Chapter 2 1 What is value added Value added is an approach to calculating GDP The process is to take Revenues of each firm and to subtract from that the cost of intermediate goods which does not include labor Then you can add together these VA results for each firm and reach the GDP of the subject economy 2 What are the components of the expenditure approach The expenditure approach to calculating GDP adds together C I G X M to reach final GDP This is consumption investment government exports and imports Imports must be subtracted because they are produced in a foreign country and therefore are not part of domestic production Due to the difficulty of discerning import from domestic goods in the market when collecting data they are subtracted from the aggregate 3 What are the components of the income approach The income approach adds together the costs of production which are Wages Interest Rent Profits Depreciation Excise Taxes Social Taxes It s a more complex way to do the same thing as above and if faced with calculating it on the test it may take some trial and error to make sure you get everything to match up to say the value added result 4 What is the difference between GNP and GDP GNP measures the production by domestic firms regardless of where this production takes place GDP measures the production which occurs within the borders of a country So under GNP a 40 000 Cadillac that is 50 Mexican made adds 40 000 to the United States production Under GDP the same Cadillac would add 20 000 to the USA s production and 20 000 to Mexico s production If given nominal GDP and the GDP deflator can you calculate real GDP The GDP deflator is defined 5 Nominal GDP Real GDP x100 If you are given the GDP deflator and nominal GDP simple algebra would Deflator 100 Play with the math on a piece of paper for a moment and you should as reveal thatReal Nominal GDP see it 6 Can you calculate the inflation and real GDP growth rate Calculating inflation is a pain For this question he will presumably give a table showing prices and quantities sold in Year 1 and Year 2 and to find inflation you can take the Year 2 quantities and use Year 1 prices In this situation Year 1 is your base year and a problem arises when you do this because if you use Year 2 as your base year you will get different growth rates in Real GDP To remedy this you can take the chain weighted growth rate To do this you multiply the gross growth rate so if there is 5 growth the gross growth rate is 1 05 for the two years together and take the square root like this Base Year 1Gross Growt h Rate BaseYear 2GrossGrowt h Rate To come up with an inflation rate you can use the GDP Deflator where Inflation Nominal GDP Real GDP x100 Governments also use the Consumer Price index which is an index of the prices of common goods that is tracked over time the Producer Price Index an index of the prices of goods that businesses buy and Core Inflation which removes the prices of volatile commodities out of inflation to find a more stable rate Chapter 3 1 Explain the terminology as it pertains to business cycles a Business Cycles Fluctuations away from the general trend in real GDP b Peaks and Troughs The relatively high positive and negative deviations from the trend in real GDP c Turning Points Peaks and troughs in the deviations from trend in real GDP d Amplitude The maximum deviation from trend in a peak or a trough This can be thought of as the highest or lowest point in a deviation from the trend Boom A series of positive deviations from trend culminating in a peak e Frequency The number of peaks in real GDP that occur per year f g Recession A series of negative deviations from trend culminating in a trough h Persistence The idea that when a deviation is above trend it tends to stay above trend and when a deviation is below trend it tends to stay below trend This means that deviations aren t jumping around like crazy but instead persist as they are and gradually change i Co movement When macroeconomic variables fluctuate together in patterns that exhibit strong j regularities Time series The format in which macroeconomic variables are measured for instance real GDP is measured in a series of quarterly observations over time This basically means that time is on the horizontal axis in a graph k Positive and Negative correlation Correlation is the word which describes when two variables tend to move in a pattern together Positive correlation means that when one variable is high the other variable tends to be high at the same time negative correlation means that when one variable is high the other tends to be low at the same time as well See page 75 for two nice little charts that explain this better than I can in words Scatter Plot Another way to plot data in which each variable is given an axis and points are plotted to represent the values of the two different variables at a given time Positive correlation can be seen by an upward sloping best fit line and a negative correlation can be seen by a downward sloping best fit line l m Procyclical countercyclical and acyclical These are ways of describing correlation one variable has with real GDP Real GDP is critical in the analysis of the economy so it gets its own words for correlation Procyclical variables increase when GDP increases countercyclical variables decrease when GDP increases acyclical variables show no correlation either way n Correlation Coefficient A measure of the degree of correlation between two variables measured between 1 and 1 If the correlation coefficient is 1 then the two variables are perfectly positively correlated and if it is 1 then the two variables are perfectly negatively correlated o Leading and Lagging Variables Variables in which the change in one variable either leads or lags the change in another variable for instance the stock market may be a leading variable for GDP p Coincident Variables A variable which neither leads nor lags but instead happens at the same time 2 Why should data be detrended Data must be detrended to see the deviations from the mean In this situation detrending is necessary to see the business cycle as it fluctuates around the mean real GDP 3 What are leading indicators and why are they useful Leading indicators are indicators which have the property of having strong cross correlation with another variable before that variable changes This provides earlier indication on the direction of the economy and if you can find a leading