MACRO STUDYGUIDE EXAM 2 Circular Flow Model Assume two groups households and businesses Clockwise inner circle land people s time Counterclockwise outer circle movement of money households use income to consume income and factors of production should be the same KEY POINT Total income generated has to be the same as the output that s produced all money earned is spent Leakages o what happens besides spending savings taxes imports Injections o Investments businesses spending with hope of future sales o Government spending Federal hospitals and roads State Schools Local Snow plowing o Exports people that buy from the US Income must be spent OR all income NOT spent must be matched by other spending This is so that total leakages total injections If leakages injections there is a recession If leakages injections there is inflation If leakages injections there is equilibrium Dynamic vs Static equilibrium o Dynamic equilibrium stability in motion like riding a bike o Static equilibrium point of rest Nominal GDP vs Real GDP GDP total dollar value of final output produced within a nation s borders in a given time period o Measures economic output Nominal GDP value of final output produced in a given period measured in the prices of that period given dollars Real GDP value of final output produced in a given period adjusted to eliminate the effects of changing prices constant dollars Sources of inflation Inflation in increase in the general average price level of goods and services not a change in specific price 2 sources demand pull and cost push Demand Pull Inflation too many dollars chasing too few goods aggregate demand shifts caused by spending too much makes for a higher GDP Cost Push supply shock something has impacted economy wide the costs of production go up so prices also go up Inflation is usually caused by demand pull too much spending after a recession Redistributive consequences of inflation 1 Price effect 2 Income effect what do you buy people who tend to buy goods and services that are increasing in price the fastest end up with fewer goods and services EX higher education and health care nominal income ruse more slowly than inflation end up with fewer goods and services EX Drug companies vs minimum wage teacher salaries vs higher education where does your income come from people whose 3 Wealth effect what do you owe and own people who own assets that are declining in real value and end up with less wealth EX stocks houses maybe debt Types of unemployment 1 Frictional unemployment brief periods of unemployment experienced by people moving between jobs 2 Structural unemployment the unemployment caused by a mismatch between the skills or location of job seekers and the requirement or location of available jobs EX type writer repairmen they are replaced by computer repairmen 3 Cyclical unemployment the unemployment caused by macroeconomic conditions i e the business cycle EX getting laid off after a recession Both frictional and structural unemployment are inevitable Gross Domestic Income Define the total income generated in an economy by the production of final goods and services during a particular period GDP GDI Components of GDI 1 Employee Compensation wages salaries benefits largest GDI component 2 Profits the reward firm owners receive for being in business 3 Rental Income Income earned by owners of rental housing or payments for the rent of natural resources smallest GDI component 4 Net Interest interest paid interest received 5 Depreciation a measure of the amount if capital that wears out or becomes obsolete during a period 6 Indirect Taxes Taxes imposed on the production or sale of goods and services or on another business activity Conceptual problems with Real GDP Household production unpaid household labor chores are not counted in GDP Underground illegal production EX marijuana sales drug cartels GDP ignores the bads when GDP is calculated the bad things that come out of it are ignored focuses only on market transactions EX oil spills are bad for everyone by good for GDP Volunteer work not calculated into GDP Leisure time spend not making money but enjoying life EX if someone cut down from 40 to 36 working hrs week GDP would see it as a bad thing Increasing Inequality GDP does not notice or care when only the rich are getting richer Alternative Approaches to well being Genuine progress indicator stuff as bad GDP in US goes up GPI in US goes down factors in the good stuff and treats the bad Better life index Human development index created by OECD includes all dimensions of well being all weighted equally maybe it shouldn t things 1 life expectancy 2 years of formal education 3 real per capita GDP averages for all three developed by United Nations looks at 3 Investment components determinants graph different uses Intended investment vs Actual investment Actual total business expenditures by firm on plant and equipment measures everything including what doesn t get sold EX new residential housing Intended the level of investment firms intend to make in a period Determinants of Investment intended 1 Interest Rates costs of borrowing or opportunity cost of using your own 2 Expectations our best guess about the future gut feeling of money consequences Investment Demand Graph High interest rates ceteris paribus leads to low investment Low interest rates ceteris paribus leads to high investment EX of shifting investment Different Uses of Investment Adds to the capital stock it therefore contributes to economic growth Causes changes in aggregate demand The Multiplier not just the calculations can you explain the concept The multiplier effect the amplified effect of a change in autonomous spending on the equilibrium level of income KKC Or KKC change in equilibrium income change in autonomous spending KKC 1 1 MPC PROBLEM SOLVING Working With Macro Data GDP deflator nominal real 100 Inflation rate new deflator old deflator old deflator Deflator is always 100 in base year Full Employment Question Steps 1 Find one and two sector equilibrium 2 Graph the model 3 YFULL 2sector eq multiplier G 4 Find G EX C 400 9YD I 200 YFULL 7500 KKC 1 1 MPC One sector constant multiplier AKA 400 10 4000 Two sector constant I multiplier AKA 600 10 6000 Find G 7500 6000 1500 10 150 G Taxes Question Steps 1 Find one and two sector equilibriums 2 Graph the model 3 Use equations C I G Y YD Y T to solve for three sector equilibrium I 100 T 200 Multiplier 4 EX C 600 75YD One sector 600 4 2400 Two