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ECN 211 Midterm: Study Guide Exam 2

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Arizona State University
ECN 211
Stefan Ruediger

ECN 211 Exam 2 Study Guide GDP Definition of GDP • Gross domestic product (GDP)- total market value of all final goods and services produced within a country during a given year; measured in dollar values o Goods are valued at their market prices, so: ▪ All goods measured in the same units (e.g., dollars in the U.S.) ▪ Things that don’t have a market value are excluded, e.g. housework you do for yourself o Includes tangible goods (like DVDs, mountain bikes, beer) and intangible services (dry cleaning, concerts, cell phone service) o Includes currently produced goods, not goods produced in the past o Measures the value of production that occurs within a country’s borders, whether done by its own citizens or by foreigners located there o Usually a year or a quarter (3 months) • Income & Expenditure o GDP measures total income of everyone in the economy o Also measures total expenditure on the economy’s output of goods & services o For the economy as a whole, income equals expenditure because every dollar a buyer spends is a dollar of income for the seller Calculation of GDP (know they exist, don’t have to know what they are) • Expenditure approach- GDP = sum of the total amount spent on all goods & services during a given period; (we will only use this one/easier to calculate) • Value-added approach- GDP = sum of the values added by all firms in the economy • Factor payments approach (income approach)- GDP = sum of the factor payments earned by all households in the economy (wages & salaries, rent, interest, & profit) GDP = C + I + G + NX (NX = exports – imports) • GDP Deflator- % change in each year GDP Deflator = Nominal GDP x 100 Real GDP Difference between real and nominal GDP • Nominal GDP- production of goods and services valued at CURRENT prices; a variable measured without adjustment for the dollar’s changing value; not corrected for inflation; in each year, measured using the “then” current prices • Real GDP- production of goods and services valued at CONSTANT prices; a variable adjusted for changes in the dollar’s value; corrected for inflation; makes it easier to track changes in the GDP over time; when we calculate GDP growth we use this one; in each year, is measured using constant prices from the base year Difference between final and intermediate Goods • Final goods- intended for the end/final user • Intermediate goods- used as components or ingredients in the production of other goods o GDP only includes FINAL goods – they already embody the value of the intermediate goods used in their production o Goods: tangibles o Services: intangibles • The GDP does NOT measure the value of intermediate goods & services, it only measures the value of final goods & services, otherwise the measure of GDP would be bloated by double counts Expenditure Approach • Expenditure approach- GDP = C + I + G + NX (NX = exports – imports); Adding the value of goods and services purchased by each type of final user 1. Consumption goods and services (C) purchased by households o Only final consumption is what counts o Consumption (C)- part of GDP purchased by households as final users (68% of GDP in the US) ▪ Note on housing costs: • For renters, consumption includes rent payments. • For homeowners, consumption includes the imputed rental value of the house, but not the purchase price or mortgage payments. ▪ Rent is a part of consumption ▪ Long term spending is a part of consumption ▪ Not included: • Imported consumption goods and components • New home construction o Would be put into investment 2. Private investment goods and services (I) purchased by businesses o Investment (I)- spending on goods that will be used in the future to produce more goods. ▪ Business purchases of equipment and software (capital equipment) ▪ New structures (factories, office buildings, houses) ▪ Changes in inventories ▪ Adds to the nation’s capital stock ▪ Excludes • Government investment • Consumer durables (cars, home appliances, furniture, …) • Human capital ▪ Ignores depreciation o Investment DOES NOT mean the purchase of financial assets like stocks & bonds ▪ Purchase of capital goods not stocks & bonds ▪ Three things you can do with your money: buy things, pay taxes, and save 3. Government goods and services (G) purchased by government agencies o Government purchases (G)- Spending by federal, state, and local governments on goods and services; Government consumption and investment purchases ▪ Goods and services o G excludes transfer payments, such as Social Security or unemployment insurance benefits 4. Net exports (NX) purchased by foreigners o Net exports (NX)- Total exports minus total imports o Total exports- U.S. production that is purchased by foreigners; Exports represent foreign spending on the economy’s goods and services. o Total imports- Americans’ purchases of goods produced outside of the United States o Everything produced in the U.S. and bought by other countries – everything produced in other countries and bought in the U.S. = net exports Problems with GDP • Doesn’t include: o Quality changes o Most non-market production o Leisure time, fairness, ‘bads’ • Underground economy – estimated • Doesn’t distinguish between o Production that makes us better off o Production that only prevents us from becoming worse off UNEMPLOYMENT Definition of unemployment • Unemployed- people not working who have looked for work during previous 4 weeks; people not looking for a job should not be included • Employed- paid employee, self-employed, and unpaid workers in a family business • Labor force- total # of workers, including the employed and unemployed LF = unemployed + employed • Not in the labor force- everyone else; kids, adults not looking for a job • Unemployment rate- % of people unemployed; not a perfect indicator of joblessness or the health of the labor