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ECON 2105, Study Guide Test 2

by: Randi

ECON 2105, Study Guide Test 2 ECON 2105

Marketplace > University of Georgia > Macro Economics > ECON 2105 > ECON 2105 Study Guide Test 2
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This study guide covers everything discussed in class up to this point that will be on the midterm. It also includes information from chapter readings 6,8-12 that will be on the test, as well as in...
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GDP, economy, growth, CPI, deflation, Calculations, loanablefunds, BPP, facevalue, bondmarket, Stocks, securitites, capitalists, Corporations, moneyillusion, menucosts, growthrate, financialmarkets, priceconfusion, wealth, poverty, BLS
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This 24 page Study Guide was uploaded by Randi on Thursday October 13, 2016. The Study Guide belongs to ECON 2105 at University of Georgia taught by McWhite in Summer 2016. Since its upload, it has received 125 views. For similar materials see Macroeconomics in Macro Economics at University of Georgia.


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Date Created: 10/13/16
ECON  2105  Study  Guide  Test  2     ECON 2105 PROF.  MCWHITE     Highlight  =  Important  Concept   Highlight  =  Key  term     Chapter  6:  Understanding  GDP,  Spending,  and  Income       • Gross  Domestic  Product   o The  market  value  of  all  final  goods  and  services  produced  in  a  country   during  a  given  period   o It  measures  a  nation’s  production  and  income  at  the  same  time   Ø You  buying  stuff  is  someone  else’s  income…  add  all  of  this  up   for  a  nation   Ø If  GDP  decreases,  the  economy  s  producing  less  and  total   national  income  falls     • GDP  is  used  to  compare  countries   o It  is  also  used  to  measure  business  cycles   o Long-­‐Term  economic  growth   o Living  Standard     • Low  GDP  is  not  always  an  indicator  of  an  economy  with  poor  health   o It  may  be  a  small  country  with  a  high  GDP  per  capita   o It  may  have  a  strong  real  GDP  growth  rate     • How  do  we  measure  how  the  economy  is  doing?   o We  look  at  if  the  economy  is  in  a  recession  and  its  real  GDP   o Recession:   § A  fall  in  GDP  over  2  quarters   § Don’t  always  prevent  a  Long-­‐Run  increase  in  GDP   • Usually  balanced  out  with  economic  growth     o Real  GDP   § Value  of  the  goods  and  services  produced  by  the  nation’s   economy  minus  the  value  of  the  goods  and  services  used  up  in   production,  adjusted  for  price  changes     • Graphs  of  dollars  values  over  time  need  to  be  adjusted  because  of  inflation     • Inflation   o An  increase  in  the  overall  price  level   o There  is  also  hyperinflation   ECON  2105  Study  Guide  Test  2     o Related  to  the  money  supply  in  the  economy  relative  to  the  quantity  of   goods  and  services   o Governments  can  cause  it  on  purpose     • Deflation   o Decrease  in  overall  price  level   o Deflation  is  not  necessarily  a  good  thing           • Real  vs.  Nominal  GDP   o Nominal:  Prices  and  other  values  in  those  years   o Real:  Prices  and  other  values  adjusted  for  inflation   § Adjusted  to  prices  in  the  base  year**   § How  much  stuff  can  I  buy  with  these  dollars?   § When  prices  go  up,  GDP  goes  up  as  well   **This  is  why    we  are  more  concerned  with  real  GDP     • A  home  may  have  cost  $7000  in  1945.  However,  it  may  cost  $62,000  in  2016.   