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McMaster University
Chemical Engineering
Joe Kim

Chapter 5 GDP (gross domestic product)  Total income of everyone in the economy; The market value of all final goods & services produced within a country in a given period of time Adding up the total expenditure by households and firms Income of a economy (wages, rent, profit) Legally sold things in the economy Rental housing; this value is easy to calculate; the rent equals both tenant’s expenditures and the landlord’s income. (if self owned estimate owner pays rent to himself) Inventory investment is added to GDP; and when used for goods production or sold then it is removed from GDP accordingly Only includes the value of final good Items are included in a nation’s GDP if they are produced domestically regardless of who buys it EXCLUDES Illegal transactions; drugs etc. Products produced and consumed at home; ex vegetables from your garden etc. When one person sells a used car to another person, the value of the car is excluded Leisure time Volunteer work Quality of the environment Unemployment  the percentage of the labor force that is out of work Retail Sales  Total spending at stores The trade deficit  The imbalance of trade between Canada and the rest of the world Market Price  measure of the amount people are willing to pay for different goods, they reflect the value of those goods Intermediate Good Ex.Paper that is made then used for greeting cards; greeting cards is the final good For an economy as a whole, income must equal expenditure In this economy, households buy goods & services from firms; these expenditures flow through the market for goods & services. The firms in turn use the money they receive from sales to pay workers wages, landowner’s rent, and firm owner’s profit; this income flows through the market for the factors of production Y=C+I+G+NX Y GDPCConsumption I Investment GGovernment Purchase NXNet Exports Consumption Is spending by households on goods & services (Ex. Spending on post secondary education) Investment Is the purchase of goods that will be used in the future to produce more goods & services Ex. Buying a new house Government Purchase Include spending on goods & services by local, territorial, provincial, & federal government. Transfer payment: it is not made in exchange for a currently produced good or service Ex. Pension Plan This is NOT counted by GDP Net Exports Equals the purchases of domestically produced goods by foreigners (exports) minus the domestic purchases of foreign goods (Imports) Real GDP  shows how the economy’s overall production of goods & services change over time. (valued at constant price) Nominal GDP  the production of goods & services valued at current prices Nominal GDP is used current prices to place a value on the economy’s production of goods economy’s production of goods & services GDP deflator Reflects the prices of goods and services but not the quantities produced Nominal GDP GDP deflator = -------------------*100 Real GDP Inflation a situation in which the economy’s overall price lever is rising Inflation Rate is the percentage change in some measure of price level from one period to the next. GDP deflator in yr 2 – GDP deflator in yr 1 Inflation rate in Yr 2 = -------------------------------------------------*100---------- GDP deflator in yr 1 CHAPTER 6 The consumer price index (CPI)  is a measure of the overall cost of the goods and services bough by a typical consumer 5 Steps of determining CPI 1. Determine the basket: which prices are most important to the typical consumer 2. Find the prices: find the price of each of the goods and services in the basket for each point in time 3. Compute the basket’s cost 4. Choose a base year and compute the index Price of basket of goods/ services in current year CPI = ------------------------------------------------------------------------ * 100 Price of basket in base year 5. Compute the inflation rate: CPI in yr2 – CPI in yr 1 Inflation rate in yr 2 = ----------------------------- * 100 CPI yr 1 Core inflation  often thought to be useful in prediction the underlying trend of changes in CPI Problems with CPI Commodity substitution bias: when prices change from one year to the next they do not all change proportionately’ some prices rise more than others ( the index will measure a much larger increase in the cost of living than consumers actually experience ) 4 year period BIAS Introduction of new goods: If there is a bigger variety of goods in a market then the dollar is worth more than in a small market. Unmeasured quality change GDP vs. CPI GDP deflator reflects the prices of all goods & services produced domestically where as the consumer price index reflects the prices of all goods and services bought by consumers The consumer price index compares the price of a fixed basket of goods & services to the price of the basket in the base year; changes the basket every four years. GDP deflator compares the price of currently produced goods & services to the price of the same good & service in the base year. 1957 gas price in 2009 dollars = 1957 gas price * ( CPI in 2009/ CPI in 1957) Indexation Used to correct the effects of inflation Ex. Many