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Exam 3 Macroeconomics Review Guide

by: amber weiss

Exam 3 Macroeconomics Review Guide Economics 111

amber weiss
GPA 3.7

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About this Document

here is pretty much a summary of this chunk of material.
Mary Anne Pettit
Study Guide
econ exam 3
50 ?




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This 8 page Study Guide was uploaded by amber weiss on Saturday April 2, 2016. The Study Guide belongs to Economics 111 at Southern Illinois University Edwardsville taught by Mary Anne Pettit in Spring 2016. Since its upload, it has received 23 views. For similar materials see Macroeconomics in Economcs at Southern Illinois University Edwardsville.


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Date Created: 04/02/16
Macroeconomics Exam 3 Review Guide  Measuring the Macro-Economy - How is the economy doing? - How do we know? - National Income Accounting: looks at accounting data for entire economy - Most important measure of national income accounting is GDP - Gross domestic product: total market value of all final goods and services produced in the US in a calendar year  Gross Domestic Product - Market value means prices used for tally (add up prices) so, GDP totals up prices of stuff produced - 2015 NOMINAL GDP- - $18.1 Trillion - Nominal- current output GDP in current places, unadjusted for inflation increases the price level overtime - Unadjusted= Nominal know both terms - Nominal figures are problematic if idea is to measure real changes in stuff produced  Nominal vs. Real - Nominal GDP: current output in current places unadjusted for inflation increases in price level overtime - Real GDP: GDP that has been adjusted for price level changes, it reflects changes in output more clearly Dishes Price Nominal GDP Year 1 3 3 $9 Year 2 3 4 $12 - Didn’t produce more but increase in Nominal GDP - A price index is used to convert nominal to real GDP - Nominal GDP is put in base year prices Dishes Price Real GDP Year 1 3 3 $9 Year 2 3 4 $12 The first red arrow is the current output ; and the second arrow pointing down is the base year price showing the REAL GDP for YEAR 2 = $9… - WE ALWAYS WANT/PREFER REAL GDP  Understanding GDP - Final not intermediate = goods produced for further processing - Avoids Double Counting - GOAL IS MORE - How much should GDP grow each year?  2%-5% (short-run fluctuations) per year - Long run trend for US GDP growth is 3% - So, what is a “bad” growth rate? {other words for bad would be: sluggish, fatigue, anemic, etc…} 1-2%, but it is still positive - Recession- standard rule of thumb is 2 consecutive quarters of falling real GDP [6 months] Quarter every 3 months  Good growth rate: 2-5%  Long run trend: 3%  GDP defines recession  Recession: standard rule of thumb is 2 consecutive quarters of falling real GDP  QUIZ: Does this data indicate a recession?  Quarter 1: 2.5%  Quarter 2: 2%  Quarter 3: 1.5%  Quarter 4: 1%  NO! It doesn’t meet the definition, it is positive and indicating growth, it is slow but it grows. In order for it to be negative there would have to be a negative sign in front of the data.  When real GDP falls the growth rate will be negative  To be negative, it would need a negative sign  So, 2 quarters of negative GDP growth  Selected “official” recessions: 1990, 2001, 2007 - 2007- ended in 2009- most recent  Longest expansion in history! 1991- 2001 - Expansion- all quarters of positive economic growth  Calculating GDP - GDP- Measures total market value of all final goods/output - GDP exclusions: 1. Purely financial transactions  Government transfer payment such as Social Security Payments  NO NEW OUTPUTS PRODUCED  Security transactions such as buying and selling stocks and bonds  Stock represents ownership 2. Secondhand sales  Cars, houses, clothes, etc… - To calculate GDP, use Expenditure Method  Expenditure method- add up all of major components or types of spending  GDP= C + I + G (Xg – M ) - Each letter is a type of spending - C = consumer spending  Spending by households - I= investment spending  NOT BUYING STOCKS AND BONDS – BECAUSE NOT INCLUDED DUE OT EXCLUSION  Spending by businesses (mostly*) 1) New capital: new tools, equipment, machinery, factories 2) Residential investment – buying a NEW home 3) Changes in inventory – stuff produced that year on shelves and in warehouses, (even if not sold) - G= government spending  Spending by all levels of government