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EC 111- Exam 2 Detailed Study Guide

by: Matt Cutler

EC 111- Exam 2 Detailed Study Guide Econ 111

Marketplace > University of Alabama - Tuscaloosa > Econ 111 > EC 111 Exam 2 Detailed Study Guide
Matt Cutler
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This study guide is an in depth version of the outline Mr. Zirlott posted for us for Exam 2
Kent 0. Zirlott
Study Guide
Economics, Zirlott, Macroeconomics
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This 6 page Study Guide was uploaded by Matt Cutler on Saturday March 5, 2016. The Study Guide belongs to Econ 111 at University of Alabama - Tuscaloosa taught by Kent 0. Zirlott in Fall 2016. Since its upload, it has received 91 views.


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Date Created: 03/05/16
Exam 2 Detailed Study Guide Thursday, March 3, 2016 10:53 PM 1. Chapter 10- GDP (Gross Domestic Product) a. Definitions and Concepts i. GDP 1) Measures total expenditure on the economies output of goods and services 2) Expenditures=Income ii. Nominal GDP 1) Values output using current prices (Current prices times quantity). Does not account for inflation iii. Real GDP 1) Values output using the prices of a base year (prices DO NOT change). Accounts for inflation (Base year prices times current quantity) iv. Recession 1) When GDP is falling for 2 consecutive quarters v. To calculate percentage change 1) (New-Old)/ Old vi. GDP Deflator 1) Measure of overall level of prices 2) (Nominal GDP/ Real GDP)*100 b. What is GDP? i. The market value of all FINAL goods and services produced within a country within a given time. ii. Goods are measure in their market prices so that all goods are measured in the same units. c. How Do you calculate GDP? What are the four components of GDP? Examples of items for each component. i. How do you calculate GDP? 1) GDP= C+G+I+X ii. Four components 1) C= Consumption a) Total spending by households on goods and services b) Largest component of GDP, Includes Rent and homeowners 2) G= Government purchases a) Spending on goods and services purchased by the government at the federal, state, and local levels. b) Excludes transfer payments, such as social security or unemployment insurance benefits. c) Includes Highways, missiles, and dams. 3) I= Investment a) Total spending on goods that will be used in the production of other goods b) i.e. capital equipment, structures c) Inventories (goods produced but not yet sold) (only counts when its going in) d) Houses that are brand new, never been lived in Investment does not include stocks, bonds, or mortgages because they are not physical goods ( they are deeds of ownerships) 4) X= Net Exports a) Exports- Imports b) Number may be negative d. What is counted in GDP and what is not? i. Included: 1) Final goods 2) Tangible goods (DVDs, mountain bikes, beer) 3) Intangible services (dry cleaning, concerts, cell phone service) 4) Currently produced goods, not goods produced in the past 5) Measures the value of production that occurs within a country's borders, whether done by its own citizens or by foreigners located there. ii. DOES NOT include: 1) Intermediate goods (to avoid double counting) EC 111 Page 1 1) Intermediate goods (to avoid double counting) 2) Stocks, Bonds, Mortgages (Because they are not physical goods) e. GDP Deflator and Inflation rate i. The percentage increase in the GDP Deflator measures inflation rate. f. GDP and Economic well being i. Real GDP per capita is the main indicator of the average person's standard of living ii. But GDP is not a perfect measure of well-being i. GDP does not value: 1) The quality of the environment 2) Leisure time 3) Non-market activity, such as child care a parent provides his or her child at home 4) An equitable distribution of income iii. Having a large GDP enables a country to afford better schools, a cleaner environment, health care, etc. iv. Lots of indicators of quality of life are positively correlated with GDP: i. Life expectancy ii. Literacy iii. Internet usage and Technology 2. Chapter 11- CPI (Consumer Price Index) a. Definitions and Concepts i. CPI i. Measures the typical consumer's cost of living ii. The basis of cost of living adjustments (COLAs) in many contracts and in Social Security ii. The Bureau of Labor Statistics (BLS) i. Surveys consumers to see what they generally include in their "basket" iii. BEA (Bureau of Economic Analysis) i. inside the department of commerce; calculates GDP b. 5 steps