Intro to Macro Study Guides
Intro to Macro Study Guides ECON 201
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This 14 page Study Guide was uploaded by Michelle Lee on Friday April 1, 2016. The Study Guide belongs to ECON 201 at Northwestern University taught by Robert Gordon in Spring 2016. Since its upload, it has received 21 views. For similar materials see Macroeconomics in Economcs at Northwestern University.
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Date Created: 04/01/16
Midterm 1 Chapter 1 ➢ Principles that Underlie Individual Choice ■ individual choithe decision by an individual of what to do, or what not to do 1) Choices are necessary because resources are scarce ■ resource: anything that can be used to produce something else ■ scarce not enough of the resources are available to satisfy the ways society wants to use them 2) The true cost of something is its opportunity cost ■ opportunity cos the real cost of an item is what you must give up in order to get it 3) “How much” is a decision at the margin ■ tradeoffcompare the costs with benefits of doing something ■ marginal decisionsecisions about whether to do a bit more or a bit less of an activity ○ these decisions require making tradeoffs at the margin: comparing costs/benefits of doing more of an activity versus doing less ■ marginal analysithe study of such decisions 4) People usually respond to incentives, exploiting opportunities to make themselves better off ■ incentives anything that offers rewards to people who change their behavior ➢ Interaction: How Economies Work ■ interaction of choicwhen one’s choices affect others choices; results of this interaction are quite different from what the individuals intend 5) There are gains from trade ■ trade provide goods/services to others and receive goods/services in return ■ gains from trad people can get more of what they want thru trade than if they tried to be selfsufficient ■ specializatioeach person specializes in a task that he/she is good at performing to increase output 6) Markets move toward equilibrium ■ equilibrium:economic situation when no individual would be better off ○ because ppl respond to incentives, markets move toward equilibrium 7) Resources should be used efficiently to achieve society's goals ■ efficienttakes all opportunities to make some ppl better off with making others worse off ■ equity:everyone gets his/her “fair“ share 8) Markets usually lead to efficiency ○ ppl usually exploit gains from trade, leading to efficiency ■ exceptions are market failure 9) When markets don’t achieve efficiency, government intervention can improve society’s welfare ● individual actions’ side effects that are not properly taken into account by the market (i.e. action that causes pollution) ● one party prevents mutually beneficial trades from occurring in an attempt to capture a greater share of resources for itself (i.e. drug company that prices drug > the cost of production, making it unaffordable for some who can benefit from it) ● some goods, by nature are unsuited for efficient management by markets (i.e. air traffic control) ➢ EconomyWide Interaction 10) One person’s spending is another’s income 11) Overall spending sometimes gets out of line with the economy’s productive capacity 12) Government policies can change spending Chapter 2 ➢ Tradeoffs and Trade ■ other things equal assumptall other relevant factors remain unchanged ■ production possibility frontieillustrate the tradeoffs facing an economy that produces only two goods, showing the maximum quantity of one good that can be produced for any given quantity produced of the other ■ comparative advantagproduces a good or service with an opportunity cost lower than other countries/people ■ absolute advantagproduces a good or service with more output per worker than other countries ○ International trade benefits both countries even if one country has higher output per worker in both industries ((comparative advantage)) ○ TheCircularFlow Diagram: ■ represents the transactions in an economy by flows around a circle ■ barte trade takes the form of this when ppl directly exchange goods/services for what they want ■ Household:person with or a group sharing income ■ Firm organization that produces goods/services for sale ■ Markets for good and servifirms sell goods and services they produce to households in this market ■ Factor marke firms buy the resources they need to produce goods and services in this market ● income distribution: the way in which total income is divided among the owners of the various factors of production ○ Midterm 2 Chapter 6 ➢ Macroeconomics: The Whole is Greater Than the Sum of Its Parts ○ Selfregulating economproblems such as unemployment are resolved w/o govt intervention, through the working of the invisible hand ○ Keynesian economics: economics slumps are caused by inadequate spending and they can be mitigated by govt intervention ○ Monetary polic uses changes in the quantity of money to alter interest rates and affect overall spending ○ Fiscal poli uses changes in govt spending and taxes to affect overall spending ➢ Charting the Business Cycle ○ Recessions: contractions, periods of economic downturn when output and employment are failing ○ Expansions: recoveries, periods