Unit-2 Macro Review

GDP, Unemployment, Inflation

Circular Flow of a closed Economy

Spending

Goods andservicesbought

Goods andservicesbought

Revenue

Goodsand servicessold

Goodsand servicessold

Labor, land,capital & entrepreneurshipLabor, land,capital & entrepreneurship

Income

= Flow of inputs and outputs

= Flow of dollars

Factors ofproductionFactors ofproduction

Wages, rent,and profitWages, rent,and profit

FIRMSFIRMS HOUSEHOLDSHOUSEHOLDS

FACTOR Market FACTOR FACTOR MARKET

PRODUCT MARKET PRODUCT MARKET

BUSINESS CYCLE: rate of GDP Growth

GDP growth by quarter1st quarter 2012

+2.2%

All 2011

+1.7%

GDP = C + I + G + (X-M)

Calculating GDP:

What Counts?

Only NEW & FINAL goodsDomestic Products

What does not Count?

Used goodsInternational productsFinancial transactionsNon-market transactionsGov’t Transfers (i.e. welfare, social security)

GDP does not measure: mix of goods, quality of products, quality of life, leisure time

Business Investment, Consumer/Business Construction,& Change in Inventories. (new houses count as investment!)

GDP = C + I + G + NX

GDP = Aggregate Demand (AD) (all spending or all income)

Spending

Goods andservicesbought

Goods andservicesbought

Revenue

Goodsand servicessold

Goodsand servicessold

Labor, land,capital & entrepreneurshipLabor, land,capital & entrepreneurship

Income

= Flow of inputs and outputs

= Flow of dollars

Factors ofproductionFactors ofproduction

Wages, rent,and profitWages, rent,and profit

FIRMSFIRMS HOUSEHOLDSHOUSEHOLDS

FACTOR MarketFACTOR MarketFACTOR Market

PRODUCT MARKETPRODUCT MARKET

All Spending = All Income:

Y = C + I + G + (X-M)

2 Ways to measure GDP

or

Labor WagesLand RentCapital InterestEntrep. ProfitTalent

4-Types of Unemployment

• Structural– Skills do not match demand for labor

• Cyclical– too low a level of GDP (recession)

• Frictional– Temporarily between Jobs

• Seasonal– Based on time of year

Natural Rate ofEmployment

(or full employment)

Allows for someFrictional & Structural

Where:Cyclical = zeroSeasonal “factored out”

• In theory, if actual inflation = expected inflation, people have time to adjust for it. (less harmful)

ExpectedInflation

Actual Inflation

Nominal Interest Rate = Real Interest Rate + Expected Inflation

versus

COLA = cost of living adjustment

GDP Deflator vs CPI

• GDP deflator – prices of all goods/services produced domestically

• CPI index – prices of a market basket of goods & services

– (including international goods)

Substitution BiasNew goodsQuality changes

What shouldbe in basket?

(115 – 100)100

X 100 = +15.0%(115 – 100)100

X 100 = +15.0%

CPI Index: 1990 100 2000 115

Called Base year

Practice Test #2

• Questions #1 - #20

Multiple Choice Answers1 D

2 C

3 C

4 D

5 B

6 A

7 E

8 B

9 A

10 C

11 B

12 D

13 C

14 A

15 B

16 D

17 A

18 A

19 A

20 A

2-Types of Inflation

• Demand-Pull Inflation:– Too many dollars chasing too few goods– Example: printing money

• Cost-Push Inflation– ↑ cost of factors of production

– example: price of oil or labor rises rapidly