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Macroeconomics

Economics 100

Study Guide IV

Definition of microeconomics: the study of how households and firms make

decisions and how they interact in markets.

Definition of macroeconomics: the study of economy-wide phenomena including

inflation, unemployment, and economic growth.

The Simple Circular Flow Model

Can you set up the more advanced circular flow?

Measuring a Nation's Income the GDP

National Income Accounting:

National income accounts are an accounting framework useful in measuring economic activity.

Three approaches--all produce the same measurement of the production of the economy.

Product approach: how much is produced.
Income approach: how much is created by production.
Expenditure approach: how much purchasers spend.

Why are all three approaches the same: We assume no unsold goods (at this point) then the market value if goods and services must equal the amount buyers spend to purchase them. (production =expenditure) What the sell receives (income) must equal to what is spent (expenditure).

Gross Domestic Product

GDP=output produced within the borders of a country

Or the Long Version

The market value if a final goods and services produced within a country in a given time period

market value: allows comparisons between different goods. Has some problems--ignores some goods, underground economy,
Final: No Intermediate Goods
G&S: all items produced and sold legally in the economy
Produced: Used goods sold do not count as part of GDP
Within a Country: No matter whether it is produce by an American
Time Period: year or quarter

The Components of GDP

GDP (Y) can be divided into four components: consumption (C), investment (I), government purchases (G), and net exports (NX).

Definition of Consumption: spending by households on goods and services, with the exception of purchases of new housing.

Definition of Investment: spending on capital equipment, inventories, and structures, including household purchases of new housing.

Definition of Government Purchases: spending on goods and services by local, state, and federal governments.

1. Salaries of government workers are counted as part of the government purchases component of GDP.

2. Transfer payments are not included as part of the government purchases component of GDP.

Definition of Net Exports: spending on domestically produced goods by foreigners (exports) minus spending on foreign goods by domestic residents (imports).

Real Versus Nominal GDP

A. There are two possible reasons for total spending to rise from one year to the next.

1. The economy may be producing a larger output of goods and services.

2. Goods and services could be selling at higher prices.

B. When studying GDP over time, economists would like to know if output has changed (not prices).

C. Thus, economists measure real GDP by valuing output using a fixed set of prices.

GDP and Economic Well-Being

A. GDP measures both an economy’s total income and its total expenditure.

B. GDP per person can tell us the income and expenditure level of the average person in the economy.

C. GDP, however, may not be a very good measure of the economic well-being of an individual.

1. GDP omits important factors in the quality of life including leisure, the quality of the environment, and the value of goods produced but not sold in formal markets.

2. GDP also says nothing about the distribution of income.

3. However, GDP does help us achieve a good life. Nations with larger GDP generally have better education and better health care.

Economic Growth and Public Policy

A. The Importance of Saving and Investment

1. Because capital is a produced factor of production, a country can change the amount of capital that it has.

B. Investment from Abroad

C. Education

a. When students are in class, they cannot be producing goods and services for consumption.

b. In less developed countries, this opportunity cost is considered to be high; as a result, children often drop out of school at a young age.

D. Property Rights and Political Stability

There is little incentive to produce products if there is no guarantee that they cannot be taken. Contracts must also be enforced.

E. Free Trade

F. The Control of Population Growth

G. Research and Development

The primary reason why living standards have improved over time has been due to large increases in technological knowledge.

Consumer Price Index

KEY POINT:

The consumer price index shows the cost of a basket of goods and services relative to the cost of the same basket in the base year. The index is used to measure the overall level of prices in the economy. The percentage change in the price level measures the inflation rate.

How to calculate the CPI

1. Fix the basket.

a. The Bureau of Labor Statistics uses surveys to determine a representative bundle of goods and services purchased by a typical consumer.

2. Find the prices.

a. Prices for each of the goods and services in the basket must be determined for each time period.

3. Compute the basket’s cost. (And some other stuff that we will not talk about in 100, but you will in 204)

a. By keeping the basket the same, only prices are being allowed change. This allows us to isolate the effects of price changes over time.

4. Compute the inflation rate.

a. Definition of Inflation Rate: the percentage change in the price index from the preceding period.

I will add some money information over the weekend!!!