Midterm Flashcards
Define Gross Domestic Product (GDP)
The sum of the market value of all final goods and services produced within a country in a given period of time.
What is double counting (GDP)
Counting intermediate goods and services in addition to the price of the end product.
Gives a total that is too big.
Define Gross National Product (GNP)
The sum of the market value of all final goods and services produced and capital owned by the permanent residents of a country in a given period of time, no matter where in the world production occurs.
Consumption (GDP)
Spending on goods and services by private individuals and households. Has to be new.
Investment (GDP)
Spending by businesses, including newly bought houses by household. Productive inputs, capital goods, inventories.
Doesn’t include stocks, bonds, mutual funds, and other products bought and sold in the financial markets.
Government Purchases (GDP)
Goods and services bought by all levels of government.
Net Exports (GDP)
Domestic spending on imports should be subtracted, while international spending on exports should be added.
Exports > Imports = Positive
Exports < Imports = Negative
Calculate GDP with The Income Approach
GDP = Wages + Interest + Rental Income + Profits
When goods are exported, that is expenditure by other countries and income for Canada.
When goods are imported, that is expenditure in Canada and income for other countries.
Calculate GDP with The Value Added Approach
Looks at all transactions.
The difference between the sale value of the product and the value of the inputs that went into it.
Any intermediary involved in the sale of used goods adds value by sourcing those goods and making them available for sale in a convenient way.
Real GDP
Calculated based on goods and services valued at constant prices (using a base year).
Holding prices constant will allow us to see how much quantities rise or fall.
Calculate Real GDP
Real GDP = (quantity of a good produced in that year) (it’s price in the base year)
Nominal GDP
Calculated based on goods and services valued at current (at the time of production) prices.
Calculate Nominal GDP
Nominal GDP = (quantity of a good produced in that year) (it’s price in that year)
What is GDP Deflator
Used to measure the overall change in prices in an economy, using the ratio between real and nominal GDP. Uses actual quantities that are produced in the economy each year, rather than using a fixed basket.
In the base year, GDP Deflator always = 100.
Nominal > Real, prices have risen, deflator > 100.
Nominal < Real, prices have fallen, deflator < 100.
Inflation
How fast the overall level of prices is changing from year to year.
GDP Per Capita
How much is produced per person in a country. Doesn’t tell you how income is distributed or how much you can buy with a given an=mount of money in a country.
GDP / Population Size.
GDP Growth Rates (sign meaning -, +)
Negative Growth Rate = Economy Shrinking.
Positive Growth Rate = Economy Growing.
Shrinking Economies
People are producing less than the year before.
Define Recession
A period of significant decline in economic activity.
GDP goes down, Unemployment goes up, Bankruptcies go up.
Define Depression
Severe or extended recession.
Limitations of GDP
Doesn’t account for home production, the underground economy, and environmental externalities.
Home Production
Goods and services that are both produced and consumed within one household.
The Underground Economy (black and grey market)
Black market: Sales of illegal goods and services. Is not reported and therefore not counted as part of GDP.
Grey market: Sits somewhere between the black market and the documented economy. Not illegal but also not reported and therefore no counted as a part of GDP.
Environmental Externalities (green GDP)
Green GDP: Subtracts the environmental costs of production from the positive outputs normally counted in GDP.
GDP verses Well Being
GDP per capita does not perfectly correlate with people’s well being.
The Market Basket
A list of specific goods and services, in fixed quantities that roughly correspond to a typical consumer’s spending.
Keeps goods and quantities constant to isolate for price change.
Define Consumer Price Index
Tracks changes in the cost of a basket of goods and services purchased by a typical Canadian household (relative to the cost in a given base year)
Define Price Index
Measures how much the cost of a market basket has risen or fallen relative to the cost in a base time, period, or location.
CPI Sign Meanings (base year, >,
CPI of base year = 100.
Basket of desired year > Basket of base year = CPI greater than 100.
Basket of desired year < Basket of base year = CPI less than 100.
Goods Included In The Typical Market Basket
Based on an average of goods and services purchased by urban consumers in different life stages and situations.
Define Substitution (CPI)
People switch between similar goods and services when relative prices shift.
Define Innovation (CPI)
As new goods and services become available, people change what they consume.
Problems With A Fixed Basket
What people buy in a given year changes with tastes and prices. If the market basket doesn’t reflect the fact that people buy less of a particular product as it gets more expensive, it will overstate actual changes in the cost of living.
What Does Hedonic Quality Adjustment Try To Do
Estimate what the price of an item would be without the improved features.
