3203 Unit 1 Study guide

Question 1

Describe endogeneous vs. exogeneous variables.

Answer 1

Endogeneous: a variable that’s explained by the relationships within the model
Ex: equilibrium price of supply and demand model bc producer in response to consumer demand

Exogeneous: outside variables used to explain the endogenous variable and whose value is independent/not affected by other parts of the model.

Question 2

Describe stocks vs. flows

Answer 2

Stock: variable measured at one specific time and represents a quantity existing at that point in time

Flow: variable measured over an interval of time measured per unit of time (ex: a year)

-Bath tub analogy: stock is the water sitting in the tub, flow is the water coming out of the faucet and down the drain

Question 3

How do you mathematically convert stocks to flows?

Answer 3

If Z = XY (levels of stocks)
%∆Z = %∆X + %∆Y

If Z = X/Y
%∆Z = %∆X - %∆Y

Question 4

Define GDP

Answer 4

Represent’s monetary value of all goods and services produced within a nation’s borders over a period of time

Question 5

Define unemployment rate

Answer 5

% of the total labor force that is unemployed but actively seeking employment and willing to work

Question 6

What is labor force?

Answer 6

Number of Employed + Number of Unemployed

Question 7

Define labor force participation rate

Answer 7

the percentage of the adult civilian population in the labor force.

Formula: LBPR=Labor Force/Adult Population

-Does not include discouraged workers

Question 8

Define inflation

Answer 8

tells us how rapidly the overall level of

prices is rising compared to previous years.

Question 9

What is the fundamental identity of national income accounting?

Answer 9

Total Production = Total Expenditure = Total Income

Question 10

What are the 3 approaches of National Income accounting?

Answer 10

1. The production approach
2. The expenditure approach
3. The income approach

Question 11

What is the production approach?

Answer 11

add up the current market value of all final
goods and services newly produced in the economy

• (price of apples * quantity of apples) + (price of oranges * quantity of oranges) + etc.

Question 12

What is the expenditure approach?

Answer 12

the total spending on currently produced final goods and services in the economy.
GDP=C + I + G + NX

-C is largest is US. transfer payments don’t count

Question 13

What is the income approach?

Answer 13

1. employee income
   2.+ Self-employed income
2. +corporate profits
   (=National income)
3. +depreciation
   (=Gross National Product)
4. • income income paid to Americans by foreigners
5. • Income to foreigners from Americans
     (Total=Gross Domestic Product)

Question 14

What are the 5 major issues with gdp?

Answer 14

1. Black and grey markets
2. Nonmarket production: stuff we do on our own instead of buying it makes gdp look lower
3. Tech improvements: underestimated by GDP
4. Economic bads: stuffs you pay to avoid (ex: vaccines to avoid the flu)
   - also if hurricane destroys house GDP goes up because people have to buy a new one
5. Leisure and quality of work

Question 15

What is the equation for the GDP deflator? What does it do?

Answer 15

(Nominal GDP/Real GDP)*100

• Index that measures price level (see handout)
• Today we use chain-weighting to calculate real GDP

Question 16

What is CPI(Consumer Price Index)?

Answer 16

A measure of price level that uses a typical bundle of household goods with quantities from the past.

-The problem is that in the real world the bundle can change over time with different preferences

Question 17

What’s the difference between CPI and GDP deflator?

Answer 17

Deflator compares base year Price with different quantities
-includes all final goods
CPI holds Q fixed
-only includes a bundle of consumer

Question 18

How do you calculate CPI?

Answer 18

CPI Numerator/CPI Denomiator x 100

*see CPI handout on how to get numerator and denominator.

Question 19

How do you correct a price for inflation using CPI or GDP deflator?

Answer 19

Price X (base year deflator / comparing year deflator)

Question 20

How do you calculate the inflation rate with each of these tools?

Answer 20

(New-old/old) x 100

Question 21

Describe the Venn diagram of the population and labor force.

Answer 21

US Population
Adult Non-institutionalized
Civilian Labor Force
Employed + Unemployed

Question 22

What are the 2 issues with the unemployment rate?

Answer 22

1. Discouraged workers: they’ve quit looking for a job actively, but they would take a job
2. Underemployed workers

Question 23

What are the 4 types of unemployment?

Answer 23

1. Frictional: search unemployed, takes time to find a job (regular unemployment)
2. Seasonal: not much to be fixed because it’s inevitable, ex: lifeguard
3. Structural: caused by wage rigidity or unusual market structure (ex: minimum wage)
4. Cyclical: workers losing their jobs due to business cycle fluctuations (booms and recessions)

Question 24

How do you calculate real interest rate?

Answer 24

if Fisher equation: i= r + ii^e

*Therefore: r= i - ii^e

[i= interest rate r=real interest rate ii^e=expected inflation rate]

-This shows that the interest rate is partly for profit but also to protect lender against inflation

Question 25

what does profit maximization imply?

Answer 25

MPK = R/P = rc firms will want an amount of capital that will make the marginal product of capital equal to the real rental price of capital

MPL = W/P = w firms will hire an amount of labor that will make the marginal product of labor equal to the real wage rate

Question 26

How is national income divided?

Answer 26

Divided among capital and labor according to alpha.

Question 27

What are the 3 characteristics of money?

Answer 27

1. Medium of exchange: more efficient than bartering
2. Unit of account: allows bus/gov/ppl to account for funds
3. Store of value: keeps stable value (consistent over time)

Question 28

Define seigniorage

Answer 28

Process where the gov collects revenue by printing money

-Aka inflation tax

Question 29

Define the following types of money:

C, M1, M2

Answer 29

C = currency (most liquid)
M1: c + traveler’s checks + demand deposits + other checkable deposits
M2: m1 + small time deposits + savings accounts and money market deposits + mutual funds

Question 30

What is the equation of exchange in stocks and in flows?

Answer 30

MV=PY
%ΔM+%ΔV=%ΔP+%ΔY

M=Money Supply V=Velocity P= Price Level Y=Price Level

Question 31

What are the issues with expected inflation?

Answer 31

• Menu costs: cost of updating price lists/menus
• Shoeleather costs: cost of having to rush when you take your money out to pay because it’s losing value( i =r + ii)
• U.S Capital gains taxes are not indexed to inflation
• Greater variability in relative prices due to less frequent price changes, misallocating resources distorts production

Question 32

What are the issues with unexpected inflation?

Answer 32

• Redistributes income (this is only bad if it affects future decisions)
• It makes people nervous about taking risks → less investment
• People try to protect themselves against the unexpected inflation  uses real resources and is wasteful
• If some prices are sticky causes changes in relative prices
• But if inflation is expected it’s easier to overcome sticky prices with time
• Problems are worse with higher inflation because higher inflation is usually more variable

Question 33

How do banks create money with fractional reserve banking?

Answer 33

1. Banks get money from the fed

2. They keep the reserve requirement in the bank and loan out the rest

Question 34

Define required reserve ratio

Answer 34

• Also known as reserve requirement

- Fraction of deposits that regulators require bank to hold in reserves and not loan out

Question 35

Define money multiplier

Answer 35

• Also known as potential deposit expansion multiplier

- Measures the maximum amount of money that a commerical bank can create by given central bank

Question 36

How do to use money multiplier?

Answer 36

MM=1/rr then MM x deposit

-example MM=1/.1=10 10x$100=$1000