Nominally  speaking,  it  costs  more  now…  in  real  terms,  it  may  not       • Purchasing  Power  Parity  (PPP)   o The  idea  that  a  unit  of  currency  should  be  able  to  buy  the  sane   quantity  of  goods  and  services  in  any  country     o China  has  the  largest  economy  based  on  PPP  as  of  last  year   o USA  has  the  largest  economy  based  on  Real  GDP  (stuff  produced)     • GDP  per  capita   o GDP  is  a  good  measure  to  compare  economies,  but  GDP  per  capita  is  a   better  comparison  to  use  between  individuals  in  the  same  economy     o GDP  per  capita  is  how  much  stuff  per  person  in  the  country   GDP  /  Population       • What  countries  produce  over  time  changes   o For  example:  The  US  has  gone  from  mostly  agriculture  à  mostly   manufactured  goods  à  to  now  mostly  services       • Market  value   o Many  countries  produce  a  lot  of  similar  and  different  things,  so  we  use   market  value  to  count  it   o The  more  valuable  items  have  heavier  weight   Price  X  the  Quantity  of  Good  Produced     ECON  2105  Study  Guide  Test  2     • Final  goods  and  service   o When  it  gets  to  the  consumer  that  is  a  final  good  or  service,  or  when  it   is  in  inventory  to  be  used  later   o Make  sure  to  avoid  double  counting   o A  majority  (about  70%)  of  US  GDP  comes  from  services!     • Goods/services  produced  in  the  US  by  foreign  countries  count  towards  US   GDP   o US  goods  produced  abroad  count  towards  Gross  National  Product  (not   GDP)     • Intermediate  good   o Goods  that  firms  repackage/bundle  with  other  goods  for  sale  at  a  later   stage   Example:  Cellphone  keyboard     • Increased  commercial  travel  adds  directly  to  GDP     • What  is  made  and  sold  this  year  adds  to  GDP   1. When  BMW  makes  care  in  the  USA  à  counts  as  USA  GDP   2. When  Ford  builds  a  car  in  Europe  à  does  not  count  as  USA  GDP     • What  makes  up  GDP?   o The  Expenditure  Method:   § Consumption  (C)   § Investment  (I)     § Government  Purchases  (G)   § Net  Exports  (NX)       Total  =  GDP       1. Consumption   o Spending  by  household  makes  up  Consumption     o Purchase  of  final  (not  intermediate)  goods  and  services   o Most  people  spend  a  majority  of  their  income  on  consumption   goods/services   o Durable  goods:   § Things  that  are  expected  to  last  more  than  a  year  (roughly   speaking)   § Example:  furniture,  automobile     o Nondurable  goods:   § Things  that  will  be  consumed  immediately  or  not  last  very  long   § Example:  Happy  Meal   o Services:   § When  you  pay  people  to  do  something   ECON  2105  Study  Guide  Test  2       2. Investment   o Spending  by  firms     o Spending  on  tools/equipment  to  produce  future  output  (capital   goods)   o A  share  of  stock  is  not  considered  part  of  GDP   o Example:     Business:  A  corporation  fixed  one  of  its  machines   Residential:  Buying  a  home   Inventory:  What  is  not  sold  to  consumers       3. Government  Purchases     o Purchases  by  local,  state,  and  federal  government   o Does  not  include  transfer  payments  (example:  social  security)   o Doesn’t  include  interest  on  debt   o Government  spending  has  increased  over  the  years   • Example  goods:  tanks,  street  signs,  missiles,  buildings     Example  services:  teachers,  trash  services,  police     4. Next  Exports     Exports  –  Imports   o Exports:   o Goods  produced  domestically,  sold  abroad   o Imports:   o Goods  produced  abroad,  sold  domestically     o Our  net  exports  have  been  negative  for  a  long  time     o A  good  has  to  be  produced/sold  in  the  same  year  to  count  towards  the   year’s  GDP     PRACTICE:   • A  1973  corvette  sold  in  2016  is  not  counted  in  this  year’s  GDP   • A  vacuum  cleaner  made  and  sold  in  2016  counts  towards  this  year’s   GDP       • Price  Level  and  GDP  Deflator     o Comparing  different  years  is  more  accurate  using  real  GDP   o Nominal  GDP:  GDP  in  the  current  year’s  prices   o Price  level:    Index  values  of  prices  in  the  economy     • GDP  Deflator:   o A  measure  of  price  level   o Calculated  value  used  to  determine  real  GDP     ECON  2105  Study  Guide  Test  2       CALCULATIONS:   • Nominal  GDP     o Take  the  market  value  of  each  good  or  service  (Price  X  Quantity)     o Add  them  all  together     • Real  GDP   o Determine  the  