market; it excludes discourages workers; does not distinguish between full-time and part-time work or people working part-time because full-time jobs are not available and some people misreport their work status u-rate = # of unemployed x 100 labor force • Labor force participation rate- % of people in the labor force LFPR = labor force___ x 100 adult population Categories of unemployment • Frictional- occurs when workers spend time searching for the jobs that best suit their skills and tastes; short-term for most workers; occurs even if there are enough jobs to go around • Seasonal- changes are constant; constant up and down • Structural- occurs when there are fewer jobs than workers; usually long-term; when wages are above equilibrium potentially cause by minimum wages, efficiency wages, unions • Cyclical- the deviation of unemployment from its natural rate; associated with business cycles Actual vs Potential GDP • Actual GDP- fluctuates more, more bumpy • Potential GDP- fluctuates less, more smooth; just a prediction Costs of unemployment • Economic cost o Opportunity cost of lost output o Output produced < Potential output o Economy: produces less output o Some groups within society: consume less output o Lost skills Measurement of unemployment • Problems o Underestimates the extent of unemployment ▪ Treatment of involuntary part-workers ▪ Treatment of discouraged workers Discouraged workers • Discouraged workers- individuals who would like a job but have given up searching for one o Not working o Searched for a job at some point in the last 12 months o Currently want a job o State that the only reason they are not currently searching for work is their belief that no job is available for them Efficiency Wages • Efficiency wages- above- equilibrium wages paid by firms to increase worker productivity CPI Consumer Price Index (CPI) Definition • Consumer Price Index (CPI)- measures the typical consumer’s cost of living; use it to calculate real GDP, real wages, and real interest rates; an index of the cost, through time; of a market basket of goods purchased by a typical household o Includes ▪ Part of GDP that consumers purchase as final users ▪ Household purchases of used goods such as used cars or used computers ▪ Household purchases of imports o Does not include ▪ Goods and services purchased by anyone other than consumers ▪ Prices of assets, such as stocks, bonds, and homes • CPI market basket- collection of goods and services that the TYPICAL CONSUMER buys CPI calculation • Don’t care about the number of dollars, but the purchasing power CPI = cost of basket in current year x 100 cost of basket in base year CPI categories • As a policy target • To index payments • Comparing dollar values over time • To translate from nominal to real values Calculating the inflation rate • Inflation rate- % change in the price index from the preceding period Inflation rate = CPI this year – CPI last year x 100 CPI last year CPI indexation • Indexation- a dollar amount automatically corrected for inflation by law or in a contract • Indexed payment- a payment that is periodically adjusted in proportion with a price index Real wages vs nominal wages – definition and calculation • Real wage- purchasing power of your wage; adjusted for inflation • Nominal wage- number of dollars you earn; not adjusted for inflation Real interest rates vs nominal interest rates – definition and calculation • Real interest rates- annual percent increase in a lender’s purchasing power from making a loan; IS corrected for inflation Real interest rate = nominal interest rate – rate of inflation • Nominal interest rates- quoted by your bank on your savings/checking account or your credit cards and other loans; annual percent increase in a lender’s dollars from making a loan; NOT corrected for inflation INFLATION Cost of inflation • Shoeleather costs- the resources wasted when inflation encourages people to reduce their money holdings; includes the time and transactions costs of more frequent bank withdrawals • Menu costs- the costs of changing prices; printing new menus, mailing new catalogs, updating webpages, etc. • Misallocation of resources from relative-price variability- firms don’t all raise prices at the same time, so relative prices can vary, which distorts the allocation of resources • Confusion & inconvenience- inflation changes the yardstick we use to measure transactions; complicates long-range planning and the comparison of dollar amounts over time • Tax distortions- inflation makes nominal income grow faster than real income (if incomes do not get regularly adjusted); taxes are based on nominal income, and some are not adjusted for inflation; inflation causes people to pay more taxes even when their real incomes don’t increase; cause real interest rates to be systematically lower Real interest rate = (nominal interest rate)(tax rate) – inflation Inflation and purchasing power • Purchasing Power- inflation, an increase in the price level, decreases the purchasing power of money • Inflation- an increase in the overall level of prices in the economy; can redistribute purchasing power from one group to another (lenders vs borrowers) Redistributive effects of inflation • Inflation redistribute purchasing power within society • Inflation can shift purchasing power: o Away from those who are awaiting future payments specified in dollars o Toward those who are obligated to make such payments Anticipated and unanticipated inflation • Anticipated inflation- does not shift purchasing power • Unanticipated inflation- does shift purchasing power; hurts lenders, benefits borrowers; = unexpected decrease in the real interest rate o Inflation rate higher than expected ▪ Harms those awaiting payment; benefits the payers o Inflation rate lower than expected ▪ Harms the payers; benefits those awaiting payment Accuracy and Bias of the CPI • CPI Biases o Substitution bias ▪ Prices vary over time ▪ Consumers respo
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