4.1 Key Macroeconomic Variables

Question 1

What is the most comprehensive measure of a nation’s overall level of economic activity?

Answer 1

The most comprehensive measure of a nation’s overall level of economic activity is the value of its total production of goods and services, called national product, or sometimes just called output.

Question 2

What is an essential concept in regard to the production of goods and services?

Answer 2

One of the most important ideas in economics is that the production of goods and services generates income.

Question 3

What is national product equal to?

Answer 3

The value of national product is by definition equal to the value of national income.

Question 4

How do we measure national income?

Answer 4

To measure national income we add up the values of the many different goods and services produced. We cannot add tonnes of steel to loaves of bread, but we can add the dollar value of steel production to the dollar value of bread production.

Question 5

What is the process of calculating national income?

Answer 5

We begin by multiplying the number of units of each good produced by the price at which each unit is sold. This yields a dollar value of production for each good. We then sum these values across all the different goods and services produced in the economy to give us the quantity of total output, or national income, measured in dollars.

Question 6

What is Nominal national income

Answer 6

Nominal national income

Total national income measured in current dollars. Also called current-dollar national income.

Question 7

How can a change in nominal national income occur?

Answer 7

A change in nominal national income can be caused by a change in either the physical quantities or the prices at which they are sold.

(1) the country produced more goods and services but at the same prices as the year before
(2) the country produced the same amount of goods and services but at higher prices than the year before.

A more realistic third possibility is a combination of the two, with quantities rising for many products and prices rising for many products.

Question 8

What is real national income?

Answer 8

Real national income

National income measured in constant (base-period) dollars. It changes only when quantities change.

Question 9

What does real national income tell us?

Answer 9

Real national income tells us the value of current output measured at constant prices—the sum of the quantities valued at prices that prevailed in the base period. Since prices are held constant when computing real national income, changes in real national income from one year to another reflect only changes in quantities. Comparing real national incomes of different years therefore provides a measure of the change in the quantity of output that has occurred during the intervening period.

Question 10

What is one of the most commonly used measures of national income?

Answer 10

One of the most commonly used measures of national income is called gross domestic product (GDP). GDP can be measured in either real or nominal terms

Question 11

What does real GDP measure?

Answer 11

Real GDP measures the quantity of total output produced by the nation’s economy during a year.

A second feature of real GDP that is less evident in part (i) is short-term fluctuations around the trend.

Question 12

What is a Recession?

Answer 12

Recessions

A fall in the level of real GDP. Often defined precisely as two consecutive quarters of negative growth in real GDP.

Question 13

What is a Business Cycle?

Answer 13

Business cycle

Fluctuations of real national income around its trend value that follow a more or less wavelike pattern.

Question 14

What does national output (income) represent?

Answer 14

National output (or income) represents what the economy actually produces.

Question 15

What is Potential output (Potential GDP)?

Answer 15

Potential output

The real GDP that the economy would produce if its productive resources were fully employed. Also called potential GDP.

Question 16

What are the differences in estimating potential output and actual output?

Answer 16

The value of potential output must be estimated using statistical techniques, whereas the value of actual output can be measured directly. For this reason, there is often disagreement among researchers regarding the level of potential output, owing to their different estimation approaches.

Question 17

What notation do we use for actual output and potential output?

Answer 17

In terms of notation, we use Y to denote the economy’s actual output and Y* to denote potential output.

Question 18

What is a trough?

Answer 18

A trough is characterized by unemployed resources and a level of output that is low in relation to the economy’s capacity to produce. There is a substantial amount of unused productive capacity. Business profits are low; for some individual companies, they are negative. Confidence about economic prospects in the immediate future is lacking, and, as a result, many firms are unwilling to risk making new investments such as expansions of their facilities.

Question 19

What is a recovery and what are its characteristics/

Answer 19

The process of recovery moves the economy out of a trough. The characteristics of a recovery are many: run-down or obsolete equipment is replaced; employment, income, and consumer spending all begin to rise; and expectations become more favourable. Investments that once seemed risky may be undertaken as firms become more optimistic about future business prospects. Production can be increased with relative ease merely by re-employing the existing unused capacity and unemployed labour.

Question 20

What is a peak?

Answer 20

Eventually the recovery comes to a peak at the top of the cycle. At the peak, existing capacity is used to a high degree; labour shortages may develop, particularly in categories of key skills, and shortages of essential raw materials are likely. As shortages develop, costs begin to rise, but because prices rise also, business remains profitable.

Question 21

What is a recession (contraction)?

Answer 21

A recession, or contraction, is a downturn in economic activity. Common usage defines a recession as a fall in real GDP for two successive quarters. As output falls, so do employment and household incomes. Profits drop and some firms encounter financial difficulties. Investments that looked profitable with the expectation of continually rising income now appear unprofitable. It may not even be worth replacing capital equipment as it wears out because unused capacity is increasing steadily.

Question 22

What is a depression?