for creating the CPI Index and calculating the inflation rate i. 5 Steps (must be in order) i. Fix the "basket" 1) The Bureau of Labor Statistics (BLS) surveys consumers to determine what's in the typical consumer's "shopping basket" ii. Find the prices 1) The BLS collects data on the prices of all the goods in the basket iii. Calculate the basket's cost 1) Use the prices to compute the total cost of the basket iv. Choose a base year and compute the index 1) The CPI in any year equals: 2) (Cost of basket in current year/Cost of basket in base year) * 100 v. Compute the inflation rate 1) The percentage change in the CPI from the preceding period equals: 2) Inflation rate = ((CPI this year - CPI Last year)/ CPI last year))*100 c. Problems with the CPI Index and measuring the cost of living i. Substitution Bias i. Over time, some prices rise faster than others ii. Consumers substitute towards goods that become relatively cheaper iii. The CPI misses this substitution because it uses a fixed basket of goods ii. Introduction of New Goods i. The introduction of new goods increases variety, allows consumers to find products that more closely meet their needs ii. In effect, dollars become more valuable iii. The CPI misses this effect because it uses a fixed basket of goods. iii. Unmeasured Quality Change (New Car) i. Improvements in the quality of goods in the basket increase the value of each dollar ii. The BLS tries to account for quality changes but probably misses some, as quality is hard to measure. ○ Each of these problems causes the CPI to overstate cost of living increases. ○ The BLS has made technical adjustments, but the CPI probably still overstates inflation by about .5 percent each year EC 111 Page 2 percent each year ○ This is important because Social Security payments and many contracts have COLAs tied to the CPI… could result in a billion dollar difference d. Differences between the CPI Index and the GDP Deflator (Both Measure Inflation!!!) i. Imported consumer goods: i. Included in CPI ii. Excluded from GDP deflator ii. Capital goods (investment goods) i. Excluded from CPI ii. Included in GDP deflator (if produced domestically) iii. The Basket: i. CPI uses fixed basket ii. GDP deflator uses basket of currently produced goods and services 1) This matters if different prices are hanging by different amounts e. Correcting Variables for Inflation i. Amount in today's dollars= Amount in year T dollars * (price level today/ Price level in year T) f. Real vs. Nominal Interest Rate i. Nominal Interest rate: i. Not corrected for inflation ii. The rate of growth in the dollar value of a deposit or debt ii. Real interest rate: i. Corrected for inflation ii. The rate of growth in the purchasing power of a deposit or debt ○ Real interest rate (REAL RATE OF GROWTH) = (Nominal interest rate) - (Inflation rate) 3. Chapter 13- Financial Systems in a Closed Economy a. Definitions and Concepts ○ The financial system- the group of institutions that helps match the savings of one person with the investment of another ○ Savings= investment in a closed economy ○ Financial markets are governed by the forces of supply and demand of loanable funds b. What are Financial Markets? i. Institutions through which savers can directly provide funds to borrowers i. The bond market 1) A bond is a certificate of indebtness ii. The stock market 1) A stock is a claim of partial ownership in a firm c. What are Financial Intermediaries? i. Financial Intermediaries: institutions through which savers can indirectly provide funds to borrowers i. Ex: 1) Banks 2) Mutual Funds- institutions that sell shares to the public and use the proceeds to buy portfolios of stocks and bonds d. National Income Identity for a Closed Economy i. It is a closed economy, so the country does not engage in national trade. So…. ii. Y= C+I+G, Y being income e. What are Private Saving, Public Saving, Budget Deficit, Budget Surplus, and National Saving? i. Private Saving i. The portion of household's income that is not used for consumption or paying taxes 1) = Y- T- C (Y= income) ii. Public Saving i. Tax revenue minus government spending 1) T-G iii. National Saving i. The portion of national income that is not used for consumption or government purchases ii. Private Saving + Public Saving (Y-T-C)+(T-G) iii. EQUALS: Y-C-G iv. Budget Deficit i. A shortfall of tax revenue from government spending EC 111 Page 3 i. A shortfall of tax revenue from government spending ii. G-T iii. Negative Public savings is the same as Budget Deficit v. Budget Surplus i. An excess of tax revenue over government spending ii. T-G iii. Public Saving f. What is national savings equal to in a closed economy? i. Investment g. The Market for Loanable Funds i. A supply-Demand model of the financial system i. Assume: only one financial market 1) All savers deposit their savings in this market 2) All borrowers take out loans from this market. 