of economic upturn when output and employment are rising ○ Business cycleshortrun alternation between recessions and expansions ○ Businesscycle peathe point at which the economy turns from expansion to recession ○ Businesscycle trou the point at which the economy turns from recession to expansion ➢ LongRun Economic Growth ■ the sustained upward trend in the economy’s output over time ○ people live better than they did half a century ago ○ crucial for many economic concerns, such as a higher standard of living or financing govt programs ➢ Inflation & Deflation ○ Inflatiorising overall level of prices ○ Deflationfalling overall level of prices ○ inflation depends on economy: ■ depression → falls ■ boom → rise ○ Price stabil overall level of prices changes slowly or not at all ○ Open economy: economy that trades goods and services w/ other countries ○ Trade defic when the value of g&s bought from foreigners > g&s sold to them ○ Trade surpluswhen the value of g&s bought < g&s sold Chapter 7 ➢ The National Accounts ■ keeps track of the flows of money between different sectors of the economy ○ Consumer spending:household spending on g&s ○ Stock a share in the ownership of the company held by a shareholder ○ Bond: borrowing in a form of an IOU that pays with interest ○ Government transfer payments from the govt to households with no g&s in return ○ Disposable income total amount of household income available to be consumed or saved ( = income + govt transfers tax) ○ Private savi equal to disposable income minus consumer spending, the disposable income not spent on consumption ○ Financial mark banking, saving, and bond markets, which channel private savings and foreign lending → investment spending, govt & foreign borrowing ○ Government borrowingtotal amount of funds borrowed by federal, state, and local governments in the financial markets ○ Government purchases of g& total expenditures on g&s by federal, state, and local govt ○ Exportsg&s sold to other countries ○ Imports g&s purchased from other countries ○ Inventorie are stocks of goods and raw materials held to facilitate business operations ○ Investment spendinis spending on productive physical capital ■ i.e. machinery, constructing buildings, and changes to inventories ○ Final goods and servic g&s sold to the final user ○ Intermediate goods and servig&s bought from one firm by another, that are inputs for production of final g&s ○ GDP: gross domestic product ■ total value of all final g&s produced in the economy during a given year ○ Aggregate spendingthe total spending on domestically produced final goods and services in the economy ■ ( = consumer spending + investment spending + govt purchases + exports imports) ➢ Calculating GDP 1. adding up the total value of all final g&s produced 2. adding up spending on all domestically produced g&s 3. adding up total factor income earned by households from firms in the economy ○ Value added: sum of value added = GDP ■ = value of sales – value of intermediate g&s purchases ○ Included in GDP: ■ Domestically produced final g&s ○ capital goods ○ new construction of structures ○ changes to inventory ○ Not included in GDP ■ intermediate g&s ■ inputs ■ used goods ■ financial assets like stocks and bonds ■ foreignproduced g&s ➢ Real GDP: Measure of Aggregate Output ○ Aggregate Output the economy’s total quantity of output of final g&s ○ Real GDP: the total value of all final g&s produced in economy for given year ■ calculated by using the prices of selected price year ○ Nominal GDP: value of all final g&s produced in economy for given year ■ calculated using the prices in the year in which the output is produced ○ Chain dollarmethod of calculating changes in real GDP using the average between the growth rate calculated using an early base year and the growth rate calculated using a late base year ○ GDP per capitaGDP divided by the size of the population; average GDP/person ➢ Price Indexes and the Aggregate Price Level ○ Aggregate price levmeasure of the overall level of prices in the economy ○ Market basket hypothetical set of consumer purchases of g&s ○ Price inde measure the cost of purchasing a given market basket in a given year, where that cost is normalized so it is equal to 100 in the selected base year ■ = (cost of market basket, given) / (cost of market basket, base) x100 ○ Inflation ra the percent change per year in a (mostly consumer) price index ■ = (price index year 2 price index year 1) / (price index year 1) x100 ○ CPI: Consumer Price Index ■ measures the cost of the market basket of a typical urban family ○ PPI: Price Producer Index ■ measures changes in the prices of goods purchased by producers ○ GDP deflator the ratio of nominal GDP to real GDP in a given year ■ = (nominal / real) x100 ● measures the aggregate price level as ratio ○ CPI, PPI, and GDP deflators normally behave similarly Chapter 8 ➢ Unemployment Rate Significance ○ U rate can overstate the true level ■ when workers are confident of finding jobs but have not yet accepted a position, and they are counted as unemployed ○ U rate can understate the true level ■ doesn’t count the discouraged, marginally attached, and underemployed workers ○ Discouraged workernonworking people capable of working but have given up searching due