Econ 104 Final Exam Study Guide Bill Goffe Section 1 GDP Real GDP vs Nominal GDP GDP The market value of all final goods and services produced in a country over a pd of time transfer payments ex social security unemployment insurance is not counted in GDP because they re payments by the Gov t intermediate goods ex tires for a car are also not counted because they re inputs on final goods 4 Components of GDP From an expenditure point of view Y C I G NX GDP consumption investments Gov t purchases net exports 1 Consumption expenditures made by households 2 Investment Final goods and services purchased by business firms ex new buildings changes in inventories and residential construction purchased by households 3 Government Purchases spending by federal state and local governments 4 Net Exports exports imports Real GDP The value of final goods and services evaluated at base year prices The prices of goods services in base year are used to calculate value of goods Services in all other years Nominal GDP Current Dollar GDP The value of final goods and services evaluated at current year prices In an economy with rising prices nominal GDP will be smaller than real GDP in years before the base year and nominal GDP will be greater than real GDP in years after the base year IN the base year Nominal GDP Real GDP GDP Deflator measure of the average prices of goods and services compared to the base year we can use the values of real GDP and nominal GDP to calculate a measure of price levels in the economy Price Level measures average prices of goods and services GDP Deflator Nominal GDP Real GDP X 100 A value of the GDP Deflator of 120 tells us that the average prices of goods services is 20 higher than the average prices in the base year GDP Limitations excludes 2 types of production 1 Household goods and services people produce for themselves 2 Underground Economy buying and selling of goods and services that are concealed from the Gov t to avoid taxes regulations because they re illegal Small in U S GDP doesn t measure leisure unless leisure results in a market transaction ex spending on a vacation GDP doesn t subtract costs of negative non market effects of production ex pollution and crime CPI Consumer Price Index measures the average price of the goods and services purchased by a typical urban household CPI Expenditures in current year expenditures in base year X 100 A value of the CPI of 218 in a given year means that in that year the average prices of the market basket has increased 118 from the base year CPI Limitations 1 Has a substitution bias because it s constructed with assumption that people buy same goods services and don t substitute for lower prices 2 Doesn t fully take into account increases in quality of products over time 3 Many times older products are replaced with new less expensive products 4 The CPI only collects data from traditional stores and doesn t sample prices at less expensive outlet stores ex Sam s Club Inflation Rate rate of change in the index from one year to the next most often used to measure growth The base year doesn t matter when calculating inflation Inflation Rate t Price Index t Price Index t 1 Price Index t 1 X 100 t current year t 1 previous year If inflation rate falls between 2 years the prices are still rising just at a smaller rate of increase Deflation a fall in prices in the economy Disinflation less inflation prices are rising more slowly Core Inflation Rate measures inflation without food and energy better sense of underlying inflation because food and energy prices are volatile Headline Inflation Rate measures inflation with food and energy Real Wages and Real Prices Real Prices removes inflation from a nominal price 2 ways to remove inflation 1 Subtraction Method real price nominal price inflation Also used for real wages 2 Division Method real price nominal price 1 X CPI 2 CPI 1 Real Interest Rates adjusts the nominal interest rate for inflation Real Int Rate Nominal Int Rate Inflation Rate provides a better measure of the true cost of borrowing and true rate of return to lending than the nominal int rate does Money an asset people are willing to accept in exchange for goods and services or payments of debt Serves 4 Functions 1 Medium of Exchange dollars 2 Unit of Account 3 Store of Value M1 cash checkable deposits M2 M1 savings accounts Credit Cards Money 4 Standard of deferred payment ex loan agreement In the US economists break it into 2 parts Harm from Inflation affects the distribution of income and can hurt people people on fixed nominal income ex retirees relying on company pensions are hurt Anticipated Inflation imposes costs by reducing purchasing power of assets ex money in checking Creates additional costs to firms from raising prices menu costs the value of money declines Unanticipated Inflation affects the distribution of income causing some people to gain and others to lose Can decrease real wages and real int rates Fairly Rare Fiscal and Monetary Policy Fiscal Policy changes in federal expenditures and taxes Can change independently of each other Gov t Budget Deficit expenditures taxes Monetary Policy conducted by Fed Reserve Charted by Congress Congress Mandate Promote Max Employment and Stable Prices Influences Federal Funds Rate ex interest rates A lower rate faster economic growth Current Values Real GDP 15 8 tril Nominal GDP 16 9 tril CPI 233 05 Inflation 1 3 Section 2 Economic Growth and Zero sum Zero Sum one person s gain comes as a loss for another person ex Poker Americans would do better with smaller shares of a rapidly growing economy than with the large shares they now possess of an economy that s barely moving Human Health and Economic Growth Long Run economic growth increases living standards Best measure of living standards is real GDP per person HIV aids slows economic growth Good health is linked to economic growth poor health undermines growth Economic Growth and Changed Lives Real GDP per capita has grown from 5 600 in 1900 to 42 349 in 2010 Today the average American purchases 8X more than in 1900 Caused by an increase in labor productivity output per worker determined by 2 factors 1 Quantity of capital per hour worked 2 Level of Technology Growth Rates Rule of 70 Real GDP Growth Rate Real GDP t Real GDP t 1 Real GDP t 1 X 100 Rule of 70 a way to estimate the of years it takes a certain variable to double 70 Growth Rate Small Differences in Growth Rates rate is important because increasing rate