EC 111 1st EditionExam #2 Study Guide: Chapters 10, 11, 13, 15CHAPTER 10: MEASURING A NATION’S INCOME- GDP is the most closely watched economic statistic because it is thought to be the best single measure of society’s well-being- GDP measures two things at once:o Total income o Total expenditure- For an economy as a whole; income must equal expenditure- Gross Domestic Product (GDP): the market value of all final goods and services produced within a country in a given period of timeo GDP is the market value… GDP adds together many different products Market prices are used to set the value for each itemo …All of… Includes all items produced and sold legally in markets GDP also includes the value of housing services- Rent- The government includes owner occupied housing in GDP by estimating a person’s house’s rental value No duties at home (mowing or housework)o …Final… GDP only includes the value final goods- The value of intermediate goods is already included in the value of the final goodo …Goods and Services… GDP includes tangible goods and intangible serviceso …Produced… GDP includes goods and services currently produced Resold items are not included in GDPo …Within a Country… Only things produced in the country- Even other country’s factories located in America- Factories belonging to America located in other countries do not counto …In a Given Period of Time… GDP measures a specific interval of time (usually a year or quarter)GradeBuddy- Seasonal Adjustment: shows quarterly data that allows to look past seasonal changes- The difference between income and GDP and expenditure GDP is called statisticaldiscrepancy- Y=C+I+G+NXo Y=GDPo C=Consumptiono I=Investmento G=Government Purchaseso NX=Net Exports- Consumption: spending by households on goods and services with the exception of purchases of new housing- Investment: spending on capital equipment, inventories, and structures, including household purchases of new housingo GDP investment means the purchases of goods (such as capital equipment, structures, and inventories) used to produce other goods and services in the future- Government Purchases: spending on goods and services by local, state, and federal governmento Army and teacher salarieso Excludes social security or insurance benefits (these are transfer payments)- Net Exports: spending on domestically produced goods by foreigners (exports) minus spending on foreign goods by domestic residents (imports)- If total spending rises one of two things must be trueo The economy is producing a higher output of goods and serviceso Goods and services are being sold at higher prices- Economists want to separate the two effects- Nominal GDP: the production of goods and services valued at current prices- Real GDP: the production of goods and services valued at constant priceso Need a base year to calculate- GDP Deflator: a measure of the price level calculated as the ratio of nominal GDP to real GDP *100o GDP Deflator= (Nominal GDP/Real GDP)*100o Always equals 100 in the base yearo GDP deflator reflects what’s happening with prices not quantitieso can be used to take inflation out of nominal GDP- GDP does not measure health, quality of education, joy, beauty, strength, intelligence, integrity etc.- GDP does usually lead to good things- GDP omits the value of goods and services produced at home, quality of environment, and does not tell us about the distribution of incomeGradeBuddyCHAPTER 11: MEASURING THE COST OF LIVING- The CPI is used to monitor changes in the cost of living over time- Consumer Price Index (CPI): a measure of the overall cost of goods and services bought by a typical consumer- The BLS uses data on prices of thousands of goods and services- How to calculate the CPI1. Fix the Basket: determine which prices are more important to the typical customer2. Find the Prices: find the prices of each good or service in the basket at each point in time3. Compute the Basket Cost4. Choose a Base Year and Compute the Indexa. CPI=price of basket of goods/services in current year/CPI in the base year5. Compute the inflation Ratea. Inflation Rate: the percent change in the price index from the preceding yearb. (CPI in year 2-CPI in year 1)/CPI in year 1- Producer Price Index: a measure of the cost of a basket of goods and services bought by firms- CPI tries to measure changes in the cost of living- CPI is computed using a fixed basket of goods when prices change there could be substitution bias. Consumers switch products- Two important things that cause GDP and CPI to divergeo GDP deflator reflects the prices of all goods and services produced domestically CPI reflects prices of all goods and services bought by consumerso GDP deflator compares the prices of currently produced goods and services and changes automatically. The CPI compares prices of fixed basket. The BLS only changes the basket occasionally- We can compare prices in the past to prices now o Amount in year T*(Price level Today/Price level in year T)- Indexed: the automatic correction by law or contract of a dollar amount for the effect of inflationo Many long term contracts include partial or complete indexation of wage to consumer price index- Nominal Interest Rate: the interest rate as usually reported without a correction for the effects of inflation- Real Interest Rate: the interest rate corrected for the effects of inflationGradeBuddyCHAPTER 13: SAVING, INVESTMENT, AND THE FINANCIAL SYSTEM- Financial System: the group of institutions that help to match one person’s savings with another person’s investment- Financial Markets: financial institutions through which savers can directly providefunds to borrowers- Bond: a certificate of indebtednesso Junk Bonds: very risky, very high interest- Stock: a claim to partial ownership of a firm- Mutual Fund: an institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bondso Index Funds: buy all stocks in a given stock index perform somewhat better on average- All financial institutions have the same goal: direct the resources of savers into the hands of borrowers- The total income in the economy that remains after paying for consumption and government purchases is:o I=Y-C-G or I=S or S=Y-C-G- National Saving (Saving): the total income in the economy that remains after paying for consumption and government purchases - Private Saving: the income that households have