Study Guide ECON 104 Final PDF

Study Guide ECON 104 Final McLeod’s Work - GDP o What is it? Define it. ▪ GDP is the total value of all final goods and services produced within a country during a specific time period. It measures the economic activity and output of t...

Study Guide ECON 104 Final McLeod’s Work - GDP o What is it? Define it. ▪ GDP is the total value of all final goods and services produced within a country during a specific time period. It measures the economic activity and output of that country. o Understand and describe the expenditure components of GDP ▪ Consumption (C) Personal Consumption Expenditure This Component measures the total spending by households on goods and services. It includes expenditures on: o Durable Goods (ex: cars, appliances) o Nondurable Goods (ex: food, clothing) o Services (ex: healthcare, entertainment). ▪ Gross Private Investment (I) This component measures spending on capital goods that will be used for future production. It includes: o Non-Residential Investments: Spending on equipment, machinery, and buildings. o Residential Investment: Spending on new housing construction. o Changes in Inventories: The difference between what businesses produce and what they sell. ▪ Government Purchases (G) (C and I) This component measures all government spending on goods and services that are directly purchased for government use. It is spending by state, federal, and local governments o Examples: ▪ Transfer Payments Pensions Unemployment Benefits ▪ Net Exports (NX) This is the value of a country’s exports minus the value of its imports. It shows the net trade position of the country: o Exports (X): Goods and services sold to other countries.  o Imports (M): Goods and services bought from other countries. o The formula is: NX = Exports – Imports o What is the GDP Calculation Formula? ▪ GDP = C + I + G + NX o What is the value-added meaning? ▪ It is how much extra value is created at each stage of production. It’s the difference between what something is worth when it’s finished and what it cost to make it. o How does it relate to calculate GDP? ▪ The value-added approach to calculating GDP adds up the extra value created at each stage of production. This way, it only counts the final value of goods and avoids counting intermediate goods multiple times. o What is the difference between Nominal GDP and Real GDP ▪ Nominal GDP: CHANGES with prices and can make it hard to compare economic performance over time ▪ Real GDP: adjusts for inflation and gives a clearer view of how the economy is truly growing. - Unemployment o Who is considered unemployed in employment surveys? ▪ Unemployed people are those who don’t have a job but are actively looking for one and are ready to work. o Who is considered employed in employment surveys? ▪ Employed people are those who have a job or are temporarily away from work, like being on vacation or sick leave. o Who is considered part of the Labor Force in employment surveys? ▪ The labor force is the total number of people who are employed or unemployed. It doesn’t include those who aren’t seeking work. o Who are the groups of people that would not be considered in the labor force? ▪ Groups that would not be considered in the labor force include: Retirees: People who have retired and are no longer seeking employment. Full-time Students: Individuals studying full-time and not actively looking for work. Institutionalized People: Those in institutions like prisons or long-term care facilities.  Homemakers: Individuals who are managing the household and not seeking employment. Discouraged Workers: Individuals who have given up looking for work due to believing there are no jobs available for them. o Key Calculations to Understand ▪ Unemployment Rate (UR) The percentage of the labor force that is unemployed UR = number of unemployed/Labor Force x 100 o Labor Force: sum of unemployed and employed ▪ Labor Force Participation Rate (LFPR) The percentage of the working-age population that is in the labor force (either employed or unemployed). LBPR = Labor Force/working-age population x 100 o Labor Force: sum of employed and unemployed ▪ Employment to Population Ratio (EPR) The percentage of the working-age population that is employed. EPR = number of employed/working-age population x 100 o What are the three types of unemployment (understanding and describing these) ▪ Frictional Unemployment It is the temporary job loss that happens when people are switching jobs or looking for their first job. It’s part of the normal process of finding a job that fits well. ▪ Structural Unemployment It happens when changes in the economy cause job losses in certain industries, often due to technological advancements or shifts in consumer demand. ▪ Cyclical Unemployment It is the extra job