CH 8 Major Points

1.GDP – market value of all final goods & services produced in a country

2.GDP = Total Production = Total Income

3.Four Categories of Expenditures of GDP: Consumption, Investment, Government Purchases, & Net
Exports

4.GDP does not measure all production. It does not include household production & the underground
economy.

5.GDP is not a perfect measure of economic well-being.

 The value of leisure in not included in GDP,

6.Nominal GDP is production valued in current year prices.

Real GDP is production valued in base-year prices.

 Inflation causes nominal GDP to give a distorted view of what happens to total production
overtime.

CH 9 Major Points
A. UNEMPLOYMENT:
1.) To be counted as Unemployed,
Three conditions - don’t have a job, available for work, and actively looked for work in the last 4 weeks.
2.) Unemployment Rate = (Unemployed / Labor Force) x 100
Labor force= employed + unemployed workers
3.) Problems with Official Unemployment Rate
a. Understates true unemployment due to discouraged workers & involuntary part-time workers.
b. Overstates true unemployment due to people claiming to be actively looking for work but are NOT (to
remain eligible for government payments to the unemployed), & Jobs in the Underground Economy.
4.) Types of Unemployment

a. Frictional: Short-term unemployment arising from the process of matching workers with jobs. Caused
by normal labor market turnover of firms and workers – businesses contracting and expanding and
people entering/exiting the labor force therefore creating the search process of matching workers with
jobs. Advice—keep looking

b. Structural: Unemployment arising from a persistent mismatch between the skills and attributes of
workers and the requirements of the jobs. Caused by structural changes in economy. Advice -- Retrain
c. Cyclical: Unemployment caused by a business cycle recession. Caused by downturn in the economy
such as business cycle recession. Advice—apply for unemployment insurance

5.) Natural Rate of Unemployment (Unemployment rate at full employment)

 Consist of frictional + structural unemployment, or no cyclical unemployment.

Natural Rate of Unemployment can be pushed up by generous unemployment compensation &

Because it is not a physical and unchanging law of nature. It is only a “natural” rate because it is
the unemployment rate that would result from the combination of economic, social, and
political factors that exist at a time – assuming the economy was neither booming nor in a
recession.

These forces include the usual pattern of companies expanding and contracting their workforces
in a dynamic economy

6.) Employment-Population ratio measures the percentage of the working-age population that has jobs.
Maybe the best indicator of the labor market.

 Employment-population ratio measures the percentage of the working-age population (16 and
over) that have jobs.
 (EMPLOYMENT / WORKING-AGE POPULATION) x 100

7.) Labor Force Participation Rate measures the percentage of working-age population in the labor
force.

 Percentage of the working-age population in the labor force

8.) High unemployment insurance payments can increase the natural rate of unemployment rate.

B. INFLATION: The percentage increase in the overall level of prices from one year to the next

1.) Consumer Price Index (CPI): measure of the overall cost of the goods and services bought by a typical
consumer; An index comparing over time consumer prices.

 Measures over time the cost of living.

= (Expenditures on market basket in current year 2020/ market basket in base year 1980) x100

 If the costs of the market basket in 2019 is the same as the costs in the base year, CPI = 100
 If the costs in 2019 are double the cost in the base year, CPI for 2019 is 200.
 CPI of 125 indicates that the cost of the market basket increased 25% since the base period.
2. Inflation rate = the percentage change in the CPI from one year to the next year

 Inflation Rate 2018 = [(CPI2018– CPI2017)/CPI2017] x 100.

3. The substitution bias and the quality bias cause the CPI to overstate the cost of living and the
inflation rate.

Substitution Bias: using a fixed market basket, the CPI assumes that consumers do not buy less
of a good whose relative price rises and more of a good whose relative price falls.

Increase in Quality bias: Quality improvements of goods and services are not filtered out
completely and show up as an increase in the cost of living (inflation)

4. To correct for the effects of inflation, divide the nominal variable by a Price Index and multiply by
hundred to obtain real variable. Nominal variables are calculated in current year prices and are no good.

Real wage = [(Nominal Wage / CPI) x 100].

So, to track changes in variables over time, use real variables; the real variable will be measured in
dollars of the base year (constant dollars).

