Final Exam Flashcards
GDP equation
Y = C + I + G + NX
NX = X - M
Y (GDP + Output / or Total Income)
C (Consumption)
I (Investment)
G (Government spending)
NX (Net exports)
X (Exports)
M (Imports)
How to measure contribution towards production
Total sales - cost of intermediate inputs
Ex : 400 + 600 + 500 = 1500
Wages + Profits = ?
Total GDP
Wages: $300 + $500 + $200 = $1000
Profits: $100 +$100 + $300 = $500
$1000 + $500 = $1500
Nominal GDP
The GDP only accounts for the changes in the prices and quantities of goods.
P * Q
Ex:
Q1: 80 P1: $30 = $2400
Q2: 90 P2: $36 = $3250
Growth rate:
(3250 - 2400) / 2400 = 35%
Real GDP
The GDP that accounts for only the change in production for goods
Pbar = (P1 + P2)/2
Pbar * Q1(80) = 2640
Pbar * Q2(90) = 2970
Growth rate:
(2970 - 2640)/2640 = 12.5%
How to calculate % change in nominal GDP
% change in Real GDP + % change in prices
Rule of 70 is the time it takes for GDP to ?
Double
70/Annual Growth rate
Ex: 70/1.45 = 40 years
Labor force participation rate
The percentage of the working age pop that is either employed or unemployed
(Employed + Unemployed)/Working age population
Unemployment
The percentage of workers who currently are not working but are actively looking for a job.
Short term: Under 10 weeks
Long term: Longer than 6 months
Output equation
Y = f(LHK)
Y (Output)
L (Labor input)
H (Human capital)
K (Physical capital)
Labor factors:
Size of pop
working age fraction
Share of people who choose to work
How many hours each worker puts in
Unemployment rate
Unemployed/Labor Force *100
*Fluctuates but is never 0
*PPL regularly flow into and out of jobs
Inflation rate
(Price this year - Price last year)/ price last year
GDP Deflator
Nominal GDP/Real GDP
A price index that tracks the prices of all goods and services produced domestically
Real GDP
Nominal GDP/Deflator
How to convert in to another time periods currency
Today’s currency =
Another times dollars * P level today/P level in another time
Real interest rate
The interest rate that accounts only for the change in production
= Nominal interest rate - Inflation rate
Ex:
5-3 = 2%
What is slope in a GDP based graph
Change in consumption/Change in income
Marginal Propensity to save = ?
change in savings/change in income
MPS = 1 - MPC
Marginal propensity to consume = ?
Change in consumption/Change in income
Cost Benefit principle
Incentives influence decisions
Opportunity cost principle
The true cost of something is the next best alternative you must sacrifice to have it.
Marginal principle
Decisions about quantities are best made incrementally
Interdependence principle
Your best choice depends on your other choices, the choices others make, developments in other markets, etc….
Circular flow diagram
Money market:
- Spending on output
- Mkt value output
- Wages + profit
- Income received
Goods market:
- Output bought
- Inputs provided
- Inputs brought
- Output sold
GDP
The market value of all final goods and services produced within a country in a given year
Three perspectives of GDP
Total spending
Total Output
Total Income
Consumption
Household spending on final goods and services
Investment
Spending on new capital that increases the capitol’s productive capacity
Government spending
Gov purchases of goods + services
Net exports
Exports - spending on Imports
Exports
Produced domestically and purchased abroad
Imports
Produced abroad and purchased domestically
Limitations of GDP
- Prices are not values
- Nonmarket activities including household production are excluded
- The shadow economy is missing
- Environmental degradation isn’t counted
- Leisure doesn’t count
- GDP ignores distribution
Comparison strategies
- Evaluate what it means per person
- Compare big numbers to the size of the economy
- Compare big numbers to their own history
- Use the rule of 70 to evaluate long term growth rates
Production function
The methods by which inputs are transferred into output, determines the total production that’s possible with a given set of inputs
Labor
The sum of all hours worked across the economy
Human capital
The accumulated knowledge and skills that make a worker more productive
Physical capital
The tools, machines and structures that are inputs in the production process
Capital stock
The total quantity of physical capital that can be used in the production of goods and services
Constant returns to scale
Increasing all inputs by some proportion will cause output to rise by the same proportion
Replication argument
If you want to double the output of your factory, double all outputs
Solow model
Used to analyze economic growth
Insight 4
The capital stock will grow as long as investment outpaces depreciation
Law of diminishing returns
You add more and more workers you will at some point stop producing as much
Catch up growth
The rapid growth that occurs when a relatively poor country invests in its physical capital
Rising depreciation
If the fraction of machines that fail each year is fixed then more machines will mean more breakdowns —> Total depreciation grows
Tech progress is driven by…
The speed at which new ideas are created
How many resources are devoted to generating new ideas
The impact of new ideas
Ideas can be freely shared
Ideas do not depreciate with use
Ideas may promote other ideas
Institution
Any part of society that keeps the society together and performs a role
Why do institutions matter?
