Econ Midterm 1
Economics – how we use our resources to produce goods to satisfy human wants.
- Objectives: goals we want to achieve
- Instruments: mechanisms we use to achieve our goals
1. Output – we want high output that grows over time
a. GDP – gross domestic product, measures output by calculating the total money value of
all goods and services produced in a year
b. In the US, GDP is about 16 trillion growing at 3% per year
2. Employment – we want to provide jobs for people who want to work
a. Unemployment rate – the percentage of the labor force that wants to work but that cannot
b. The average unemployment rate in the US is 5.6%
c. The unemployment rate will never be 0 because there will always be some people taking
time to find the right job, people who are mismatched, or people who were displaced by
structural shifts in the economy
d. The rate we think is best is about 5.5%
3. Price Stability – we want stable prices and a low inflation rate
a. The average inflation rate in the US has been about 4%
4. External Balance – we would prefer a balance of imports and exports and stable exchange rates
a. In the past few years we have had a trade deficit
5. Government Budget – a balanced government budget is a goal, or smaller deficits
a. Right now, the debt ratio is about 73% of GDP
b. We see large deficits in recessions, as revenue falls off and spending rises
The debt ratio is the ratio of debt to GDP
- % Change R = % Change Debt - % Change GDP
- R = Debt / GDP Adebt trap is when a nation cannot pay its debts, and then continue to buy bonds at higher and higher
interest rates. These higher interest rates add to the deficit and push the debt ratio up further.
- There are only three ways out: default, start a massive austerity program, or be bailed out by
another government (usually with strings attached)
Fiscal policy – control of government expenditures and taxation to promote high output and stable prices
- In a recession, you would cut taxes and increase government spending
Monetary policy – control of money, credit, and interest rates by the central bank, or the Fed
- In a recession, the Fed will cut interest rates to make it easier to borrow
- They do this by pumping more money into the banks, which gives them more money to lend,
which will lower interest rates
Employment Act of 1946 – made it the job of the Fed to promote max employment, production, and
We measure output by the flow of
consumptionexpenditures expenditures of goods and services
$ and income by the flow of income
goods & services from production.
GDP can be calculated by the
Business Firms expenditure side (or the flow of
product side) or the earnings side
(the flow of cost side)
$ $ The expenditure approach
wages, int., profit calculates: consumption,
investment, government spending, and net exports.
The earnings approach calculates: wages and benefits, corporate profits, proprietor’s income, rental
income, net interest, depreciation, and production taxes.
- Consumption – spending to satisfy immediate wants
- Investment – spending by firms on new equipment, households on new housing, and additions to
inventories (stocks of goods produced but not yet sold)
- Government spending – school supplies, defense, employee salaries
- Net exports – what we sell abroad – what we purchase aborad
When calculating GDP, only focus on the price of the final product, no intermediate products to avoid
double counting. We also subtract depreciation from GDP, and call the remained the Net Domestic Product (NDP).
Disposable income – how much income households have available after taxes for spending and saving.
- Transfer payments: income received by households not as wages, but as transfers from others
mostly through the tax system, such as social security or welfare.
Nominal GDP is measured in prices of that year, and Real GDP is measured in constant prices of some
base year, calculated by dividing the nominal GDP by the GDP deflator.
Price index – a weighted average of prices expressed relative to some base year. The GDP deflator is the
price index for GDP.
Value added – only the value added is defined as sales receipts minus purchases from other firms. The
final total value added should come out equal to the final selling price.
GDP does not tell us about things such as pollution, leisure time, or household production.
On theAS-AD graph, Q on the horizontal axis stands for total output, or GDP, and P on the vertical axis is
the price level for the economy as a whole.
Aggregate demand – the