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Midterm Exam Review Macro.docx

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ECON 1010
Xue Qing Xu

Midterm Exam Review 1/31/2012 11:28:00 AM The midterm exam covers chapters 20, 21, 22, and 23. Not be covered: 1. For chapter 20: "Mathematical Note" on pp. 482-483. 2. For chapter 22: "Growth Theories and Policies" on pp. 531-535 except the last subsection; the last subsection on "Achieving Faster Growth" on p. 535 was discussed in class and may be covered in the exam. ------------------------------------------------------------------------------------- CHAPTER 20: MEASURING GDP AND ECONOMIC GROWTH GDP (gross domestic product) is the market value of all final goods and services produces in a country in a given time period. This definition has four parts: market value, final goods and services, produces within a country and in a given time period. GDP is a market value-goods are services are valued at their market prices. GDP is the value of the final goods and services produced. A final good (or service) is an item bought by its final user during a specified time period. A final good contrasts with an intermediate good, which is an item that is produced by one firm, bought by another firm, and used as a component of a final good or service. Excluding intermediate goods and services avoids double counting. GDP also measures production within a country- domestic production. And GDP measures annually. GDP measures the value of production, which also equals total expenditure on final goods and total income. The equality of income and value of production shows the link between productivity and living standards. Circular flow diagram: households sell and firms buy the services of labor capital, and land in factor markets. For these factor services firms pay income to households: wages, interest for the use of capital, and rent for the use of land (Y). Firms sell and households buy consumer goods and services in the goods market (C) . Firms buy and sell new capital equipment in the goods market and put unsold output into inventory. The purchase of new plant, equipment, and buildings and additions to inventories are investment (I). Governments buy goods and services from firms and their expenditure on goods and services is called government expenditure (G). Governments finance their expenditure with taxes and pay financial transfers to house holds. These financial transfers are not part of the circular flow of expenditure and income. Rest of the world: the value of exports (X) minus the value of imports (M) is called net exports. If net exports are positive, the net flow is from Canadian firms to the rest of the world. And if it is negative it from the rest of the world to Canada. GDP: Y=C+I+G+(X-M) Aggregate income equals aggregate expenditure equals GDP Why is domestic product gross? Gross means before deducting the depreciation of capital. The opposite of gross is net. Depreciation is the decrease in the value of a firms capital that results from wear and tear and obsolescence. Gross investment is total amount spend on purchases of new capital and on replacing depreciated capital. Net Investment is the increase in the value of firms capital. Net investment = Gross investment – Depreciation Statistics Canada uses two approaches to measure GDP: expenditure approach, income approach. Real GDP- value of final goods and services produced in a given year when valued at prices of a reference base year. Nominal GDP- value of goods and services produced during a given year valued at the prices that prevailed in that same year. Nominal is just a precise name for GDP. The uses and limitation of real GDP: economist use real GDP for two main purposes: to compare the standard of living over time and to compare the standard of living across countries. Real GDP per person tells us the value of goods and services that the average person can enjoy. The two features of our expanding living standard are: growth of potential GDP per person AND fluctuations of real GDP around potential GDP Potential GDP: when all the economy’s labor, capital and entrepreneurial ability are fully employed. Lucas Wedge- dollar value of the accumulated gap between what real GDP per person would have been and what real GDP per person turned out to be. Business cycle is a periodic but irregular up and down movement of total production and other measures of economic activity. Two problems arise in using real GDP to compare living standards across countries: 1. the real GDP of one country must be converted into the same currency units as the real GDP of other country. 2. The goods and services in both countries must be valued as the same price. Factors not in GDP that influence the standard of living are: household production, underground economic activity, health and life expectancy, leisure time, environmental quality and political freedom and social justice. Midterm Exam Review 1/31/2012 11:28:00 AM CHAPTER 21 MONITORING JOBS AND INFLATION Unemployment results in: lost of production and income, lost human capital. When doing a labor force survey the population is divided into two groups: 1. The working age population-number of people aged 15 and older 2. People too young to work (under 15 years). And then the working age population is divided into two groups: 1. People in the labor force 2. People not in the labor force. The labor force is the sum of employed and unemployed workers. To be counted as unemployed: 1. Without work but has made specific efforts to find a job within the previous four weeks. 2. Waiting to be called back to a job from which he or she has been laid off. 3. Waiting to start a new job within 30 days. Four labor market indicators: the unemployment rate, involuntary part-time rate, employment to population ratio and the labor force participation rate. Unemployment rate: ((# of people unemployed) / labor force)) x 100 The unemployment reaches its peak during recessions. Involuntary part-time rate: (# of involuntary part-time workers / labor force) x 100 Labor force participation rate: percentage of the working age population who are members of the labor force. (Labor force / working age population) x 100 Employment to population ratio: percentage of the working-age population who have jobs. (Employment / working age population) x 100 Underutilized labor that are excluded from unemployment: 1. Marginally attached workers-currently neither working nor looking for work but has indicated that he or she wants and is available for a job. 2. Part-time workers who want full time jobs Discouraged workers: is a marginally attached worker who has stopped looking for a job because of repeated failure to find one. Natural Unemployment: unemployment arises from job search activity. The churning economy some of the changes come from the transitions that people make through the stages of life. For example being unhappy at working changing professions. The unemployment rate at full employment is called the natural unemployment rate. Full employment occurs when there is no cyclical unemployment OR when all unemployment is frictional and structural. Unemployment can be classified into three types: frictional, structural, cyclical. Frictional unemployment: unemployment that arises from normal labor market turnovers. Natural Structural unemployment: is unemployment created by changes in technology and foreign competition that change the skills needed to perform jobs or locations of jobs. Structural lasts longer then frictional. Cyclical unemployment: is the fluctuating unemployment over the business cycle. Potential GDP is real GDP produced at full employment. Real GDP minus potential GDP is the output gap. Price level: average level of prices and the value of money. Inflation rate: annual percentage change in the price level. We are interested in price level because we want to measure inflation rate and distinguish between real and nominal values of economic variables. Inflation is a problem because it redistributes income and wealth and diverts resources from production. From a social perspective this waste of resources is a cost of inflation. Hyperinflation-inflation rate that is so rapid that workers are paid twice a day because money loses its value. Consumer Price index (CPI): measures the average of the prices paid by urban consumers for a fixed basket of consumer goods and services. CPI is defined to equal 100 for the reference base period. For example in September the CPI was 115.7 therefore urban consumers paid 15.7 percent higher on average in 2008 then it was in 2002. Constructing CPI involves three stages: selecting the CPI basket, conducting the monthly price survey and calculating CPI. The CPI basket is based on a consumer expenditure survey. Consumer Price Index (CPI): (Cost of basket at current period prices) / (Cost of basket at base period prices) x 100 The inflation rate is the percentage change in the price level from one year to the next. Inflation rate = (( CPI this year – CPI last year ) / CPI last year) x 100 When the inflation rate is high the price level rises rapidly and when it is low the price level rises slowly. The biased CPI: CPI might overstate the true inflation for four reasons. New goods bias, quality change bias, commodity substitution bias, outlet substitution bias. New goods bias- goods not available in the
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