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INTRO MACROECONOMIC THEORY Final Exam Notes - 4.0ed this final!

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University of Pittsburgh
ECON 0110

Factors of production: land, labor, capital, entrepreneurship Rational Economic Behavior: individual tries to maximize benefit with a given cost or minimize the expected cost of achieving a benefit. Positive and Normative Statements - Positive (If this, than this) o Theory/statement about how economy works o factual - Normative (should be) o Value judgment o Opinion-based Common errors in Economic Reasoning - Fallacy of False cause o Association does not imply causation - Fallacy of Composition o False belief that what is true for individual must be true for whole - Ceteris Paribus fallacy o All things being equal fallacy o Economy is constantly changing, no constants in economics What is meant by fiscal policy - Fiscal policy: o Using govn’t purchases, transfer payments, taxes & other borrowing to influence economy-wide variables, such as inflation, unemployment, & economic growth - Monetary policy: o Manipulation of interest rates, required reserve ratio, and money supply to influence economy-wide variables. Employment act of 1946: - Mandated federal govn’t to be promote o Maximum employment o Maximum production o Maximum purchasing power Macroeconomic Goals in U.S. - Full employment o Reduce job losers - Price Stability o Low Inflation o Maintain purchasing power of U.S. $ - Economic growth o Increase output of goods & services o ^ output / capita o Measured through GDP - Smooth out Business Cycle o Limit peaks/ valleys o Recessionary/ expansionary fiscal & monetary policies Phases of Business Cycles…period when: - Expansion: real GDP is growing - Peak: turning point of maximum GDP - Recession: real GDP is decreasing - Trough: turning point of minimum GDP Importance of John maynard Keynes: The General Theory of Employment, Interest & Money, 1936 - Proposed govn’t should stimulate depressed economy through increasing aggregate demand o Increase spending o Cut taxes - Saw no natural market forces to restart output/employment Adam Smith: Invisible Hand, advantages of Specialization - The wealth of Nations, 1776 o Rational economic decision making (invisible hand) guides economy to most efficient allocation of resources & production o Laissez- faire Production Possibilities Frontier Assumptions: 1. Fixed resources a. Land, raw material, capital, labor 2. Fixed technology 3. Full employment of resources Law of increasing costs – diminishing marginal returns - Economic growth shifts the frontier - Technological advancements “ “ “ Capital goods vs. consumption goods; future growth vs. present consumption Defense goods vs. consumption goods Opportunity Cost - The best alternative to a choice - Lost / gained ComparativeAdvantage - Lowest opportunity cost among producers AbsoluteAdvantage - Most product makeable amongst other producers Types of economic Systems - Laissez faire: minimal govn’t interference - Capitalism: price mobility, emphasis on private ownership of resources and free market - Command Economy: central planners decide pricing / resource allocation - Socialism: high govn’t ownership to provide public useage. - Barter economy: requires double coincidence of wants o Underground economy Role of profit in economy: increases value of production factors Role of prices in economy: signals to increase / decrease production Forms of Business Enterprise: advantages / disadvantages 1. Sole Proprietor a. Advantages i. Right to all profits ii. Makes all choices b. Disadvantages i. Unlimited liability ii. Business often ends with death iii. Hard to amass start-up capital 2. Partnership a. Advantages i. Multiple owners who share decision making ii. Slightly easier to amass start-up capital b. Disadvantages i. Unlimited liability ii. Must agree with partner 3. Corporation a. Advantages i. Stockholders can pool money / resources ii. Limited liability iii. Corp sued like a person b. Disadvantages i. Stockholders have limited influence ii. Corps income gets taxed twice 1. Corporate tax & dividend income tax Limited and Unlimited Liability - Limited: only amount invested can be lost - Unlimited: everything owned even outside of business Corporate income taxes & double taxation Stocks: small ownership in corporation Mutual Funds: investors pool funds into corporation who buys stock which grow funds nd Dividends: Portion of After-tax profits distributed to stockholders; 2 tax Retained Earnings: Portion of after-tax profits kept by corporation for reinvestment in company Bonds- sold when institution needs to borrow money, paid out after specified time w. interest and original par value, interest may/may not be taxable Corporate Bonds: taxable interest, risk varies due to corporation Municipal Bonds: non-taxable interest, Risk varies city-city Treasury Bonds: taxable interest, least risk of all bonds, almost zero danger of default Budget - Balanced Budget, Surplus, Deficit