ECN203 Final Review.doc

Economics 203 Review Sheet Final Exam: Chapters 11-17 (Regular Time/Place: Monday, Dec. 9 ; 10:15-11:45am; Stolkin Auditorium- Physics Bldg) I. Chapter 11- Economic Indicators A. Production 1. Definitions: Gross Domestic Product (GDP), Potential (Full) GDP a. Gross Domestic Product (GDP) – value of all new production in a nation or region in a given period of time b. Full or Potential GDP (Y^F) – highest amount of production that an economy can achieve and sustain c. Actual GDP (Y) – actual amount of production 2. What’s a recession? Depression? a. Recession – actual GDP falls for two consecutive quarters or more b. Depression – prolonged, deep decline in GDP (Great Depression) B. Labor Terms 1. Unemployment—3 types: Define a. Frictional i. Enough jobs, people haven’t found jobs yet. Happens because job search takes time b. Structural i. Enough jobs, a mismatch between skills and jobs. Happens because economy grows/changes c. Demand-deficient unemployment i. Not enough jobs for all actively seeking employment (unhealthy enconomy) 2. Natural rate of unemployment a. Sum of the frictional and structural rates i. If estimated as 4% and actual u-rate is 7%, the 3% difference is due to demand-deficient unemployment ii. If economy is at full employment, the unemployment rate equals the natural rate (cannot be 0%) 3. Problems with Unemployment Rate a. Duration in which someone is unemployed b. Discouraged workers c. Underemployed C. Inflation 1. Real vs. nominal values (e.g. GDP) a. Nominal value – a value measured in current dollars i. Does not account for changes overtime b. Real value – a value measured in constant dollars overtime i. Accounts for changes overtime 2. Inflation & the price level a. Price level – an aggregate measure of prices in the economy b. Inflation – the price level rises. This causes a fall in purchasing power of money c. Deflation – the price level falls. This causes a rise in purchasing power of money 3. Price Index (calculate price index when given cost of basket in base and target years) a. Consumer price index – measures price changes of goods the typical household buys – most widely used measure of inflation II. Chapter 12—Macro Model A. Aggregate Demand (AD) 1. Why is AD downward sloping? a. Because AE is measured in nominal current dollars 2. What shifts AD? a. AD shifts right (increases) when AE rises b. AD shifts left (decreases) when AE falls c. An increase in C, I, G, or X causes aggregate expenditures to increase and aggregate demand to rise d. An increase in T or M causes aggregate expenditures to decrease and aggregate demand to fall e. G and T are policy tools of the government, larger deficits can stimulate the economy (increases AD) f. Larger trade deficits reduce AD while smaller trade deficits add to AD - What are the 6 components of aggregate expenditures? o Consumption © - total expenditures by households on goods and services o Investment (I) – total expenditures by businesses on capital goods and new inventories. Also, household purchases of newly-built homes o Government Spending (G) – total government expenditures o Net Government Taxation (T) – total tax revenue collected by government minus transfer payments o Exports (X) – total expenditures by foreign sector on domestic production o Imports (M) – total expenditures that domestic sectors spend on production from other nations B. Aggregate Supply 1. Long-run aggregate supply (LAS)—vertical at full employment (Y ) because in the long run all markets have adjusted and economy reaches a production level of full GDP at any price level 2. Short-run aggregate supply (AS) – markets in economy have not adjusted fully a. What is the connection between the shape of the AS and the price level? i. Shape of AS is due to the effect of production on prices in the economy b. Shifts in AS—changes in basic costs of production in the economy (change in wages across the economy or in price of oil) C. Macro model—combining AS, AD and LAS 1. Determine actual real GDP (Y), price level (P) and unemployment in economy a. Determines causes of major economic problems 2. How does Y, P and unemployment change with shifts in either AD or AS? i. A fall in AD causes Y to slow, unemployment to rise, and deflation ii. A decrease in AS causes Y to slow, unemployment to rise, and inflati III. Chapter 13—Aggregate Demand (changes in 6 components of Aggregate Expenditures shifts the AD) A. Consumption spending (C)—What are the causes of consumption? – largest component of AE 1. Real GDP (real income) 2. Wealth 3. Consumer confidence (autonomous consumption) (also causes AD to shift) B. Investment (I)—Determined in long-term financial capital market 1. Supply of financial capital a. Slopes up—as interest rate (r) increases, more willing to lend capital b. What shifts supply of long-term financial capital? (we will not shift for these reason, but still must no the i. Level of I is determined in the long-term financial capital market – market for borrowing funds for I ii. When premiums change, short line shifts iii. perception of default risk for making a loan (higher the risk, higher the interest want to charge)