3) There is one interest rate, which is both the return to saving and the cost of borrowing. ii. The Supply of loanable funds comes from saving: i. Households with extra income can loan it out and earn interest ii. Public saving, if positive, adds to national saving and the supply of loanable funds. 1) If Negative, it reduces national saving and the supply of loanable funds. iii. The slope of the supply curve (with interest rate as and loanable funds as the axes) slopes upward because at a higher interest rate, it makes saving more attractive. iii. The Demand for loanable funds comes from investments: i. Firms borrow the funds they need to pay for new equipment, factories, etc. ii. Households borrow the funds they need to purchase new houses. iii. Slopes downward 1) Because more people are more likely to borrow money at lower interest rates. h. How do Savings Incentives, Investment Incentives, and Budget Deficit affect the Market for Loanable Funds and the Interest Rate? i. Real interest rates equal the supply and demand of loanable funds. (Equilibrium) ii. Savings incentives 1) Cutting taxes, tax incentives for saving, increases the supply of loanable funds. 2) Decreases interest rate iii. Investment incentives 1) Investment tax credit increases the demand for Loanable funds. 2) Interest rate rises iv. Other factors that will shift savings or investment 1) Savings a) Changes in income b) Expectations  Government Budget Deficit reduces national saving and the supply of loanable funds. Causes interest rate to rise and investment to decrease. 2) Investment a) Technological Progress (Shifts demand curve, because when new technology comes out, businesses must keep up) b) Expectations 3) Budget Deficit, Crowding out, and Long run Growth a) Our analysis: increase in budget deficit causes fall in investment. The govt borrows to finance its deficit, leaving less funds available for investment b) This is called crowding out. c) Recall from the preceding chapter: investment is important for long-run economic growth. Hence, budget deficits reduce the economy's growth rate and future standard of living. v. The Government Debt. a) The government finances deficits by borrowing (Selling government bonds) b) Persistent deficits lead to a rising govt debt. c) The ratio of govt debt to GDP is a useful measure of the government's indebtedness relative to its ability to raise tax revenue d) Historically, the debt-GDP ratio usually rises during wartime and falls during peacetime- until the early 1980s EC 111 Page 4 4. Chapter 15- Unemployment a. Definitions and Concepts i. Bureau of Labor Statistics (BLS) 1) Splits labor force into three groups a) Employed- (includes military) 1) Paid employees, self-employed, and unpaid workers in a family business, full time and part time workers, and those not working because of a temporary absence from a job (Vacation, health, seasonal) b) Unemployed: 1) People not working who have looked for work during previous 4 weeks, also includes temporary layoffs who are waiting to be recalled to a job c) Not in the Labor Force 1) Everyone else (Minors, retirees, inmates, full time students, disabled, discouraged workers, illegal immigrants, and volunteers) ii. Discouraged Worker 1) Someone who is able to work, but has stopped looking for a job b. What is the Labor Force? Who is included in the Labor Force? Who is not included in the Labor Force? i. The Labor Force 1) The total number of workers, Including the employed and unemployed. 