Macro CH1 Summary Flashcards
Three definitions of GDP
measure of aggregate output
Production perspective:
1.GDP is the value of the final goods and services produced in an economy during a given period.
2. The sum of the value added to the economy during a given period.
Income perspective:
3. The sum of incomes in the economy during a given period
Nominal GDP
quantity of goods produced x the current price
Two reasons it increases:
1. Rise in production of goods
2. Rise in the price levels
Real GDP
quantity of goods produced x constant price level
Explanation (GDP adjusted for inflation):
A base year with certain prices is taken and only the changes in quantity and not price levels are taken into consideration.
- called: GDP in terms of goods, GDP at constant prices
- -> economic growth often defined as % change in real GDP
average price level of goods
aggregate price level
The best measure of the aggregate price level is probably the GDP price index.
The GDP price index is the ratio of nominal GDP to real GDP multiplied times 100.
labor force
employment + unemployment
discouraged workers are not part of the labor force. They gave up looking for a job.
unemployment rate
u= U/L
u = unemployment rate U= Unemployed people L= Labor force
participation rate
Labour force/ Total population of working age
Deflation
sustained decline in the price level; negative inflation rate
average standard of living
real GDP per capita
expansions
periods of positive GDP growth
recessions
periods of negative GDP growth
How to measure the inflation rate?
two measures of the price level:
- GDP deflator
- consumer price index
CPI consumer price index
measures the average price of consumption, or equivalently the cost of living
Pure inflation
prices and wages increase proportionally. Does not exist
Why do economists care about inflation?
During periods of inflation, not all prices and wages rise proportionately
Inflation leads to other distortions
When is the economy overheating?
When inflation increases and operates above its potential
What Is an Overheated Economy?
An overheated economy is one that has experienced a prolonged period of good economic growth and activity that has led to high levels of inflation (from increased consumer wealth). This sharp rise in prices causes inefficient supply allocations as producers overproduce and create excess production capacity in an attempt to capitalize on the high levels of wealth.
What determines the level of aggregate output in the short term?
by movements in demand for example due to changes in consumer confidence; leads to a decrease in output (a recession) or a increase in output (an expansion)
What determines the level of aggregate output in the medium run?
level of output is determined by supply factors: the capital stock, the level of technology and the size of the labor force
What determines the level of aggregate output in the long run?
factors like the education system, the saving rate, and the role of the government
C in the decomposition of GDP
consumption.
These are goods and services purchased by consumers
The largest component of GDP
I in the decomposition of GDP
Investment (I), also called fixed investment.
What is fixed investment made up of?
Sum of non-residential investment (purchase by firms of new plants or new machinery)
and residential investment (purchase of new houses)
G in the decomposition of GDP
G government spending. Purchase of goods and services by the national, regional and local governments.
Note: Does not include government transfers, like unemployment benefits and pensions, not interest payments on the government debt. They are not purchases of goods and services.
IM in the decomposition of GDP
IM imports; these are subtracted from the GDP formula
X in the decomposition of GDP
the purchase of domestic goods and services by foreigners.
What is the difference between exports and imports called?
(X-IM) is called net exports (NX), or the trade balance.
What is a trade surplus?
If exports exceed imports
What is a trade deficit?
If imports exceed exports.
inventory investment
Inventory investment = Production - Sales
the difference between production and sales
Some of the goods produced in a given year are not sold in that year..
Total demand for goods symbol
Z
What is disposable income and what is the symbol?
Yd;
income that remains once consumers have received transfers from the government and paid their taxes.
endogenous
variables depending on other variables in the model
exogenous variables
taken as given; I has a line above it, indicating that it is exogenous
Which variables describe fiscal policy?
T, G; the choice of taxes and spending by the government.
Which variables are exogenous?
I, G and T
Why are G and T exogenous?
- Governments do not behave with the same regularity as consumers or firms.
- G and T are chosen somewhat arbitrarily by the government
Why is the symbol Y used for both production and income
Because GDP can be looked at from the production side and from the income side. Production and income are identically equal.
Y is used for GDP
balanced budget of the government
taxes equal government spending
What is autonomous spending?
Part of the demand for goods that does not depend on output or income.
Is autonomous spending usually positive?
Yes it is.
Only if government were running a very large budget surplus - if taxes were much larger than government spending - could autonomous spending be negative.
What is the effect of the multiplier?
Any change in autonomous spending (from a change in investment, to a change in government spending, to a change in taxes) will have the same qualitative effect: it will change output by more than its direct effect on autonomous spending.
for example the Co increases by 1 billion which is part of the autonomous spending, than the output Y is increased by more than 1 billion
Saving
the sum of private and public saving
government budget surplus
if taxes exceed government spending
budget deficit
if taxes are less than government spending
two equivalent ways of stating the condition for equilibrium in the goods market
Production = Demand Investment = Saving
(1-c1)
propensity to save
IS relation
‘investment equals saving’:
what firms want to invest must be equal top what people and the government want to save
in a modern economy investment decisions are made by firms, whereas saving decisions are made by consumers and the government.
Measures form aggregate production/income
- economic growth
- recession
- stability and growth pact (SGP)
What is SGP?