True Cost Of Living verses Market Basket Price
If a higher price represents higher quality, the true cost of living may not have actually increased.
Define All Items Inflation
Changes in prices for the entire market basket of the average urban consumer.
Define Core Inflation
Price changes using eight of CPI’s most volatile components (mostly related to energy and food) excluded.
Why Is Core Inflation Used
Energy and food prices fluctuate a lot. They might be very high or low at the time CPI is calculated. Including them might overstate or understate the real change in overall prices.
Producer Price Index
Measures the prices of goods and services purchased by firms. Considered a good predictor of future consumer prices
Define Nominal
Something that has not been adjusted for inflation.
Define Indexing (payments that are indexed to inflation) (COLAs)
Automatically increasing payments in proportion to the cost of living.
What Is Purchasing Power Parity (PPP)
Purchasing power should theoretically be the same everywhere, when stated in a common currency
Why Is PPP Normally Violated
Transaction costs, Non-tradeables, Trade restrictions.
Transaction Costs (PPP)
Transportation costs, the time and money needed to find sellers in different countries.
If the price difference is small and the costs of making transactions in another country are high, the trade off involved may not be worth it.
Non-tradeables (PPP)
Housing, food, some services (i.e. haircuts), etc.
Trade Restrictions (PPP)
Tariffs and trade restriction increase cost or difficulty of international trade. Discourages people from fully taking advantage of lower prices in other countries.
Purchasing Power Indexes (PPI) (steps)
- Find market basket for goods and services that can be compared across countries
- Measure basket price; calculate the overall cost of purchasing it in each country
- Build an index showing how much the basket costs in each country relative to some base (Comparative price index, CPI)
CPI = [(Exchange rate predicted by PPP - Official exchange rate) / (Official exchange rate)] * 100%
Comparative Price Index (CPI) (-,+)
Negative CPI: Price levels in that country are lower than we’d expect if PPP held true. That country has a higher real purchasing power.
Positive CPI: Price levels in that country are higher than we’d expect if PPP held true. That country has a lower real purchasing power.
What is Purchasing Power Parity (PPP) Adjustment
Recalculating economic statistics to account for differences in price levels across countries. Gives us a more realistic sense of differences in living standards.
How Does The National Household Survey (NHS) Dictionary Define Unemployment
People who are on temporary lay off and are expected to return to their job. People with definite arrangement to start a new job in four weeks or less.
What Counts As Unemployed
Civilian, non-institutionalized population, age 15 +.
What Doesn’t Count As Unemployed
Adults in the armed forces, inmates in an institution, full time students, stay at home parents, people unable to work due to a disability, people who have inherited wealth and choose not to work.
Limitations To The Unemployment Rate
Doesn’t include workers who gave up hope of finding a job. Discouraged workers and the underemployed.
Define Discouraged Workers
People who looked for work in the previous year but have given up looking because of the condition of the labour market.
Define Underemployed
Workers who are in jobs that are not suited to their skill level or workers with part time jobs but would like to work full time.
Define Recession (Unemployment)
Increasing percentage of people who were unemployed for a long stretch of time. Short stints of joblessness between positions and long term inability to find work.
Define Unemployment
The gap between the number of people who want work and the number of jobs offered at the prevailing wage.
Natural Rate Of Unemployment (equilibrium rate of unemployment)
All economies experience some level of unemployment, regardless of how well or badly the economy is doing in the short term.
Frictional unemployment, structural unemployment, and real wage/classical unemployment.
Frictional Unemployment
Caused by workers who are changing their location, job, or career.
Structural Unemployment (definition and reasons for)
Caused by a mismatch between the skills workers can offer and the skills that are in demand.
Consumer preferences constantly shifting, new technology being invented, skills that are in demand today may not be in demand next year. People have educational qualifications and job experience, and family and community qualities that are hard to change in the short run.
How Can The Government Take Steps To Minimize Structural Unemployment
Provide information to the unemployed on which professions are experiencing a demand for labour. Subsidize retraining programs.
Real Wage / Classical Unemployment
Wages that remain persistently above the market clearing level. Acts like a price floor, creates surplus labour.
Cyclical Unemployment
Unemployment caused by short term economic fluctuations in the business cycle.
Define Business Cycle
Ups and downs reflected by changes in GDP growth.
Business Cycle Effects (what, up, down)
Affects the demand for labour.
Economy up, demand for workers up.
Economy down, demand for workers down.
Effect Of Economic Slow Down
Reduction in the total demand for labour at any wage. Labour demand curve shifts left, equilibrium moves down along the supply curve, new equilibrium at a lower quantity and a lower wage.