2) People not included: People that are "Not in Labor Force" c. Calculating the Labor Force Participation Rate, and the U-Rate i. Labor Force Participation Rate 1) % of the adult population that is in the labor force 2) (Labor Force/ Adult Population) * 100 ii. Unemployment Rate 1) % of the labor force that is unemployed 2) (# of unemployed/ labor force) * 100 d. Problems with the U-Rate i. The U-rate is not a perfect indicator of joblessness or the health of the labor market: i. It excludes discouraged workers. ii. It does not distinguish between full-time and part-time work, or people working part time because full-time jobs are not available iii. Some people misreport their work status in the BLS Survey (Phantom Worker) iv. It does not include workers being paid "under the table" ii. Despite these issues, the u-rate is still a very useful barometer of the labor market & economy e. What is the natural rate of unemployment and what is it composed of? i. the normal rate of unemployment around which the actual rate fluctuates around (generally around 5-6%) ii. Made up of two things: i. Frictional Unemployment ii. Structural Unemployment f. What is Cyclical Unemployment? i. The deviation of unemployment from its natural rate ii. Associated with business cycles g. What is Frictional Unemployment? What are the causes of Frictional Unemployment? (Job Search, Sectoral Shifts, Unemployment Insurance) i. Frictional unemployment a) Occurs when workers spend time searching for the jobs that best suit their skills and tastes b) Short-term for most workers c) Things that make up frictional unemployment i) Job search is the process of matching workers with appropriate jobs  Things govt can do to help speed up job search process One. Govt employment agencies- provide information about job vacancies to speed up the matching of workers with jobs Two. Public training programs- aim to equip workers displaced from declining industries with the skills needed in growing industries ii) Sectoral shift (Changing economy)- changes in the composition of demand across EC 111 Page 5 ii) Sectoral shift (Changing economy)- changes in the composition of demand across industries or regions of the country iii) Unemployment insurance (UI) (safety Net) - a govt program that partially protects workers' incomes when they become unemployed One. Increases frictional unemployment Two. Benefits end when a worker takes a job. Three. Increasing or extending unemployment insurance raises frictional unemployment  Reduces uncertainty over incomes  Gives the unemployed more time to search, resulting in better job matches and thus higher productivity h. What is Structural Unemployment? What are the causes of Structural Unemployment? (Minimum Wage Laws, Unions, Efficiency Wages) i. Structural unemployment (Has a graph) a) Occurs when there are fewer jobs than workers b) Usually longer-term c) Occurs when wage is kept above the equilibrium…Three reasons for this: i) Minimum-wage laws  The minimum wage may exceed the equilibrium wage for the least skilled or experienced workers, causing structural unemployment  But this group is a small part of the labor force, so the min. wage can't explain most unemployment  But increasing the minimum wage raises unemployment by increasing the Qs of labor and decreasing the Qd of labor. Qs=Employees ii) Unions Qd= Employers  Union- a worker association that bargains collectively with employers over wages, benefits, and working conditions.  When unions bargain successfully, wages and unemployment rise in that industry  The typical union worker earns 15-20% higher wages and gets more benefits than a nonunion worker for the same type of work  Spillover effect – "Insiders"- workers who remain employed, they are better off. – "Outsiders"- workers who lose their jobs, they are worse off.  Some outsiders go to non-unionized labor markets, which increases labor supply and reduces wages in those markets.  Are Unions good or bad??? – Critics:  They are cartels. They raise wages above equilibrium, which causes unemployment and/or depresses wages in non-union labor markets – Advocates:  Unions counter the market power of large firms, make firms more responsive to workers' concerns. iii) Efficiency wages (Not minimum wage)  Firms voluntarily pay above-equilibrium wages to boost worker productivity. And by increasing worker productivity, the firms profit can increase as well.  Different versions of efficiency wage theory suggest different reasons why firms pay high wages.  4 reasons why firms might pay efficiency wages: – Worker health- paying higher wages allows workers to eat better, makes them healthier and more productive. – Worker turnover- hiring and training new workers is costly. Paying high wages gives workers more incentive to stay, reduces turnover. – Worker quality- offering higher wages attracts better job applicants, increases quality of the firm's workforce (Saban) Worker Effort- workers can work hard or shirk. Shirkers are fired if caught. – Is being fired a good deterrent. EC 111 Page 6


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