Midterm 1

Question 1

What principles affect the way individuals behave?

Answer 1

Trade-offs
The cost of soemthing is what you give up to get it—explicit cost + opportunity cost
Rational people think at the margin
People respond to incentives—sometimes regulations lead to perverse incentives (seatbelt laws do not reduce car accident death but increase pedestrian death)

Question 2

What are the main principles of how individuals interact?

Answer 2

1) trade can make everyone better off
2) markets are usually a good way to organize economic activity (invisible hand)
3) governments can sometimes improve market outcomes (property rights, avoid market failures, promote equality)

Question 3

Definition of GNP

Answer 3

The market value of all final goods and services newly produced by domestic factors of production during the current period

Question 4

GDP definition

Answer 4

The market value of final goods and services newly produced domestically during the current period

Question 5

Difference between GDP and GNP. Also, write an equation that shows GNP in relation to GDP

Answer 5

GNP includes goods and services produced by Americans abroad while GDP only includes goods and services produced within us borders.

GNP = GDP + Net factor payments

Question 6

What are net factor payments?

Answer 6

Net factor payments= factor payments from abroad — factor payments to abroad

Factor payments from abroad:
Wages earned by US citizens working abroad, profits earned by US owned businesses located abroad, and income generated from the foreign assets owned by US citizens

Question 7

What is the fundamental identity of national income accounting?

Answer 7

Total production = total income= total expenditure

Question 8

What is the product approach to finding GDP?

Answer 8

Compites economic activity by summing the value added by all producers

Value added: value of a producers output — the value of the inputs it purchases from other producers

Question 9

What are some issues with using the market value for goods and services to determine GDP

Answer 9

Goods not sold in formal markets are left out such as household production, actions to produce cleaner air and water, and underground economies

Question 10

Intermediate goods and services vs final goods

Answer 10

Intermediate goods and services are those produced then used up in the production of other goods and services within the same period (flour produced in 2018 and used up in 2018 to make bread; the trucking company that delivers the flour to the bakeries are an intermediate service)

Everything else and Capital goods and inventory investments are final

Question 11

What is the income approach?

Answer 11

Calculate GDP by adding up the incomes received by producers, workers, land owners, capital owners, and governments

Question 12

National income

Answer 12

National income = compensation of employees (including benefits), proprietors income + rental income of persons + corporate profits + net interest + taxes on production and imports + business current transfer payments + current surplus of government enterprises

Question 13

Why might GDP using product approach and income approach not match up?

Answer 13

Because of Different data sources

Question 14

What must one consider when capital goods/ fixed capital is being measured within GDP?

Answer 14

Depreciation; consumption of fixed capital, value of the capital that wears out during the period over which economic activity is being measured.

Question 15

What are some equations that help when there is discrepancy betweeen product approach and income?

Answer 15

Net national product = national income + statistical discrepancy

GNP = net national product + depreciation

GDP = GNP — net factor payments

GDP = national income + statistical discrepancy + depreciation — NFP

Question 16

What is the expenditure approach to measuring GDP and what is the income-expenditure identity

Answer 16

Measures the total spending on final goods and services produced within a nation during a specified period of time

Income-expenditure identity:
Y = C + I + G + NX

Question 17

What does consumption include?

Answer 17

Durable goods, non durable-goods, and services bought by households (does not include purchases of housing) (domestic spending on goods and services produced domestically and abroad)

Question 18

What does Investment include?

Answer 18

Newly produced goods bought for future use or spending on capital. (Includes business fixed investment, residential fixed investment, and inventory investment) (does not include purchase of financial assets)

Question 19

What does Government spending include?

Answer 19

Goods and services bought by federal, state, and local governments (does not include transfer payments such as social security and welfare)

Question 20

What is included in Net Exports?

Answer 20

Net exports (NX) = exports - imports

Question 21

Difference between nominal and real GDP?

Answer 21

Nominal GDP values output using current prices (not corrected for inflation) while real GDP values output using the prices of a base year in order to correct for inflation

Question 22

What is real gdp per capita?

Answer 22

Main indicator of a persons standard of living — real gdp divided by population

Question 23

What the measures (price measures) of the cost of living?

Answer 23

CPI, GDP deflator, PCE price index

Question 24

What are price measures based on a changing basket of goods? (Paasche índices)

Answer 24

GDP deflator and the personal consumption expenditure price index (PCE)

Question 25

What is the GDP deflator?

Answer 25

deflator = nominal GDP/ real GDP x100

Measures the current level of prices relative to the level of prices in the base year
GDP deflator for a base year always 100

Question 26

What is the PCE?

Answer 26

Personal consumption expenditure price index: measure of the price level based on a comprehensive evaluation of how much consumers spend each month, counting expenditures on durable goods, consumer products, and services

Calculated only using the Consumption component of gdp

Takes into account changes in relative prices

Question 27

How do you calculate the inflation rate?

