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EC 102 Midterm ReviewGDP- market value of all final goods and services produced within a country in a yearTo measure GDP:1. Expenditure method: add up value of expenditures of all final G&S in economy2. Value-added method: calculated GDP by adding up the value added at each stage of production3. Income method: adds incomes generated by each stage of productionNominal GDP- value of all G & S measured at current pricesP109 Q109+ P209 Q209+ P309 Q309+…Real GDP- value of all G & S measured at constant price levelP105 Q109+ P205 Q209+ P305 Q309+…GDP deflator- ratio of nominal GDP to real GDP x 100measures price levelused for comparisonPotential 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 produceConsumer price index- measures change in price of things that average consumer buysHow to find CPI:1. survey to determine typical consumer’s basket of goods2. each month, collect price data of all item sin basket (do not ∆ basket)3. choose a base yr4. calculate CPIDisinflation- 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 prices have fallen.2. 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 goods1GDP Deflator = nominal GDP x 100 Real GDPper capita GDP = Real GDP = Y(per person) population = pop.Inflation btwn 2 yrs = GDP deflator for later yr- GDP deflator for earlier yrGDP in earlier yrCPI= cost of basket that month x 100 cost of basket in base yrGDP deflator includes all goods includes only domestic goods uses ∆ing basket of goodsEC 102 Midterm ReviewCPI uses:Track ∆s in typical households costs of livingAdjusts many contracts for inflation (COLA)Allows comparison of dollar value over timeCosts of Inflation: “shoe leather costs”: the resources wasted when inflation encourages people to reduce their money holdingsmenu costs- price of ∆ing prices frequentlytax distortions- inflation makes nominal income grow faster than real incomeconfusion & 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 debtorlower than expected inflation- high inflation is more variable/ less predictable than low inflationarbitrary redistributions are frequent when inflation is highnominal interest rate = ireal interest rate = rinflation rate = πi= r + πForecasting, use πei= r + πe∆s in price level and interest rate:as P goes up, π goes upas π goes up, πe goes upsince i = r + πe, as πe goes up, i goes upP increases, so i increasesEmployed- worked, even part time, in the last wkUnemployed- did not work in the last wk, but looked for work in the last monthLabor force= employed + unemployedNot in labor force- did not work in last wk and did not actively look for work in last monthTypes of unemployment:Frictional- quit one job, btwn jobsStructural- skills obsolete, mismatched w/ their locationCyclical- varied w/ business cycle, policymakers target derivation of unemployment from natural rateLabor force participation rate- % of adult pop. that is in labor force2Value in later yr dollars = (value in earlier yr dollars ) CPI later CPI earlierUnemployment rate= # unemployed x 100 # in labor forceLabor force partic. Rate = labor force x 100Adult pop.EC 102 Midterm Review*Natural Rate of Unemployment=NAIRU= frictional unemploy.+ structural unemploy.Factors Which Influence Natural Rate:Govt PoliciesTraining policies (structural, lower natural rate)Ex: Trade Adjustment Program (job sent overseas)Unemployment compensation (in US, ½ average wage for 6 months)Tends to increase frictional unempl.Decrease opp. Cost of unempl.Longer in Canada and Euro.Labor mkt polices- legal restrictions on hours, vacations, retirement, and esp. firing (very restrictive in Euro)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 demandLabor 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 ½ of govt employees unionizedEfficiency wages- above equilibrium wages paid by firms to increase workerReduce turnover, reduce absenteeism, increase productivity, increase job applicantsDownside: increase equilibrium wages can increase unemploy.Growth- the ∆ in real GDP over timeGrowth= Annual %∆ Real GDP= %∆YReal per capita GDP most closely correlates w/ improvement in living standardThe Rule of 70Economic Growth: ultimate determinant of variable such as: nutrition, literacy, infant mortality, life expectancy3Growth rate of real per capita GDP= %∆ (Y/pop) = %∆Y-%∆pop Growth btwn 2 yrs= GDP later yr- GDP earlier yrGDP earlier yrYears to double= 70Growth RateEC 102 Midterm ReviewNew 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 systemKey to economic growth: accumulation of knowledge capitalPhysical capital subject to decreasing returns to capitalKnowledge capital subject to increase returns to capitalGovt policy can increase accumulation of knowledge:1. protect intellectual property w/ patents & copyrightsa. patent: exclusive right to produce a product for a period of 20 yrs2. subsidizing search and development3. subsidizing

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BU CAS EC 102 - Midterm Review

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