base  year  (this  will  be  given)   o (Nominal  GDP/  Price  Level)  X  100     • GDP  Deflator  (Price  Level)   (Nominal  GDP  /  Real  GDP)  X  100   *base  year  will  always  be  100     • We  use  growth  rates  to  determine  where  the  economy  is  going   o This  changes  from  year  to  year   • Example:   Nominal  GDP  Growth  Rate  for  2014  =     (GDP2014  –  GDP2013)  /  GDP2013  X  100     • Price  Level  Changes   (GDP.Deflator  2014  –  GDPDeflator2013)  /  GDPDeflator2013  X  100     • With  the  changes  in  the  price  level  and  the  Nominal  GDP,  we  can  determine   the  change  in  real  GDP   Growth  in  Nominal  GDP  =  Growth  in  Real  GDP  =  Growth  in  Price  Level       • Issues  with  GDP:   1. Non-­‐market  goods/services   2. Underground/illegal  markets   3. No  value  for  standard  of  living   • Environmental  quality   • Leisure  time   • Higher  per  capita  GDP  correlates  with  higher  standard  of  living       1. Non-­‐Market  Activities     Example  1:     o You  go  to  Lowes  and  buy  tiles  to  fix  your  kitchen…  this  is   included  in  GDP   o You  hire  someone  to  fix  the  kitchen  for  you…  this  is   included  in  GDP   ECON  2105  Study  Guide  Test  2     o You  watch  videos  online  and  fix  the  kitchen  yourself…  Not   included  in  GDP   Example  2:   o Your  house  is  a  mess,  so  you  hire  a  maid…  this  is  included   in  GDP   o You  clean  the  house  yourself…  Not  included  in  GDP            Example  3:   o You  hire  a  professional  lawn  care  company  to  cut  your   grass…  this  is  included  in  GDP   o You  pay  your  neighbor’s  kid  to  do  it  for  you…  probably  not   included  in  GDP  (cash  exchange)     • Cash  exchanges  may  not  be  documented  and  sent  into  the  IRS     • In  countries  where  governments  are  more  corrupt,  there  is  usually  a   higher  cash  economy       2. Illegal  markets   • Exchanges  on  black  markets  are  not  counted  in  GDP   • Illegal  markets  can’t  be  prevented  and  are  hard  to  keep  track  of     3. No  value  for  standard  of  living   • Standard  of  living  is  subjective   • Environmental  quality:   o Less  environmental  regulation  could  improve  GDP   o Would  this  be  a  good  thing?   • More  spending  to  prevent  crime/treat  cancer  could  increase  GDP   • Leisure  time:   o Are  we  better  off  if  we  spend  a  lot  of  time  at  work?       ECON  2105  Study  Guide  Test  2     Chapter  8:  The  Price  Level  and  Inflation     • Consumer  Price  Index  (CPI)     o For  a  given  period,  a  measure  of  costs  of  a  standard  basket  of   goods/services,  relative  to  the  cost  of  said  basket  in  a  base  year   o CPI  is  a  basic  tool  for  economists  to  measure  the  price  level  and   inflation  in  the  economy  for  consumers     o Also  known  as  a  measure  of  the  cost  of  living       • What’s  in  a  “basket”  of  goods/services?   o Goods  consumers  would  buy  on  a  regular  basis   o Examples:  food,  housing,  medical  care,  transportation     • What  is  not  in  the  “basket”?   o CPI  does  not  include  stocks,  bonds,  real  estate,  life  insurance,   investments,  or  taxes   o These  goods  are  savings  goods  and  consumption  expenses     • Bureau  of  Labor  Statistics  (BLS)  is  in  charge  of  CPI   o They  determine  what  is  important  to  consumers   o The  basket  should  reflect  where  consumers  put  their  resources   s   CPI  =  (Price  of  Basket  in  the  current  year)  X  Quantity  of  Base  Year     (Price  of  Basket  in  the  base  year)  X  Quantity  of  Base  Year     *the  Q  stays  the  same  from  the  base  year   *the  basket  is  not  GDP     • Price  Index=   (Basket  Price  in  Current  Year/  Basket  Price  in  Previous  Year)  X  100     • Price  in  an  earlier  period’s  dollars=   (Price  Today)  X  (Price  Level  of  Earlier  Time/  Price  Level  Today)     ECON  2105  Study  Guide  Test  2     • CPI  vs.  