Economics Midterm Study Guide: Fall 2010, Study notes of Introduction to Macroeconomics

Download Economics Midterm Study Guide: Fall 2010 and more Study notes Introduction to Macroeconomics in PDF only on Docsity! Economics Midterm Study Guide Fall 2010 1. Free Market System Most countries have, except Cuba and N. Korea, Karl Marx called it “capitalism” as derogatory term, form of economic organization in which resource allocation decisions left to individual producers and consumers acting in own best interests without central direction. Outputs demanded depend on pattern of consumer preferences.Trouble with keeping unemployment low. 2. Perfect Free Market System Doesn’t exist, Hong Kong is closest because not taxes, gov’t has police, few gov’t intervention 3. Entrepreneurship Idea, plan somehow make money, make a product everyone wants and it’ll do well 4. Invisible Hand Adam Smith--guides you to maximize your profit without gov’t intervention, individuals pursue self-interest and work hard which will better the society, justification of the Free Market system 5. Regulation Must need it because people might lie, cheat, and steal so gov’t regulates, very few altruists 6. Socialism Not profitable because workers have no incentive to work harder if everyone has the same wages (Cuba: everyone equally poor) 7. Russia Was once socialist country, became capitalist but bad conditions of citizens were still prevalent because money went to military for Afghanistan 8. China, Vietnam Proclaim socialism as justification for one-party rule but all government members also have businesses because they understand capitalism gives them a higher standard of living 9. US: Immigrants Incentive because there are more opportunities they are unhappy where they are, raise economy of US 10. Rio, Brazil Favelas=slums. Biggest social gap in a town in the world. 11. Collateral Something pledged as security for repayment of a loan, to be forfeited in the event of a default. If poor in favelas had property, they could put up property as collateral to jumpstart income. 12. Property Incentive To get as much out of your property as possible. 13. Pilgrims Video Young people had incentives to work hard, incentive: danger of failing, shared private property, Allerton fur trade of River Kennebeck 14. Opportunity costs Value of the next best alternative that must be given up because of that decision; value of what must be given up to acquire the item. Explicit cost is money. (Mentioned in Benjamin Franklin’s “Poor Richard’s Almanac”) Ex: Opportunity cost of making a car is making 30 fridges. 15. Price ceiling Imposed when there is a supply shortage so prices can’t increase too much. Black market may arise. Figure 8 16. Price floor Legal minimum below which price charged cannot fall of a commodity. Leads to surplus, which leads to no buyers which leads to government buying it. 17. Problems of price control 1. Favoritism/corruption--suppliers choose who gets what 2. Unenforceability--limiting prices fails and people must pay for regulators 3. Auxiliary restrictions--policing of new suppliers and control of what is consumed 4. Limits volume of transactions, sometimes always under equilibrium level 5. Misuse of resources--Cheap bread fed to cows instead of being fed grains 18. Law of comparative advantage Two nations benefit from trading, each can gain because one country will be better at making one product while the other will be better at making another product. (Ex: China better at making small plastic goods, US better at providing higher education) 19. Fiscal policy Control taxes and gov’t spending. Try to steer aggregate demand in desired direction. 20. Monetary policy Control over money and interest rates, attempt to tame business cycle 21. Stagflation Inflation that occurs while economy is slowly growing or in a recession. GDP decreases while prices increase. Figure 12 22. Booms lead to inflation, busts lead to unemployment 23. Stabilization policy Government programs designed to prevent or shorten recessions, counteract inflation, stabilize prices 24. Trade off between inflation and unemployment Low unemployment leads to high inflation, high unemployment leads to low inflation 25. Standard of living Increases when productivity increases 26. Abstraction Ignoring the many details, focus on the important elements 27. Theory Explains how relationships in economics work 28. Hypothesis Reasoned guess 29. Correlation Variables move up and down together, but do not cause each other 30. Economic models Equations, graphs, charts--shows what can happen in real- life version 31. Banks Reserves Banks are required to keep more $ in reserve meaning banks cannot lend as much. 32. Cuba Was once run by American mafia with prostitution and gambling. Revolution made sense. Bailed out 500,000 government workers during 10 Sept - 12 Sept 2010 weekend. Almost everyone is gov’t worker. Only those in private sector will prosper. 33. Division of Labor Specialization for higher production rate, coined by Adam Smith. 68. Optimal decision For person X, selected after implicit or explicit comparison of consequences of each possible choices and that is show by analysis to be the one that effectively promotes goals of person X 69. Principle of increasing costs As production of a good expands, the opportunity cost of producing another unit generally increases. 70. Inefficiency Big firms produce goods smaller firms should be making because of detail, vice versa. Favorism/nepotism (promotes brother despite lack of skill) -- Restrictive labor practices (fireman on diesel-engine locomotive, but no more fire) -- Discrimination-race, gender (If black woman more qualified than white man but latter hired) 71. Allocating Scarce Resources 1. How to utilize resources efficiently, reach PPF 2. Decide which possible combinations of goods to produce 3. How much of total output of each good to distribute to each person 72. Unemployment People looking for a job who do not have one. Calculated by (# unemployed / # labor force). Take population of 310 mil, subtract anyone less than 16.5 years old, military (2.5 mil), institutionalized-jail, mental = 240 mil. 73. Participation rate Number of Americans actively offering their labor. 