Term 1 Flashcards
What are the 3 ways of defining GDP?
- Value of the final goods and services produced in the economy during a given period
2) Value added in the economy during a given period
3) Sum of incomes (wages + profits) in the economy during a given period
Intermediate goods
Goods used in the production process
Nominal GDP ($Y)
The sum of quantities of final goods produced multiplied by their current price
Real GDP (Y)
The sum of quantities of final goods multiplied by constant prices
Why is real GDP better than nominal?
We want to measure production and its change over time (not prices)
Base year
Year used to construct prices
Difficulties with measuring GDP
1) The quality of products is changing over time
2) Many new services are free (e.g. Google)
3) Measuring illegal production is difficult
4) Home production is normally excluded from GDP
Real GDP in chained dollars
Weighted average of all final goods, giving greater weight to production with greater importance in the economy
Unemployment
The number of people who do not have a job but are actively looking for one
Labour force
The sum of employment and unemployment
Unemployment rate
The ratio of the number of people who are unemployed to the number of people in the labour force
Discouraged workers
Those who give up looking for a job and so are no longer counted as unemployed
Participation rate
The ratio of the labour force to the total population of working age (18-65)
Significance of unemployment
1) Directly affects the welfare of the unemployed
2) High unemployment is a signal that the economy is not using its human resources efficiently
3) Very low unemployment could mean the economy runs into labour shortages
Inflation
A sustained rise in the general level of prices (the price level)
Inflation rate
The rate at which the price level increases
Deflation
A sustain decline in the price level
GDP deflator
The ratio of nominal GDP to real GDP
Relationship between nominal GDP, real GDP and GDP deflator
Nom GDP = Real GDP x GDP deflator
Rate of growth of nominal GDP =
The rate of inflation + the rate of growth of real GDP
Differences between inflation rate and CPI
1) Some of the goods in GDP are sold to firms, the government or foreigners rather than consumers
2) Some of the goods bought by consumers are not produced domestically (imported)
Consumer Price Index (CPI)
Measure of the cost of living (calculated through consumption basket of typical consumer)
Significance of inflation
1) Inflation affects income distribution when not all prices and wages rise proportionally
2) Inflation leads to distortions due to uncertainty, and because of its interaction with taxation
Consumption
Goods and services purchased by consumers
Investment
The sum of non-residential and residential investment
Government Spending
Purchases of goods and services by foreigners
Imports
Purchases of foreign goods by domestic consumers, firms, and government
Trade surplus
Exports > Imports
Trade Deficit
Imports > Export
Inventory investment
difference between production and sales (add goods produced this year but not sold and vice versa)
Consumption function
Function of disposable income (income that remains once consumers have received their government transfers and paid their taxes)
Keynesian consumption function equilibrium condition
Y = 1/(1-c1) * (c0 + I + G - c1T)
1) C = c0 +c1*YD
2) Substitute formula for disposable income: C = c0 + c1(Y-T)
3) Add I, G and T (exogenous)
What are c0 and c1 in the Keynesian consumption function?
1) c0 is consumption when disposable income is zero
2) c1 is marginal propensity to consume
Autonomous spending in Keynesian consumption function
The part of the demand for goods that does not depend on output (c0 + I + g + c1T)
Why is autonomous spending positive?
If T=G (balanced budget) and c1 is between 0 and 1 then G-c1T is positive
What is the multiplier?
1/(1-c1) - larger the closer c1 is to 1
Why is the increase in output larger than the initial shift in demand?
1) Production depends on demand, which depends on income, which is itself equal to production
20 An increase in demand leads to an increase in production and income, which in turn leads to a future increase in demand
Dynamics of adjustment
The adjustment of output over time (how long this takes depends on how and when firms revise their production schedule)
