Econ 352x Michaux Michael 2012 Fall Weeks 1 5 Midterm 1 Study Guide Lectures 1 9 Topic 1 Study of national economy taken as a whole Macroeconomics Microeconomics Aggregation Focus is on economy wide variables Gross Domestic Product GDP Unemployment rate Inflation Interest and exchange rates Budget and trade deficits These variables capture economic performance and are useful in studying Long run productivity and economic growth Short run fluctuations recessions and booms Increasing general price level inflation Effects of globalization on a nation s economy Effects of government policies on economy Positive analysis what does policy do Normative analysis what is a good policy The Classical view Prices and wages adjust rapidly and economy achieves equilibrium All unemployment is frictional and voluntary The Keynesian view Prices and wages are sticky downward adjustment rarely occurs Unemployment is a result of disequilibrium Math Review A concave function exhibits diminishing returns to scale DRS These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute Marginal Product of Capital or MPK is the slope of the function in the k dimension holding l constant Marginal Product of Labor or MPL is the slope of the function in the l dimension holding k constant We are interested in rates of change or changes in addition to changes in magnitudes e g the rate of change of GDP growth rate of GDP between N periods is Annual compounding DGDP 100 GDPt N GDPt 1 N GDPt Continuous compounding DGDP 100 log GDP t N log GDPt N GDP per capita GDP Population It is a measure of variability or volatility of the series around the average The further away more numbers are from the average the higher the standard deviation is Two series are positively correlated when increases in one are usually accompanied by an increase in the other If one tends to increase when the other decreases the correlation is negative e g GDP and investment in the US are positively correlated The strength of correlation is measured by the correlation coefficient which lies between 1 and 1 GDP GDP is defined as the market value of final goods and services newly produced by domestically located capital and labor during the year Newly produced Counts only things produced in the given period excludes things produced earlier Final goods and services Don t count intermediate goods and services used up production of other goods and services in the same period that they themselves were produced Final goods services are those that are not intermediate Exception Capital goods goods used to produce other goods are final goods since they are not used up in the same period that they are produced GDP can be measured in three ways 1 Production Value Added Approach The total amount of output produced excluding output used up in intermediate stages of production 2 Expenditure Approach The total amount spent by the ultimate purchasers of output 3 Income Approach The total income received by producers of output Expenditure Approach Y GDP C I G NX where C Consumption I Investment purchases of capital goods G Government Purchases NX Net Exports X M Exports Imports Income Approach Computes GDP by examining how the factors of production labor and capital are compensated National Income Compensation Proprietor s Income Rental Income Corporate Profits Interest Employee Compensation Wages and benefits paid to employees Proprietor s Income Income of the self employed labor capital income Individual Rental Income Income earned by renting out land or structures Net Corporate Profits very volatile Corporate Revenue wages interest rents other costs Net Interest Interest earned Interest paid by individuals All approaches to GDP accounting yield the same result Fundamental identity of national income accounting Production Expenditure Income First equality Arises from using the market value to measure production consumers exhaust production with their expenditures Second equality Arises because individuals businesses and the government use their incomes to consume and invest GNP Value of final goods and services produced by domestically owned factors of production within a given period GNP GDP Net Factor Income from Abroad Inflation Rate of growth of the price level Discrete compounding v Continuous compounding CPI v GDP deflator two price indices The Consumer Price Index CPI measures how the price of a fixed basket of goods changes The CPI overstates the cost of living because it doesn t take into account consumer adjustment to changes in relative prices Nominal GDP or NGDP is the value of output at current prices Real GDP or RGDP is the value of output in base year prices currently 1996 GDPD GDP Deflator GDPD is a variable weight price index It reflect prices of goods people actually purchased in the current year instead of the basket they purchased in the base year Disadvantage The current basket may have goods that did not exist during the base year Measure of Savings Distinguish between savings and wealth Savings is a flow wealth is a stock Savings of any economic entity Current income minus Spending on current needs Investment Purchases of capital goods S I Private household business saving Spvt Private disposable income Consumption Y NFP T TR INT C Government federal state local saving Sgovt Govt receipts Govt outlays T G TR INT National saving S Spvt Sgovt Topic 2 Real Interest Rate Rate at which the real value or purchasing power of an asset usually a riskless bond increases over time Nominal interest rate is the rate at which the nominal value of increases over time Real interest rate Nominal interest rate Inflation rate Formula r i When you borrow or lend the inflation rate is unknown People form expectations on inflation and therefore we talk of expected real interest rate Formula r i re i e Production Frontier Recall that a production function relates the amount of output that can be produced to the amount of inputs and the level of productivity General form Y A F K L The inputs are called factors of production e g Capital K Labor L Land R D If doubling all inputs doubles output the production function is said to exhibit constant returns to scale CRS If output less than doubles production is said to be decreasing returns and if it more than doubles increasing returns K L and Y can be in any convenient units since A can chosen to be in the right unit to