U.S. income Tax System Paid on taxable income, not gross income - Taxable income o Gross income – exemptions – deductions = taxable income o Various items deducted or standard deduction - Personal Exemptions o Each member of household subtracts specific amount Standard vs. Itemized Deduction - Itemized: eligible expenses taxpayers can report in U.S. on their federal income tax returns in order to decrease their taxable income. - Standard: a dollar amount that non-itemizers may subtract from their gross income based upon filing status Average tax rate vs. marginal tax rate - Average: total taxes paid / taxable income - Marginal: The tax rate paid on the NEXT (additional) dollar earned Classification of taxes - Progressive: as income ^, tax rate ^ o Higher income = higher proportion of income paid - Proportional / flat tax: same proportion of income paid for everyone o S.S. tax - Regressive tax: tax as % of income increasing as income decreases o Sales tax: though it’s a flat % of a product’s cost, that extra money is a greater % of lower income-earner’s wages than of higher income-earner’s wages What is an equitable tax system? - Horizontal equity: o People w/ equal incomes pay approximately equal taxes o Problem: people w/ equal income don’t always have equal deductions - Vertical equity: o People w/ higher income should pay more o Problem: how much more? Benefits principle: - Those who benefit from public spending should bear the burden of the tax that pays for it o Ex: gasoline tax  highway maintenance - Why most taxes are not based on B. principle o Too cumbersome o Too many different taxes to pay for govn’t programs Ability to pay principle - Those w/ greater ability to pay should pay more - People with higher income should pay more taxes than people w/ lower incomes o How much more? - Tax base: measure of value that determines how much a person pays - Few states have progressive income taxes o Would create interstate competition o People will move to state with lower taxes The S.S. System - Tax paid on wages, salaries, sole proprietor profits, & partnership profits - Employer / employee both pay 6.2% of wages to S.S. fund - Self-employed worker pays entire 12.4 percent o Not paid on interest income, dividends, capital gains, royalties o Basically pure monetary gains, just goods/services production profits - No deductions/ exemptions - Paid on very first dollar of wage earnings o Ex of Flat tax^^ Present value: n PV = (FN)/(1+i) Gross Domestic Product (GDP) - Market value of all goods and services produced in the U.S. during a given year Components of Consumption (by consumers). ~2/3 of all spending - Durables: cars, airplanes, furniture - Non-durables: food, gas, clothing - Services: teachers / doctors Components of Investment (by businesses) ~1/6 of all spending - Depreciation - New plant / equipment - New residential construction - Change in inventories Component of Govn’t Spending ~1/6 of all spending - Transfer payments - State, federal, and local Imports & Exports ~ -2%? - Imports: 12% Exports = 10% ValueAdded - Value added to a good / service that the end of one production stage Calculation of Real GDP - GDP = ( GnP/ Consumer Price Index) * 100 Inventories: intended & unintended - Items produced which have yet to be sold - Intended: change in production to satisfy consumer demand exactly - Unintended: 45 degree line shows Expected consumption vs. Y . d o Consumption function crosses with it o Below 45 degree line = lower than expected  increase in inventories, ^ saving by consumers  Above = higher  decrease in inventories, ^ DISsaving by consumers Definitions of Employment and Unemployment - Employed if: th o Worked for pay anytime during the week which includes the 12 day of the month o Worked unpaid for 15 +hours in family business o Temporarily absent due to illness / vacation - Unemployed if: o Did not work during survey week o Available for work o Looking for job w/in last 4 weeks o Did not look for job because laid off (benefits) - CNP: represents potential labor force - all people 16+, not inmates of jail/mental institutions or living in assisted-living homes o CNP = unemployed + employed + not in labor force Civilian Labor Force - Employed + Unemployed - Civ. Unemployment rate = # unemployed / Civ LF Trends in unemployment since 1929: - High: o 1935 (great depression) o 1977 (OPEC) o 1982 o 1990-1991 - Low: o WWII Discouraged Workers & underemployed workers - Discouraged: give up in job search, fall out of unemployment classification - Underemployed: people working at jobs below skill level, or not enough hours…not counted as unemployed Civilian Labor Force Participation rate = civilian labor force / CNP - Trends in LF participation rate: o As unemployment benefits ^, U (rate) ^ Types of Unemployment 1. Frictional a. Temporary, jobs available but just haven’t connected b. Re-entrants, switching jobs 2. Structural a. caused by changes in structure of economy b. usually significant job lo
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