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Intro to Econ Week 7

by: Katie Truppo

Intro to Econ Week 7 Econ 201

Katie Truppo
GPA 3.4

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Modeling the economy
Into Economics: Survey Course
Kenneth Baker
Class Notes
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This 11 page Class Notes was uploaded by Katie Truppo on Saturday August 20, 2016. The Class Notes belongs to Econ 201 at University of Tennessee - Knoxville taught by Kenneth Baker in Fall 2015. Since its upload, it has received 3 views.


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Date Created: 08/20/16
The Economy IV: Modeling the Economy The Economy IV: Modeling the Economy Aggregate Demand: quantity of total domestic output that all economic agents-domestic consumers, firms and government and foreign buyers-are prepared to buy (demand) at each price level AD= C+I+G+NX Downward Slope 1. Real Balance Effect (Wealth Effect) As P rises, consumers feel less wealthy; spend less 2. Interest Rate Effect As P rises, nominal interest rates also rise; firms borrow less 3. Net Exports Effect (foreign exchange effect) As P rises, U.S. goods become more expensive relative to foreign goods; we export less and import more AD Shifters Anything that changes C, I, G, or NX shifts graph left or right AD: Consumption Shifters (C) Changes in consumer wealth rise in consumer wealth means households can afford to spend more Changes in tax rates decrease in tax rate leads to more money leftover in your paycheck Changes in consumer confidence rise in consumer confidence means households are optimistic about future AD: Investment Shifters (I) Changes in expected rate of return on investment general improvement of business environment leads to higher borrowing and investment spending Changes in business confidence rise in confidence about future leads to greater confidence and investment spending AD: G and NX Shifters Changes in any level of government spending (federal state or local) (G) War spending Cutbacks to reduce deficit Changes in foreign wealth (NX) Rise in foreign economy increases their demand for U.S. goods Decrease in the value of the dollar relative to a currency makes U.S. goods cheaper than before AD: Other Shifters Money Supply (MS) Increase in money supply, increase in AD Aggregate Supply: the quantity of total output (domestic goods and services) that firms are willing and able to produce at each price level Classical Aggregate Supply Assumes that all market participants can make adjustments to market changes Means that prices are flexible Considered more true when economy is operating at potential GDP Keynesian Aggregate Supply Assumes that some market participants are unable to adjust to market changes Means that prices can be fixed Considered more true when the economy is operating below potential GDP Potential GDP: Economists predict what a country is capable of producing The Economy III: Inflation Inflation: a sustained increase in the overall level of prices of goods and services in an economy over a period of time Disinflation: a slowdown in the inflation rate (still inflated but decreasing) Deflation: a decrease in the overall level of prices of goods/services in an economy over a period of time Inflation: Common Measures CPI: Consumer Price Index Measures weighted average change of prices for goods and services bought GDP Chain Price Index CPI: Uses 1. As an economic indicator 2. As a means of adjusting dollar values (indexing) 3. As a deflator of other economic series CPI: Defined Calculated and reported by Bureau of Labor Statistics under the Dept. of Labor Reported monthly and annually Calculating CPI: Steps 1. Decide what goods to include and how much of each Produces a typical “shopping basket" 2. Find the prices of each good for each year Employs hunders to collect prices of thousands of goods around the country 3. Calculate the cost of the basket CPI= Cost of basket in current year/cost of basket in base year x100 Inflation rate= CPI this year- CPI last year/ CPI last year x100 CPI: Basket Weights Mostly housing, transportation, food/beverage Uses: Indexing Converting real quantities into dollars Goal is to leave purchasing power of social security recipients exactly the same from year to year Uses: Deflating Converting quantities measured in current dollars into real values, eliminating effects of inflation Used to compare prices of goods/services or purchasing power from different time periods Purchasing Power: the amount or real quantities of goods/services that a wage or salary buys To put salary (or price) from year y into year x: Salary (CPI year of x/ CPI year of y) Problems with CPI New goods bias Smart phones, DVD players This makes each dollar spent more valuable Changes in quality bias Improvements in the quality of goods/services make your dollar more valuable Substitution Bias Consumers change the amounts of goods they buy when prices change but the CPI basket is slow to adjust Real versus Nominal Interest Rates Nominal interest rate: quoted interest rate (i) Real interest rate: rate adjusted for inflation (r) r=i-inflation rate Real versus Normal Wages Nominal wage (money wage): your quoted dollar wage $10 per hour Real Wage: your nominal wage adjusted for inflation 4 cheeseburgers per hour Cost-Pull Inflation: some increases in the cost for goods/services cause inflation to go up Demand-Pull Inflation: some increases in the demand for goods/services cause inflation to go up The Economy II: Business Cycle and Unemployment "The economy” or real GDP, moves in cycles Some periods it grows slow, some fast, some backwards Affects employment of millions of people Stages of Business Cycle 1. Expansion Period where economy (real GDP) is "growing" growing at potential rate or fast 2. Peak Turning point in cycle, from expansion to contraction High point before downturn 3. Contraction (Recession) Period where economy is contracting Growing rate at less than potential rate, or even decreasing 4. Trough Turning point in cycle Unemployment Calculations ALL civilian, non institutionalized adults, 16 and over placed into 3 groups 1. Employed Worked in the last week Worked in the last 4 weeks Are available for work 2. Unemployed Worked last week (No) Have you looked for work in the last 4 weeks (Yes) Are you