Economics Unit 3
Economics Unit 3
Measuring a Nation’s Income
a. Microeconomics- study of how individual households and firms make decisions and how they interact in markets
b. Macroeconomics- the study of economy-wide phenomena (inflation, unemployment and economic growth)
c. Gross Domestic Product (GDP)- market value of all final goods and services produced within a country in a given period of time
i. Measures total income of everyone in economy
ii. Measures total expenditures of goods and services
iii. Only includes final goods
d. Components of Expenditure:
i. Consumption-spending by households on goods and services, with the exception of purchases of new housing
ii. Investment- spending on capital equipment, inventories and structures, including household purchases of new housing
iii. Government purchases- spending on goods and services by local, state and federal governments
iv. Net exports- spending on domestically produced goods by foreigners (exports) minus spending on foreign goods by domestic residents (imports)
1. Exports—imports
e. Transfer payments- not made in exchange for a currently produced good
f. Nominal GDP- production of goods and services valued at current prices
i. Measures prices
g. Real GDP- production of goods and services valued at constant prices
i. Measures production
ii. Choose a year as a base year
h. GDP deflator- a measure of the price level calculated as a ration of nominal GDP to real GDP x 100
i. Reflects prices of goods and services
i. Gross Domestic Product—all goods and services that a nation provides in a given time
i. Measurement of standard of living
j. Income approach- adding up total income earned in economy
k. Investments- spending by businesses and firms
l. GDP Deflator vs. CPI
i. GDP deflator- everything
1. Reflects price of all goods and services produced domestically
ii. CPI- what every normal person consumes
1. Reflects prices of all goods and services bought by consumers
Measuring the Cost of Living
m. Consumer price index- measure of the overall cost of the goods and services bought by a typical consumer
i. Monitor changes in the cost of living over time
n. Inflation- economy’s overall price level is rising
o. Inflation rate- % change in price level from the previous period
p. To calculate index: (year price/base year price) X 100
q. Producer price index- a measure of the cost
r. CPI tries to gauge how much incomes must rise to maintain a constant standard of living
s. Problems in measuring standard of living:
i. Substitution bias- prices do not always change proportionately from year to year
1. Consumers substitute toward goods that have become relatively less expensive
ii. Introduction of new goods- greater variety makes each dollar more valuable
iii. Unmeasured quality change- if quality deteriorates, value of a dollar falls even if it remains the same
t. Indexation- the automatic correction of a dollar amount for the effects of inflation by law or contract
u. Cost of living allowance (COLA)- partial or complete indexation of the wage to CPI
i. Automatically raises the wage when the consumer price index rises
v. Nominal interest rate- the interest rate as usually reported without a correction for the effects of inflation (interest rate the bank pays)
i. How fast number of dollars in bank account rises over time
w. Real interest rate- the interest rate corrected for the effects of inflation
i. How fast purchasing power rises
x. Real Interest Rate=Nominal Interest Rate—Inflation Rate
y. Sticky wage theory- unanticipated inflation (no raise in wages)
i. Do not keep pace with inflation
ii. No wage increases with inflation increases
z. COLA- Cost Of Living Adjustment
aa. Consumer prices index- doesn’t measure every single good—measures quality of new products
Production and Growth
a. Growth rate measures how rapidly real GDP per person grew in the typical year
b. Productivity- the amount of goods and services produced from each hour of a workers time
i. Key determinant of living standards
c. Country’s standard of living depends on ability to produce goods and services
d. Resources make a nation produce
e. Productivity determined by: physical capital, human capital, natural resources and technological knowledge
f. Physical capital- the stock of equipment and structures that are used to produce goods and services
i. Inputs to goods and services are factors of production
g. Human capital- the knowledge and skills that workers acquire through education, training and experience
h. Natural resources- the inputs into the production of goods and services that are provided by nature (land, rivers, mineral deposits)
i. Technological knowledge- society’s understanding of the best ways to produce goods and services—developed through human capital
j. Diminishing returns- the property whereby the benefit from an extra unit of an input declines as the quantity of the input increases
k. Higher savings rate leads to higher level of productivity and income, but not to higher growth in these variables
l. Catch-up effect- the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich—“most improved”
m. Foreign direct investment- a capital investment owned and operated by a foreign entity
n. Foreign portfolio investment- investment financed with foreign market operated by domestic producers
o. Brain drain- emigration of many of most highly educated workers to richer countries
p. Government can fosters economic growth by protecting property rights and promoting political stability
q. Property rights- ability of people to exercise authority over resources they own
r. Inward-oriented policies- aimed at raising productivity and living standards within a country by avoiding interaction with the rest of the world
s. Outward-oriented policies- integrate countries into world economy—usually means higher rate of economic growth
t. GDP per person: tells quantity of goods and services available for typical individual in economy
u. Government lends support to invisible hand by maintaining property rights and political stability
v. Compound interest- the accumulation of interest over time
w. Rule of 70: 70/%= # of years for investment to double
Unemployment and Its Natural Rate
ab. When a country keeps its workers as fully employed as possible, it achieves a higher level of GDP than it would if workers were left idle
ac. Natural rate of unemployment- amount of unemployment economy naturally experiences (6%)
ad. Cyclical unemployment- year to year fluctuations in unemployment around natural rate
i. Closely associated with growth and recessions in economic activity
ae. Bureau of Labor Statistics measures unemployment
af. Labor force- the total number of workers (employed + unemployed)
ag. Unemployment rate- % of labor force that is unemployed (#unemployed/labor force9 X 100
ah. Labor force participation rate- measures percentage of adult population that is in labor force (labor force/adult population) X100
ai. Discouraged workers- individuals who would like to work but have given up looking for a job
aj. Most spells of unemployment are short, but it is long term when observed at any given time
ak. Frictional unemployment- unemployment that results because it takes time for workers to search for the jobs that best suit their tastes and skills (time spent between jobs)
al. Structural unemployment- unemployment that results because the number of jobs available in some labor market is insufficient to provide a job to everyone who wants one (workers may lack skills needed)
am. Job search- the process by which workers find appropriate jobs given their tastes and skills
an. Consumers determine amount of frictional unemployment
ao. Sectoral shifts- changes in composition of demand among industries or regions
ap. Unemployment insurance- a government program that partially protects worker’s incomes when they become unemployed
aq. When minimum wage above equilibrium level, result is surplus of labor=unemployment
ar. Union- a workers association that bargains with employees over wages and working conditions
i. Group of sellers acting together in the hope of exerting a joint market power
as. Collective bargaining- the process by which unions and firms agree on the term of employment
at. Strike- the organized withdrawal of labor from a firm by a union
au. Right to work laws- works of a unionized firm have the right to choose to join union or not
av. Efficiency wages- above-equilibrium wages paid by firms in order to increase worker productivity
aw. Reasons for efficiency wage theory: worker health, turnover, effort and quality
ax. Reservation wage- lowest wage a worker will accept
ay. Adverse selection- one person knows more about the attributes of a good than another
az. Reasons why economies experience unemployment: job search, minimum wage laws, unions, efficiency wages
ba. Underemployment- a time of recession when workers are not earning what they should be earning
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