Review Session 2 - Chapters 6-8 AP Macroeconomics Review Session 2 - Chapters 6-8

Measuring Economic Growth Gross Domestic Product/GDP – The dollar value of all final goods and services produced within a country’s borders in one year The Expenditures Approach adds up all the spending done in the economy by households, businesses, the government, and other countries. GDP = Consumption + Investment + Government + (Exports – Imports) The Income Approach adds up all the income earned in the economy including wages, rent, interest, and profit National Income = Wages + Rent + Interest + PRofit

Measuring Economic Growth Nominal GDP – GDP measured in current prices; it does not account for inflation from year to year Real GDP – GDP adjusted for inflation and expressed in constant, or unchanging, dollars Three things NOT included in GDP Intermediate goods – GDP includes only final goods (don’t count the car and each of its parts, the car is only counted in GDP) Non-production transactions including used goods or financial transactions (stocks, bonds, SS payments) Non-market activities (illegal production or labor)

Business Cycles Peak – business activity has reached a temporary maximum Recession – period of decline in total output, income, employment, and trade; lasts 6 months or longer Depression – severe and prolonged recession Trough – recession or depression at its lowest level Expansion/Recovery – output and employment expand toward full employment

Measuring Unemployment Frictional Unemployment – temporarily unemployed or being between jobs; individuals are qualified workers with transferrable skills, but they aren’t working Structural unemployment – Changes in the structure of the labor force make some skills obsolete; workers DO NOT have transferrable skills; these jobs will NEVER come back Cyclical unemployment – results from economic downturns; as demand for G & S falls, demand for labor falls and workers are fired. Labor force = the # of employed workers + the # of those unemployed AND looking for work Unemployment rate is given as a percentage. # 𝑢𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑 & 𝑙𝑜𝑜𝑘𝑖𝑛𝑔 # 𝑖𝑛 𝑙𝑎𝑏𝑜𝑟 𝑓𝑜𝑟𝑐𝑒 × 100

Measuring Unemployment Natural Rate of Unemployment The amount of unemployment that exists when the economy is healthy. In the U.S., the NRU is around 4-6%. The economy is considered to be at full employment when there is no cyclical unemployment. GDP Gap – the amount by which actual GDP falls short of potential GDP because of unemployment Problems with the Unemployment Rate Discouraged job seekers – People that are no longer looking for a job because they gave up. Since these people are not counted in the labor force, the unemployment rate may be underestimated. Underemployed workers – Someone who wants more hours but can’t get them is still considered fully employed. This is not taken into consideration. Does not take into account cash-only workers.

Inflation Inflation – rise the general level of prices The amount of real goods and services that a dollar can buy is called purchasing power. Nominal value of the dollar is the actual value. The real value is what it can buy. Anticipated inflation what we believe will occur to prices. Unanticipated inflation is unexpected. This “hurts” lenders, savers, and people on fixed incomes. It “helps” borrowers Real rate of interest – nominal rate of interest – anticipated rate of inflation

Causes of Inflation Demand-Pull Inflation – “too much money chasing too few goods”; the economy demands more than it can produce and this drives up prices Cost-push inflation – if the per unit cost of production increases, then producers will be willing to supply less G & S at various prices. This will drive up prices. Wage-Price Spiral – a self-perpetuating increase in wages and prices Deficit spending leads to crowding out effect Growth of the money supply

Ways to Measure Inflation Consumer Price Index (CPI) An index number that shows how prices change over time for a fixed basket of consumer goods Most commonly used 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑚𝑎𝑟𝑘𝑒𝑡 𝑏𝑎𝑠𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑏𝑎𝑠𝑒 𝑦𝑒𝑎𝑟 𝑚𝑎𝑟𝑘𝑒𝑡 𝑏𝑎𝑠𝑘𝑒𝑡 ×1 00 GDP Deflator The deflator is an index number that measures all prices and is used to convert nominal GDP into real GDP Most accurate 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃 𝑅𝑒𝑎𝑙 𝐺𝐷𝑃 × 100

CPI Practice Assume the value of a market basket for a given year is $550 and the same basket in the base year was $500. Calculate the CPI. If the CPI for a given year is 90 then the change in prices between that year and the base year is _____. Year Market Basket Base Year 2009 Base Year 2010 2009 $20 100 ? 2010 $40 2011 $50

GDP Deflator Practice The Nominal GDP is $100 billion and the Real GDP is $80 billion. Calculate the GDP Deflator. The Real GDP is $100 billion and the GDP Deflator is 200. Calculate Nominal GDP. The Real GDP is $200 billion and the GDP Deflator is 120. Calculate Nominal GDP. The Nominal GDP is $300 billion and the GDP Deflator is 150. Calculate the Real GDP. The Nominal GDP is $100 billion and the GDP Deflator is 125. Calculate the Real GDP.

Other Key Terms Deflation – a decrease in the general level of prices; considered to be worse than inflation Disinflation – a decrease in the rate of inflation; prices are going up but not as fast as before Velocity of Money – the velocity of money is the average times a dollar is spent and re-spent in a specific period of time; usually measured as a ration of GNP to a country’s total money supply Economies that exhibit a higher velocity of money relative to others tend to be further along in the business cycle and should have a higher rate of inflations, all things held constant.

Quantity Theory of Money Assumes that increases in the quantity of money tend to create inflation and vice versa. Suggests there is a mechanical and fixed proportional relationship between changes in the money supply and the general price level 𝑀 × 𝑉 =𝑃 × 𝑄 M = Money Supply V = Velocity of Money P = Price Level Q = Quantity/Output Assume the amount of money is $5 and it is being used to buy 10 product with a price of $2 each. How much is the velocity of money? If the velocity and output stay the same, what will happen if the amount of money increases to $10?

Free Response on AP Central by Topic Inflation Impact – 2003 #1, 2004B #1, & 2011B #3 Nominal – Real Interest Rates – 2005 #1, 2005B #2, 2006 #2, 2006B #2, 2007 #2, 2009 #1, 2010B #2, 2001B #3, & 2012 #1 & 3 GDP – 2007 #3 & 2001B #3 Inflation Expectations – 2009 #1 & 2013 #2 From Unit 1 Circular Flow – 2003B #1 PPC – 2003B #2, 2004B #3, 2005B #2, 2007B #2, 2008 #3, 2010B #1, 2012 #1, & 2016 #3 Abs./Comp. Advantage – 2015 #2