available for work (Yes) 3. Not in labor force (everybody else) Worked last week (No) Have you looked for work in the last 4 weeks (No) Are you currently available for work (No) Retirees, full time students, stay at home parents Employment Civilian Adult Population: E+U+NILF Civilian Labor Force: E+U Unemployment Rate (U rate): Unemployment _____________ x100 Labor force (E+U) Labor Force Participation Rate (LFP rate) Labor force ___________ Adult Civilian Pop. Unemployment 1. Frictional unemployment Unemployed while searching for jobs that better match your skills Temporary job Quit to look for better job, first time job seekers, recently relocated 2. Structural unemployment Unemployed because current skills are obsolete Temporary? Workers without proper education, technology advances, shift in consumer demand, globalization Natural Rate: frictional+structural unemployment 3. Cyclical unemployment Unemployment due to business cycles in the economy When entire economy is in a downturn Shortcomings with U Rate Doesn’t count: Discouraged workers Underemployed Time Frame Macroeconomics: The Economy I: GDP GDP (gross domestic production): the most closely watched macroeconomic variable in the world Market value of all goods and services produced within a country during a given time period final: does not count everything produced, only final goods includes goods and services only measures production inside a countries borders BEA: Bureau of Economic Analysis Calculate GDP quarterly and yearly Measured by: 1. Value added approach 2. Expenditure approach 3. Sum of factor payments approach Expenditure Approach: calculating GDP by adding the value of all final goods and services purchased by each type of final user GDP Components: C, I, G, NX C: Consumption (spending by U.S. households) I: Investment (spending by U.S. firms) G: Government (spending by U.S. governments) NX: Net Exports (spending by foreign buyers) GDP= Y= C+I+G+NX (NX=X-M x is exports, m is imports) 1. Consumer spending Households, all goods and services 2/3 of final goods and services produced in U.S. are purchased by households 2. Investment Spending Purchasing a good that will provide services/benefits in the future (most often entails borrowing) Fixed business capital: New capital and equipment Residential: New housing and apartment Change in inventories: Unsold items Most volatile of components 3. Government Spending Includes federal, state and local governments Not including transfer payments (interest or national debt, social security, unemployment benefits) 4. Net Exports Exports: good/services produced inside U.S. and sold abroad Imports: goods/services produced abroad and purchased by U.S. consumers Add exports, subtract imports from GDP Different Measures of GDP Nominal GDP (current GDP): production of goods and services valued at current prices Real GDP: production of goods and services valued at constant prices GDP chain price index: an index used to measure the aggregate changes in the price level of all final goods and services produced within a country Nominal GDP _____________ x100 Real GDP Chain index is changes in the weighted averages of prices It must be true for an economy that total spending is equal to total income GDP means both the amount produced by an economy AND the amount of income earned by an economy Micro Topic: Gains From Trade Trade allows us to enjoy a larger variety of goods Trade allows for more total goods to be produced and consumed Globalization Benefits Consumers have access to variety of products and cheaper products FDI creates jobs in both rich and poor countries Access to better technology, cheaper inputs, more financial capital, larger market Grow and prosper through specialization and division of labor Cooperate regionally to have larger international presence Engenders more cross border cooperation on global issues Greater sharing of information, technology, knowledge Criticisms Increased risk of spread of economic contagion Creates a global “Race to the Bottom" Large multinational firms in constant search for cheapest production Market distortions creates uneven playing fields, disproportionately harm poor countries Lending to poor countries by the large international organizations saddles them with debts they’re unable to pay Exacerbate the problem of inequality Reduces the national sovereignty of governments Absolute Advantage When a person (country) is more productive than another person (country) A comparison of productivities across people (countries) Slope=opportunity cost Comparative Advantage When one person (country) can produce a good at a lower cost than another person (country) A comparison of the opportunity costs between people/countries Specialization: we produce what we do best, making the most with our available resources Adam Smith: if a foreign country can supply us with a commodity cheaper than we can make it, better buy it off them with some part of the produce of our own industry employed in a way in which we have some advantage Elasticity (Missed Lecture 9/24) If Ed>1, demand for good is “elastic" Quantity demanded changes by more than price If Ed<1, demand for good is “inelastic" If Ed=1, demand for good is "unit elastic" Small change in Qd is inelastic, big change is elastic Elasticity Factors Necessities tend to be inelastic Luxuries tend to be elastic Goods with no substitutes (coffee, gas) tend to be elastic Goods with substitutes (jeans, flavored coffee) tend to be inelastic More expensive, more elastic More inexpensive, more inelastic Short run (don’t have time to change buying habits) tend to be inelastic Long run (have time to change) tend to be elastic Calculating Elasticity Point method: measures elasticity of certain point on the demand curve Arc method: measures the elasticity between 2 points on the demand curve; measures elasticity over a range of demand curve Midpoint Percentage change: change divided by original value Midpoint percentage change: change in quantity/demand divided by average quantity/demand depends on both P and Q Big Ideas If demand is elastic: quantity changes by more than price if P falls, Q rises, and so does TR price changes by more than quantity if P rises, Q falls, and so does TR TR follows quantity Slope is constant, elasticity changes


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