Week 5: Economic growth, Employment, and Inflation

Question 1

def macroeconomics

Answer 1

the performance of the national economy and the global
economy

Question 2

what is economic coordination

Answer 2

mechanisms and processes through which different economic agents—such as firms, consumers, and governments—interact and allocate resources efficiently within an economy. It ensures that production, distribution, and consumption are harmonized to meet demand and supply dynamics.

Question 3

through what does economic coordination happens primarily ?

Answer 3

price adjustments
-> When demand for a good increases, its price rises, signaling firms to produce more. When supply exceeds demand, prices fall, leading firms to reduce production. This mechanism ensures resources are allocated efficiently without the need for central planning.

Question 4

what are the different mechanisms through which economic coordination happens?

Answer 4

firms, market, property rights, money

Question 5

explain firms as a mechanisms through which economic coordination happens

Answer 5

firm= an economic unit that brings together resources (factors of production like labor, capital, and raw materials) to produce and sell goods and services. It organizes these resources efficiently to maximize profit.

Question 6

explain market as a mechanisms through which economic coordination happens

Answer 6

market= where buyers and sellers interact. It provides a system for exchanging goods, services, and information. Markets exist for various products and services, from consumer goods to financial assets.

Question 7

explain property rights as a mechanisms through which economic coordination happens

Answer 7

These are the rules that define who owns what, how resources can be used, and what can be done with them (e.g., selling or leasing). Well-defined property rights help ensure efficient resource allocation and prevent conflicts over ownership.

Question 8

explain money as a mechanisms through which economic coordination happens

Answer 8

Money serves as a medium of exchange, making trade easier. Instead of bartering, people use money to buy and sell goods and services efficiently. It also acts as a unit of account and a store of value.

Question 9

what is a factor market

Answer 9

all of the resources that businesses use to purchase, rent, or hire what they need in order to produce goods or services (machinery, investment, labour…)

Question 10

what does macroeconomic measurment means?

Answer 10

Macroeconomic Measurement – Understanding how the economy is quantified.

Question 11

what is national income accounting

Answer 11

National Income Accounting – Methods used to calculate economic activity, like GDP, ensuring that: the sum of all production (output) matches the sum of all income (earned) + policymakers and economists can measure economic performance and make comparisons over time.

Question 12

what is Loanable Funds Market

Answer 12

– The interaction between savers and borrowers, determining interest rates.

Question 13

what is money market

Answer 13

Money Market – The market for short-term borrowing and lending, crucial for understanding monetary policy.

Question 14

what is GDP

Answer 14

gross dmestic product
-> the market value of all final goods and services produced within a country in a given time period (usually a year or a quarter). It serves as a key indicator of economic activity and growth.

Question 15

why is GDP relevant?

Answer 15

Why Are Some Countries Rich and Others Poor?
GDP helps compare economic performance across countries. Higher GDP generally means a country has more resources for development, infrastructure, and social services.

How Do We Measure Standard of Living?
GDP per capita (GDP divided by population) gives an average measure of economic well-being. However, it does not account for income distribution, health, education, or environmental factors.

Question 16

what are intermediate goods

Answer 16

These are goods used in the production of final goods
-> do not depend on the product but on it’s use (ex: chocolat can be sell in supermarket as a final product or it can be sell to a bakery, that uses it to make a cake)

Question 17

what is double counting

Answer 17

occurs when the value of intermediate goods is included in GDP along with the value of the final goods, leading to an overestimation of economic output.
-> To avoid double counting, GDP only includes the value of final goods and services (the finished car, not the steel inside it)

Question 18

what are the 3 approaches for GDP measurment

Answer 18

*Total Production Approach: Summing the value of all final goods and services produced.
*Total Expenditure Approach: Adding up all spending in the economy (Consumption + Investment + Government Spending + Net Exports).
*Total Income Approach: Measuring GDP as the total income earned by workers and businesses (wages, profits, rents, etc.).
-> These three measurements are equal because one person’s spending is another person’s income, forming a circular flow of economic activity (Total Income = Total Expenditure = Total Production)

Question 19

what is the circular flow model

Answer 19

a simplified economic model that shows how money, goods, and services flow between different economic agents in an economy. It illustrates the interaction between households and firms, and how income and expenditure move through the system.
2=/ types: Two-Sector Circular Flow (Basic Model) and Expanded Circular Flow (Including Government and Foreign Sector)

Question 20

explain the Two-Sector Circular Flow as a circular flow model

Answer 20

There are two key actors in the simplest model:
-Households: Own factors of production (labor, land, capital) and consume goods and services.
-Firms (Businesses): Produce goods and services using inputs (factors of production) from households.