longterm contracts between firms & unions include partial or complete indexation of the wage to the consumer price index. ( cost-of-living-allowance) automatically raises the wage when the CPI rises Nominal interest rate: The interest rate that measures the change in dollar amount Real interest rate : The interest rate corrected for inflation Real interest rate = Nominal interest rate – Inflation rate Chapter 7 Productivity  refers to the quantity of foods & services that a worker can produce for each hour of work Physical Capital per Worker The stock of equipment and structures that are used to produce goods &services(factors of prod) Human Capital per Worker Knowledge and skills that workers acquire through education, training and experience ( FOP) Natural Resources per Worker Inputs into production that are provided by nature, such as land, rivers and mineral deposits Technological Knowledge The understanding of the best ways to produce goods & services One way to raise future productivity is to invest more current resources in production of capital Encouraging saving and investment is one way government can encourage growth and, in the long run, raise the economy’s standard of living Diminishing Returns When workers already have a large quantity of capital to use if producing goods and services, giving them an additional unit of capital increases their productivity only slightly In the long run, the higher saving rate leads to higher levels of productivity and income, but not to higher growth in these variables. The healthier or taller a population the more productive it is. Catch-up effect  Controlling for other variables, such as the percentage of GDP devoted to investment, poor countries do tend to grow at a faster rate than rich countries Foreign direct investment  A capital investment that is owned and operated by a foreign entity Foreign portfolio investment  An investment that is financed with foreign money but operated by domestic residents GNP (gross national product)  is income earned by residents of a country both at home & abroad World Bank  An organization that tries to encourage the flow of capital to poor countries Education  is at least as important as investment in physical capital for a country’s long run economic success Externalities  is the effect of one person’s actions on the well being of a bystander Brain Drain  The emigration of many of the most highly educated workers to rich countries where these workers can enjoy a higher standard of living Property rights  An important prerequisite for the price system to work is an economy-wide; the ability of people to exercise authority over the resources they own Inward oriental policies  these policies are aimed at raising productivity and living standards within the country by avoiding interaction with the rest of the world Outward oriented policies  A country that eliminates trade restrictions will therefore experience the same kind of economic growth that would occur after a major technological advance. The Patent System enhances the incentives for individuals and firms to engage in research which raises standards of living Malthus Theory Attempts by charities or governments to alleviate poverty were counterproductive he argues, because they merely allowed the poor to have more children, placing ever greater strains on society’s productive capabilities When population growth is rapid, each worker is equipped with less capital. If there are more people, then there are more scientists, inventors, engineers to contribute to technological advance, which benefits everyone Chapter 8 Financial system  consists of those institutions in the economy that help to match one person’s savings with another person’s investment Financial markets  are the institutions through which a person who wants to save can directly supply funds to a person who wants to borrow funds The Bond Market A bond ( debt financing) is a certificate of indebtedness that specifies the obligation of the borrower to the holder of the bond Date of maturity  the time at which the loan will be repaid Bond term  the length of time until the bonds matures Credit risk  the probability that the borrower will fail to pay some of the interest or principle ( default ) The Stock Market Stock represents ownership in a firm and is, therefore, a claim to the profits that the firm makes. ( equity financing ) The price at which shares trade an stock exchanges are determined by the supply & demand for the stock in these companies A stock index is computed as an average of a group of stock prices Financial intermediaries are financial institutions through which savers can indirectly provide funds to borrowers Banks  primary job is to take in deposits from people who want to save and use these deposits to make loans to people who want to borrow They facilitate purchases of goods & services by allowing people to write cheques against their deposit Medium of exchange  an item that people can easily use to engage in transactions Mutual funds  is an institution that sells shares to the public and uses the proceeds to buy a selection or portfolio of various types of stocks, bonds, or both Index funds  which buy all the stocks in a