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1BB3 Macro Exam Review Ch5-15

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Bridget O' Shaughnessy

Macro Exam review Chapter 5: Measuring a nation's income gross domestic product (GDP) measures the total income of a nation it is the most closely watched economic statistic because it is though thought to be the best single measure of a society's economic well being for an economy as a whole, income must equal expenditure every transaction has 2 parties: buyer and seller GDP - the market value of all final goods and services produced within a country in a given time period it is the measure of how much stuff to make market value - $, market transaction all - within the market (does not include prostitution, drugs, etc) final - want to avoid double counting. only include things that are sold to the final buyer g&s produced in the country - where it takes place is important and not who owns the firm in a given period of time GDP adds together many different kinds of products into a single measure of the value or economic activity includes all items produced in the economy and sold legally in markets also includes the market value of the housing services provided by the economy's stock of housing only includes the value of final goods tangible & intangible goods includes g&s currently produces, not from past measures the value of production within the geographic confines of a country specific time intervals GDP = Y + I + G + NX consumption + investment + government purchases + net exports consumption: spending by the households on g&s, with the exception of purchases of new housing investments: spending on capital equipment, inventories, and structures, including household purchases of new housings gov't purchases: spending on g&s by local, territorial, provincial, and federal gov'ts net exports: the value of a nation's exports minus the value of its imports; also called trade balance (exports-imports) real GDP: the production of g&s valued at constant prices nominal GDP: the production of g&s valued at current prices GDP deflator: a measure of the price calculated as the ratio of nominal to real GDP times 100 GDP=(nominal GDP/ real GDP)*100 economists use the term inflation to describe a situation in which the economy's overall price level is rising. The inflation rate is the percentage change in some measure of the price level from one period to the next using the GDO deflator, the inflation rate between 2 consecutive years in computed as follows: inflation rate in yr 2 = (GDP deflator in Yr 2 - GDP deflator in Yr 1 / GDP deflator in Yr 1)*100 GDP deflator is one measure that economists use to monitor the average level of prices in the economy GDP excludes the value of leisure , clean environment and any sort of activity outside the market 3 ways to calculate GDP output (basic prices) -add stuff together by looking at the purchasing side of each transaction -everything sold within Canada, adding up according to who is buying it expenditure (market prices) -adding all the income that is generated by the activity of purchases/sales income (market prices) each transaction has a buyer and seller the difference between GDP at market prices and GDP at basic prices is that basic prices do not includes sales tax while market prices do Chapter 6: Measuring the cost of living (refer to inflation rate/gdp deflator handout) the consumer price index is used to monitor changes in the cost of living over time when the CPI rises, the typical family has to spend more $ to maintain the same standard of living inflation : situation in which the economy's overall price level is rising inflation rate : % change in the price level from the previous period CPI : a measure of the overall cost of the g&s bought by a typical consumer CPI = [(Price of basket of goods/services in current year)/price of basket in base year]*100 use CPI to calculate inflation rate inflation rate in yr 2 = [(CPI Yr2 - CPI Yr 1)/CPI Yr 1]*100 core inflation: the measure of the underlying trend of inflation problems in measuring the cost of living commodity substitution bias : when prices change from one year to the next, they do not all change proportionally. consumers substitute towards goods that have become relatively less expensive introduction of new goods: new items allow a bigger variety to choose from. greater variety makes each dollar more valuable unmeasured quality change: the quality of a good deteriorates from one year to the next, the value of the dollar falls, even if the price of the good stays the same GDP deflator CPI Reflects the prices of all goods and services Reflects prices of all goods and service bought by produced domestically consumers Compares the prices of the currently produced g&s Compares the price of the fixed basket of g&s to to the price of the same g&s in the base year the price of the basket in the base year the purpose of measuring the overall level of prices in the economy is to permit comparison between dollar figures from different point of time indexation: the automatic correction of a dollar amount for the effects of inflation by law or contract cost of living: automatically raises the wages when CPI rises nominal interest rate: the interest rate