ECO2013 Exam 2 10/31/13Chapter 7: Taking the Nation’s Economic PulseGDP- The market value of final goods and services produced within a country during a specific period (usually a year)1. Only final goods and services count2. Only transactions involving production count3. Only production within the country is counted4. Only goods produced within the current period are countedFirst way to measure GDPExpenditure approachGDP=sum of purchasesGDP=Y=C+I+G+XC=consumption; purchases for goods and services by consumersI=Investment; businesses buying final goods and services to use in their production of another good ANDconsumers buying houses*Business plants and equipment are investment goods*A substantial amount of net investment indicates that the capital stock of the economy is growing, thereby enhancing the economy’s future productive potential. G=Government purchases*Government component includes both (1) expenditures on items like office supplies, law enforcement, and the operation of veterans’ hospitals and (2) the purchase of long-lasting capital goods,like missiles, highways, and dams for flood control.X=exports-importsLargest component of GDP is consumption.Second way to measure GDPIncome ApproachSumming up the income payments to the resource suppliers and the direct cost of producing the goods and services.National income+ indirect business taxes+ depreciation+ net income of foreignersHigher income levels are caused by more output.GNP-the total market value of all final goods and services produced by the citizens of a country. It is equal to GDP minus the net income of foreigners.Nominal v. Real valuesNominal (money) values- current year data onlyReal values- adjusted for inflationUse a price index to adjust nominal values into real values.GDP deflator designed to measure the change in the average price of the market basket of goods included in the GDPCPImeasures the impact of price changes on the cost of a typical bundle of goods and services purchased by householdsGDP deflator is broader and covers almost all goods bought.Inflation- the percentage change in an index, an increase in the general level of prices.Problems with GDP as a measuring rod:1. It does not count non-market production2. It does not count the underground economy3. It makes no adjustment for leisure4. It probably understates output increases because of the problem of estimating in the quality 5. It does not adjust for harmful side effectsChapter 8: Economic Fluctuations, Unemployment, and InflationThe four phase of the business cycle are expansion, peak, contraction, and recessionary trough.The business cycle varies and is unpredictable.The average annual growth rate is 3%.Total population divided into 2 categories:Unemployed but want to beemployedEmployedIn labor forceNot in labor force (students,retirees, disabled)Over age 16Under age 16Unemployed- not currently employed but actively seeking a job or waiting to return to a job.Three calculations to know1. Labor force participation rate = (employed Labor force participation rate = (employed + unemployed) / civilian pop. over age 162. Unemployment rate = unemployed / rate = unemployed / (employed + unemployed) OR (employed (employed + unemployed) unemployed) OR unemployed / labor unemployed / labor force3. Employment / population ratio = Employment / population ratio = employed / civilian pop. over age 16A declining unemployment rate suggests the labor market and the economy are improving.The three types of unemployment:1. Frictional Unemployment- caused by imperfect information. Occurs because employers are not fully aware of all available workers add their qualifications and available workers are not fully aware of all the jobs offered by employers. Caused by constant change in the labor market.2. Structural Unemployment- reflects an imperfect match of employee skills to skill requirements of the available jobs.3. Cyclical Unemployment-reflects business cycle conditions. When there is a general downturn in business activity, cyclical unemployment increases.Productivity, or output per worker, is the primary source of long term economic growth.Some unemployment is unavoidable and arguably desirable.Natural rate of unemployment: “normal” frictional and structural unemployment Approximately 5% Full employment exists when the natural unemployment rate existsPotential output is the level of output that can be achieved and sustained in the future, given the size of the labor force, its expected productivity, and the natural rate of unemployment consistent with the efficient operation of the labor market. Actual output can differ from the economy’s potential output. Best thought of as 3% growth rate Trend line=maximum sustainable rateActual and Potential GDP Potential output is the maximum sustainable output level consistent with the economy’s resource base, given its institutional arrangements.Actual and potential are equal when the economy is at full employment.Inflation is a persistent increase in the general level of prices.Why is inflation bad?1. It reduces investment2. It distorts information delivered by prices: relative prices are skewed because some prices adjustmore quickly than others3. Less productive use of resourcesWhen actual GDP>potential GDP, unemployment falls, upward pressure on pricesWhen actual GDP<potential GDP, unemployment rises, downward pressure on pricesHigh and variable levels of inflation are harmful for several reasons. Because unanticipated inflation alters the outcomes of long-term projects like the purchase of a machine or operation of a business, it will both increase the risks and retard the level of such productive activities. It distorts the information delivered by prices. People will respond to high and variable rates of inflation by spending less time producing and more time trying to protect their wealth and income from the uncertainty created by inflation.Production from jobs is more important than the jobsMost economists believe that the rapid expansion in the money supply is the primary cause of inflation.Chapter 9: An Introduction to Basic Macroeconomic MarketsFiscal policy is the use of government taxation and expenditure policies for the purpose of achieving macroeconomic goals. Monetary supply is the deliberate control of the money supply, and, in some cases, credit conditions, for the purpose of achieving macroeconomic goals. There is a circular flow of output and
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