ Total Revenue of Year 1 *100 ii. INFLATION 1. Then subtract that number from the year 1 number (100) a divide by year 1 *100 2. For year 3 do year 3-year 2 b. Producer Price Index- measures the cost of a basket of goods and services bought by firms rather than consumers c. Problems in measuring the cost of Living i. CPI tries to gauge how incomes must rise to maintain a constant standard of living ii. Substitution Bias- all prices do not change proportionately. Consumers respond to this by buying different amount of goods and substiting them 1. If you use the same fixed basket of goods you ignore substitution and the nume is too high iii. Introduction of new goods- when a new good is introduced consumers have more variety tochoose from and this reduces the cost of maintaining well being 1. the effect of the new good is not taken into consideration iv. Unmeasured quality change-if the quality of a good deteriorates from one year to the next while its price remains the same, the value of the dollar falls d. GDP Deflator vs Price Index i. GDP Deflator reflects the prices of all goods and services produced domestically ii. Consumer price index reflects the prices of all goods and services bought by consumers iii. An airplane sold to the air force is part of the GDP not consume price iv. A Volvo made in sweeden is in Consumer price but not GDP v. When oil rises, the consume rprice index rises by more than the GDP deflator vi. The consumer price doesn’t change whats in the basket very often, the GDP is calculated by whatever is produced 2. 6-2 Correcting economic variables for the effects of Inflation a. Amount in todays dollars = amount in year t dollars * Price level today/Price level in yearT b. Indexation i. Indexed- when some dollar aount is automatically corrected for changes in price level by law or contract ii. Cost of living allowance 1. Automatically raises the wage when the consumer price index rise c. Real and nominal interest rates i. Nominal is the actual numbe ii. Real is that adjusted by the CPI and inflation iii. Real = nominal - inlfation Chapter 10 1. How is unemployment measured a. The bureau of labor statistics counts it b. Employed- all people paid as employees, work In their own business or as unpaid workers in a family members business, full time and part time workers are counted i. it includes those who had jobs which they are temporarily absent from c. Unemployed- people who are not employed, available for work and have tried to find employment during the last 4 weeks d. Not in Labor Force- people who are in neither the first 2 catagories, full time student, retired, house mom e. Labor Force- the sum of the employed and unemployed f. Unemployment rate- the percent of the labor force that is unemployed g. Labor force participation rate- labor force/adult population h. Natural rate of unemployment- normal rate that the rate fluctuates i. Cyclical unemployment-deviation of unemployment from its natural rate j. Discouraged workers- ones who lost a job, looked and can find anything so they give up their not in unemployment stats k. Most spells of unemployment are short term but viewed at any iven time its long term l. Frictional unemployment- unemployment that results from the process of matching workers and jobs i. Always some amount of it m. Structural unemployment- occurs when quantity of labor markets may be insufficient to give a job to everyone who wants one n. Job search- one reason economies always experience some unemployment i. Process of matching workers with appropriate jobs o. Unemployment Insurance i. Program that offers workers partial protection against job leoss ii. We pay benefits to people who were laid off iii. They get 50% of their salary for 26 weeks MIDTERM 2 Chapter 7 2. Productivity a. Productivity- quantity of goods and services produced from each unit of labor input 3. How is it determained? a. Physical Capital- stock of equipment and structures used to produce goods and services b. Human Capital- knowledge and skills owrkers acquire through education, training and experice c. Natural Resources- inputs into production provided by nature d. Technical Knowledge- understanding of the best ways to produce goods and services 4. Economic Growth and Public Policy a. Foreign Direct Investment- a capital investment owned and operated by a foreign entity b. Foreign portfolio investment- an investment financed with foreign money but operate by domestic residents c. Inward oriented policies- attempt to increase productivity and living standards by avoiding interaction with the rest of the world d. Many economists think they should use outward oriented policies instead e. Brain Drain – emigration of skilled workers to better countries Chapter 8 1. Financial Institutions in the US Economy a. Financial Market- institutions which a person who wants to save can directly supply funds to a person who wants