ECON 201 Final Exam Review I INTRODUCTION TO MACROECONOMICS Reading Chapters 2 5 7 include chapter 6 appendix skim chapter 8 appendix Output unemployment and inflation how are they measured and why do we care about them Output Y total quantity of goods services produced Unemployment Rate UR of people who want to work but have no job Inflation Rate at which prices in the economy are growing falling Y is measured using national gross domestic product NGDP NGDP is defined as market value at current prices of all final goods and services produced domestically in that period New output not used eg buying a used car doesn t count Domestic not foreign imports excluded Final not intermediate transactions to avoid double counting Categories of final transactions C anything consumers buy I plants equipment are durable capital NOT paper assets like stocks bonds G everything bought by gov t including labor NOT transfer payments however Exports all goods services sold overseas even if it s an intermediate transaction RGDP corrects NGDP for inflation Per capita RGDP RGDP Population RGDP does not include 1 Home production e g subsistence farming child care 2 Leisure e g American taking a vacation 3 Environmental quality 4 Underground economy Unemployment is measured by Bureau of Labor Statistics BLS survey 60 000 households every member 16 or over is classified as 1 Employed Any job for pay even part time 2 Unemployed No job but actively sought work in last month 3 Not in labor force No job not actively seeking in last month e g Retirees full time parents and students Headline UR underestimates extent of labor market weakness 1 Underemployment involuntarily part time workers 2 Discouraged and other marginally attached workers want to work but haven t looked in over a year Headline UR U 3 U 5 counts discouraged marginally attached as unemployed rather than not in labor force 1 U 6 counts both marginally attached and underemployed as unemployed Note U 6 U 5 U 3 Headline UR is inevitable Frictional UR temporary voluntary unemployment due to mobility of switching an employer or occupation Cyclical UR involuntary medium term unemployment due to decline in overall economy o Keynesian fiscal policy in a recession is aimed at reducing the rate of cyclical UR Structural UR long term involuntary unemployment due to persistent structural factors that make finding a job more difficult o ALWAYS higher for black Hispanic people vs white people due to racial discrimination o Younger workers o Less educated workers o Skill mismatch obsolete workers o Changing international trade patterns GDP Gap Y potential output Y actual output Costs are paid for by o Unemployed low income o Taxpayers employers everyone pays for UR insurance o Profits fall in recessions o GDP Gap encompasses only costs of cyclical unemployment but not structural which is persistent lost output o Psychological causes Inflation is a weighted average of price growth of different products weight depends on how important each product is to a household budget Price Index CPI inflation by BLS Measured by 1 Periodic household of spending patterns estimates basket of goods services consumed an average household each month 2 Monthly survey of stores other retail outlets websites records prices of goods and services how they change from month to month Shortcomings 1 CPI is only accurate for the typical household your own inflation may be different depending on your basket 2 CPI TRUE by about 0 3 0 4 every year because it overstates true increase in cost of living It doesn t reflect households changing spending patterns in face of relative price changes CPI is fixed weight price index assumes basket of products consumed by average household is fixed from month to month In reality substitution occurs when consumers respond to relative price changes by consuming less goods whose relative price is rising 3 CPI may not adequately correct for quality in the change of goods and services People assume inflation erodes purchasing power of wages but this is largely a myth Holding nominal wage growth fixed higher inflation does reduce real wage growth however nominal wage growth is roughly equal to a change in inflation on average leaving real wages roughly unchanged 2 Menu costs shoe leather costs real resources lost counteracting the effects of People fail to realize they are more likely to get a higher raise if inflation is higher rather than if it s low When inflation rises nominal wage growth rises and vice versa o Employers can afford to offer higher raises than when inflation rate is high o Employees demand higher gNW raises due to increase in living standards and are able to bargain if other businesses are willing to hire and offer more Inflation tax is paid by foreigners underground criminal economy inflation Time and resources spent going to banks more often to avoid inflation tax Hyper inflation Extreme episodes of inflation o Such as Germany in 1922 1923 Inflation 300 per month inflation tax on cash became extremely large o Caused by rapid growth in supply of money o Governments do so because they are trying to use seigniorage revenue to fill shortfall of tax revenue o Seigniorage Revenue gov t earns by printing money Fiscal crisis 1 Large chronic budget deficit wherein tax revenue gov t spending 2 Gov t unable to borrow money to finance deficit creditors lose faith in its ability to pay Options 1 Default on existing debt 2 Try to balance budget by increasing taxes and decreasing spending 3 Print a lot of money to create seignorage revenue Recent US economic history Three Economic Crises I Great Recession 2007 2009 Huge increase in house prices doubled from 2000 2006 Surging demand driven by easy financial conditions o Mortgage interest rates below 6 o Relaxed lending standards zero down payment subprime loans poor credit history Alt A loans unverified income good credit history people who couldn t afford them teaser loans People believed housing prices would keep rising quickly in the future and as they continued to grow home buying and mortgage lending was less risky Speculative bubble prices of some assets rise above estimated fundamental value based on expected future stream of dividends or other benefits over time Housing market was a bubble Sustained because belief that if price increases lately it will continue to rise bubbles will always eventually burst Bubble bursts Home owners default on mortgages FI fail e g Lehman Bros Sept 2008
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