- Property rights - control over a tangible or intangible resource
- Government stability - corruption and political instability discourage investment and corruption
- Efficient regulation - Reg and rules are essential to a well-functioning economy, but they can also be inefficient or excessive
- Gov. policy encourages innovation - creates incentives through intellectual property laws. And it subsidizes research and development
Working age population
Those age 16 or older who are not in the military or institutionalized
*No upper limit for working age population
Labor force
The employed plus the unemployed
Equilibrium unemployment rate
The long run unemployment rate to which the economy tends to return
*A dynamic labor mkt makes it easier for new people to enter the mkt and find a job quickly
Marginally attached
Someone who wants a job and who has looked for a job within the past year, but who isn’t counted as unemployed because they aren’t currently searching for work
Labor Market graph
Labor demand is the employers who are seeking to buy labor
*Downward sloping
Labor supply is the workers because they supply labor
*Upward sloping
Unions
Organizations representing workers who band together to negotiate jointly
Minimum wages
Keeps wages from falling below the set minimum wage
Hysterisis
When a period of high employment leads to higher equilibrium unemployment rate
Underemployed
Someone who has some work but wants more hours or the job isn’t adequately using their skills
Types of unemployment
Frictional- Unemployment due to the time it takes for employers to search for workers and for workers to find jobs
Structural- Unemployment that is due to wages not falling and bringing labor demand and supply into equilibrium
Cyclical-Unemployment is due to a temporary downturn in the economy
Substitution bias
The overestimate of the cost of living that occurs because people substitute towards goods whose prices rise by less.
Producer price index
A price index that tracks the prices of input into the prod process
Nominal variable
A variable measured in dollars
(whose value may fluctuate over time)
Money Illusion
The mistaken tendency to focus on nominal dollar amounts instead of inflation-adjusted amounts.
Money functions
Money is a medium of exchange
Money is a unit of account
Money is a store of value
Menu costs
The marginal cost of adjusting prices
Shoe leather costs
The costs incurred trying to avoid holding cash
Grade inflation
Distorts the signals that grades send
Inflation fallacy
The mistaken belief that inflation destroys purchasing power
Dissaving
The amount of money that is spent
Consumption smoothing
Maintaining a steady or smooth path for your consumptions spending over time
Permanent income
Your best estimate of your long-term average income
Consumption is driven by permanent income rather than current income
Five insights
- A temp change in income leads to a small change in consumption
- A permanent change in income leads to a large change in consumption
- An anticipated change in income leads to no change in consumption
- Learning about future income changes leads to a change in consumption
- It’s hard to forecast changes in consumption
Credit constraints
Limits on how much you can borrow
Hand to mouth consumers
Spend their income as they receive it
Types of changes in income
Temporary
Changes CS by a small amount and HTM by a large amount
Overall changes moderately
Permanent
Changes both CS and HTM by a large amount
Overall changes by a large amount
Anticipated
Changes CS by a large amount
HTM does not change
Overall changes moderately
Efficient market hypothesis
The theory that at any point in time the stock prices reflect all publicly available information
Business investment vs regular Investment
Business Investment is anything besides inventory stock
and
Inventory stock is considered a separate investment
Current Account
Measures how much we import relative to exports
Financial Account
Measures Financial Outflows relative to financial Inflows
A deficit in the current account = ? in the financial account
A surplus
Okuns rule of thumb
for Every 0.5% the Output Gap falls the Unemployment rate rises by 1%
PV of future income
Yearly income/ (R+D)
Capital
Assets such as equipment, structures, and intellectual property that used repeatedly to produce output
Capital stock
The total quantity of capital at a point in time
Compounding
The accumulation of money over time, as you earn interest on both principal + accrued interest
Discounting
Converting future values into the equivalent present values
Marginal Benefit
Next year’s profit
Marginal Cost
Consider both depreciation + forgone interest
User cost of capital
The extra cost associated with using one more machine next year
*Rental Cost
Market for loanable funds
The mkt for the funds used to buy, rent or build capital
*Savers supply funds
*Investors demand funds
Budget surplus
When Gov revenues exceed spending
Budget deficit
When Gov spending exceeds revenue
Crowding out
The decline in private spending and particularly investment that follows from a rise in Gov borrowing
Types of investment
Inventories, Housing, Business
Types of Bond risks
Default- Not getting paid
Term- Arises when there’s uncertainty about future interest rates
Liquidity- Arises when your Bond will be hard to sell
Treasuries
Bonds issued by the Gov
Fundamental value
The present value of the future profits that a company will earn
Relative valuation
As assessment of the value of an asset by comparing it to similar assets
Random walk
When a price follows an unpredictable path
Greater fool theory
The idea is that people buy an investment because they expect other people to buy it from them at a higher price
Globalization
The increasing global integration of economies, cultures, political institutions and ideas
Financial inflows
Investments made by foreigners in the US
Financial Outflows
Investments by Americans in foreign countries
Nominal Exchange rate
The price of a country’s currency in terms of another country’s currency
Higher price of a dollar
- An appreciation of the dollar
- A depreciation of the foreign currency
-Stronger dollar
-Higher exchange rate
-Imports are cheaper
-Exports are more expensive for foreign buyers
Lower price of a dollar
A depreciation of the dollar
An appreciation of the foreign currency
Weaker dollar
Higher exchange rate
Imports are cheaper
Exports are more expensive for foreign buyers
Trade weighted index
A summary measure of the value of the US dollar
Foreign exchange market
The market in which currencies are bought and sold
Real exchange rate
Allows you to measure the price of domestic goods relative to their foreign competitors
Bilateral trade balance
How much we buy from a specific country compared to how much they buy from the US
Business cycle
Short-term fluctuations in economic activity
—> Not cycles because fluctuations are not rhythmic
Peak vs Trough
Economic high points vs low points
unusual expansion
rapid bounce back following a recession
comovement
variables that move up and down together
Leading indicator
Variables that tend to predict the future path of the economy
EX: Business confidence, consumer confidence, the stock market
Lagging indicator
Variables that tend to follow the business cycle movement with a bit of delay
Ex: Unemployment
Seasonally adjusted
Data stripped of predictable seasonal patterns
Annualized rates
Data converted to the rate that would occur if the same rate had occurred throughout the year
Aggregate expenditure
The total amount of goods and services that people want to buy across the whole economy
AE = IS
Decrease AE = Increase R
A decrease in the real interest rate will cause AE to do what
Increase which means that output and the output gap increase as well.