What Does Wages Are Sticky Mean
Wages are slow to respond to shifts in the economy.
Why Are Wages Sticky
Workers may be on contracts that are difficult to change, employers may choose not to raise and lower wages (actual wages may be temporarily above market clearing level; causes cyclical unemployment).
Unemployment As A Lagging Or Trailing Indicator (Cyclical Unemployment)
Employers wait to see how bad a recession looks before making the difficult decision to lay off workers. They also wait to see how solid a recovery looks before committing to taking on new employees.
While playing wait and see firms might try to decrease or increase hours of existing employees.
Factors That May Stop Wage Rates From Falling
Minimum wage and unions and bargaining.
Minimum Wage (definition, supporters, opponents)
The lowest wage a firm can legally pay its workers
Supporters: Workers deserve a basic standard of living.
Opponents: If minimum wage is above the equilibrium, it will be binding. Could drive jobs “under the table”
Unions And Bargaining
Benefits members because it enables them to drive a harder bargain with employers. Harmful to the unemployed.
Define Labour Unions
A group of employees who bargain (together) with their employers over salaries, benefits, and work conditions.
Reasons For Efficiency Wages
- Workers are less likely to quit; firms save on advertising for interviewing and training new people.
- Higher wages encourage workers to be more productive and to work harder.
- Higher wages attract better job applicants; increasing quality in a firms work force.
Define Efficiency Wages
Deliberately setting wages above the market rate in order to increase productivity.
Result Of Efficiency Wages On Unemployment
Can create unemployment and strengthen the impact of unemployment.
When employers fire workers (rather than cut pay), the rising level of unemployment worsens the consequences of losing a job.
Employment Insurance (EI)
Paid by the government, recipients must be actively looking fir work and reporting to work related activities.
Doesn’t directly affect wage rate but it affects how quickly people find jobs and therefore the natural rate of unemployment.
Taxes And Workers Rights
Expect, all else equal, lower taxes would reduce unemployment.
Policies that protect workers leads to greater unemployment. Employers would be reluctant to hire people if they know that it will be difficult to get rid of them.
Define Compounding Of Interest
Earlier interest payments get added to the account and earning interest in turn.
Results Of Compounding
Results in total changes in GDP over time that are bigger than the annual growth rate would at first suggest. The base from which growth is measured gets bigger every year.
Define Productivity (growth)
The only way that the family can consume more and enjoy a higher standard of living is to increase the amount each person produces. (Typically measured in output per worker).
Countries And Productivity (short and long run)
A country’s income depends on how productive its workers are.
Short run: The more a country produces, the more it can consume. It can temporarily push consumption higher than production by borrowing money.
Long run: Debts have to be paid. The only why to consume more is to produce more.
Define Economic Growth
Increases in productivity per person leads to increases in per capita income. (Raises standard of living)
Components Of Productivity
Physical capital, human capital, natural resources, and technology.
Define Physical Capital
The stock of equipment and structures that allows for the production of goods and services.
i.e. a manufacture’s factory and machines, a cellular network’s towers and cables
How To Calculate Physical Capital
Add up the value of all tools, equipment, and structures.
Taking into account both new investment and the retirement of older capital, we can tell how much physical capital has been added to the economy on net.
Level Of Savings And Physical Capital
Households put savings into the bank. The bank then loans funds to firms so that they can purchase new equipment which increases productivity.
In countries with low levels of savings, firms will have trouble finding the money that they need to invest in their factories and businesses.
Define Human Capital
The set of skills, knowledge, experience, and talent that determines the productivity of workers.
Human Capital is not always improving, it can become outdated or deteriorated.
Define Natural Resources
Production inputs that come from the Earth - lakes, mineral deposits, forests, etc
Define Renewable Resources
Can be replenished over time.
Define Non-Renewable Resources
Can not be replenished over time.
Define Technology
All changes that lead to the economy to use inputs more efficiently.
Helps the same inputs produce more outputs.
Moore’s Law
People are constantly finding better and more effective ways to do things, as a result, their productivity is continuously increasing.
What Is A Production Function
An equation that captures the relationship between the quantity of inputs and the resulting quantity of outputs.
What Is Growth Accounting
The relationship between the growth rate of inputs and the resulting growth rate of outputs.
g(y) = g(a) + ag(k) + (1-a)g(l)
Formula Meaning
g = the percentage change in the variable g(y) = the growth rate of output g(a) = the growth rate of technology g(k) = the growth rate of capital g(l) = the growth rate of labour a = the share of GDP that is distributed to the owners of capital 1-a = the share of output that is distributed to labour
What Is The Growth Accounting Equation For
Offers a way to measure the importance of technology on economic growth.
