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
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 –
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
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)
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,
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
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
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)
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
New goods bias- goods not available in the