to borrow b. Bond- certificate of indebtedness that specifies obligations to the borrower and holder of the bond. i. Municipal- given by government ii. Date of Maturity- when it will be repaid iii. Principle- promise of interest and repayment iv. Term- length of bond till it matures v. Perpetuity- never matured, only gives back interest vi. Credit Risk- probability that borrower will fail to pay back the whole thing vii. Default- failure to pay viii. Junk bonds- very high interest c. Stock- ownership in a firm i. Claim to profits ii. Equity finance- sale of stock to raise money iii. Debt finance- sale of bonds d. Financial intermediaries- financial instituions which savers can indirectly provde fund to borrowers i. Banks- medium of exchange e. Mutual funds- institution that sells shares to the public and uses proceeds to buy a selection (portfolio) of various types of stocks, bonds or both i. Allows people with less money to diversify their holdings ii. Allows ordinary people access to the skills of professional money managers 2. 8-2 Saving and Investment in the National Income Accounts a. Accounting- how various numbers are defended and added up b. Identity- an equation that must be true because of the way the variables in the equation are identified c. Closed economy- does not interact with other ones d. Open Economy- interacts with other economies e. National Saving or Saving- GDP – Consumption – Government spending i. Saving= investment f. Private saving is GDP – taxes – consumption g. Public Saving is Taxes- government purchases h. Budget Surplus- Taxes exceed government Purchases i. Budget Deficit- Government Purchases exceed Taxes j. Saving and investment are different i. Saving is putting it in a bank ii. Investment is investment in new capital 3. 8-3 Market for Loanable Funds a. Market for loanable funds- economy has only one financial market which is this i. All savers go to this market to deposit their saving, all borrowers go to take out loans ii. Loanable Funds- refores to all income people have chosen to save and lend out rather than use for their own consumption 1. Supply and demand of loanable fudns correspond to real interest rate b. Saving Incentives i. American save a smaller fraction of their incomes compared to other countries ii. Part of this is do to lack of incentives and taxes on dividends iii. IF you save 1000 dollars in a bod for 30 years the payout is 13 grand, after taxes its only 5 grand c. Investment incentives i. Increses demand for loanable funds d. Government budget deficits and suprlusses i. A government budget deficit or surplus affects supply of loanable funds 1. Surplus shifts it up 2. Deficit shifts it down, less supply ii. Crowding out- less people borrow when the gov runs a budget deficit because interest rate goes up iii. When gov runs a budget deficit they borrow more from private sector and therefore private sector has less to give out Chapter 9 1. 9-1: Present Value: Measuring the Time Value of Money a. Money today is more valuable than the same amount of money in the future b. Present Value- amount today that would be needed at current interest rates to produce that future sum c. Future Value- what the money is worth in the future d. Compounding- how often you add the interest e. P(1+r)^nv f. Discounting- finding present value of future sum Last Third 2. Chapter 11 a. Section 1: Meaning of Money i. Money- the set of assets in the ecnomy that people regularly use to buy goods and services from each other 1. If you own a large share of Microsoft, like Bill Gates does, your wealthy but this asset is not a form ofmoney ii. Functions of Money 1. Medium of Exchange- an item that buyers give to sellers when the purchase goods and services 2. Unit of Account- the yardstick people use to post prices and record debt 3. Store of Value- An item that people can use to transfer purchasing power from the present to the future a. Wealth refers to all the stores of values including monetary and non monetary assets 4. Liquidity- the ease with which an asset can be converted into the ecnomony’s medium of exchange iii. Section 2: Kinds of money 1. Commodity money- intrinsic value means that the item would have value een if it were not used as money a. Gold- industry of making jewlrey b. Gold Standard if economy uses gold as money c. Ciggarretes was used in Russia and in Jail as money 2. Fiat Money- an order of decree, money without intrinsic value a. Paper dollars in your wallet and paper dollars used in monompoly iv. Section 3: Money in the US economy 1. Quantity of oney circulating is Money Stock a. Currency- paper bills and coins in the hand of the public b. Demand Deposits- Balances in bank accounts that depositors can access on demand simply by writing a check or swiping a debit card store 2. M1 a. Demand Deposits, travelers checks, currency, oth
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