local government, local and federal government  Excludes transfer payments – same as purely financial transactions Example) Social Security  New things: Bridges, computers, airplanes is all money the government spends - The rest of this equation will be completed on Friday, March 18th  GDP= C + I + G + (Xg – M ) - C  Consumer Spending - I  Investment Spending  This is NOT Buying Stocks and Bonds  Spending by Businesses (mostly) 1. New tools, equipment, machinery, factories (new capital) 2. Residential Spending – (buying a new home) 3. Changes in Inventory - G  Government Spending  Spending by all levels of government  Excludes transfer payments (purely financial transactions) - Exports (gross Xg) :  Our stuff to others - Imports (M) :  Their stuff to us  Components of GDP - Consumptions - Consumer spending Is the biggest component of total spending 70 – 75% - Spending by households on: 1. Durable goods: 11% - goods that last 1-3 years computers, cars, appliances, cell phones, electronics, instruments, and books 2. Nondurables : 29% - consumables – less than a year : food, alcohol, tobacco, toiletries, medication, fuel products 3. Services : 60% - things you pay to do for you : legal services, personal grooming, home repair services, restaurants, car services  Factors that determine consumption 1. Income - Income is the most important determinant of consumer spending remember circular flow of economic activity - Output = income - Producing stuff generates income for people- consumers, businesses, and governments - Disposable income : income after savings - Disposable income: consumption + saving - Saving is not spending  Factors that determine consumption … Continued - Consumer spending 1. Income (continued…)  Disposable income: income after taxes  Disposable income = consumption + saving  More income means more consumption and more saving (less income = less of both) 2. Prices (Walmart and gas prices)  Higher prices reduce consumption  Lower prices increase consumption  You feel “richer” with LOWER prices 3. Wealth Effects: amount of accumulated wealth a person has will (may? Should?) affect a person’s ability and willingness to spend now  Changes in wealth can change consumer behavior  Wealth: value of financial assets such as stock portfolios and retirement accounts and value of real assets - - your home, car  VERY IMPORTANT: The best measure of wealth is net-worth- value of assets (home, bank, accounts, portfolio, etc.) MINUS liabilities (claims) {mortgages credit card, debt, loans – school? Car?}  Important accounting tool: balancing sheet Assets Liability (bank claim) and Owners equity 1) $200,000 $200,000 - “0” 2) $300,000 $200,000 3) $200,000 $200,000 - OWE $100,000 Asset example: VALUE OF HOME = $200,000 Liability: VALUE OF MORTGACE LOAN = $200,000 Assume you buy a home for $200,000 and borrow $200,000  Wealth effects using balance sheet 1. Home purchased using mortgage loan - Owner equity = 0 2. Assume home prices rise - Home equity loan or Second Mortgage ($100,000) 3. Home Prices Fall - You owe more than value of home {upside down or under water} 4. Credit Conditions - Availability of credit and interest rates, impact how much households spend- - Easy credit and low rates encourage consumption - Tight credit and high rates discourage consumption 5. Taxes- change disposable income - Increase taxes decrease consumption - Decrease taxes increase consumption 6. Expectations Expectations impact consumers’ confidence (how they feel) that may or may not be reflected in A change in real spending consumption {lay off? Foreclosure? Terrorist attack?} is what Influences them.  More components of GDP: Investment, Government Spending, and Exports  Investment Spending - Investment spending: 18% pf total output - Spending by businesses on: 1. New capital: tools, equipment, machinery, factories  Business fixed investment  Nonresidential Fixed Investment  These 2 terms mean the same thing as capital The biggest component of investment: 75% The biggest component of investment spending so, 75% of the 18% 2. Residential investment = new home 25%  4% subprime market = Shaky credit  4% of 25% of 18% 3. Changes in inventory = 3%  Still count the stuff people didn’t buy  Increase in inventory are ADD to GDP  Decrease in inventory are subtracted  Nature of investment spending - Investment spending is the GDP component that fluctuates (moves up or down) the most  Sensitive, moody  Consumer spending = stable(more) – linked to (generally) more stable determinants  Consumer spending- biggest, income is biggest claim to fame  Determinants of investment spending 1) Expectations- changes by businesses  Expected rate of return on the investment spending will the new the new equipment, building, tool; pay off? Long-run? Short-run?  