5.) The Interest Rate is the cost of borrowing funds, expressed as a percentage of the amount borrowed.
(10/200) x100=5%

Nominal Interest Rate: stated interest rate on a loan.

 Nominal interest rate = real interest rate + inflation rate.

Real Interest Rate: nominal interest rate MINUS the Inflation rate; Measures the TRUE cost of borrowing
and TRUE return from lending.

 Real interest rate = nominal interest rate – inflation rate.

It is possible for the nominal interest rate to be less than real due to Deflation.

6. Problems Caused by Inflation

 Inflation raises, in general, both the cost of living & nominal incomes.
 Unanticipated inflation redistributes income between lenders & borrowers.

Deflation causes consumers to reduce consumer spending, waiting for even lower prices, and increases
the burden on borrowers by increasing the real interest rate.

Suppose you borrow $1000 at an interest rate of 5%. If the expected real interest rate is 2%,
then the rate of inflation over the upcoming year that would be most beneficial to you would be an
inflation rate greater than 3%

ACTUAL>EXPECTED – borrowers gain; ACTUAL<EXPECTED –lenders gain bruhhhh inflation not

CH 10 Major Points

Economic Growth, the Financial System, & Business Cycles

ECONOMIC GROWTH

1.) Real GDP per capita measures the standard of living

2.) Rule of 70:

 70/Growth rate ≈ Number of Years to Double

3.) Increases in real GDP per capita depend upon increases in labor productivity (output per worker).

Increases in labor productivity depend upon increases in the quantity of capital per worker and the level
of technology, with technology being the most important.

4.) Potential GDP is the level of real GDP attained when all firms are producing at capacity.

FINANCIAL SYSTEM

5.) The financial system is crucial for economic growth by providing funds for investment projects
(capital equipment, training workers, new technologies, R&D).

BUSINESS CYCLES

6.) Alternating periods of economic expansion & economic recession around the long-run economic
growth trend.

7.) Two Phases (Expansion & Recession) & Two Turning Points (Peak & Trough).

Sequence: Expansion, Peak, Recession, Trough

8.) Inflation usually increases with expansion & decreases with recession.

9.) Unemployment increases with recession & decreases with expansion, other than at the beginning of
the expansion. Unemployment tends to increase at the beginning of an expansion b/c more begin to
look for jobs; firms still operating below capacity, so slow to hire and may even continue to lay off
workers.

CH 12

1.Total spending (aggregate expenditure, AE) determines in any particular year the level of real GDP (Y).

 Changes in total spending (AE) are what cause changes in the short run in real GDP and
employment.
 If total spending < total production (GDP), Inventories increase, leading to a decrease in total
production and employment and vice versa.

2.Macroeconomic equilibrium occurs where planned aggregate expenditure (AE) equals total production
(real GDP).

 Assuming that Potential GDP and prices are fixed. (does NOT measure economic growth or
inflation)
 AE model is a short run model of the economy to explain the business cycle
3.Unintended inventories (real GDP – aggregate expenditure) signal whether to increase or decrease
production & employment.

4.Consumption spending depends on current disposable income (+), household wealth (+), expected
future income (+), & the interest rate (-); when interest rate goes up consumption goes down.

5.The marginal propensity to consume (MPC) indicates the amount that consumption spending
increases when income increases: $50 of $100 spent, MPC=.5

 Slope of the consumption function (I.e., the amount by which consumption spending changes
when income changes. MPC of 0 means that when income increases, spending remains
unchanged.

6.Investment spending depends on expectations of future profitability (+), the interest rate (-), &
business taxes (-).

7.Net exports depend on foreign real GDP (+) & the exchange rate between the dollar & other
currencies (-).

8.Macroeconomic equilibrium occurs where the planned aggregate expenditure (AE) line intersects the
Y = AE 45 degrees-line.

9.Changes in autonomous expenditure (Spending) shift the AE line and change equilibrium real GDP.

10. The multiplier effect implies that the change in autonomous expenditures leads to a larger change in
real GDP.

11. Multiplier = change in Equilibrium Real GDP / Change in Autonomous Expenditure = 1/1-MPC

12. The multiplier equation implies that the Δ Real GDP = Δ Autonomous Expenditure x (1/1-MPC)

 Real GDP = Vertical Shift in AE Line x Multiplier