Answer 22

In historical discussions, a recession that is deep and long lasting is often called a depression, such as the Great Depression in the early 1930s, during which aggregate output fell by 30 percent and the unemployment rate increased to 20 percent!

Question 23

What are the different names for the falling/rising half of business cycle?

Answer 23

These terms are non-technical but descriptive: The entire falling half of the business cycle is often called a slump, and the entire rising half is often called a boom.

Question 24

What is an Output gap?

Answer 24

Output gap

Actual output minus potential output, .

Y - Y* = Output gap

When the actual output is less than potential output ( Y

Question 25

What is a recessionary gap?

Answer 25

Recessionary gap

A situation in which actual output is less than potential output, Y < Y*.

Question 26

What is an Inflationary gap?

Answer 26

Inflationary gap

A situation in which actual output exceeds potential output Y > Y*

When actual output exceeds potential output (Y>Y∗)(Y>Y*), the gap measures the market value of production in excess of what the economy can produce on a sustained basis. Y can exceed Y∗Y* because workers may work longer hours than normal or factories may be operating extra shifts.

Question 27

What is an important caveat when thinking about economic growth?

Answer 27

Although economic growth makes people materially better off on average, it does not necessarily make every individual better off.

For example, if growth involves significant changes in the structure of the economy, such as a shift away from agriculture and toward manufacturing (as happened in the first part of the twentieth century), or away from manufacturing and toward services (as has been happening for a few decades), then these changes will reduce some people’s material living standards for extended periods of time.

Question 28

How are National income and employment related?

Answer 28

National income and employment are closely related. If more output is to be produced, either more workers must be used in production or existing workers must produce more. The first change means a rise in employment; the second means a rise in output per person employed, which is a rise in productivity.

Question 29

Definition of Employment

Answer 29

Employment

The number of persons 15 years of age or older who have jobs.

Question 30

Definition of Unemployment

Answer 30

Unemployment

The number of persons 15 years of age or older who are not employed and are actively searching for a job.

Question 31

Definition of Labor force

Answer 31

Labour force

The number of persons employed plus the number of persons unemployed.

Question 32

Definition of the Unemployment rate.

Answer 32

Unemployment rate

Unemployment is expressed as a percentage of the labour force.

Question 33

How do we calculate Unemployment rate?

Answer 33

Unemployment rate = (Number of people unemployed / Number of people in the labour force) × 100 percent

Question 34

What is full employment?

Answer 34

When the economy is at potential GDP, economists say there is full employment.

Question 35

Two reasons there will still be some unemployment even when the economy is at potential GDP.

Answer 35

First, there is a constant turnover of individuals in given jobs and a constant change in job opportunities. It may take some time for these people to find new jobs. So at any point in time, there is unemployment caused by the normal turnover of labour. Such unemployment is called frictional unemployment.

Second, because the economy is constantly adapting to shocks of various kinds, at any moment there will always be some mismatch between the characteristics of the people seeking employment and the characteristics of the available jobs. The mismatch may occur, for example, because labour does not currently have the skills that are in demand or because labour is not in the region of the country where the demand is located. This is a mismatch between the structure of the supplies of labour and the structure of the demands for labour. Such unemployment is therefore called structural unemployment.

Question 36

What are the social significance and ramifications of unemployment?

Answer 36

The social significance of unemployment is enormous because it involves economic waste and human suffering. Human effort is the least durable of economic commodities.

The loss of income associated with unemployment is clearly harmful to individuals. In some cases, the loss of income pushes people into poverty. Research has shown that crime, mental illness, and general social unrest tend to be associated with long-term unemployment.

Question 37

Long-run growth has had three general sources.

Answer 37

First, the level of employment has increased significantly. Rising employment generally results from a rising population, but at times is also explained by an increase in the proportion of the population that chooses to participate in the labour force.

Second, Canada’s stock of physical capital—the buildings, factories, and machines used to produce output—has increased more or less steadily over time.

Third, productivity in Canada has increased in almost every year over the past half-century.

Question 38

What is Productivity a measure of?

Answer 38

Productivity is a measure of the amount of output that the economy produces per unit of input. Since there are many inputs to production—land, labour, and capital—we can have several different measures of productivity.

Question 39

What is Labour Productivity?

Answer 39

Labour productivity

The level of real GDP divided by the level of employment (or total hours worked).

Question 40

Why is GDP/hour worked typically more accurate?

Answer 40

The second is a more accurate measure of productivity because the average number of hours worked per employed worker changes over time.

Question 41

What does inflation mean?

Answer 41

Inflation means that prices of goods and services are going up, on average.

Inflation

A rise in the average level of all prices. Usually expressed as the annual percentage change in the Consumer Price Index.

Question 42

What is the definition of Price level?

Answer 42

Price level

The average level of all prices in the economy, expressed as an index number.

Question 43

What is CPI?

Answer 43

Consumer Price Index (CPI)

An index of the average prices of goods and services commonly bought by households.

Question 44

What is the purchasing power of money?

Answer 44

Purchasing power of money

The amount of goods and services that can be purchased with a unit of money

The purchasing power of money is negatively related to the price level.

