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SPTE 380: Final Exam
What is GDP?
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The market value of all final goods and services produced within a country in a given period of time.
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Two ways of measuring GDP
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The total income of everyone in the economy.
The total expenditures on the economy's output of goods/services.
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4 components that make up GDP
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Consumption - spending by households - groceries.
Investment (Spending on goods that will produce more goods and services - capital)
Government purchases (Federal, state and local spending. Doesn't include wages)
Net exports (Exports - Imports)
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Things not included in GDP
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Used cars. Citizen payments from government, items produced in previous years.
Things that don't have market value.
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Nominal GDP
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values output using current prices. Doesn't take into account inflation.
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Real GDP
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Values output using the prices of a base year. Corrected for inflation.
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Benefit of using nominal GDP
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Good for assessing economy and current prices today.
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Benefit of using real GDP.
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Good for comparing changes in economy over time.
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How economic growth is measured:
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Increase in real GDP over time. Basically:
Increase in production OR
Increase in the producer/spending per person.
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Equation for how long it takes real GDP to double:
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70/ annual percentage rate of growth.
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Supply factors contributing to economy growth
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Increase in quantity/quality of natural resources.
Increase in quantity/quality of human resources
Increase in the supply of capital goods.
Increase in technology.
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Demand factors determinant of growth
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Households, businesses, and governments must purchase the economy's expanding output.
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Efficiency factor of growth:
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Must achieve efficiency and full employment (operating on the PPF)
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Argument for growth being desirable and sustainable (good):
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It being higher standards of living.
Promotes human imagination (which could solve problems of growth)
Increase in leisure time and material goods
Allows for the expansion and application of human knowledge.
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Phases of the business cycle:
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Peak - highest point
Trough - lowest point
Expansion - rising
Recession - dipping
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Reasons for business cycles
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Demand shocks (drastic changes in demand) or supply shocks (drastic changes in supply)
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Causes of shocks (and thus, business cycles)
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Irregular innovation, political events, monetary factors, productivity changes, financial instability (Great Recession).
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Which goods are most effected by business cycles?
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Durable goods
(Capital goods - houses, plants, other new construction things)
(Consumer durables - automobiles, applicances, other goods that cost a lot)
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Which goods are least affected by the business cycle?
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Non-durable goods.
(Services - haircuts, cell phone service, cable/internet)
(Food and clothing, necessities)
Things you have to have no matter what.
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Labor force
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Total number of workers, including the employed and unemployed. All people who are working or who are actively searching for work.
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Not in the labor force:
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The young, institutionalized, or those who are not looking for work.
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Employed:
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Paid employees, self-employed, part-time, and unpaid workers in a family business.
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Unemployed:
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People not working who have been looking for work during the previous four weeks.
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Problems with the unemployment rate
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Discouraged workers aren't counted because they haven't sought work in last four weeks.
Doesn't account for underemployed workers, such as part-time employees who want to work full-time.
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Three types of employment
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Structural, frictional and cyclical
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Frictional unemployment
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Unemployment caused by delays in matching available jobs and workers.
Like delays between graduation and getting a job. Government adds to this.
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Structural unemployment
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Caused by changes in the industrial makeup of the economy.
Creative destruction: introduction of new products/technology collapses other industries, jobs.
Example: Book stores, telephone operators, factory jobs.
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Cyclical unemployment
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Caused by recession.
Not enough jobs for people who want jobs.
Greatest concern.
Ex. An individual who loses his job because of decreased demand for products.
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Components for natural unemployment
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Frictional and structural unemployment
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Full unemployment
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Not everybody is employed.
Only natural unemployment though.
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How is inflation typically measured in the United States?
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The Consumer Price Index. Measures the typical consumer's cost of living from year to year.
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What is inflation?
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A general rise in the price level.
Means the dollar is worth less.
The dollar can buy fewer goods and services. Reduces the purchasing power of money.
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How CPI is calculated (steps)
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1. Fix the "basket"
2. Find the prices
3. Compute the baskets cost
4. Choose a base year and compute the index.
(100 x cost of basket in current year/cost of basket in base year)
5. Compute the inflation rate
(inflation rate = (CPI this year - CPI last year)/CPI last year x 100%)
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Problems with CPI (how it overstates increases in the cost of living)
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Substitution bias, introduction of new goods, unmeasured quality change.
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Substitution bias (problem with CPI)
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Over time, some prices rise faster than others, and consumers will substitute toward goods that become relatively cheaper.
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Introduction of new goods (problem w/ CPI)
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Increases variety, allows consumers to find products that more closely meet their needs.
BLS doesn't use online retailers.
CPI misses this because it uses a fixed basket of goods.
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Unmeasured quality change (problem w/ CPI)
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Improvements in the quality of goods in the basket increase the value of the dollar.
BLS tries to account for quality changes, but probably misses some, as quality is hard to measure.
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Percent change in real income =
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Percent change in nominal income - percent change in price level.
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Real interest rates =
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Nominal interest rates - inflation.
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Who is hurt by unanticipated inflation?
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Fixed-income receivers (unexpected inflation means the dollar they're paid with is worth less. Purchasing power of their real income is worth less.)
Savers (value of accumulated savings deteriorates. Amount in your account is worth less than it was before inflation).
