MGEA06: Midterm Review (Including Assignments)

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Economics for Management Studies

Helen  Li     MGEA06H3     Midterm  Prep  Review  (Including  important  formulas)     • Fiscal  policy:  government  changes  either  its  spending  pattern  or  its  tax  policy  to   pursue  economic  goals   o E.g.  Reducing  tax  rates  -­‐>  government  can  encourage  people  to  buy  more   stuff,  thus  putting  upward  pressure  on  economic  output   • Monetary  policy:  government  makes  changes  to  the  money  supply  in  pursuit  of   economic  goals   o E.g.  Taking  money  out  of  circulation  puts  downward  pressure  on  the   aggregate  price  level     ▯ Can  limit  inflation   • Monetary  policy  uses  money  and  banking  variables  to  influence  the  economy   o Money  supply  and  interest  rates   • Fiscal  policy  is  about  spending  and  saving  by  the  government   o When  the  government  changes  spending  or  taxation,  this  is  considered  fiscal   policy   • Inflation  is  when  there  is  an  overall  increase  in  price  level     • Exports:  products  that  are  produced  at  home  and  then  sold  abroad.     • Imports:  goods  produced  somewhere  else  and  then  consumed  by  citizens  of  the   home  country     • A  closed  economy  describes  the  scenario  when  a  nation  does  not  engage  in  trade   with  other  countries   o NO  imports/  exports     • Trade  surplus:  exports  >  imports     • Trade  deficit:  occurs  only  when  imports  exceed  exports     • Business  cycle:  series  of  booms  and  busts,  or  cycles  of  expansion  and  contraction  in   the  economy   o As  economy  grows  in  size  -­‐>  economy  -­‐>  period  of  expansion     o Economy  must  reach  the  high  point  of  its  expansion  -­‐>  peak   o Once  this  peak  has  been  reached  -­‐>  begins  to  shrink  -­‐>  contraction     1) Before  it  can  be  said  a  peak  or  trough  has  occurred,  the  economy  must  begin  to   expand  or  contract   a. If  the  economy  has  not  changed  directions,  then  the  previous  expansion  or   contraction  simply  continues,  although  possibly  at  a  slower  rate   2) A  contraction  is  not  necessarily  a  recession   a. A  recession  is  widely  defined  as  at  least  two  consecutive  quarters  of  negative   growth,  whereas  a  contraction  does  not  have  any  length  requirement  (note,   the  National  Bureau  of  Economic  Research  makes  the  official  recession   pronouncement  and  occasionally  strays  from  this  two-­‐quarters  rule)     • Gross  domestic  product:  total  value  of  all  final  goods  and  services  produced  in  a   country       • GDP  -­‐>  measure  of  the  productive  capacity  of  an  economy,  we  only  include  final   goods  and  services   o Savings  and  foreign  investment  -­‐>  not  final  goods  and  services         • Unsold  goods  that  are  produced  in  the  current  time  period  are  counted  in  current   GDP  as  a  part  of  the  investment  components  since  they  will  be  turned  into  final   goods  in  the  future  at  their  time  of  sale                     • Some  modern  economies,  such  as  many  in  the  Middle  East,  still  base  their   economies  on  natural  resources,  but  this  is  not  a  guarantee  to  future  economic   growth   o Finding  alternatives  in  energy  generation  -­‐>  future  growth     • Frictional  unemployment:  caused  by  the  scarcity  of  information;  workers  don't   know  all  the  jobs  available,  which  makes  it  harder  to  match  them  properly  to  their   skills.     o Internet  -­‐>  job  searching  easier     ▯ Reduce  frictional  unemployment     • When  economy  is  performing  well  -­‐>  little  cyclical  unemployment   o Unemployment  resulting  from  a  downward  turn  in  the  business  cycle   o Because  cyclical  unemployment  is  lower  during  economic  expansions,  much   of  the  existing  unemployment  is  frictional  in  nature  as  workers  move  from   job  to  job  searching  for  a  good  match     • A  union  negotiating  higher  wages  for  its  members  leads  to  an  increase  in  the   quantity  supplied  of  labor   o Due  to  now  higher  costs  -­‐>  the  quantity  demanded  decreases   ▯ More  people  being  willing  to  work  but  fewer  firms  being  willing  to   hire   ▯ Surplus  of  workers  at  higher  wage   ▯ Harmful  to  workers  who  no  longer  are  able  to  find  work  once  the   wage  increases   ▯ Unemployment  increases  as  the  wage  increases   • The  natural  rate  of  unemployment  equals  the  addition  of  frictional   unemployment  and  structural  unemployment     • In  general  terms,  anything  that  pushes  wage  levels  above  the  market  equilibrium   rate  can  increase  the  natural  rate  of  unemployment   