Midterm 1 Flashcards
What principles affect the way individuals behave?
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)
What are the main principles of how individuals interact?
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)
Definition of GNP
The market value of all final goods and services newly produced by domestic factors of production during the current period
GDP definition
The market value of final goods and services newly produced domestically during the current period
Difference between GDP and GNP. Also, write an equation that shows GNP in relation to GDP
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
What are net factor payments?
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
What is the fundamental identity of national income accounting?
Total production = total income= total expenditure
What is the product approach to finding GDP?
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
What are some issues with using the market value for goods and services to determine GDP
Goods not sold in formal markets are left out such as household production, actions to produce cleaner air and water, and underground economies
Intermediate goods and services vs final goods
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
What is the income approach?
Calculate GDP by adding up the incomes received by producers, workers, land owners, capital owners, and governments
National income
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
Why might GDP using product approach and income approach not match up?
Because of Different data sources
What must one consider when capital goods/ fixed capital is being measured within GDP?
Depreciation; consumption of fixed capital, value of the capital that wears out during the period over which economic activity is being measured.
What are some equations that help when there is discrepancy betweeen product approach and income?
Net national product = national income + statistical discrepancy
GNP = net national product + depreciation
GDP = GNP — net factor payments
GDP = national income + statistical discrepancy + depreciation — NFP
What is the expenditure approach to measuring GDP and what is the income-expenditure identity
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
What does consumption include?
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)
What does Investment include?
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)
What does Government spending include?
Goods and services bought by federal, state, and local governments (does not include transfer payments such as social security and welfare)
What is included in Net Exports?
Net exports (NX) = exports - imports
Difference between nominal and real GDP?
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
What is real gdp per capita?
Main indicator of a persons standard of living — real gdp divided by population
What the measures (price measures) of the cost of living?
CPI, GDP deflator, PCE price index
What are price measures based on a changing basket of goods? (Paasche índices)
GDP deflator and the personal consumption expenditure price index (PCE)
What is the GDP deflator?
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
What is the PCE?
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
How do you calculate the inflation rate?
The inflation rate for period t is the % change in prices from period t-1 to period t
% change = new — old / old x100
What is a price measure based on a fixed basket of goods (and services) (laspeyres indices) and what is it?
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)
How to calculate CPI
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
What are some problems associated with CPI?
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)
What are the effects of the problems with CPI?
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
How to compare dollar figures from different times
Amount in target year dollars=
amount in year x dollars * (price level in target year/price level in year x)
What does indexation mean?
A dollar amount is indexed for inflation if it is automatically corrected for inflation by law or in a contract
Real vs nominal interest rates
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)
Who is counted as employed?
People with jobs (can be paid employees, self-employed, or unpaid workers in a family business)
Who are the unemployed?
People who are jobless, looking for a job (for the last 4 weeks), and available for work
What is the labor force
Labor force = number of employed + number of unemployed
People who are neither employed nor unemployed are not in the labor force
Unemployment rate equation
Unemployment rate = (number of unemployed/ labor force) x 100
What is the labor force participation rate?
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
What is the adult population / the civilian non-institutional population 16 years old and over?
Adult population = labor force + those not in labor force
Employment population ratio
Employment population ratio = # of employed/ adult population
Downsides to unemployment rate measure?
Does not count discouraged workers or distinguish between part time or full time and people sometimes misreport their work status
What constitutes the natural rate of employment?
Frictional and structural unemployment
What is cyclical unemployment
Cyclical unemployment is the deviation of unemployment from its natural rate
Natural rate of unemployment def
Normal rate of unemployment around which the actual unemployment rate fluctuates
Frictional unemployment
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
Structural unemployment:
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