GDP  Deflator   o Real  GDP  holds  Price  constant   § CPI  holds  goods/services  constant     o GDP  and  Deflator  consider  all  goods/services  in  the  US   § CPI  considers  a  basket  of  goods/services  relevant  to   consumers     o GDP  is  not  affected  by  changes  in  the  price  of  foreign  goods   § CPI  can  be  if  it  is  part  of  the  basket     • Inflation  Rate  =  [(Price  2  –  Price  1)/  Price  1]  X  100     • Issues  with  Inflation   1. Uncertainty  about  the  future  decisions   2. Price  Confusion   3. The  cost  of  holding  money  (“shoe  leather  costs”)   4. Money  Illusion   5. Menu  Costs   6. Wealth  Redistribution  and  Tax  Distribution       1. Uncertainty   o Not  knowing  what  to  expect  from  the  price  levels  in  the  future   changes  behavior  of  individuals  and  firms     2. Price  Confusion   o What  is  causing  prices  to  change?   o You  may  mistake  inflation  with  changes  in  demand  or  changes  in  the   markets  for  your  inputs         3. Holding  Money  (Shoeleather  costs)   o Shoeleather costs are the resources that are wasted when people change their behavior to avoid holding money o If  inflation  is  increasing,  the  value  of  money  decreases   o This  is  not  as  big  an  issue  in  countries  with  stable  credit  and  updated   banking  systems   o This  was  a  bigger  issue  in  the  past       ECON  2105  Study  Guide  Test  2     4. Money  Illusion   o Money illusion occurs when people interpret nominal changes in wages/prices as real changes.   o As  inflation  increases,  real  values  of  money  become  more  difficult  to   determine     5. Menu  Costs   o Menu  costs  are  the  costs  of  changing  prices   o Less  informed  customers  think  you’re  just  raising  prices  and  shop   elsewhere…  until  they  realize  it’s  increasing  every  where  else  as  well       6. Wealth/Taxes   o Wealth  distribution:   § Borrowers  are  made  better  off  by  inflation     § The  real  value  of  money  paid  back  is  less     o Taxes:   § Taxes  don’t  account  for  inflation   § If  you’re  wages  rise  to  maintain  the  real  value  of  your  pay,   what  happens?   • The  IRS  actually  changes  tax  rate  margins  yearly     • Capital  Gain  taxes   o Taxes  on  the  gains  realized  for  selling  an  asset  for  more  than  its   purchase  price             ECON  2105  Study  Guide  Test  2     Limitations  with  CPI:   1. Substitution  Effect   2. Changes  in  Quality   3. New  Products  in  the  Economy     • The  estimate  from  CPI  may  over  or  underestimate  the  true  change   • It  is  important  that  CPI  is  accurate  because  employers  use  it  to  adjust  for   wages   o As  CPI  increases,  so  do  wages     1. Substitution  Effect   o Consumers  respond  to  price  changes   o When  price  rises,  Quantity  Demanded  falls  and  consumers  will  buy   other  goods  if  it’s  an  option   o CPI  assumes  no  change  in  the  amount  bought  which  exaggerates  the   price  effect       2. Quality  Changes   o CPI  makes  no  distinction  about  quality  of  goods   o If  you’re  paying  a  higher  price  for  a  better  product,  that  is  not  an   inflation  effect   § Advances  in  technology  usually  cause  prices  of  some  goods  to   decrease  overtime   o CPI  will  be  biased  upward   § Upward  bias:  prices  are  estimated  to  have  gone  up  more  than   what  they  really  have         3. New  Products   o The  CPI  is  updated,  but  not  quickly   o New  goods  tend  to  decrease  in  price  at  first,  so  that’s  not  captured  in   the  delay   o The  surveys  are  done  in  stores,  which  misses  online  sales   o The  solution  is  a  chained  CPI     § Chained CPI is a measure of the CPI in which the typical consumer’s basket of goods is updated monthly § It  keeps  track  of  upward  bias       • Billion  Prices  Project  (BPP)   o This  is  an  independent  index  that  tracks  prices  across  the  internet   o Many  prices  can  be  monitored  daily   ECON  2105  Study  Guide  Test  2       4. Substitution  Effect   o Substitution  causes  the  basket  of  goods  the  typical  consumer  buys  to   change.     