as usually reported without a correction for the effects of inflation real interest rate: the interest rate connected for the effects of inflation real interest rate = nominal interest rate - inflation rate Chapter 7:Production & Growth Productivity: the quantity of goods and services produced from each hour of a worker’s time  How to determine productivity o Physical Capital- the stock of equipment and structures that are used to produced goods and services i.e. tools o Human capital- The knowledge and skills that workers acquire through education, training and experience E.g. highschool, University o Natural Resources- The inputs into the production of goods and services that are provided by nature such as lands, river and mineral deposits i.e. forest o Technological Resources- Society understanding of the best ways to produce goods and services e.g. Labor becomes easier with better technology  Production function shows how we combine input to produce output o Equation Y= A X F(K, I, H, N) o Y=output o A= varriable that affects the available production technology o K=physical capital o L=labor o H=human capital o N= natural resources  If a production function produces constant return scale o Increasing by a constant rate xY= A X F( xL, xK, xH, xN) o Production per worker Y/L= A X F (1, K/L, H/L, N/L) Diminishing marginal product  Product is equal to the output  Marginal product: the extra output produced by increasing an input by 1 unit  **Diminishing marginal product: the more units of labour added the smaller extra output becomes  Catch-up affect: poor countries tend to grow faster than rich countries What government policy do to raise productivity and living standards? 1. Encourage saving (K) a. Consume less and save more b. E.g. impose a consumption tax 2. Allowing foreign investment (K) 3. Spend on education (H) a. More educated individuals- more ideas for society b. Brain drain problem: emigration or highly educated people to rich countries 4. Improve property rights and reduce political stability (K, A) 5. Free trade (A) a. Can be a substitute for technology 6. Research and Development- R&D (A) a. Grants (e.g. funded research at universities b. Patent system (enhances the incentive for individuals and firms to engage in research) Chapter 8 : Saving, Investment & the financial system Financial System- the group of institutions in the economy that help match one persons saving with another persons investment. Financial institutions can be grouped into two categories- financial markets and financial intermediaries Financial markets are the institutions where a person who wants to save can supply funds to someone who wants to borrow ( Bond Market, Stock Market). A bond is an IOU, where the buyer is promised to get a higher amount of money at a later time. Junk bonds offer a higher interest rate, but are much riskier. Stock is a claim to partial ownership in a firm. However, stocks are much more riskier and are paid AFTER bond holders. Financial Intermediaries are institutions through which savers can indirectly provide funds to borrowers (banks and mutual funds). Banks act as the medium of exchange. Mutual funds are an institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds. Advantage of a mutual fund is it allows people with small amounts of money to diversify their stock purchases. In a closed economy, there is no trade. So GDP can be written as Y=C + I + G Y-C-G=I *(Y-C-G) is national saving, therefore S=I S= Y-C-G Since there is public and private saving, we can write this out as S= (private saving) + (public saving) S= (Y-T-C) + (T-G) *a budget surplus if T>G in public saving * a budget deficit if G>T in public saving SAVING (households) is the supply of Loanable funds. (the higher the interest rate the more they want to save) INVESTMENT (Firms) is to source of the Demand for loanable funds. (the higher the interest rate the less they want to invest) The demand curve for loanable funds slopes downwards, and the demand curve for loanable funds slopes upwards. A change in tax laws encourage savers to save more, shifting the supply of loanable funds to the right. An investment tax credit (less tax) would shift the demand of loanable funds to the right. Government debt- the sum of all past budget deficits and the surpluses. This shifts the supply of loanable funds to the left. (less money in the economy) * when the government reduces national saving by running a budget deficit, the interest rate rises, and investment falls Chapter 9 - Unemployment & it's natural rate  measuring unemployment is the job of Statistics Canada  every month Stats Canada produces data  labour force survey - 50 000 households  3 categories (age 15 & older) o employed  if he or she spent some of the previous week working at a paid job o unemployed  if he or she is on temporary layoff or is looking for a job o not in labour force  in neither (could be a full time student, homemaker, retiree)  military is not included when calculating unemployment because they do not have the flexibility to just leave and walk into another job  labour force: the total # of workers, including both employed and the unemployed o labour force = # of employed + # of the unemployed  unemployment rate : the % rate of the labour force that