Decreasing Marginal Returns To Factors Of Production
Countries that start with very little physical capital will get a higher return from adding a unit of capital than will a country that starts at a higher initial level.
Define Convergence Theory (catch up effect)
Poor countries will grow faster than rich ones, until they catch up and all countries “converge” at the same growth rate (but not the same level of income)
Define Investment Trade Off
A reduction in current consumption to pay for the investment in capital intended to increase future production and ultimately future consumption.
Define Domestic Savings
Savings that come within a country.
Domestic income minus consumption spending.
From private households spending less than they earn or government revenues exceeding non capital expenditures.
Government Investments And Private Companies
Governments often fund the underlying infrastructure that private companies rely on for their operations. i.e. roads, bridges, ports, sewer systems, etc
Define Foreign Direct Investment (FDI)
An investment that occurs when a firm runs part of its operation abroad or invests in another company abroad.
Benefits and consequences of FDI
Benefits
- Helps build up capital stock when domestic savings arn’t sufficient.
- When foreign companies invest in local firms, they can transfer human capital to local managers and workers.
Consequences
- Foreign firms with money to invest are highly sought after and can drive a hard bargain to receive special tax breaks or legal exemptions.
- The transfer of knowledge or technology may also not happen to the extent some would wish.
Government Involvement In Technological Development (due to positive externality)
Innovation has the free rider problem. Firms will under produce innovation. Governments are enticed to support research and development.
Poverty Trap
The richer you are the better able you are to pay for things that will help you be even richer in the future. The poorer you are the less able you are to pay for the things that can make you richer.
Aggregate Expenditure (Y)
The total of all expenditure in a country.
Y=C+I+G+NX
Components Of Consumption (aggregate expenditure)
Current Income, wealth, expected future income, the interest rates on saving and borrowing.
Effect Current Income Has On Consumption
People who earn more tend to spend more. Marginal propensity to consume (MPC)
Marginal Propensity To Consume (MPC)
A constant fraction of an increment if disposable income.
MPC = (change in consumption) / (change in disposable income) = (“delta” C) / (“delta” YD)
Commonly assumed poor houses have a higher MPC.
Effect Wealth Has On Consumption
Assumed that Increased wealth leads to increased consumption.
Effect Expected Future Income Has On Consumption
rise and fall
Smooth consumption.
Expected income to rise: More willing to dip into savings or borrow in order to fund a higher level of consumption today.
Expected income to fall: Consume less now in order to save more for the future.
Positive relationship with aggregate consumption.
Effect Interest Rate Has On Consumption (higher)
Higher interest rate discourages people from borrowing on credit cards and taking other loans to pay for purchase, decreases consumption. Also Encourages saving, decreases consumption.
Negative relationship with aggregate consumption.
Components Of Investment (aggregate expenditure)
Expected profitability, the interest rate, and business taxes.
What Is Investment
Changes in capital; including changes in machines, structures, software, and even rental housing.
Effect Expected Profitability Has On Investment
When firms expect their projects will be profitable, they will invest more to grow their business.
Innovations that open up new spheres for profit usually spur high rates of investment in physical capital.
Positive relationship between expected profitability and the current level of aggregate investment.
Effect Interest Rate Has On Investment (borrowing)
Interest rate can be thought of the cost of borrowing. When the cost of borrowing decreases (inflation rate decreases) then the amount of borrowing increases and vice versa.
Negative relationship between the interest rate and the amount of aggregate investment in an economy.
Holds true for firms that finance their investments by retaining earnings from their profits. Housing is also stimulated by a lower interest rate.
Effect Business Taxes Has On Investment
Business taxes reduce profits and therefore, when taxes rise, firms have less incentive to invest.
Shows a negative relationship between business taxes and aggregate investment in an economy.
Government Spending (aggregate expenditure) (short run)
In the short run, government spending is not directly affected by aggregate income, wealth, and interest rate This is because the government chooses how much to spend based on beliefs about what citizens need.
Transfer payments are not included in government spending.
Effect Transfer Payments Have On Aggregate Income
Transfer payments, like EI or Social Security benefits, are often negatively associated with aggregate income.
Components Of Net Exports (aggregate expenditure)
Domestic income, foreign income, exchange rates, tastes for foreign goods, and trade policies.
Effect Domestic Income Has On Net Exports
As domestic income rises, so does consumption.