67% x 240 mil = 150 mil 74. Baby Boomers In 2011, many will reach retirement age of 65 meaning there will be more jobs open in Western Europe, US, and Japan. 75. Structural unemployment Technology replaces your job, must be retrained, US does a poor job doing that. 30-40% of unemployed 76. Seasonal unemployment Job availability depends on seasons, like no ripe tree plants for California farmers 77. Frictional unemployment Being in between jobs 78. Cyclical unemployment Unemployment based on economy and business cycle 79. Underemployed Have jobs lower than skill or job capability 80. Obama’s Race to the Top Awards states for educational programs they’re setting up, like charter schools, not public schools. Battle with teacher unions who are losing jobs, he wants to extend the school year. 81. Aggregate demand and supply curve Shows quantity of domestic product that is supplied at each possible value of price level Figure 2 AS = aggregate supply, AD = aggregate demand 82. Demand-pull inflation AD grows faster than AS. But if AS increases and AD increases, you can avoid inflation. 83. Increase in AS = increase in labor force Figure 3 84. Cost-push If prices are high, ask boss for 10% raise, boss must increase prices of products, cycle continues... 85. Consumer price index (CPI) Measures inflation, GDP deflator and PPI 86. Zimbabwe Money worth different amounts each hour, dramatic economic changes 87. Inflation curve Increase in general price level. Figure 4 Deflation curve--recession Expansion 88. Demand schedule Table to show quantity demanded during specified period, changes depending on price of product (but all other determinants stay constant) 89. Demand curve shifts Will increase if consumer average incomes rise, even if price of goods remain the same. Increase in demand if increase in population. Increase for certain products if increase in particular population segment. Increase during “rages,” like for Pokemon cards in the ‘90s (Ex: Change in demand for beef. Decrease if chicken and pork prices decrease. Increase if prices for ketchup and buns decrease.) 90. Supply As price of a commodity rises, quantity supplied normally rises. As prices fall, quantity supplied falls. 91. Supply schedule Quantity supplied table as price of product changes. 92. Supply curve shifts Will increase if technology progresses. Decrease if price of inputs that supplies must buy increases. (Ex: Increase of beef supply means increase of beef price means increase of supply of cowhides for leather) 93. Shortage Too much demanded over quantity supplied 94. Surplus Too much supplied meaning sellers can’t sell all 95. Equilibrium Perfection in quantity supplied and demanded 96. Stable Equilibrium Pendulum of change does not vary too much, eventually returns to original position. Price below equilibrium price cannot persist in free market because shortage forces push of price upward. 97. Law of supply and demand Free market forces of supply and demand push price toward an equal quantity supplied and quantity demanded. It’s magical. 98. Changes in supply and demand curve 1. Any influence that makes demand curve shift to the right and does not affect upwards-sloped supply curve will raise equilibrium price and equilibrium quantity. Figure 5 2. Any influence that makes demand curve shift to the left and does not affect upwards- sloped supply curve will lower equilibrium price and equilibrium quantity Figure 6 3. Any change that shifts supply curve to right and does not affect demand curve will lower equilibrium price and raise equilibrium quantity. Figure 7 4. Any change that shifts supply curve to the left and does not affect demand curve will raise equilibrium price and lower equilibrium quantity. (Ex. Tax increase on both buyer and seller) 99. Laffer Curve The theoretical representation of the relationship between government revenue raised by taxation and all possible rates of taxation. Figure 10 132. Prince index Cost of market basket of goods relative to cost in some “base” period, simply year used to compare 133. CPI in given year (cost of market basket in given year/cost of market basket in base year) x 100 134. Real spending of year (nominal spending of year/price index of year) x 100 135. Real GDP (Nominal GDP/GDP deflator) x 100 136. Index number problem Relative prices changing = no such thing as “perfect price index” correct for every consumer 137. Broken Window Analogy Money would have been spent anyway, how money enters economy doesn’t matter 138. Circular flow leakages--savings (leaves flow because just sits in bank) and more imports than exports -- injections--banks loan your money to someone else 139. Wealth Effect Wealthy even if income is low. Wealth is the value of your assets. Income is what you receive from employer 140. Investment Flow of resources into production of new capital; labor, steel, other inputs--> construction of factories, warehouses, railroads, other pieces of capital. High rates contribute to rapid technical progress. 141. Growth policy Ensuring economy sustains high long-run growth rate of potential GDP 142. Stabilization policy Keeping actual GDP close to potential GDP in short run, so society does not have high unemployment nor high inflation 143. Growth rate of potential GDP Sum of growth rates of hours of work and labor productivity. Focus on smarter workers. 144. Determinants of productivity growth 1. Rate at which economy builds up stocks of capital 2. Rate at which technology improves 3. Workforce quality (rate at which it’s improving) 145. Human capital Amount of skill embodied in workforce. Most commonly measured by amount of education and training. For given capital stock, labor force and technology, labor productivity will be higher when workforce has more education. 