to the state of the job market ○ Marginally attached workwould like to be employed and have looked for a job in the recent past but arecurrentllooking for work ○ Underemployment: number of people who work part time because they cannot find a fulltime job ○ generally strong negative relationship between growth in the economy and the rate of U ○ Jobless recovery period in which the real GDP growth rate is positive but the rate of U is still rising ➢ Natural Rate of Unemployment ○ never dropped below 2.9% because of job creation and destruction ○ Frictional unemploymen unemployment due to the time workers spend in job search ■ Job search workers who spend time looking for employment ■ # of people seeking jobs = # of jobs offered ○ Structural unemploymen more people are seeking jobs in a particular labor market than there are jobs available at the current wage rate, even when the economy is at the peak of the business cycle ■ usually caused by binding minimum wages ○ Efficiency wagewages that employers set above the equilibrium wage rate as an incentive for better employee performance ○ Natural rate of unemploymen = structural + frictional unemployment ○ Cyclical unemployment deviation of the actual rate of unemployment from the natural rate ■ due to downturns in the business cycle ○ causes of the natural rate of unemployment ■ changes in labor force characteristics ■ changes in labor market institutions ■ changes in govt policies ○ the ones designed to help workers are one reason for high natural rates of U in Europe ➢ Inflation and Deflation ○ Real wage: the wage rate / price level ○ Real income income / price level ● thelevelf prices doesn’t matter rate of infla does ○ high rates of inflation impose significant costs ■ Shoeleather costincreased costs of transactions caused by inflation ■ Menu costs:real cost of changing a listed price ■ Unit of account cos arise from the way inflation makes money a less reliable unit of measurement ○ Interest ra the price, calculated as a percentage of the amount borrowed, that lenders charge borrowers the use of their savings for one year ○ Nominal interest ra the interest rate expressed in dollar terms ○ Real interest ra = the nominal interest rate – the rate of inflation ➢ Winners and Losers from Inflation ○ if the inflation rhigherthan expected,orrowergain b/c they will repay their loan with funds that have a lower real value than expected ○ if the inflation ralowerthan expected,lenderswill gain b/c borrowers will repay their loans with funds that have a higher real value than expected ➢ Inflation: Easy Disinflation: Hard ○ Disinflatio the process of bringing the inflation rate down ○ because disinflation is so costly, policy makers try to avoid getting into situations of high inflation in the first place Chapter 9 ➢ Comparing Economies Across Time and Space ○ economic growth is measured using real GDP per capita ○ in the US, real GDP per capita increased eightfold since 1900, resulting in a large increase of living standards ○ many countries have real GDP per capita much lower than that of the US. More than half of the world’s population has living standards worse than those existing in the US early 1900s ○ growth rates of real GDP per capita differ substantially among nations ➢ Sources of LongRun Growth ○ Labor productivity (productiv output per worker or output per hour ○ Physical capitaconsists of humanmade resources such as buildings and machines ○ Human capital: improvement in labor created by the education & knowledge embodied in the workforce ○ Technological progress an advance in the technical means of g&s production ○ Aggregate production functiohypothetical function that shows how productivity depends on the quantities of physical capital per worker and human capital per worker as well as state of technology ■ GDP per worker = Technology x (physical capital)x (human capital) ○ Diminishing returns to physical cap when the aggregate production function exhibits a successive increase in the amount of physical capital per worker leading to a smaller increase in productivity, and the amount of human capital per worker and the state of technology is fixed ○ Growth accounting:estimates the contribution of each major factor in aggregate production function to economic growth ○ Total factor productiv the amount of output that can be achieved with a given amount of factor inputs ➢ Differences in Growth Rates ■ savings and investment spendings, ■ education ■ research and development ○ R&D: research and development; spending to create and implement new technologies ➢ Government’s Role in Growth ○ government policies can increase growth rate thru four main channels: 1. Government subsidies to build infrastructure ● Infrastructur roads, power lines, ports, info networks, underpinning for economic activity 2. Government subsidies to education 3. Government subsidies to R&D 4. Maintaining a wellfunctioning financial system ○ protection of property rights allow innovators to accrue rewards for her innovation ■ patents allow innovator to use or sell the innovation ○ political stability and good governance ○ Convergence hypothesis:international differences in GDP tend to narrow over time ➢ East Asia’s Miracle ○ emphasis on education and adoption of tech from