Question 45

How does inflation affect the purchasing power of money?

Answer 45

Inflation reduces the purchasing power of money. It also reduces the real value of any sum fixed in nominal (dollar) terms.

Question 46

What is anticipated inflation?

Answer 46

If households and firms fully anticipate inflation over the coming year, they will be able to adjust many nominal prices and wages so as to maintain their real values. In this case, inflation will have fewer real effects on the economy than if it comes unexpectedly.

Question 47

What is unanticipated inflation?

Answer 47

Unanticipated inflation, on the other hand, generally leads to more changes in the real value of prices and wages. Suppose workers and firms expect 2 percent inflation and they increase nominal wages accordingly. If actual inflation ends up being 5 percent, real wages will be lower and the quantities of labour demanded by firms and supplied by workers will change. As a result, the economy’s allocation of resources will be affected more than when the inflation is correctly anticipated.

Question 48

Definition of interest rate.

Answer 48

Interest rate

The price paid per dollar borrowed per period of time, expressed either as a proportion (e.g., 0.06) or as a percentage (e.g., 6 percent).

When economists speak of “the” interest rate, they mean a rate that is typical of all the various interest rates in the economy.

Question 49

What is the prime interest rate?

Answer 49

The prime interest rate, the rate that banks charge to their best business customers, is noteworthy because when the prime rate changes, most other rates change in the same direction

Question 50

What is the Banke rate?

Answer 50

Bank rate, the interest rate that the Bank of Canada (Canada’s central bank) charges on short-term loans to commercial banks such as the Royal Bank or the Bank of Montreal.

Question 51

What is the Nominal interest rate?

Answer 51

Nominal interest rate

The price paid per dollar borrowed per period of time.

Question 52

What is the Real interest rate?

Answer 52

Real interest rate

The nominal rate of interest adjusted for the change in the purchasing power of money. Equal to the nominal interest rate minus the rate of inflation.

Question 53

What does the burden of borrowing depend on?

Answer 53

The burden of borrowing depends on the real, not the nominal, rate of interest.

Question 54

What are the two important variables that reflect the importance of the global economy to Canada?

Answer 54

Two important variables reflecting the importance of the global economy to Canada are the exchange rate and trade flows.

Question 55

Definition of exchange rate

Answer 55

Exchange rate

The number of units of domestic currency required to purchase one unit of foreign currency.

Question 56

Definition of Foreign exchange

Answer 56

Foreign exchange

Foreign currencies that are traded on the foreign-exchange market.

Question 57

Definition of Foreign-exchange market

Answer 57

Foreign-exchange market

The market in which different national currencies are traded.

Question 58

Definition of Depreciation.

Answer 58

Depreciation

A rise in the exchange rate—the domestic currency has become less valuable so that it takes more units of domestic currency to purchase one unit of foreign currency.

Question 59

Definition of Appreciation

Answer 59

Appreciation

A fall in the exchange rate—the domestic currency has become more valuable so that it takes fewer units of domestic currency to purchase one unit of foreign currency.

Question 60

What is trade balence?

Answer 60

Net exports are the difference between exports and imports and are often called the trade balance.

Answer 61

The increase in employment reflects the new hiring by firms to produce more output.

The increase in unemployment reflects an increase in the labour force.

If the rise in the labour force exceeds (in absolute​ number) the rise in employment, then the number of unemployed workers will increase.

Question 62

During a​ recession, suppose unemployed workers leave the labour force because they are discouraged about their inability to find a job. What happens to the unemployment​ rate?

Answer 62

Unemployment denotes the number of adult workers who are not employed but who are actively searching for a job.​

If unemployed workers leave the labour force because they are discouraged about their inability to find a​ job, they should not be included neither into the labour​ force, nor to unemployed.

Therefore both number of people unemployed and number of people in the labour force decrease by the same absolute amount.

As far as number of people unemployed is obviously smaller than number of people in the labour​ force, this leads to a decrease in the unemployment rate.

Question 63

Consider an imaginary​ 10-year period over which output per person falls, but GDP increases. How can this happen?

Answer 63

Question 64

Is a long term decline in output per person good for the economy?

Answer 64

Overall living standards depend on the amount of output per person​, rather than on the amount of total output. A decline in output per person​, if sustained over many​ years, is probably undesireable because average living standards will be declining.

Question 65

How do you compute the output gap?

Answer 65

The output gap is computed by subtracting the potential output from actual output.

Question 66

How do you calculate Labor productivity?

Answer 66

GDP/(Employment) * (Hours)

Question 67

When given the exchange rate between two separate countries for 1 Canadian dollar, how do we calculate the exchange rate between the other two countries?

Answer 67

Divide 1/(The exchange rate of the chosen country) to find out how much 1 Canadian dollar is worth there.

Take those two dollar amounts and divide them by each other to find out how much each dollar is worth between those countries.

Answer 68

Question 69

How do you calculate inflation from the CPI index?

Answer 69