Answer 27

The inflation rate for period t is the % change in prices from period t-1 to period t

% change = new — old / old x100

Question 28

What is a price measure based on a fixed basket of goods (and services) (laspeyres indices) and what is it?

Answer 28

Consumer price index (CPI)
CPI includes parts of C and it is a measure of the overall cost of the goods and services bought by a typical consumer based on a fixed basket of goods relative to the same basket in some base year (computed and reported every month by the bureau of labor statistics)

Question 29

How to calculate CPI

Answer 29

Compute the baskets cost— use the prices for the goods and services in the basket to compute the total cost of the basket. Cost of the basket = p(Q1) + p(Q2) …

Then choose a base year and compute CPI
CPI = cost of basket in current year / cost of basket in base year x 100

Compute the inflation rate using the CPI’s —the percentage change in the CPI from the preceding period

Question 30

What are some problems associated with CPI?

Answer 30

Substitution bias: overtime, some prices rise faster than others. Because CPI uses a fixed basket, it misses the fact that consumers substitute toward goods that become relatively cheaper, mitigating the effects of price increases

Introduction of new goods and services:
The introduction of new goods and services increases variety, allows consumers to find products that more closely meet their need. In effect, dollars become more valuable. CPI misses this effect because it uses a fixed basket of goods

Unmeasured quality change: improvements in quality of goods and services in the basket increase the value of each dollar. The BLS tries to account for quality changes but probably misses some (probably overstates about 0.5% annually)

Question 31

What are the effects of the problems with CPI?

Answer 31

Causes the CPI to overstate cost of living increases which may affect social security payments and contracts that have COLA’s ties to the CPI (cost of living adjustments)

Bc of this, the FED has switched its main inflation indicator from CPI to CPE

Question 32

How to compare dollar figures from different times

Answer 32

Amount in target year dollars=

amount in year x dollars * (price level in target year/price level in year x)

Question 33

What does indexation mean?

Answer 33

A dollar amount is indexed for inflation if it is automatically corrected for inflation by law or in a contract

Question 34

Real vs nominal interest rates

Answer 34

the nominal interest rate: the rate not corrected for inflation (the rate of growth in the dollar value of a deposit or debt)

The real interest rate: corrected for inflation (rate of growth in the purchasing power of a deposit or debt)

Real interest rate = I - n (pi)

Real interest rate = nominal interest rate (i) — rate of inflation (pi)

Question 35

Who is counted as employed?

Answer 35

People with jobs (can be paid employees, self-employed, or unpaid workers in a family business)

Question 36

Who are the unemployed?

Answer 36

People who are jobless, looking for a job (for the last 4 weeks), and available for work

Question 37

What is the labor force

Answer 37

Labor force = number of employed + number of unemployed

People who are neither employed nor unemployed are not in the labor force

Question 38

Unemployment rate equation

Answer 38

Unemployment rate = (number of unemployed/ labor force) x 100

Question 39

What is the labor force participation rate?

Answer 39

Labor force participation rate = (labor force/ civilian non-institutional population 16 years old and over) x 100

Civilian non institutional population 16 years old and over is aka adult population

Question 40

What is the adult population / the civilian non-institutional population 16 years old and over?

Answer 40

Adult population = labor force + those not in labor force

Question 41

Employment population ratio

Answer 41

Employment population ratio = # of employed/ adult population

Question 42

Downsides to unemployment rate measure?

Answer 42

Does not count discouraged workers or distinguish between part time or full time and people sometimes misreport their work status

Question 43

What constitutes the natural rate of employment?

Answer 43

Frictional and structural unemployment

Question 44

What is cyclical unemployment

Answer 44

Cyclical unemployment is the deviation of unemployment from its natural rate

Question 45

Natural rate of unemployment def

Answer 45

Normal rate of unemployment around which the actual unemployment rate fluctuates

Question 46

Frictional unemployment

Answer 46

Occurs when workers (firms) spend time searching for the jobs (job candidates) that best suit their skills (needs) and tastes

Short term for most workers

Policies that affect job search will influence frictional unemployment and the natural rate

Examples of policies that will facilitate job search: government employment agencies and public training programs

Technological innovation may also facilitate job search process

Unemployment insurance: increases frictional unemployment because workers have incentive to not get a job

Sectoral shifts:
Changes in the composition of demand across industries or regions of the country displaced workers must search for new jobs appropriate for their skills and tastes

Question 47

Structural unemployment:

Answer 47

Occurs when there are fewer jobs that workers caused by:

Minimum wage laws: min wage may exceed the equilibrium wage for unskilled workers

Unions: unions exert market power to negotiate higher wages for union members

Efficiency wages: firms voluntarily par higher than equilibrium wage to boost worker productivity

Usually long-term