other countries, high savings and investment spending ➢ Latin America’s Disappointment ○ rate of savings and investment spending are much lower than Asia’s ○ underemphasis of education ➢ Africa’s Troubles ○ political instability, civil wars, no property rights, bad geographic conditions ○ worker productivity is hampered by malnutrition ➢ Sustainability ○ Sustainable longrun economic growtgrowth that can continue in the face of the limited supply of natural resources and the impact of growth on the environment ○ government action to address climate change and greenhouse gasses should be in the form of marketbased incentives, like carbon tax. Chapter 10 ➢ Matching Up Savings and Investment Spending ○ Savingsinterest spending identsavings and investment spending are always equal ■ GDP = C + I + G + X – Im ○ Budget surplus tax revenue > govt spending ○ Budget defici tax revenue < govt spending ○ Budget balance tax revenue – govt spending ■ can be surplus or deficit depending on the sign ○ National savingtotal amount of savings generated within the economy ■ = private savings + budget balance ○ Net capital infltotal inflow of funds – total outflow of fends of a country ■ = imports – exports ○ Loanable funds market hypothetical market that illustrates the market outcome of the demand for funds generated by borrowers and the supply of fends provided by lenders ○ Equilibrium interest r rate at which the quantity of loanable funds supplied = quantity of loanable funds demanded ○ Crowding out occurs when a govt budget deficit drives up the interest rate and leads to reduced investment spending ○ shifts in demand: ● changes in perceived business opportunities ● changes in govt borrowing ○ shifts in supply: ● changes in private savings behavior ● changes in net capital inflows ➢ Inflation and Interest Rates ○ Real Interest Rate = Nominal Interest Rate – Inflation Rate ○ Fisher Effec increase in expected future inflation drives up nominal interest rate, leaving expected real interest rate unchanged ➢ The Financial System ○ Wealth: a household’s value of accumulated savings, by purchasing assets ○ Financial asset paper claim that entitles buyer to future income from the seller ■ i.e. loans (from the bank’s perspective) ■ Liabilit a requirement to pay income in the future ○ Physical asset tangible objects that can be used to generate future income ➢ Tasks of a Financial System 1. Reducing Transaction Costs ● Transaction costexpenses of negotiating and executing a deal 2. Reducing Risk ● Financial ri uncertainty about future outcomes that involve financial losses/gains ● Diversificati investing in several diff things so that the possible losses are independent events 3. Providing Liquidity ● Liqui asset that can quickly convert to cash with little loss of value ● Illiqu asset cannot be converted to cash with little loss of value ➢ Types of Assets ○ Loans: lending agreement between individual lender and borrower ○ Bonds: an IOU issued by the borrower ■ Defauloccurs when a borrower fails to make payments as specified by the load or bond contract ○ Loanbacked security asset created by pooling individual loans and selling shares in that pool ○ Stocks:share in the ownership of a company ➢ Financial Intermediary ■ an institution that transforms the funds it gathers from many individuals into financial assets ○ Mutual funds a financial intermediary that creates a stock portfolio and then resells shares to individual investors ■ Pension fundsa type of mutual fund that holds assets in order to provide retirement income to its members ■ Life insurance compansells policies that guarantee a payment to policyholder’s beneficiaries when the policyholder dies ○ Bank: financial intermediary that provides liquid assets in the form of bank deposits to lenders and uses those funds to finance the illiquid investment spending needs of borrowers ○ Bank deposit claim on a bank that obliges the bank to give the depositor his or her cash when demanded ➢ Asset Price Expectations ○ Efficient markets hypotheasset prices embody all publicly available info ○ Random walk: movement over time of an unpredictable variable ○ financial market fluctuations can be a source of shortrun macroeconomic instability Chapter 11 ➢ The Multiplier ○ MPC: increase in consumer spending when disposable income rises by $1 ○ MPS: increase in household savings when disposable income rises by $1 ○ Total increase in real GDP ■ = (1 + MPC1 + MPC2 + MPC3 + …) x ($GDP Raise) ○ Autonomous change in aggregate spendinginitial change in the desired level of spending by firms, households, or govt at a given level or real GDP ■ ∆Y = Multiplier x ∆AAS ○ Multipli ratio of the total change in real GDP caused by autonomous change in aggregate spending to size of that autonomous change ■ = 1 / (1 MPC) ➢ Consumer Spending ○ most important factor affecting consumer spending is current disposable income (income after taxes paid & govt transfers received) ○ Consumption Functionan equation showing how an individual household’s consumer spending varies with current household’s disposable income ■ c = a + MPC + yd ○ c= indvl consumer spending ○ a= constant term, autonomous consumer spending ○ yd= current disposable income
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