given stock index, perform somewhat better on average than mutual funds that take advantage of active management by professional money managers Accounting  refers to how various numbers are defined and added up Closed economy  is one that does not interact with other economies Open economy  interacts with other economies in the world National savings (s) Y –C – G = I S=(Y-T-C)+(T-G) T= Taxes Private savings (Y-T-C)  is the amount of income that households have left after paying their taxes and paying for their consumption. Public savings(T-G) is the amount of tax revenue that the government has left after paying its spending Budget deficit  if government spends more than it receives in taxes; shifts the supply curve left Budget surplus  If the government spends less than it receives in taxes For the economy as a whole, saving must be equal to investment Investment refers to the purchase of new capital Market for Loan able funds All savers go to this market to deposit their savings, and all borrowers go to this market to get their loans Loan able funds refer to all income that people have chosen to save and lend out Savings is the source of supply of loan able funds Investment is the source of the demand for loan able funds The tax change would alter the incentive for households to save at any given interest rate, it would affect the quantity of loan able funds supplied at each interest rate If a reform of tax laws encouraged greater saving, the result would be lower interest rates and greater investment Investment tax credit  gives a tax advantage to any firm building new factories or buying a new piece of equipment (effects demand) If a reform of the tax law encouraged gather investment, the result would be higher interest rates and greater savings Government Debt  the sum of all past budget deficits minus the sum of all past budget surpluses A change in the government budget balance represents a change in public saving therefore changing supply curve Crowding out  the fall in investment because of government borrowing When the government reduces national saving by running a budget deficit, the interest rate, rises, and investment falls A budget surplus increases the supply of loan able funds, reduces the interest rate, and stimulates investment. Chapter 9 Natural rate of unemployment  refers to the amount of unemployment that the economy normally experiences Cyclical unemployment  refers to the year-to-year fluctuation in unemployment around its natural rate, and its closely associated with short run ups and downs of economic activity Three categories of people in the economy Employed, Unemployed Not in labor force Labor force  the sum of the employed and unemployed Number of unemployed Unemployment rate = -----------------------------------------------*100---- Labor force Labor force Labor force participation rate = ------------------------*100- Adult population It is best to view the official unemployment rate as a useful but imperfect measure of joblessness Natural rate of unemployment  what economists judge to be the rate of unemployment to which the economy rends to return in the long run Canada to be currently 6 – 8 % Four ways to explain unemployment in long run Takes time for workers to search for the jobs that are best suited for them Frictional unemployment  unemployment that results from the process of matching workers and jobs Structural unemployment  this occurs when the quantity of labor supplied exceeds the quantity demanded Sector shifts  changes in the composition of demand among industries or regions Most economists agree that eliminating Employment Insurance would reduce the amount of unemployment in the economy. Yet economists disagree on whether economic well being would be enhanced or diminished by this change in policy. If the wage is kept above the equilibrium level for any reason, the result is unemployment. When job search is the expiation for unemployment, worker are searching for the jobs the best suit their tastes and skills When the wage is above the equilibrium level, the quantity of labor supplied exceeds the quantity of labor demanded and workers are unemployed, because they are waiting for jobs to open up. Union  is a worker association that bargains with employers over wages and working conditions Unionization is highest in industries in the public sector and lowest in the food and accommodation industry Collective bargaining  the process by which unions and firms agree on terms of employment Unions are often thought to cause conflicts between different groups of workers; between the insiders who benefit from high union wages and outsiders who do not get union jobs The increase in labor supply, reduces wages in industries that are not unionized Outsiders can respond to their status in one of two ways. Some of them remain unemployed and wait for the chance to become insiders and earn higher wages in industries and earn the high union wage, others take jobs in firms that are not unionized Even if unions have the adverse effect of pushing wages above the equilibrium level and causing unemployment, they have the benefit of helping firms keep a happy productive work force Four reasons why economies experience some