- Government deficit max 3% of GDP
- Government debt max 60% of GDP
economic growth
increase in production of goods
shortcomings of GDP as measure of total production
What is not taken into consideration:
- Production households
- shadow economy
shortcomings of GDP as measure of well-being
What is not taken into consideration:
- Leisure
- Health
- Eduction
- Environmental pollution
- Crime
- Income distribution
Lorenz curve
shows the inequality in income distribution
- A perfect equality is displayed by a straight line
- the Lorenz curve shows that for example 40% of the households only earn 25% of the income and this means there is inequality.
Alternative measures for well-being
- Human Development Index (HDI)
(factors: health, education, living standards, incorporates GDP) - Well-being Index
(Career-, Social-, Financial, Physical-, Community-wellbeing)
Necessary steps to determine the effect of fiscal policy in goods market
- GDP
- Demand for goods
- Supply of goods
- IS relation (=equilibrium condition in goods market)
- Effect of change/”shock” on equilibrium
- Fiscal policy
Second hand bike produced in 2015 and sold in 2016. Which year is the bike in GDP calculation?
2015
Effect of “shock” on equilibrium in goods market
changes in autonomous spending lead to change in equilibrium income
ceteris paribus
all other factors constant
Suppose firms will invest an additional amount of 1 billion
Is this a shift in the curve or a movement along the curve?
It is a shift in the curve, because I belongs to autonomous spending which is changed. This leads to a change in Z (demand) due to change in autonomous spending, given Y.
How is fiscal policy incorporated in the IS-model?
Fiscal policy is G (Government spending) and T (Taxes)
Goal is:
- stimulate/slow down economy
- employment
Influence aggregate demand:
- expansionary policy (G increases and/or T decreases)
- contractionary policy (G decreases and/or T increases)
Limitations of fiscal policy (General)
- Delay macroeconomic data
- Expected data could differ from actual data
- Policy can be implemented too late
- Fiscal policy cannot be implemented as fast as monetary policy
- Crowding out
Current limitations of fiscal policy
- government deficit
- government debt
- Stability and Growth Pact (SGP)
Please explain briefly the concepts of inflation and deflation and what impact each of these
might have on consumers and the economy as a whole.
inflation is a sustained increase in the general price level of goods and services in an economy over a period of time . Deflation is a decrease in the general price level of goods
and services. High or unpredictable inflation is harmful to the economy as it adds inefficiencies and makes it difficult for companies to budget or plan long-term. High inflation also redistributes income. It also increases the price of exports. High deflation, on the other hand, causes a transfer of wealth from borrowers and holders of illiquid assets, to the benefit of savers and of holders of liquid assets and currency, and because confused
pricing signals cause underinvestment by firms.
Please, provide a formal definition of the concept economists rely on to measure consumer
prices. What are the two main issues that arise when calculating that index?
To measure the average price of consumption, i.e. the cost of living, economists look at the Consumer Price Index. The index is the value of a basket of consumer goods (produced locally and abroad) in terms of prices accessible to consumers. The two issues in
calculating CPI are related to (i) the quality of goods in the economy varies over time, and
(ii) the weights assigned to different goods and services in the basked change over time.
What is not counted in GDP
illegal activities
and household activities
GDP and GNP differenct
GDP is only for the domestic market
GNP is about nationality so when for example an American produces something in Germany it counts as GNP
In period 1 The intermediary good was produced with a market value of 20$ and in period 2 the final good with 50$ worth.
What is the GDP contribution in period 2?
The contribution is 30$ in period 2.
What is investment in economics?
Investments can be made by firms and households.
Investment by firms:
- capital equipment
- inventory
- structures
Investment by Households:
- new homes
What is consumption in economics?
- Any expenditure on final goods or services by households except for new homes.
value add approach of GDP. What is summed up?
the incremental values added in production are summed up
A U.S. car rental company spends $1m to buy 30 new Fords that were made in the US. What changes in the formula for GDP?
Investment increases by $1m.
You buy 100,000 of IBM stock. What changes in formula for GDP?
No impact, because it is not consumption and no investment. Investment is only made by a firm or when consumers buy a new house in something new produced. No consumption either because it is not used up.
Microsoft buys $100m of IBM stock. What changes in formula for GDP?
No impact. Investment is only made by a firm in something new produced. Stocks are no new product.
The Social Security Administration makes a $2000 payment to a retiree. What changes in formula for GDP?
No impact. It is no government expenditure but a transfer only. Nothing new is produced.
The Social Security Administration buys a new accounting system for $1m
Government spending increases by $1m. GDP increases by $1m.
What can you find out when looking at the GDP?
Economic activity and size and influence of an economy.
Was GDP ever intended to measure wellbeing?
No, It was a way to approximate production
Clearly explain how this inflation is measured.
Inflation is percentage change in the price level as
measured by Consumer Price Index (CPI)/bundle of
goods for households or consumers.
Clearly explain
what core inflation is and how it differs from (general)
inflation.
Core inflation = inflation excl. volatile categories like
food and energy
Name two (and not more than two) limitations of fiscal policy.
Delay macroeconomic data, Expected data could
differ from actual data, Policy can be implemented too
late, Fiscal policy cannot be implemented as fast as
monetary policy, Crowding out, Rules regarding Stability
and Growth Pact (SGP) (Government deficit max 3%
of GDP, Government debt max 60% of GDP)
GDP Deflator
Nominal GDP/Real GDP *100
Capital Stock Definition
In economics, capital stock is the plant, equipment, and other assets that help with production.