C increases
I increases
G increases
NX increases
monetary policy
The process of setting interest rates in an effort to influence economic conditions
Federal funds rate
The inflation rate on a set of overnight loans that are almost certain to be repaid the next day
Risk free interest rate
The interest rate on a loan that involves no risk
Risk premium
The extra interest that lenders charge to account for the risk of loaning money
shock types
Spending- Any change in the spending conditions that change the real i.r at which people can spend
IS curve
Financial- Any change in borrowing conditions that change the real interest rate at which people can borrow
MP curve
Supply-Any change in the supply conditions that change the unexpected inflation in the economy
Phillips curve
self fulfilling prophecy
Inflation expectations create a self-fulfilling prophecy.
Vicious cycle —> High Inflation
Virtuous cycle —> Low inflation
Adaptive expectations
Some people might expect recent levels of inflation to continue
Anchored expectations
Those who might believe that the federal reserve will deliver on its promise to ensure inflation is around 2%
Rational expectations
Those who use all available information and deep understanding of macroeconomic relationships to come up with the most accurate forecast possible with available data.
Rational expectations
Those who use all available information and deep understanding of macroeconomic relationships to come up with the most accurate forecast possible with available data.
Sticky expectations
There is also evidence that people revisit their views about inflation only irregularly, and so they stick with their previous views for long periods of time
Demand pull inflation
inflation resulting from excess demand
Neutral interest rate
The real i.r at which GDP = potential GDP
= Federal Funds Rate - Inflation
Discount window
When banks get loans from the FED to meet their reserve requirements
Lender of last resort
FEDS role as a lender that banks can turn to when they are in trouble
Forward guidance
Providing info about the future course of monetary policy in order to influence market expectations of future i.r
Quantitative easing
Purchasing large amounts of long term gov bonds and other securities
Types of Taxes percentages
Progressive
- A tax where those with more income tend to pay a higher share of their income in taxes
Regressive
-A tax where those with less income pay a higher share of their income in taxes
Proportional
-Everyone pays the same percentage on their taxes
Marginal vs Avg tax rate
The marginal tax rate is the tax rate you pay if you earn another dollar.
Whereas the avg tax rate is the total tax divided by the total income earned.
Automatic stabilizer
Spending and tax programs that adjust as the economy expands and contracts, w/o policy makers taking any deliberate action
Mandatory vs Discretionary spending
Mandatory spending is spending on programs that does not get determined annually
Discretionary spending is spending that congress appropriates annually
Types of taxes
Income taxes
Taxes are collected on all income regardless of the source
Payroll taxes
Taxes on earned income
Corporate taxes
Taxes paid by the owners of the corporation
Excise tax
A tax on a specific product
Property tax
A tax on a the value of a property
Sales tax
A tax on purchases that’s typically a percentage of the purchase price of goods and services
Fiscal policy
the process of using spending and tax policies to influence the economy
Timely
Targeted
Temporary
Expansionary vs Contradictory fiscal policy
Expansionary
Lower Taxes and raise spending = Higher Output
Contradictory
Raise Taxes and lower spending = Lower output
Tax expenditures
Special deductions, exemptions, or credits that lower your tax obligations to encourage you to engage in certain activities
Government regulations
Allows the Gov to require spending while others pay the bill
Discretionary fiscal policy
Temporarily changes gov. taxes or spending to boost or slow the economy
Gross Gov. debt vs Net Gov debt
Gross gov Debt
Total accumulation amount of money the gov. owes
Net gov debt
The debt that the gov owes to individuals, businesses and other gov both here and abroad
Unfunded liabilities
A commitment to incur expenses in the future w/o a plan to pay for those expenses
Real federal funds rate
Nominal FED Funds rate - Inflation
Neutral I.R + 1/2(Inflation -2%) + OG