is unemployed o unemployment rate = (# of unemployed/labour force) * 100  labour force participation rate : the % of the adult population that is the labour force o labour force participation rate = (labour force/adult population) * 100  discourages searchers: individuals who would like to work but have given up looking for a job  natural rate of unemployment: the rate of unemployment to which the economy tends to return to in the long run  cyclical unemployment: results from a reduction is overall consumer spending. as overall demand for goods and services declines in all industries, fewer workers are needed in all industries  frictional unemployment: unemployment that results because it takes time for workers to search for the jobs that best suit their tastes & skills  structural unemployment: unemployment that results because the # of jobs available in some labour markets is insufficient to provide a job for everyone who wants one. occurs when the skills or location of workers no longer matches the patterns of demand in the economy.  job search: the process by which workers find appropriate jobs given their tastes and skills o gov't run employment agencies o public training programs , which aim to ease the transition of workers from declining to growing industries and to help disadvantaged groups escape poverty o advocates of gov't programs designed to facilitate job search believe that the programs make the economy operate more efficiently by keeping the labour force more fully employed and reduce the inequities in a constantly changing market economy  employed insurance (EI): a gov't program that partially protects workers' incomes when they become unemployed  the longer you give people unemployment and the more money you give them will make the unemployment higher  minimum wage laws o minimum wage laws are binding most often for the least skilled and least experienced members of the labour force, such as teenagers o if the wage is kept above the equilibrium level for any reason, the result is unemployment o when job search is the explanation for unemployment, workers are searching for the jobs that best suit their skills & tastes. By contrast, when the wage is above equilibrium level, the quantity of labour supplied exceeds the quantity of labour demanded and workers are unemployed because they are waiting for jobs to open up.  unions & collective bargaining o union: a worker association that bargains with employers over wages & working conditions o collective bargaining: the process by which unions and firms agree or the terms of employment o strike: the organized withdrawal of labour from a firm by a union  a threat of a strike makes a factory pay more, wages go up  efficiency wages: above equilibrium wages paid by firms in order to increase worker productivity o worker health  better paid workers eat a more nutritious diet, and those who eat a better diet are healthier and more productive o worker turnover  the frequency with which they quit depends on the entire set of incentives they face, including the benefits of leaving and the benefits of staying. the more a firm pays its workers, the less often its workers will choose to leave  firms are about turnover because it is costly for firms to hire & train new workers even after training, new workers aren't as productive o worker effort  high wages make workers more eager to keep their jobs, giving workers an incentive to put forward best efforts  firms use wages above equilibrium level, providing an incentive for workers not to shirk their responsibilities and then get fired o worker quality  higher wages attracts a pool of workers to apply for its jobs who have a greater talent --> increasing quality of work force rather than lower wages and anyone will apply  asymmetric info and reservation Chapter 10 : The monetary System  Money: assets regularly used to buy goods and services  When prices rise the value of money falls  The only reason money has value is because we use it to buy stuff  If a cashier didn’t accept our money it would have no value 3 functions of Money 1. Medium of exchange- is an item that buyers give to sellers when they purchase goods and services 2. Unit of account-the yardstick people use to post prices and record debts 3. Store of value –an item that people can use to transfer purchasing power from the present to the future Liquidity  The ease with which an asset can be converted into the economies medium of exchange o Assets from most to least liquid (currency, stocks, fine arts) Commodity v.s. fiat money  Commodity money: money that takes the form of commodity with intrinsic value  Fiat money: established as money by government decree, with no intrinsic value The reason the 20 dollar bill has value is because the cashier thinks it has value Money in the Canadian economy Money= Currency + Demand deposits  Currency: Paper bills and coins in the hands of the public  Demand deposits: the balance in bank accounts that depositors can access on demand by writing a cheque or using a debit card. The legal tender requirement means that?  People are more likely to accept the dollar as a medium of exchange  Credit cards are not medium of exchange, it’s not money, it’s not an
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