146. Capital Supply of plant, equipment, software 147. Investment depends on interest rate Real interest rate low = more investment 148. Virtuous Cycle Figure 15 149. Vicious Cycle Figure 16 150. Property rights Laws and conventions that assign owners the right to use property as they see fit, for example, sell property and reap benefits while they own it. Country with set property rights will give people an incentive to invest. 151. On-the-job training Skills that workers acquire while at work rather than in school or in vocational training programs. Investment in human capital, just as higher education is. 152. Invention Act of discovering new products of new ways of making product 153. Innovation Act of putting new ideas into effect by bringing new products into market, changing product design, improving way things are done 154. Research and Development (R&D) Activities aimed at inventing new products or improving existing ones. Federal government R&D spending in fiscal year 2009 was $150 billion, half went to Pentagon. 155. Cost disease of personal services Service activities that require direct personal contact tend to rise in price relative to other goods and services. Example: Wages of university professors must increase to adjust to the current prices, but not a huge change in productivity of services (which is educating students) 156. Development assistance “Foreign aid,” refers to outright grants and low- interest loans to poor countries from both rich countries and multinational institutions like World Bank, spur economic development 157. Foreign direct investment Purchase or construction of real business assets like factories/offices/machinery, in foreign country 158. Problems for developing countries Bad geographical location, poor health of citizens, political instability 159. Goal of tax cuts (1975 and 2001) To try to get consumers to spend more since their disposable income will be greater; however, they do not spend more. 160. Aggregate demand Total amount that all consumers, business firms, government agencies, foreigners spend on final goods and services 161. Consumer expenditure (C) Consumption, total value of all consumer goods and services demanded 162. Investment spending (I) Sum of expenditures of business firms on new plant and equipment and households on new homes. Financial “investments” not included 163. Government purchases (G) Goods and services purchased by all levels of government 164. Net exports ( X -IM ) Indicates what we sell to foreigners and what we buy from them 165. Disposable income (DI) Sum of all incomes of all individuals in the economy after all taxes have been deducted and all transfer payments have been added. DI = GDP - (Taxes + Transfer Payments) = GDP - Taxes - Transfers = Y - T 166. Circular flow of expenditures and income Figure A 167. Transfer payments Sums of money that the government gives certain individuals as outright grants rather than payments for services rendered to employers. Ex: Social Security benefits, grants 168. Scatter diagram Graph showing relationship between two variables. Very useful in predicting how one variable will change in response to another variable. Create a straight line close to all points. (Slope) = (Vertical change / horizontal change) 169. Slope of scatter diagram Indicates how consumer spending responds to changes in disposable income. For example, ______ cents of additional spending per dollar of income. 170. Consumption function Shows relationship between total consumer expenditures and total disposable income in economy, holding all other determinants of consumer spending constant. 171. Marginal propensity to consume (MPC) Tells us how much more consumers will spend if disposable income rises by $1. (MPC) = ( change in C / Change in DI that produces change in C). Tells how much additional spending induced by each dollar change in disposable income. 172. Shifts in consumption function Change in price causes movement along demand curve, change in any other factor influences in shift of entire demand curve 173. Money-fixed assets Asset whose value is a fixed umber in dollars, purchasing power of it can decline whenever price level rises, meaning asset can really buy less 174. Long-run income prospects Consumers decide current consumption spending by looking at long-run income prospects 175. Permanent changes in income taxes Causes greater increases in consumer spending than temporary cuts of equal magnitiude do 176. Psychological perceptions Keynes pointed out psychological perceptions such at these are subject to abrupt shifts so that fluctuations in investment can be major cause of instability in aggregate demand. Business confidence influences it also. 177. GDPs in relations to other countries Our imports rise when our GDP rises and fall when our GDP falls. Our exports are relatively insensitive to our own GDP, but are quite sensitive to the GDPs of other countries. 178. Government outputs Valued at cost of inputs needed to produce them 179. Gross private domestic investment (I) includes business investment in plant, equipment, software, residential construction, inventory investment. 180. Net national product (NNP) Measure of production. Conceptually identical to national income. National income estimate income and production independently. 181. Depreciation Value of portion of nation’s capital equipment that is used up within the year. It tells us how much output is needed just to maintain the economy’s capital stock. 182. GDP and equilibrium We have reasoned that GDP will rise whenever it is less than total spending, C + I + G + (X-IM) and that GDP will fall whenever it exceeds C + I + G+ (X-IM). Equilibrium can occur, then, only when there is just enough spending to absorb the current level of production. 183. Expenditure schedule Shows relationship between national income (GDP) nd total spending