o Increasing  minimum  wage  and  union  membership  -­‐>  push  up  wages,  leading   to  an  excessive  supply  in  the  labor  market  and  structural  unemployment     • Government  policy  that  disrupts  the  labor  market  -­‐>  structural  unemployment,  &   push  up  the  natural  rate   o Providing  extra  financial  benefits  to  the  unemployed  -­‐>  lead  to  more  workers   deciding  not  to  take  up  low  paying  jobs   o If  large  number  of  young  people  enter  the  labor  market  (US  baby-­‐boomers   came  of  age)  -­‐>  increase  in  the  natural  rate   o Some  policies  -­‐>  cause  a  decrease  in  the  natural  rate  of  unemployment     • Reducing  workers  collective  bargaining  rights  -­‐>  role  of  unions  in  setting  wages   would  be  reduced  -­‐>  reduce  going  market  wage  rate  -­‐>  decreasing  the  natural  rate   of  unemployment   o Some  government  programs  -­‐>  reduce  the  natural  rate  of  unemployment   o More  government  training  programs  -­‐>  help  to  train  or  retrain  workers  to   meet  local  employment  needs   • One  of  the  causes  of  frictional  unemployment  -­‐>  lack  of  perfect  information   between  employers  and  potential  employees   o Increased  information  on  job  opportunities  -­‐>  reduce  job  search  time  =  reduce   the  natural  rate  of  unemployment   • Important  -­‐>  just  because  something  reduces  the  natural  rate  of  unemployment   does  not  mean  it  is  equitable  or  even  desirable.     o E.g.  some  people  may  consider  actions  like  reducing  workers  collective   bargaining  rights  as  a  having  a  serious  impact  on  individual  rights   • The  natural  rate  of  unemployment:  unemployment  that  exists  even  when  the   economy  is  healthy  and  growing,  not  during  recessions.     • Unemployment  from  recessions  is  known  as  cyclical  unemployment       • Menu  costs:  costs  associated  with  changing  and  updating  listed  prices  in  stores,   restaurants  and  other  purveyors  of  goods  and  services   • Hyperinflation  -­‐>  listed  prices  need  to  be  changed  repeatedly   o Brazilian  inflation  (1990s)   • During  high  inflation  people  are  reluctant  to  hold  cash  since  inflation  causes  the   purchasing  power  of  cash  to  decrease  -­‐>  many  people  will  try  to  convert  to  get  $$     • Shoe-­‐leather  costs:  effort  and  wear  and  tear  that  people  incur  trying  to  avoid  the   decrease  in  value  of  cash   o People  also  face  transaction  costs  in  the  form  of  bank  fees,  when  converting   money  into  other  more  stable  forms   o The  role  of  currency  as  the  basis  for  contracts  and  calculation  is  referred  to   as  the  unit-­‐of-­‐account  role  of  money     • Inflation  alters  the  purchasing  power  and  value  of  money  and  reduces  the  quality  of   economic  decision-­‐making   o Makes  money  a  less  reliable  source  of  measurement  -­‐>  results  in  uncertainty   about  future  purchasing  power     • Unit-­‐of-­‐account  costs:  prevalent  in  the  tax  system  since  nominal  prices  are   increasing  and  marginal  tax  rates  are  based  on  nominal  prices             • The  unemployment  rate  is  a  measure  largely  meant  to  see  when  things  are  going   wrong  in  an  economy   o Note  -­‐>  economy's  poor  health  can  cause  people  to  give  up  on  looking  for  a   job   ▯ Discouraged  workers     • Nominal  (raw)  GDP:  reflect  the  total  market  value  of  all  final  goods  and  services  in   an  economy  over  a  given  period   o An  increase  in  the  aggregate  price  level  of  these  final  goods  and  services,   through  inflation  -­‐>  increase  nominal  GDP   o Increase  in  prices  does  not  represent  actual  growth  in  the  economy  =  most   economists  use  real  GDP  (removes  the  effect  of  inflation  in  growth  rates)           • Wages  and  standard  of  living  are  generally  tied  to  GDP  per  capita   o E.g.  For  people  interested  in  development,  it  means  that  small  changes  in   human  and  physical  capital  can  lead  to  large  changes  in  standard  of  living  for   those  living  in  the  most  poverty     o The  rule  of  70  -­‐>  used  to  calculate  the  number  of  years  it  will  take  for  the   economy  to  quadruple  or  any  other  multiple     • Productivity:  production  per  worker,  or  production  per  hour  worked   o In  other  words,  total  production  relative  to  the  number  of  workers  or   relative  to  total  population   o Productivity  can  also  be  defined  as  GDP  per  capita     • Growth  is  generated  by  three  main  sources   1) Growth  in  human  capital   2) Growth  in  physical  capital   3) Growth  in  technology  
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