Lenders/creditors (lenders get paid back in cheaper dollars)
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Who is unaffected by unanticipated inflation?
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Flexible income receivers like:
COlAs (Cola ajustments)
Social security recipients
Union members.
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Who is helped by unexpected inflation?
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Debtors, who get to pay back the loan with cheaper dollars.
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Hyperinflation
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Extraordinarily rapid inflation.
Devastates an economy.
Businesses don't know what to charge.
Consumers don't know what to pay.
Money becomes worthless.
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Cause of inflation
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An increase in the money supply.
As government increases the amount in circulation, the value of money falls.
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Two reasons inflation exists
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Large government debts (gov'ts printing out more money to pay off debts, Germany)
Gov't stimulating the economy. (More money, more expansion)
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Government budget (outlays)
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Includes all items of G in the GDP equation.
$3.5 trillion, or more than $10,000 per person.
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Three major divisions of gov't spending
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Mandatory outlays (entitlement programs - government spending on ongoing programs, including social security, medicare, etc.
Interest payments (payments made to current owners of U.S. treasury bonds. They own the debt.
Discretionary spending (Can be altered. Bridges and roads, payments to gov't workers, defense spending, etc.).
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Social security
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Gov't-administered retirement funding program.
Workers contribute portion of earnings to the Social Security Trust Fund w/ promise they'll receive it back.
Goal: No American worker retires without at least some retirement income.
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Medicare
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Mandated federal program that funds health care for retired people.
Goal: Provide medical insurance for all retired workers.
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Social Security and Medicare's impact on gov't and the U.S.
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Make up 40% of gov't spending.
Three reasons why its done:
People live longer
You must pay in to receive the benefits.
Baby boomers are starting to retire.
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Income tax structure in the U.S.
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Progressive tax system, where your marginal tax rate increases as your income increases.
The wealthiest 20 percent of households paid 94% of the taxes in 2009.
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Budget deficit
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Occurs when gov't spending exceeds gov't revenue
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Gov't debt is:
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the accumulation of all deficits and surpluses. At a point in time, what does your debt and savings look like?
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Fiscal policy
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Active changes in government or taxation.
Goal is to:
Promote full employment
Price stability (control inflation)
Encourage economic growth
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Expansionary fiscal policy
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Used during a recession
(An increase in gov't spending OR,
A decrease in taxes, OR, a combination of both)
Creates a budget deficit.
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Contractionary fiscal policy
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Used during times of inflation or economic booms
(Decrease in gov't spending OR an increase in taxes OR combination of both)
Creates a gov't surplus.
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Automatic stabilizers (to fiscal policy)
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Taxes vary w/ GDP - individuals pay less taxes when incomes fall.
Progressive tax system - as income falls, you pay less in taxes.
Transfer payments vary inversely with GDP.
(Unemployment benefits, welfare payments)
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Problems associated with fiscal policy
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Problems of timing (recognition lag, administration lag, operational lag)
Political considerations (politicians set it)
Future policy reversals
Offsetting state and local finance
Crowding out effect.
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3 Functions of money
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Medium of exchange (an item buyers give to sellers when they want to purchase goods and services)
Unit of account (a measurement people use to post prices and record debt)
Store of value (an item people can use to transfer purchasing power from the present to the future)
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Components of the money supply (M1)
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Currency (paper bills and coins in the hands of the non-bank public)
Checkable deposits (balances in bank accounts that depositors can access on demand by writing a check.
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Why is money valuable?
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Acceptability (currency and checkable deposits are accepted as a medium of exchange)
Legal tender (Paper money is a valid and legal means to pay any debt contracted in dollars.)
Relative scarcity (depends on supply and demand. The more available, the less valuable it is.)
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Fed consists of:
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The Board of Governers, 12 regional banks, and the FOMC.
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Reserves
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The checkable deposits of a bank at the Fed.
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Required reserves
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How much a bank is required to keep at the Fed.
Checkable deposits X reserve ratio.
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Excess reserves
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Reserves above what the Fed requires a bank to store.
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Who is in charge of monetary policy?
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The Federal Open Market Committee
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Goals of monetary policy
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Keep unemployment low and keep inflation low (conflicting mandates)
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3 tools of monetary policy
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Open market operations (purchase and sale of U.S. government bonds by the Fed) - most important, used.
Reserve requirement (affecting how much money banks can use to make loans)
Discount rate (interest rate on loans the Fed makes to loans.
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Contractionary monetary policy
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Used in periods of high or rising inflation
The Fe can sell securities, increase the reserve ration and increase the discount rate.
Makes money tight, makes it harder to get loans. Investment spending falls, money supply decreases. Inflation falls.
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Difference between monetary policy and fiscal policy
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Monetary policy: speed and flexibility (no political delays), isolation from political pressures, also more subtle than fiscal policy.
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Problems with monetary policy
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Lack of oversight - independent
Keeping federal funds rate too low for too long created financial instability.
It takes time for the Fed to decide and implement policy changes. Recognition and operational lag.
Cyclical asymmetry - difficult to pull economy out of recession.
Liquidity trap - a situation in a recession when the Fed adding reserves has little to no impact on the banking system.
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Federal Reserve Bank covering South Carolina
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Richmond.
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