Chapter 4 Flashcards
There are three different but equivalent approaches to measuring GDP:
1 - The total spending on goods and services by different groups - households, businesses,
government and foreigners.
2 - The total of production in different industries - agriculture, mining, manufacturing…etc.
3 - The total of income earned by different groups in the form of wages, profits…etc.
What is the most widely used method of measuring GDP?
It is the spending approach.
To measure GDP through spending, simply add up total spending on goods and services produced in a nation during a given period.
Personal & Public Consumption + Government Expenditures + Public & Private Investments + (Exports - Imports)
C + I + G + (X - M)
What is GNP and how is it calculated?
Gross National Product (GNP) is a related measure of economic activity and differs from GDP by including foreign income earned by citizens and excluding income earned by foreigners in the domestic economy.
GNP = GDP + Z
where Z = foreign income earned by citizens MINUS income earned by foreigners in the domestic economy.
What is real GDP?
If inflation were significant, it would be desirable to remove the impact of inflation and look at GDP changes based purely on the output of goods and services.
Which is GDP excluding the impact of inflation, based on money with the same purchasing power.
What is nominal GDP?
The GDP measure that incorporates both the production of goods and services and the impact of higher prices (inflation).
What are cyclical companies?
All economies go through recurrent phases of expansion and contraction with varying degrees of severity and for differing lengths of time. Such periodic booms and busts are referred to as business cycles.
The fortunes of the majority of firms tend to follow these cycles of the waxing and waning of economic activity - such companies are referred to as cyclical companies.
What are defensive companies?
Defensive companies that are immune to or barely sensitive to the business cycle.
Examples of defensive industries are food producers, pharmaceuticals and utilities.
What are the four stages of the business cycle?
The business cycle can be described by its four distinct stages: prosperity [expansion], recession, depression, and recovery.
When the business cycle has just recovered and is followed by prosperity, this would be considered…?
An expansionary phase is characterized by recovery followed by prosperity
When the business cycle has just entered into a recession which may prolong to a depression, this would be considered…?
A contractionary phase the economy goes through a recession, which may prolong to a depression.
What defines a recession?
A recession is said to occur when gross domestic product (GDP) declines for two consecutive quarters.
What defines a depression?
A depression is an extremely long and severe recession in which GDP falls and unemployment rises dramatically.
What defines a slowdown?
A slowdown need not result in a depression if a recovery gets under way before the economy tumbles too far down.
What are the duration of the expansion and contractionary phases?
These periods of expansion and contraction can vary from several months to several years.
What are the 10 leading indicators of the business cycle?
1 Average weekly hours of production workers.
2 Initial claims for unemployment insurance.
3 Manufacturer’s new orders.
4 Vendor performance - slower deliveries diffusion index.
5 New orders for non-defense capital goods.
6 New private housing units authorized by local building permits.
7 Yield curve spread between 10 year T – bond yield and federal funds rate.
8 Stock prices, based on 500 common stocks (in the U.S the famous S & P 500).
9 Money supply figures (particularly M2).
10 Index of consumer expectations.
What are the four coincident indicators in a business cycle?
1 Employees on nonagricultural payrolls.
2 Personal income less transfer payments.
3 Industrial production.
4 Manufacturing and trade sales.
What are the seven lagging indicators of the business cycle?
1 Average duration of unemployment.
2 Ratio of trade inventories to sales.
3 Change in index of labor cost per unit of output.
4 Average prime rate charged by banks.
5 Commercial and industrial loans outstanding.
6 Ratio of consumer installment credit outstanding to personal income.
7 Change in consumer price index for services.
What is a composite index?
Since indicators include a significant number of variables, it is customary to create a composite index that averages all of the indicators in a given category.
Composite indexes of leading indicators are tracked to better predict the possible direction of the economy in the future.
What is unemployment?
A nation’s unemployment rate is the percentage of the civilian labor force, defined as people sixteen years of age and older not in school or other institutions who are either working or actively looking for work.
What is inflation?
Inflation is a persistent increase in prices. It is generally measured as the percentage change in an index such as the Consumer Price Index (CPI), which looks at increases in the overall level of prices paid for the goods and services typically purchased by consumers.
What is the impact of inflation on bond holders and lenders?
If inflation turns out to be higher than expected, recipients of fixed payments, such as those on pension plans, or holders of bonds are likely to be losers, while lenders benefit.
What is demand-pull inflation, and what causes it?
Demand-pull inflation occurs when consumers want to purchase more goods and services than the economy can produce.
As demand outstrips supply, prices are bid up causing inflation.
One possible reason for this phenomenon is an expansion of money supply in excess of the rate at which the real economy is growing.
What is cost-push inflation?
Cost-push inflation occurs when the cost of a key raw material or important inputs – steel, oil, labor - sets off a spiral of rising price for finished goods and services. These rising costs of production are passed on to consumers.
What is an expansionary fiscal policy?
An expansionary fiscal policy is one that increases direct government spending and/or increases transfers and/or decreases taxes.
Increases in government expenditure stimulate the economy by increasing the aggregate demand for goods and services.
Lower taxes should encourage businesses to invest more and consumers to spend more.
What is a contractionary fiscal policy?
A contractionary fiscal policy is the opposite of an expansionary fiscal policy, brought about by the government reducing direct spending and/or transfers, and potentially also increasing taxes.
What is a budget deficit?
A good indicator of the direction of fiscal policy is to examine the magnitude of the budget deficit, defined as the difference between government expenditures and tax revenues.
What does an increase in the budget deficit indicate?
An increase in the budget deficit is indicative of an expansionary fiscal policy, as the stimulant will be provided by higher government expenditure, lower taxes, or both.
How are budget deficits financed?
Budget deficits need to be financed by government borrowing, and this will be reflected by increased issuance of treasury bonds and bills.
What are the three functions of money in the economy?
It is a 1. medium of exchange, 2. a unit of account, and 3. a store of value.
- As a medium of exchange it is used in the economy for transactions involving the buying and selling of goods and services.
- As a unit of account it provides a yardstick to measure and record economic value.
- As a store of value it can be used to transfer purchasing power from the present to the future.
What is M1 money supply?
The narrowest definition of money is termed M1. M1 is the currency in circulation plus the deposits in checking accounts and traveler checks.
What is M2 money supply?
M2 is defined as M1 plus time deposits such as savings accounts.
What is the relation between security prices and interest rates?
Security/prices and interest rates tend to be inversely related.
Security prices declining with increases in the interest rate and vice versa.
Who carries out monetary policy?
Monetary policy is carried out by the Central Bank.
What is the impact of an increase in money supply with interest rates?
An increase in money supply will tend to drive down interest rates and stimulate investments and consumption, thus helping the economy to expand.