Increase in consumption, leads to an increase in purchases of imports (also, increase in purchases of domestic goods and services). When imports increase, net exports decrease.
Domestic income and net exports and usually negatively related.
What Is Domestic Income
Income earned by those living within a country.
Effect Foreign Income Has On Net Exports
Increases in foreign income tends to increase exports.
Foreign income and net exports are usually positively related.
What Is Foreign Income
Income earned by those living outside a country.
Effect (Real) Exchange Rates Has On Net Exports
When real exchange rates increase, domestic goods get more expensive relative to foreign goods. Normally leads to an increase in imports and a decrease in exports.
Real exchange rates are negatively associated with net exports.
Effect Tastes For Foreign Goods Has On Net Exports
When tastes for foreign goods increase, domestic consumption expenditure shifts towards the consumption of imports.
Tastes for foreign goods are negatively associated with the level of net exports.
Effect Trade Policies Has On Net Exports
Should be analyzed on a case by case basis.
Not clear if it will increase or decrease net exports. Will be treated as an autonomous expenditure.
Define Autonomous Expenditure
Expenditure that is not affected by the current level of income in the economy.
i.e. basic food and housing need to be consumed even if there is zero income.
Keynes’s Insight
Firms don’t always produce the most that they can at a given price. Instead, they produce what they can sell at a given price.
Define Planned (Expected) Investment
The amount that firms actively decide to put into new capital resources and inventory accumulation.
Actual Investment (define, negative, positive)
The amount of new capital investment and actual inventory changes.
When firms draw down existing inventories, actual inventory investment is negative.
When firms accumulate inventories, actual inventory investment is positive.
How Actual And Planned Inventories Affect Production Decisions (actual >,
Actual > planned, decrease production levels.
Actual < planned, increase production levels.
Actual = planned, maintain production levels.
Planned Aggregate Expenditure (PAE)
The level of aggregate expenditure that consists of consumption, planned investment, government spending, and net exports.
Split into two parts: one part that depends on income and the other part that depends on all other factors.
PAE = A + bY
Formula Meaning + Graph (x-axis, y-axis)
PAE = planned aggregate expenditure A = (constant) represents the autonomous sources of spending b = positive coefficient that relates spending to national income (the slope of the curve) Y = national income
x-axis = actual aggregate expenditure (output, GDP, Y) y-axis = PAE
How Actual And Planned Inventories Affect Output (actual >,,
Actual > planned, Y > PAE, decrease in Y.
Actual < planned, Y < PAE, increase in Y.
Actual = planned, Y = PAE, no change in Y.
Define Keynesian Equilibrium
Planned aggregate expenditure = actual aggregate expenditure.
PAE = Y
Graphically a 45 degree line.
Equilibrium Aggregate Expenditure (graph, PAE1 above, PAE 1 below)
Intersection of PAE = Y and PAE1.
If PAE1 is above PAE = Y, make less
If PAE1 is below PAE = Y, make more
PAE Curve Shifts/Location (higher, lower)
Higher levels of PAE (like an increase in autonomous expenditure) will have a PAE curve higher up on the expenditure diagram. (lower interest rates, more business optimism, etc)
Lower levels of PAE (like a decrease in autonomous expenditure) will have a PAE curve lower on the expenditure diagram. (less government spending, higher exchange rates, etc)
Define Recessionary Output Gap
When equilibrium aggregate expenditure is below the level needed for full employment. (PAE1 will be lower than PAEfe). Graphically, the change in x.
Define Inflationary Output Gap
When the current level of output is above the level corresponding to full employment. (PAE1 will be higher than PAEfe). Graphically the change in x.
Define Multiplier Effect
An increase in consumer spending that occurs when spending by one person causes others to spend more too, increasing the impact on the economy of the initial spending.
Why Does The Multiplier Effect Occur And How Does It End
Happens to to an interaction between the consumers’ response to changes in income and firms’ reactions to the gap between planned and actual inventories.
Will come to a halt when the economy has returned to the Keynesian equilibrium (unplanned aggregate expenditure is equal to zero or where planned aggregate expenditure equals output (PAE = Y))
Positive Marginal Propensity To Consume (multiplier effect)
An initial change in government spending or consumption due to a change in taxes will affect aggregate expenditure directly and it will start a cycle in which changes in expenditure cause changes in consumption, which in turn cause changes in expenditure, and so on, until the economy returns to Keynesian equilibrium.
Define Expenditure Multiplier + How To Calculate
The factor by which output increases in response to an initial change in aggregate expenditure.
Expenditure Multiplier = (change in x) / (change in y)