Expected future sales (demand) and profit 2) Interest rates- figure into many formula  Interest rates are PRICES—NOT JUST 1 RATE  Rates on long-term debt usually higher  Higher rate rejects more risk- why more? {Divorce, children, disaster, sick, etc…)  Rates different but tend to move together  Higher interest rates- less investment  Lower rates- stimulate more investment 3) Technology and innovation  Advances spur investment spending  More efficient ways of communicating, producing, and distributing  New products require new equipment  Major trading partners:  Who buys our stuff? 1. Canada 6. Germany 2. Mexico 7. Brazil 3. China 8. South Korea 4. Japan 9. Netherlands 5. United Kingdom 10. Hong Kong  Trading partners (% of US imports)  Whose stuff do we buy? 1. China 6. South Korea 2. Canada 7. Saudi Arabia 3. Mexico 8. United Kingdom 4. Japan 9. France 5. Germany 10. India  GDP = C + I + G + (Xg-m) - 2013: C= 71% I=13% G= 19% (-3%) - 2015: C= 68% I= 16% G= 18% (-2%)  Shortcoming of GDP (issues) 1. Non-Market transactions (GDP excludes this…) - Productive activity you do for yourself or others that isn’t counted in GDP - Paying someone else to do the task - Time spent not counted - Examples: babysitting, cutting grass, taxes, etc… 2. Underground economy - Off books, black market - Could be criminal activity, doesn’t get counted in GDP - Working off the books 3. Leisure activity - Consumption over leisure - Way less time to work – output - 8hour days, paid holidays, etc… 4. GDP and the environment - Transportation, oil spills, utilities, deforestation, coal fracking - This is not a way to access the amount of damage 5. Composition and distribution - Composition: “what is it” composed of? - Distribution: “who gets what” 6. Quality improvements - We’re better now vs. then - Technology better now vs. then 7. Per capita output: GDP/population - Real GDP per capita best measure - Output per person output{aka gdp} / population Macroeconomic goals 1. economic growth 2. price stability 3. full employment 1) Economic growth - Long run trend or potential GDP associated with about 3% rate of growth Why 3% ? Why so much?? - How can we have had a record of 3% economic growth over long- haul? - Remember, more stuff per person means a higher standard of living - Key concept: long run aggregate supply – is another name - GDP= aggregate supply “total amount of stuff” - GDP is measured by adding up the spending components - Why the continued growth? Because the US is very good at producing stuff - Why are we so good at producing? High worker productivity- more output per person ; determinants of worker productivity a. Educated, health, skilled workers and parents (1 teachers) – human capital (investment) US has 99% literacy rate [4 th grade] 85% of those over the age 25 have high school degree (some districts only 50-60% graduation rate) b. Quality, capital, and technology Tools, equipment, buildings, ability, skill, creativity to innovate—develop sophisticated production methods c. Incentives provided by a market economy with a strong legal and social framework. Encourages productivity and entrepreneurship, incentives are necessary to reward risk- taking. The ability to earn profit, high wages, and own property are powerful incentives in market economies 2) Price stability - How is this measured? - Inflation rate: % increase from 1 year to the next in the average prices of goods and services in the typical market basket for an average consumer. Price changes, some increase and some decrease. - Consumer price index: (CPI) most commonly used to measure inflation rate Price Stability (continued…) - CPI data available monthly from BLS - How much inflation is too much? - Current FED Chair Janet Yellen is okay with 2% inflation to a point. - Falling Price Level: deflation = not good Real vs. nominal, whats the big deal? - Very important example: - Assume you get a 3% raise, remember we love in a nominal world, assume that you also know what the current inflation rate is about 3% as well. What is the real value of your raise? It would be zero. Nominal rate – Inflation rate = real rate


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