unemployment Job search Minimum wage laws Unions Efficiency wages Firms operate if wages are above equilibrium level Worker health In other words, concern over nutrition may explain why firms do not cut wages despite surplus of labor Worker Turnover A firm can reduce turnover among its workers by paying them a high wage Worker Effort A third type of efficiency wage theory emphasizes the link between wages and worker effort Firms raise wages above the equilibrium level, providing an incentive for workers not to shirk their responsibilities Worker Quality Higher paying jobs attract more skilled workers Chapter 10 Barter  the exchange of one good or service for another Money is the set of assets in the economy that people regularly use to buy goods & services from other people Three functions of money; Medium of exchange is an item that buyers give to sellers when they purchase goods and services A unit of account  the yard stick people use to post prices and record debt A store of value  is an item that people can use to transfer purchasing power from the present to the future Wealth  Total of all stores of value, including both money and non monetary assets Liquidity  the ease with which as asset can be converted into the economy’s medium of exchange Intrinsic value  means that the item would have value even if it were not used as money ex. Gold or cigarettes Money stock  the quantity of money circulating in the economy Demand deposit  balances in bank accounts that depositors can access on demand simply by writing a chequ or using a debit card Canadian economy includes not just currency but also deposits the banks and other financial institutions that can be readily accessed and used to buy goods and services Money without intrinsic value is called fiat money. Fiat money is established as money by government decree Bank of Canada(Central Bank)  an institution designed to control the quantity of money in the economy Bank of Canada 4 jobs Issue currently Acts as banker to commercial banks Acts as banker to the Canadian Government Control the quantity of money that is made available to the economy; money supply Monetary policy  Decisions by policy makers concerning money supply Reserves  are deposits that banks have received but have not loaned out Fractional-reserve banking  a banking system in which banks hold only a fraction of deposits as reserves Reserve ration  the fraction of deposits that banks hold as reserves Reserve requirements  a minimum on the amount of reserves that banks hold Excess reserves  reserves above minimum If bonds hold all deposits in reserve, banks do not influence the supply of money When banks hold only a fraction of deposits in reserve banks create money At the end of the process of money creation, the economy is more liquid in the sense that there is more of the medium of exchange, but the economy is no wealthier than before Money multiplier  the amount of money the banking system generates with each dollar to reserves The money multiplier is the reciprocal of the reserve ration The higher the reserve ration, the less of each deposit bank loan out, and the smaller the money multiplier Open market operations  long term money supply fluctuation Central banks can increase the supply of money in circulation by buying something They can decrease the supply of money by selling something. The purchase or sale of government of Canada bonds by the bank of Canada Foreign exchange market operations  the purchase or sale of foreign money If Bank of Canada buys foreign currency it increases money supply If Bank of Canada sells foreign currency for Canadian dollars it withdraws money from circulation therefore reducing the money supply Sterilization  the process of offsetting foreign exchange market operations so that the effect on the money supply is cancelled out. Changing reserve requirements Reserve requirements  regulations on the minimum amount of reserves that banks must hold against deposits Changing the overnight rate  Short term money supply fluctuation Bank of Canada acts as bankers to commercial banks Transfers between banks are done by the Bank of Canada Bank rate  the interest rate charged by the Bank of Canada on loans to the commercial banks Overnight rate  the interest rate on very short-term loans between commercial banks The bank of Canada can alter the money supply by changing the bank rate which in turn causes changes in the overnight rate A higher overnight rate discourages banks from borrowing reserves from the Bank of Canada reserves Therefore increases in the overnight rate reduces the quantity of reserves in the banking system, which in turn reduces the money supply 2 problems that Bank of Canada faces; Bank of Canada can’t control the amount of money that households choose to hold as deposits in banks Bank of Canada does not control the amount the commercial banks choose to lend Chapter 11 A rise in the price level means a lower value of money because each dollar in your wallet now buys a smaller quantity of goods & services The quantity of goods & services that can be bought with 1 $ equals 1/P if P is the price of goods & services measured in terms of mo
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