How Money and Goods Flow:
-Factor Market: Households supply labor and other resources to firms in exchange for income (wages, rent, interest, profits).
-Product Market: Firms produce goods and services, which households buy using their income.

Question 21

explain the Expanded Circular Flow as a circular flow model

Answer 21

To make the model more realistic, we add:
-Government: Collects taxes from households and firms, and spends on public goods (schools, roads, healthcare).
-Financial Sector: Households save money in banks, which firms borrow for investment.
-Foreign Sector: Includes exports (money flows into the economy) and imports (money flows out).

Key Principle:
-Total Income = Total Expenditure = Total Production
-One person’s spending is another person’s income, keeping the economy flowing.

Question 22

Does my purchase of a domestically produced BMW car that was manufactured in 2015 add to
the Netherlands’ GDP this year?

Answer 22

NO:
1. GDP Measures Current Production (only includes goods and services produced in the given year)
2. Secondhand Goods Are Not Included
The sale of used goods is not included in GDP to avoid double counting (it was counted in 2015 when it was first sold).

What Would Be Counted?
-Dealer Services: If you buy the car from a dealership, any service fee or markup from the dealer would count as part of GDP under the services sector.
-Repairs and Maintenance: If you pay for services like a new paint job or engine repairs, those services contribute to GDP.

Question 23

what is the formula that represents Gross Domestic Product (GDP) using the expenditure approach

Answer 23

calculates GDP by summing all spending on final goods and services in an economy:
GDP = C + I + G + (X - M)
-> C (Consumption): Spending by households on goods and services (e.g., food, rent, healthcare).
I (Investment): Spending by businesses on capital goods (e.g., machinery, buildings) and by households on new housing.
G (Government Spending): Expenditures by the government on goods and services (e.g., infrastructure, public services).
X (Exports): Goods and services produced domestically and sold abroad.
M (Imports): Goods and services produced abroad and purchased domestically
-> X-M:Since GDP measures domestic production, we subtract imports (M) because they are not produced within the country- Net exports (X - M) account for the balance of trade

Question 24

what does total expenditure means

Answer 24

total spending

Question 25

what is GDI

Answer 25

(Gross Domestic Income) → GDP from income approach, where: W (Wages): Income from labor. P (Profits): Earnings of businesses. R (Rents): Income from property. I (Interest): Earnings from investments. T (Taxes on production and imports): Indirect taxes like sales tax. S (Subsidies): Government payments to firms, subtracted since they are not market income. GDI=W+P+R+I+T−S

Question 26

what is economic growth

Answer 26

the increase in real GDP over time. It indicates higher productivity, better living standards, and greater economic opportunities. -> It can be represented by an outward shift of the Production Possibility Frontier (PPF), meaning the economy can produce more goods/services.

Question 27

what is price level

Answer 27

the average of current prices across goods and services in an economy.

Question 28

what are inflation and deflation + why is it not good

Answer 28

*inflation: the rate at which the price level increases over time, reducing purchasing power. *deflation: falling of the price level. It increases the value of money because goods and services become cheaper. -Inflation erodes the purchasing power of money, meaning consumers will need more money to buy the same goods and services. -deflation can lead to serious economic problems, including lower wages and higher unemployment, as businesses struggle with declining revenues.

Question 29

Quantity Effect vs. Price Effect

Answer 29

They help distinguish whether economic expansion comes from actual production increases or price changes (inflation): *Quantity Effect: Economic growth occurs when the economy produces more goods and services (increase in real GDP). -> ex: A country produces 10 million cars in 2024 instead of 9 million in 2023, leading to higher real GDP *Price Effect: When prices increase without a corresponding rise in output, nominal GDP rises, but this is due to inflation, not real growth. -> ex: The same 9 million cars are produced, but each car is 10% more expensive, increasing nominal GDP without real growth

Question 30

what is nominal GDP=/ real GDP

Answer 30

nominal GDP= Measured using current prices, includes inflation real GDP= Adjusted for inflation, reflects the actual quantity of goods and services produced.

