EC 102 Midterm Review 1 GDP market value of all final goods and services produced within a country in a year To measure GDP 1 Expenditure method add up value of expenditures of all final G S in economy 2 Value added method calculated GDP by adding up the value added at each stage of production 3 Income method adds incomes generated by each stage of production Nominal GDP value of all G S measured at current prices P1 P1 09 Q2 09 Q1 09 09 P3 09 P2 09 Q3 Real GDP value of all G S measured at constant price level 05 Q3 09 P3 GDP deflator ratio of nominal GDP to real GDP x 100 measures price level used for comparison 09 P2 09 05 Q1 05 Q2 per capita GDP Real GDP Y population pop per person GDP Deflator nominal GDP x 100 Real GDP Potential GDP an estimate of what GDP would have been if all factors of production were used at normal rates 8 hour day an economy s capacity to produce Inflation btwn 2 yrs GDP deflator for later yr GDP deflator for earlier yr GDP in earlier yr Consumer price index measures change in price of things that average consumer buys How to find CPI 1 survey to determine typical consumer s basket of goods 2 each month collect price data of all item sin basket do not basket 3 choose a base yr 4 calculate CPI CPI cost of basket that month x 100 cost of basket in base yr Disinflation inflation is going down so prices are increasing just not as fast inflation positive Deinflation prices are going down inflation neg CPI may overstate b c 1 substitution bias CPI uses fixed weights so its ability to substitute toward goods whose relative 2 prices have fallen Increase in quality bias some of the increase in the price of a product may reflect an improvement in the product s quality while the rest represents true inflation It s hard to separate the two 3 new product bias the mkt basket used in the CPI calculation is not updated frequently so it fails to include new products whose prices tend to fall rapidly after intro 4 Outlet bias increasingly consumers buy from outlets but BLS buys from retailers who generally charge full price CPI includes only goods typically bought by consumers includes imported goods uses a fixed basket of goods GDP deflator includes all goods includes only domestic goods uses ing basket of goods EC 102 Midterm Review 2 CPI uses Track s in typical households costs of living Adjusts many contracts for inflation COLA Allows comparison of dollar value over time Costs of Inflation shoe leather costs the resources wasted when inflation encourages people to reduce their money holdings menu costs price of ing prices frequently tax distortions inflation makes nominal income grow faster than real income confusion distortion inflation s yardstick we use to measure transaction complicates long range planning and dollar comparison over time Costs of unexpected inflation arbitrary redistribution of wealth higher than expected inflation transfers purchasing power from creditor to debtor lower than expected inflation high inflation is more variable less predictable than low inflation arbitrary redistributions are frequent when inflation is high nominal interest rate i real interest rate r inflation rate Forecasting use e i r i r e s in price level and interest rate as P goes up goes up as goes up e goes up since i r e as e goes up i goes up P increases so i increases Value in later yr dollars value in earlier yr dollars CPI later CPI earlier Employed worked even part time in the last wk Unemployed did not work in the last wk but looked for work in the last month Labor force employed unemployed Not in labor force did not work in last wk and did not actively look for work in last month Unemployment rate unemployed x 100 in labor force Types of unemployment Frictional quit one job btwn jobs Structural skills obsolete mismatched w their location Cyclical varied w business cycle policymakers target derivation of unemployment from natural rate Labor force participation rate of adult pop that is in labor force Labor force partic Rate labor force x 100 Adult pop EC 102 Midterm Review 3 Natural Rate of Unemployment NAIRU frictional unemploy structural unemploy Factors Which Influence Natural Rate Govt Policies Training policies structural lower natural rate Ex Trade Adjustment Program job sent overseas Unemployment compensation in US average wage for 6 months Tends to increase frictional unempl Decrease opp Cost of unempl Longer in Canada and Euro very restrictive in Euro Labor mkt polices legal restrictions on hours vacations retirement and esp firing Min wage could increase natural rate overall prob not imp fator in nat l rate Currently 7 25 nationally Forces wage to remain above equilibrium unemployment Qlabor supplied Qlabor demand Labor Unions Bargain w employers over wages benefits working conditions overall prob not imp factor in nat l rate Can keep wages above equilib in unionized industry and thus cause enemploy 9 of private work force is unionized BUT 1 3 to of govt employees unionized Efficiency wages above equilibrium wages paid by firms to increase worker Reduce turnover reduce absenteeism increase productivity increase job applicants Downside increase equilibrium wages can increase unemploy Growth the in real GDP over time Growth Annual Real GDP Y Real per capita GDP most closely correlates w improvement in living standard Growth rate of real per capita GDP Y pop Y pop Growth btwn 2 yrs GDP later yr GDP earlier yr GDP earlier yr The Rule of 70 Years to double 70 Growth Rate Economic Growth ultimate determinant of variable such as nutrition literacy infant mortality life expectancy EC 102 Midterm Review 4 New Growth theory a model of long run economic growth that emphasizes that tech is influenced by economic incentives and so is determined by working of the market system Key to economic growth accumulation of knowledge capital Physical capital subject to decreasing returns to capital Knowledge capital subject to increase returns to capital Govt policy can increase accumulation of knowledge 1 protect intellectual property w patents copyrights a patent exclusive right to produce a product for a period of 20 yrs Productivity GDP Y output per labor hr Person hrs L 2 subsidizing search and development 3 subsidizing education 4 Solow Model basic growth model Productivity Q of G S that can be produced by 1 hr of work Person hr one person working one hr What determines productivity Capital technology K physical capital Capital per labor hr K L increased K L results in