o As  price  increases,  quantity  demanded  decreases   o Consumers  will  buy  other  goods  if  its  an  option         ECON  2105  Study  Guide  Test  2     • Social  Security  is  adjusted  based  on  the  CPI   o Cost  of  Living  Adjustment  (COLA)     o COLA  keeps  real  Purchasing  Power  from  going  down     • CPI  assumes  you  buy  the  same  amount  of  goods  every  year…  this  is  why  the   base  year  is  constant         ECON  2105  Study  Guide  Test  2     Chapter  9:  Savings,  Interest  Rates,  and  the  Market  for  Loanable   Funds     • For  a  company  to  have  long  term  growth,  there  must  be  an  adequate  level  of   investment       • 2  groups  in  the  financial  markets:   1. Those  that  have  funds  that  they  choose  no  to  use  at  the  present   (lenders)   2. Those  who  have  an  immediate  need  for  capital  to  invest  in  an   idea/project  (borrowers)       • A  financial  market  is  a  means  to  bring  the  above  two  groups  together     • Loanable  funds  market   § Savers  supply  funds  to  borrowers   § Future  production  depends  on  present  investment  which   needs  funding       • When  people  start  retiring,  they  draw  money  out  of  the  global  funds  market   o This  causes  interest  rates  to  go  up   o This  means  the  loans  you  qualify  for  gets  smaller     • 2  ways  to  get  funds   1. Direct  Finance   • Occurs  when  borrowers  go  directly  to  savers  for  funds   • Example:  stocks  and  bonds   2. Indirect   • Occurs  when  savers  lend  funds  to  financial   intermediaries,  which  loan  these  funds  to  borrowers   • Example:  banks  (and  others)   *most  of  us  deal  within  the  indirect  method   • Stocks   o Ownership  shares  in  a  firm     • The  stock  market  is  borrowing/lending  by  selling  rights  to  potential  profits     • Generally  speaking  in  the  stock  market:   o Stock  or  equity  in  the  company  is  sold   o There  is  no  guarantee  of  payment   o Only  select  groups  of  people  receive  dividends             ECON  2105  Study  Guide  Test  2     • Large  corporations  can  issue  stock   o Corporations  receive  funds  at  the  initial  price  offering  (IPO),  not  as   share  prices  rise   o You  buy  shares  from  brokers  (not  directly  from  the  company)   § Brokers  are  examples  of  a  Secondary  Market   • Place  where  securities  are  traded  after  their  first  sale   Example:  New  York  Stock  Exchange         • Most  of  our  dealings  with  financial  markets  are  through  Indirect  funding   o The  US  banking  system  is  the  most  common  example           • Bank   o Maintain  deposits  of  customers   o Also  give  out  loans   § Banks  consolidate  small  individual  savings  and  lend  those  to   investors     • Demand:  Those  looking  to  spend  money  now   • Supply:  Those  saving  now     • Like  any  market,  there’s  a  price  to  borrow  money   o In  the  loanable  funds  market,  this  is  called  the  interest  rate     • The  interest  rate  is   1. An  incentive  to  save  instead  of  spend   2. The  cost  of  spending  money  you  don’t  have       • Increasing  interest  rates  cause  individuals  to  spend  less  and  save  more   o Also  causes  firms/individuals  to  borrow  less     • Real  Interest  Rate   o Interest  rate  that  is  corrected  for  inflation   o It  is  the  rate  of  return  in  terms  of  real  purchasing  power       • Nominal  Interest  Rate   o Interest  rate  before  it  is  corrected  for  inflation   o It  is  the  stated  interest  rate       • FISHER  EQUATION   Real  Interest  (r)  =  Nominal  (i)  –  Inflation  (π)   Also  can  be  written  as:     i  =  r  +    π     ECON  2105  Study  Guide  Test  2     • Equilibrium  of  Loanable  Funds  Market   Plans  of  Savers  =  Plans  of  Borrowers       ECON  2105  Study  Guide  Test  2     Factors  that  shift  the  DEMAND  for  funds:   1. Productivity  of  capital   • Firms  borrow  in  order  to  finance  capital  purchases   • If  capital  is  more  productive,  the  demand  for  loans  will   