Question 31

why use real GDP?

Answer 31

Allows for comparisons over time (since inflation distorts nominal GDP). Helps compare standards of living across countries.

Question 32

what is GDP deflator

Answer 32

a measure of the overall price level in an economy and is used to adjust nominal GDP to real GDP: GDP Deflator= (Nominal/real GDP)×100 -> If the GDP deflator is greater than 100, prices have increased since the base year (inflation). If it’s less than 100, prices have decreased (deflation).

Question 33

what is potential GDP

Answer 33

The economy’s maximum sustainable output when all available labor, capital, and resources are fully utilized. -> When the economy is at full employment, all available workers and resources are used efficiently, and GDP is at its potential level. -> Potential GDP per person is a key indicator of a country’s long-term productive capacity and standard of living.

Question 34

what is business cycle?

Answer 34

fluctuations in real GDP over time: =/ phases: -Expansion: Real GDP grows (rising employment, income, and production). -Peak: The highest point before GDP starts declining. -Recession: A period of declining real GDP (falling output, job losses). -Trough: The lowest point before economic recovery begins. -> Real GDP fluctuates above or below potential GDP during the business cycle, causing periods of booms and busts.

Question 35

If a homeowner cuts his or her lawn, is the value of this work included in real GDP? Suppose that the homeowner hires a neighborhood kid to cut the lawn. Is this activity included in real GDP?

Answer 35

NO and NO: Unpaid household work is not included in GDP. Paid labor and market transactions are included in GDP (but there probably not declared)

Question 36

what are the limitations of real GDP (not included in)

Answer 36

1. Household Production (Not Included in GDP): Work done within households that isn’t sold in the market (e.g., cooking, cleaning, child care). Issue: If a country has more household production and less reliance on paid services, its GDP may appear lower, even if the actual well-being is high. 2. Underground Economic Activity: Economic transactions that go unreported to avoid taxes or regulations (e.g., informal jobs, illegal trade). Issue: In countries with large informal sectors, GDP underestimates total economic activity. 3. Leisure Time (Not Accounted for in GDP): Free time people have for rest, hobbies, or social activities. Issue: GDP only measures work-related production, ignoring the value of leisure. Example: Two countries with the same GDP but different work hours: Japan (longer work hours, less leisure) France (shorter work hours, more leisure) Even if GDP is the same, France may have a higher standard of living due to better work-life balance. 4. Environmental Quality (Ignored by GDP): The health of the natural environment (clean air, water, sustainable resources). Issue: GDP counts economic activity, even if it damages the environment, without subtracting the costs of pollution or resource depletion. 5. real GDP per capita may not fully reflect the differences in standards of living, job quality, or environmental impact + Currency values and price levels vary across countries. Therefore, when comparing real GDP using nominal exchange rates, this could distort the comparison.

Question 37

what is GDP per capita

Answer 37

GDP per capita = Real GDP / Population It is often used to compare the standard of living between countries, but it does not capture non-economic factors like health, education, or happiness. Example: S. A may have high GDP per capita due to oil wealth, but Norway’s strong welfare system, healthcare, and education lead to a better standard of living.

Question 38

growth rate

Answer 38

growth rate measures how fast real GDP is increasing over time: Growth Rate= (Real GDP in current year−Real GDP in previous year/ Real GDP in previous year)×100

Question 39

how does potential GDP Growth:

Answer 39

-> Sustained Increase in Potential GDP: economic growth happens when potential GDP increases, and this increase is sustained year after year, typically driven by improvements in labor productivity and technological advancements. 1. increase in a population: more people= more workers-> increase in labor input. This increases real GDP, but not necessarily potential GDP unless these workers are employed in productive sectors. -> Quantity vs. Quality of Labor: Simply adding more people doesn’t guarantee higher potential GDP—it depends on education, skills, and capital investment. 2. increase in labor productivity (how much output each worker can produce) leads to an increase in potential GDP + leads to higher potential GDP per hour of labor (so better life conditions for workers) Example: If workers can produce more output per hour due to better technology, education, or capital (like machinery), this increases potential GDP without needing a population increase.

Question 40

what is the aggregate production function

Answer 40

the relationship between labor and real GDP -> curve labeled PF (Production Function) demonstrates that as labor increases, real GDP rises. However, the curve's shape reflects the law of diminishing returns: each additional unit of labor contributes less to GDP growth.