loss that happens during a recession or economic downturn, beyond the usual frictional and structural unemployment o What is the natural rate of unemployment? ▪ It is the level of unemployment that happens even when the economy is doing well. This includes frictional and structural unemployment but excludes cyclical unemployment. Sum of frictional and structural unemployment  - Inflation o How do we describe inflation? ▪ It is the increase in the general price level of goods and services over time. o What are the effects of unanticipated and anticipated inflation? (understanding these) ▪ Anticipated Inflation When people expect inflation, they can prepare for it by asking for higher wages. This makes anticipated inflation less disruptive because people can adjust their finances. ▪ Unanticipated Inflation Unexpected inflation can hurt people with fixed incomes, like retirees, because their money loses value. But those with valuable assets or businesses that can raise prices might benefit. o It HELPS debtors and HURTS creditors, vice versa Chapter 8 (start of Kagundu work) - Aggregate Expenditure (AE) and Equilibrium Output (Y) o What are the main components of aggregate expenditure? ▪ Consumption (C) Spending by households on goods and services. ▪ Investment (I) Spending by businesses on capital goods (like machinery) and changes in inventories. o What is the difference between planned and actual investment? ▪ Planned investment is what businesses INTEND to spend on things like equipment and new buildings. ▪ Actual investment is the REAL amount they end up spending. The difference can happen if businesses change their plans based on UNEXPECTED events. o What is the condition for macroeconomic equilibrium in the aggregate expenditure model? ▪ The economy is in macroeconomic equilibrium when Aggregate Expenditure (AE) equals Real GDP. This means that the total spending in the economy matches the total output of goods and services. o How does the economy adjust to a macroeconomic equilibrium in the aggregate expenditure model?  ▪ If AE is greater than real GDP, it means spending exceeds production, leading to increased production and income. ▪ If AE is less than real GDP, it means production exceeds spending, leading to reduced production and income. ▪ The economy adjusts to reach the point where AE equals real GDP. o What are the determinants of household consumption expenditures ▪ Current Disposable Income: More income usually means more spending. ▪ Household Wealth: Higher wealth increases spending. ▪ Expected Future Income: If people expect higher future income, they may spend more now. ▪ Interest Rate: Higher interest rates can reduce spending because borrowing becomes more expensive. o What is the meaning of the marginal propensity to consume (MPC)? ▪ It is the fraction of additional income that is spent on consumption. It is the slope of the consumption function. Change in consumption/change in income (C/Y) o What is the meaning of the marginal propensity to save (MPS)? ▪ It is the fraction of additional income that is saved. MPS = 1 – MPC MPC + MPS = 1 o What are the determinants of planned investment? (understanding and explaining) ▪ Expectations of Future Profitability: Higher expected profits increase investment. ▪ Interest Rate: Lower interest rates encourage more investment. o What is the meaning of the 45-degree line in the AE model? ▪ The 45-degree line represents points where AE equals real GDP. It is used to graphically determine equilibrium. o What is the meaning of the multiplier effect? ▪ The multiplier effect shows how an initial change in spending leads to a larger change in real GDP. Multiplier: 1/1 – MPC Chapter 9 - What is the meaning of fiscal policy?  o This refers to the use of government spending and taxation to influence the economy. It aims to manage economic growth, control inflation, and reduce unemployment. - What is the difference between automatic stabilizers and discretionary fiscal policy? o Automatic Stabilizers ▪ These are government programs that automatically adjust with the economy. They automatically help stabilize the economy WITHOUT new government actions. Examples: o Unemployment Benefits o Progressive Taxes o Discretionary Fiscal Policy ▪ This is when there are deliberate changes in government spending or taxes. It requires NEW government decisions and laws to address specific economic issues. Examples: o New Infrastructure Projects o Tax Cuts - What are the effects of fiscal policy on real GDP and price level? o Expansionary Policy: Increasing spending or cutting taxes to boost the economy, which raises GDP and can increase inflation. o Contractionary Policy: Decreasing spending or raising taxes to slow the economy, which lowers GDP and can reduce inflation. - Key Multipliers to Understand o Government Spending Multiplier: ▪ Meaning: it is how much GDP increases for each dollar the government spends. ▪ Example: If the multiplier is 2, $1 billion in spending increases GDP by $2 billion. Formula: 1/1 - MPC o Tax Multiplier: ▪ Meaning: it is how much GDP changes for each dollar change in taxes. ▪ Example: If the multiplier is -1.5, cutting taxes by $1 billion increases GDP by $1.5 billion. Formula: -MPC/1 - MPC o Balanced Budget Multiplier: ▪ Meaning: it is when the effect on GDP when both spending and taxes change by the same amount.  ▪ Example: If both increase by $1 billion, GDP also increases by $1 billion. Formula: it is ALWAYS 1 - What is the meaning of a government budget balance and its related concepts? o Budget Deficit: ▪ The government spends more than it earns. ▪ Effect: It increases public debt. o Budget Surplus: ▪ The government earns more than it spends. ▪ Effect: It can reduce public debt o Balanced Budget ▪ It is when government spending equals its revenue. ▪ Effect: There is no change in public debt. o Public Debt ▪ It is the total money the government owes. ▪ Effect: High debt means more interest payments and can affect financial stability. Chapter 10 - What is money and why do we need it in an economy? o Money is any asset that is widely accepted, and people commonly use it to buy things, pay for services, or settle debts. o Why do we need it? ▪ It makes buying and selling easier by acting as a medium of exchange. ▪ It provides a way to compare the value of different goods and services. ▪ It allows people to save and store wealth for future use. - What is a barter system and what are the limitations to this system? o It is a system where goods and services are exchanged directly for other goods and services without using money. o What are the limitations? ▪ Double Coincidence of Wants: when both parties must have what the other wants. ▪ Lack of Common Measure of Value: It is hard to compare the value of different goods and services. ▪ Indivisibility of Certain Goods: Some goods cannot be divided into smaller units. - What are the functions of money? (understanding and describing)  o Medium of Exchange: Money is used to buy and sell goods and services. o Unit of Account: Money provides a standard measure of value, making it easier to compare prices. o Store of Value: Money can be saved and retrieved in the future, maintaining its value over time. - What are the qualities or features that make somethings more suitable for use as money? (understanding and describing) o Widely Accepted: money must be accepted by everyone in the economy. o Standardized Quality: money must be uniform in quality so that all units are the same. o Durable: money must last over time and not degrade quickly. o Portable: money must be easy to carry and use. o Divisible: money must be divisible into smaller units to make various transactions. - What are the types of money? o Fiat Money: Money that has value because the government declares it as legal tender (e.g., U.S. dollar). o Commodity Money: Money that has intrinsic value, such as gold or silver. o Legal Tender: Money that must be accepted if offered in payment of a debt. - What are the broad measures of money and the assets included in each measure? o M1: Includes currency, checkable deposits, and other liquid deposits. o M2: Includes M1 plus small-denomination time deposits and money market mutual funds. - What is the money creation process by commercial banks? o Banks create money by lending out a portion of their deposits, which are then redeposited and lent out again, increasing the total money supply. - What are the main aspects of a balance sheet? o Assets: Loans, reserves, and securities. These are usually things of value. o Liabilities: Deposits and borrowings. These usually need to be paid back. o Shareholders' Equity (Bank Capital): The DIFFERENCE between a bank’s assets and liabilities. - What is the meaning of these following concepts? o Bank Reserves: Cash in bank vaults plus deposits at the central bank. o Required Reserves: Minimum reserves a bank must hold, set by the central bank. o Required Reserve Ratio: Percentage of deposits banks must keep as reserves. o Excess Reserves: Reserves held by banks above the required minimum.  - What is the money multiplier? o It is the ratio of the amount of money created by the banking system to the number of reserves. o MM = 1/required reserve ratio ▪ Example: If the required reserve ratio is 10%, the money multiplier is 10. - What are the assumptions implied in the money creation process by commercial banks? o Banks lend out all their excess reserves. o Borrowers redeposit all the funds in the banking system. o No cash withdrawals by the public. - What is the history of the U.S. Federal Reserve System? o Roles of the Fed: ▪ Conduct monetary policy. ▪ Supervise and regulate banks. ▪ Maintain financial stability. ▪ Provide banking services to the government and financial institutions. o Structure: ▪ Board of Governors: Seven members appointed by the President. ▪ Regional Federal Reserve Banks: Twelve banks across the U.S. ▪ Federal Open Market Committee (FOMC): Includes the Board of Governors and presidents of the regional banks, responsible for open market operations. - What is the relationship between the demand for money and the interest rate? o Higher interest rates reduce the demand for money because holding money becomes more expensive compared to earning interest. - What is the relationship between the interest rate and securities prices? o As interest rates rise, the price of existing securities falls, and vice versa. - What are the tools of monetary policy? (understanding and describing) o Open Market Operations: Buying and selling government securities to influence the money supply. o Discount Rate: The interest rate charged by central banks on loans to commercial banks. o Reserve Requirements: The fraction of deposits banks are required to hold as reserves. Chapter 11 - What is the meaning of the aggregate supply (AS)? o It is the total quantity of goods and services that producers in an economy are willing and able to supply at different price levels. - What is the AS curve? o The short-run aggregate supply (SRAS) curve shows how much goods and services firms are willing to produce at different price levels, assuming some costs like wages and input prices stay the same. ▪ Upwards Sloping: why? In the short run, as prices for goods and services rise, producers are willing to supply more because higher prices can increase their profits. ▪ Flatter at Low Levels of Output: why? When the economy is operating below full capacity (low output), there are unused resources (like labor and capital). Producers can increase output without significant cost increases, so the SRAS curve is relatively flat. ▪ Steeper at High Levels of Output: why? As the economy approaches full capacity (high output), resources become scarcer and more expensive to utilize. Increasing output further leads to higher costs, making the SRAS curve steeper. - What are the factors that shift the AS curve? o Changes in the Quantity of Labor: More workers or longer working hours can increase production. o Changes in the Quality of Labor: Better education, skills, and training can make workers more productive. o Changes in the Stock of Capital: More machinery, tools, and buildings allow for greater production capacity. o Improvements in Technology: Advances in technology can make production processes more efficient, increasing output. - What is the meaning of aggregate demand (AD)? o It is the total quantity of goods and services demanded across the economy at different price levels. - What is the relationship between the interest rate (r) and aggregate output (Y)? o That is the IS Curve. ▪ It shows the relationship between the interest rate and aggregate output in the goods market.  Higher Interest Rates: Reduce investment and consumption, leading to lower aggregate output. Lower Interest Rates: Increase investment and consumption, leading to higher aggregate output. - What is the relationship between the interest rate (r) and the price level (P) o That is the Fed Rule. ▪ This explains how the central bank adjusts interest rates based on changes in the price level. If prices rise, the Fed might increase interest rates to control inflation or stabilize the economy. If prices fall, the Fed might lower rates to encourage spending and investment. - How is the AD curve derived from the IS curve and the Fed Rule? o The AD curve is derived by combining the IS curve (relationship between r and Y) and the Fed Rule (relationship between r and P). o AD is a relationship between price level (P) and quantity of aggregate output (Y) demanded. - What are the variables that cause the AD curve to shift? o Monetary Policy: Changes in interest rates or the money supply by the central bank. o Fiscal Policy: Changes in government spending or taxation. o Households’ Expectations of Future Income: Optimism about future earnings can influence consumption. o Firms’ Expectations of Future Profitability: Expectations about future profits can affect investment decisions. - The Long-Run Aggregate Supply o What is the meaning of potential GDP? ▪ It is the level of output the economy can produce when operating at full capacity, with all resources fully employed. o Why is aggregate output not affected by changes in the price level in the long run? ▪ In the long run, prices of inputs and outputs fully adjust, meaning output is determined by the economy’s resources, technology, and institutions, not by the price level. o What is the short run and long run macroeconomic equilibrium in the AD/AS model? ▪ Short-Run Equilibrium: Occurs where the AD curve intersects the SRAS curve. The economy may be at, above, or below potential GDP.  ▪Long-Run Equilibrium: Occurs where the AD curve intersects the LRAS curve. The economy is at potential GDP, and there is no cyclical unemployment. o What happens when the short run equilibrium is below potential GDP? ▪ The economy is in a recessionary gap, with unemployment higher than the natural rate. Over time, wages and input prices may fall, shifting the SRAS curve to the right and moving the economy back to potential GDP. Chapter 12 - What are the effects of fiscal policy? o Fiscal policy involves government decisions on spending and taxation to influence the economy. ▪ Expansionary Policy It is used to stimulate economic growth, increase aggregate demand, and reduce unemployment, especially during a recession or period of economic slowdown. o Increase government spending, decrease taxes. ▪ Contractionary Policy It is used to slow down economic growth, reduce inflation, and avoid an overheating economy. o Decrease government spending, increase taxes. - What are the effects of monetary policy? o Monetary policy involves the central bank’s actions to control the money supply and interest rates to achieve economic objectives. ▪ Expansionary Policy Lower interest rates, increase money supply. ▪ Contractionary Policy Raise interest rates, reduce money supply. - What is the Fed’s response to Z factors? o The Fed changes interest rates and uses other methods to handle problems and keep the economy stable. - What is the shape of the AD curve when the Fed cares more about the price level than output? o If the Fed focuses more on controlling prices than on output, the AD curve can become steeper. The Fed might raise interest rates to reduce inflation, even if it means lower output and higher unemployment. - What happens when there is a zero-interest rate bound?  o Definition: Interest rates are at or near zero, so the central bank can't lower them further to stimulate the economy. o Monetary policy becomes less effective because the central bank cannot use interest rate cuts to boost spending and investment. - What is the impact of cost or supply shocks and how does the Fed respond to these shocks? o Cost Shocks: Unexpected increases in production costs (e.g., higher oil prices) can reduce aggregate supply, leading to higher prices and lower output. o When interest rates are at zero, the Fed can’t lower them further. It uses other methods, like buying assets or future plans, to help the economy while trying to balance inflation and growth. - What are the effects of demand shocks and how does the Fed respond to these shocks? o Demand Shocks: Sudden changes in aggregate demand (e.g., consumer spending surge or decline) can affect output and prices. o The Fed changes interest rates to stabilize the economy. It lowers rates to encourage spending during a recession and raises rates to control inflation when the economy is too hot. Chapter 19 - What is the balance of payment systems? o Current Account: ▪ Tracks: Trade in goods and services, income from abroad, and transfers like remittances. ▪ Includes: Exports, imports, income payments, and transfers. o Financial Account: ▪ Tracks: Investments and financial transactions between countries. ▪ Includes: Foreign investments, buying and selling of assets, and changes in reserves. o Capital Account: ▪ Tracks: Capital transfers and changes in ownership of non-financial assets. ▪ Includes: Debt forgiveness, transfers by migrants, and ownership changes of intangible assets. - What is the foreign exchange market and exchange rates? o Demand in the Foreign Exchange Market:  ▪ The need for foreign currency from people or businesses wanting to buy goods, services, or financial assets from another country. o Supply in the Foreign Exchange Market: ▪ The amount of a country’s currency that people or businesses are willing to exchange for foreign currency. o Equilibrium in the Foreign Exchange Market: ▪ Occurs when the quantity of currency demanded equals the quantity supplied, setting the exchange rate. - What are the shifts in demand and supply in the foreign exchange market o Currency Appreciation: ▪ When a country’s currency becomes stronger relative to other currencies, meaning it can buy more foreign currency. ▪ Causes: Increased demand for a country’s exports, higher interest rates, or favorable economic conditions. o Currency Depreciation: ▪ When a country’s currency becomes weaker relative to other currencies, meaning it can buy less foreign currency. ▪ Causes: Decreased demand for a country’s exports, lower interest rates, or unfavorable economic conditions.