increase     2. Expectations  of  investors   • Investor  Confidence:  A  measure  of  what  firms  expect  for   future  economic  activity   • If  a  firm  believes  its  sales  will  increase  in  the  future,  it   invests  more  today  to  build  for  future  sales     3. Expectations  of  inflation  rate         Factors  that  shift  the  SUPPLY  of  funds:   1. Discount  rate  of  investors  (also  known  as  time  preferences)   o People  prefer  to  receive  goods  and  services  sooner  rather  than  later   o People  with  the  strongest  time  preferences  are  the  least  patient   § They  want  funds  now   o If  someone  saves  money,  it  is  said  they  have  a  low  discount  rate     2. Income/wealth  changes   o As  nations  gain  wealth,  they  save  more     3. Consumption  patterns  (smoothing)   o Consumption  smoothing  is  accomplished  with  the  help  of  the  loanable   funds  market   o It  is  being  able  to  spread  out  income/spending  in  a  way  that  is   consistent  and  balanced  way  throughout  the  consumer’s  lifetime   o Dissaving:  People  withdraw  funds  from  their  previously  accumulated   savings         4. Relative  saving  options     5. Expectations  of  inflation  rate   o Inflation  makes  the  real  value  of  your  debt  go  back  down       ECON  2105  Study  Guide  Test  2     Examples:     • Effect  on  supply  and  demand  of  loanable  funds  market  when  inflation  is   expected  to  increase     Inflation   S’         S               D’     D   Quantity  of     Loanable  Funds       • Effect  on  demand  of  loanable  funds  market  when  expectations  of  investors   increase   Example:  Apple  predicts  that  the  economy  is  going  to  pick  up.     Inflation       S                   D’     D     Quantity  of     Loanable  Funds       ECON  2105  Study  Guide  Test  2     • Effect  on  supply  of  loanable  funds  market  if  wealth  increases   o The  amount  of  funds  available  is  going  to  change     Inflation       S       S’                         D       Quantity  of     Loanable  Funds             ECON  2105  Study  Guide  Test  2     Chapter  10:  Financial  Markets  and  Securities       • Saving  vs.  Investing   o If  you  put  $200  in  the  bank  this  is  saving   o A  company  takes  out  a  loan…  this  is  investing       • A  decrease  in  income  causes  interest  rates  to  increase     • Bond  prices  and  interest  rates  are  inversely  related     • Bond   o A  bond  is  a  debt  instrument  with  a  fixed  interest  payment   o Bonds  are  less  risky  than  stocks   o Bonds  can  be  wither  long-­‐term  or  short-­‐term   *Long-­‐term  bonds  have  higher  rates  of  interest       • Interest  Rate:   (Face  Value  –  Initial  Price)  /  Initial  Price     • Face  value   o Also  known  as  par  value   o This  is  the  value  of  the  bond  at  the  maturity  date  (when  the  loan   repayment  is  due)     • Discount  bond   o Bond  is  sold  for  less  than  what  it’s  face  value  is     o The  face  value  is  still  due  at  maturity  though   Example:  A  bond  is  $1,000.  It  is  sold  for  $900.   Interest  Rate:  (1000-­‐900)/(900)  =  11.1%         ECON  2105  Study  Guide  Test  2     • Effect  on  supply  of  bond  market  when  expectations  of  investors  increase:   o When  supply  of  bonds  is  going  up,  it  drives  the  price  down         Price   S             S’                     D         Quantity           • Bond  market  when  wealth  increases:           S                         D’     D                     ECON  2105  Study  Guide  Test  2     • Default  Risk   o The  chance  that  the  borrower  will  not  pay  back  the  funds  owed  pay   back  their  bonds)   o Default  risk  (ρ)   I = r + π + ρ *California  and  Illinois  have  the  worst  credit  rating  in  the  United  States     • The  government  spends  more  than  it  takes  in     • Deficit   o Yearly  difference  between  taxes  and  costs     • Debt   o The  total  of  all  deficits     • Security   o A  tradable  contract  that  entitles  its  owner  to  