Question 41

what is the key differences in economic growth (btwn labour hours and productivity; and aggregte labour hours and productivity)

Answer 41

*Interaction Between Labor Hours and Productivity: -Labor hours (how many hours people work) and labor productivity (how efficiently they work) are interdependent. -The interaction effect means that just increasing the number of workers or their hours doesn’t necessarily improve potential GDP if they aren’t also becoming more productive. *Increase in Aggregate Labor Hours vs. Productivity -Increase in aggregate labor hours (total supply of labor available in an economy)= often a consequence of economic growth (as more people find jobs), this can increase potential GDP. -Increase in productivity is a cause of economic growth, driving the long-term improvement in potential GDP.

Question 42

what is the unemployment rate vS employment rate

Answer 42

Formula: Unemployment Rate= (Number of Unemployed/ Labor Force) ×100 -> the percentage of the labor force that is actively seeking work but is unable to find a job. labor force= employed and unemployed people who are actively seeking work. Unemployed People = Individuals without a job who are actively looking for work. Formula: Employment Rate= (Number of Employed/ Working-Age Population)×100 -> shows the proportion of the working-age population (usually those aged 16-64) that is employed.

Question 43

what is the economically active rate

Answer 43

Formula: Economic Activity Rate= (Labor Force/ Working-Age Population)×100 -> measures the proportion of the working-age population that is either employed or actively seeking work

Question 44

what are the different types of unemployment

Answer 44

When real GDP grows, businesses demand more labor, leading to lower unemployment. Conversely, in a recession, real GDP contracts, leading to higher unemployment. 1. Frictional Unemployment 2. Structural Unemployment 3. Cyclical Unemployment 4. Natural Unemployment

Question 45

Frictional Unemployment

Answer 45

occurs when people are temporarily between jobs, such as those entering or re-entering the workforce, or changing jobs. Example: A recent graduate looking for their first job, or someone quitting their job to find a better opportunity. Characteristics: It’s usually short-term and reflects job search and career transition.

Question 46

Structural Unemployment

Answer 46

occurs due to long-term changes in the economy that alter the demand for skills or the location of jobs. Example: Technological advancements making some jobs obsolete or international competition moving jobs to other countries. Characteristics: It reflects a mismatch between the skills of the workforce and the needs of the economy. Solution: Addressed through retraining programs and policies to adapt to new industries.

Question 47

cyclical unemployment

Answer 47

tied to the business cycle -> during recessions, demand for goods and services falls, leading to a reduction in labor demand and higher unemployment. Characteristics: It fluctuates with the economic cycle and usually improves when the economy recovers. Solution: can be reduced through monetary and fiscal policies (such as interest rate cuts or government stimulus).

Question 48

natural unemployment

Answer 48

includes frictional and structural unemployment but excludes cyclical unemployment. Natural rate of unemployment is the rate of unemployment that the economy experiences even when it’s performing well, and the labor market is functioning efficiently. Characteristics: It’s the baseline unemployment rate that is typically always present in an economy.

Question 49

is this sentence "Unemployment rate = 1 - employment rate" correct?

Answer 49

NO: If the employment rate is high, the unemployment rate is typically low, but they are not directly inversely related.

Question 50

what is full employment

Answer 50

situation where the economy is operating at its potential GDP, and only natural unemployment (frictional and structural) exists. Full employment doesn’t mean 0% unemployment, because there will always be some level of frictional and structural unemployment. -> Unemployment Rate at Full Employment = Natural Unemployment Rate

Question 51

unexpected surge in either inflation or deflation can lead to several negative outcomes

Answer 51

1. Redistributes Income: -Inflation: People with fixed incomes suffer because their purchasing power decreases, while people with assets tied to inflation (such as real estate) may benefit as the value of their holdings rises. -Deflation: Debtors suffer, as the real value of their debt increases, while creditors may benefit because the money they are repaid is worth more. 2. Redistributes Wealth: -Inflation: as those who own real assets (like property) see the value of their wealth increase, whereas those holding cash or bonds may see the value of their savings decrease. -Deflation tends to increase the real value of money, benefiting those with cash savings but hurting those with debts (because the real value of debts increases). 3. Reduces Real GDP and Employment: -Inflation: creates uncertainty in the economy-> reduce investment and consumption-> lower real GDP and higher unemployment as businesses struggle to plan for the future. -Deflation: reduction in consumer spending, as people expect prices to fall further and delay purchases-> businesses cut back on production and lay off workers-> decline in real GDP and increased unemployment. 4. Diverts Resources from Production: -> Inflation and deflation can cause businesses and individuals to focus less on productive activities and more on hedging against inflation or protecting against deflation. This can divert resources away from investments in growth and innovation and into speculative activities (like hoarding goods or investing in gold).