certain  rights   o A  bond  is  a  security  that  represents  debt  unpaid     • Treasury  Securities   o Bonds  sold  by  the  federal  government   o T-­‐Bills   § Short-­‐term  bonds,  less  than  52  weeks  until  maturity   o T-­‐Notes   § 1-­‐10  years  until  maturity   o T-­‐Bonds   § Longer  than  10  years  until  maturity       • Securitization   o The  creation  of  new  security  by  combining  otherwise  separate  loan   agreements   o Combining  different  assets  (like  mortgages)  and  then  selling  them  to   investors   o Taking  things  that  aren’t  usually  considered  assets  and  making  them   tradable         ECON  2105  Study  Guide  Test  2     Chapter  11:  Economic  Growth  and  the  Wealth  of  Nations     • In  wealthy  countries  there  is  a  presence  of  stable  legal,  banking,  and  political   systems   • Economic  Growth:   Percent  Change  in  Q  =    (%Change  in  Y    − %Change  in  P  −  %Change  in  Population)     • Human  Capital   o The  resource  represented  by  the  quantity,  knowledge,  and  skills  of  the   workers  in  an  economy     • Institution   o A  significant  practice,  relationship,  or  organization  in  a  society   o The  official  and  unofficial  conditions  that  shape  the  environment  in   which  decisions  are  made     • Private  Property  Rights   o Individuals  can  own  property  (houses,  land,  and  other  resources)   o When  their  property  is  used  in  production,  they  own  the  resulting   output     • Resources   o Also  known  as  factors  of  production   o Inputs  used  to  produce  goods/services     • Rule  of  70   o If  the  annual  growth  rate  of  a  variable  is  x%  the  size  of  that  variable   doubles  every  70/x  years   o This  is  an  approximation   o Shows  that  small/consistent  growth  rates  that  are  sustained  can   greatly  improve  the  living  standards     • Technological  Advancement   o Introduces  new  techniques  or  methods  so  that  firms  can  produce   more  valuable  outputs  per  unit  of  input       • Technology   o The  knowledge  that  is  available  for  use  in  production     • When  markets  aren’t  competitive,  people  face  barriers  to  entry     • International  Trade  barriers  reduce  the  benefits  from  specialization  and   trade   ECON  2105  Study  Guide  Test  2     Chapter  12:  Growth  Theory     Production  function   o Relationship  between  the  inputs  a  firm  uses  and  the  output  it  creates   q  =  output  of  the  firm   o The  production  function  for  a  single  firm  =     q  =  f  (human  capital,  physical  capital)       k  =  human  capital   L  =  labor     NR=  Natural  Resources       Aggregate  Production  Function   o Relationship  among  all  the  inputs  used  in  the  macroeconomy  and  the   total  output  of  that  economy,  where  GDP  is  output     GDP  =  Y  =  F  (physical  capital,  human  capital,  natural  resources)     Marginal  Product  (MP)   o The  MP  of  an  input  is  the  change  in  output  divided  by  the  change  in   input   o Economist  use  this  to  quantify  how  helpful  an  additional  resource   may  be   MP  of  Input  x  =  Change  in  output/  Change  in  input  x     Diminishing  Marginal  Product   o The  marginal  product  of  an  input  falls  as  the  quantity  of  the  input   rises     Convergence   o The  idea  that  per  capita  GDP  levels  across  nations  will  equalize  as   nations  approach  a  steady  state   Depreciation     o A  fall  in  the  value  of  a  resource  over  time   o This  is  natural  with  capital     Endogenous  Growth   o Growth  driven  by  factors  inside  the  economy     Exogenous  Growth   o Growth  that  is  independent  of  any  factors  in  the  economy     Net  Investment   Investment  –  Depreciation       ECON  2105  Study  Guide  Test  2     Steady  State   o The  condition  of  a  macroeconomy  when  there  is  no  investment       § Voluntary  investment  and  production  occurs  only  if:   Expected  payoff  ≥ costs             .  


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