Question 52

price indexs

Answer 52

help measure the change in the price level over time. Some common price indexes include: -Consumer Price Index (CPI): measures the average price change over time of a basket of consumer goods and services. It’s often used to track inflation at the consumer level. BUT doesn’t measure the prices of all goods in the economy, like capital goods or government spending, so it’s not a complete measure of inflation across the entire economy. -GDP Deflator: broader measure of inflation because it includes the prices of goods in investment, government expenditure, and net exports (exports minus imports).

Question 53

real variables

Answer 53

adjust for inflation 1. Real Wage Rate:adjusts the nominal wage (the wage paid in current dollars) by the inflation rate, as measured by the GDP deflator or the CPI. This gives a clearer picture of how much people can actually buy with their wages over time. Formula: Real Wage Rate=Nominal Wage/ GDP Deflator -> how wages are changing in real terms, or how much buying power people have. 2. Real Interest Rate: adjusts the nominal interest rate for inflation. This reflects the actual purchasing power that is gained or lost when borrowing or lending money. Formula: Real Interest Rate= Nominal Interest Rate−Inflation Rate If inflation is high, the real return on an investment or loan may be negative, even if the nominal interest rate appears attractive. -> The exception to these relationships typically involves hyperinflation or stagflation, situations where inflation leads to severe economic dislocation, disrupting the usual patterns of inflation’s effects.

Question 54

what are the main theories of economic growth?

Answer 54

1. Classical growth theory or Malthusian theory (by Smith, Riccardo… but assimilated to Malthus): Economic growth is temporary because any increase in GDP per person leads to population growth, which in turn lowers GDP per person back to the subsistence level (bare minimum to survive). → mechanism : If GDP per person rises, population increases (more food, more births) ; More people mean more competition for resources (land, food, jobs) ; This drives wages down and brings living standards back to subsistence => Result: No long-term economic growth, just cycles of temporary improvement followed by decline. → Criticism: The theory failed to predict modern economic growth because it did not account for technological progress, which allows economies to grow despite population increases. 2. Neoclassical growth theory (by Solow): GDP per person grows due to capital accumulation (investment in machinery, infrastructure) and technological progress BUT growth stops if technological progress stops. → mechanism: Investment in capital (machines, buildings) increases output BUT diminishing returns reduce the impact of more capital over time=> Only technological progress can sustain long-term growth. → criticism: New growth theory: It assumes that technological progress happens by chance rather than being influenced by human action+ It predicts global income convergence (poor countries catching up to rich ones), but real-world evidence shows that convergence is slow and uneven. 3. New Growth Theory (by Romer): Economic growth is driven by people's choices and incentives to innovate. Growth can continue indefinitely because knowledge and technology do not have diminishing returns. -> mechanism: Technological progress is not random—it happens because firms and individuals actively invest in R&D SO profit-seeking behavior drives innovation (people will always innovate because they want to maximize profit) ; unlike physical capital, knowledge does not wear out or become less productive ; once a new technology is discovered, everyone can benefit (it becomes a public good). -> criticism: The real interest rate (return on investment) doesn’t always fall with more capital. Instead, innovation creates new profitable opportunities, keeping investment levels high.

Question 55

what's the diff btwn consumption expenditure, investment and government expenditure

Answer 55

-Consumption Expenditure: spending by households on goods and services for immediate use; part of aggregate demand but does not contribute directly to future production capacity. EX: food -Investment: spending on capital goods that will be used to produce future goods and services. This includes business purchases of machinery, equipment, infrastructure, and construction of buildings. Investment increases future productive capacity. EX: A firm purchasing new machinery -Government Expenditure: Spending by the government on goods and services; include public sector wages, infrastructure projects, military spending, and social services; contributes to aggregate demand and may be for consumption or investment purposes. EX: the gov building a highway