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Ch4 GDP

GDP (gross domestic product): market value of the nal goods and services produced within a country
in a given time period.

Four Parts of GDP De nition:

• Market Value: the prices at which items are traded in markets. (To measure total production)
• Final Good and Service: item that is bought by its nal user during a speci ed time period. (To
calculate GDP)
• p.s. Intermediate Good(service): good or service made and bought by rms for nal goods
or services(if add to nal good/service will cause double counting)
• Produced Within a Country: Only goods and services that are produced within a country count
as part of that country's GDP.
• In a Given Time Period: normally either a quarter of a year(quarterly/annual GDP data)
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Households and Firms:

• Households sell and rms buy the services of labour(wages), capital(interest), and land(rent) in factor
markets
• Firms’ retained earning: pro ts that are not distributed to households—are part of the household
sector's income.(income that households save and lend back to rms)
• Y => aggregate income(Total income)—received by households, including retained earnings(wages
for labour, interest for capital, rent for land, and pro t for entrepreneurship)
• C => consumption expenditure - total payment for consumer good and service, not include real
estate
• I => investment - Firms purchase of new plant, equipment, and buildings and the additions to
inventories and household purchasing real estate.

Governments
• G => government expenditure - good/service bought by government (taxes, social bene t not
included)

Rest of the World

• X => export
• M => import
• X - M => net export(NX)

GDP(Aggregate Production) = Total(Aggregate) Expenditure = Total(Aggregate) Income

Aggregate Expenditure(Red Flows): consumption expenditure + investment + government expenditure

+ net exports

Aggregate Income(Blue Flows): the total amount paid for the services of the factors of production used
to produce nal goods and services—wages, interest, rent, and pro t.

Y (Income Approach) = C + I + G + X - M (Expenditure Approach)

Gross: before subtracting the depreciation of capital

Net: after subtracting the depreciation of capital

Net Investment = Gross Investment - Depreciation

• Depreciation: the decrease in the value of a rm's capital that results from wear and tear and
obsolescence.

• Gross Investment:
• The total amount spent both buying new capital and replacing depreciated capital.
• Is one of the expenditures included in the expenditure approach to measuring GDP
• The resulting value of total product is a gross measure

• Net Investment: The amount by which the value of capital increases

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Gross Pro t: rm's pro t before subtracting depreciation, is one of the incomes included in the income
approach to measuring GDP

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Further Adjustment (not sure it will be included in the test or not)

Indirect Tax: tax paid by consumers when they buy goods and services (An indirect tax makes the
market price exceed factor cost)

Direct Tax: tax on income

Subsidy: payment by the government to a producer(With a subsidy, factor cost exceeds market price)

Statistical Discrepancy: Gap between the expenditure approach and the income approach
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Real GDP:
• The value of nal goods and services produced in a given year when valued at the prices of a
reference base year.
• One of the broadest measures of economic health

Nominal GDP: The value of nal goods and services produced in a given year when valued at the prices
of that year

(Calculating refer to textbook)

Standard of Living: Calculate “Real GDP Per Person (Real GDP/Population)” in di erent years.

Potential GDP: The maximum quantity of real GDP that can be produced while avoiding shortages of
labour, capital, land, and entrepreneurial ability that would bring rising in ation. Grows at steady pace,
but not constant pace. Occurs when full-employment.

Lucas Wedge: The cost of slowdown in productivity growth

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Business Cycle
• Periodic but irregular up-and-down movement of total production and other measures of economic
activity.
• Every cycle has two phases: Expansion, Recession
• And two turning points: Peak, Trough

Expansion: A period during which real GDP increases(between through and peak)

Recession: A period during which real GDP increases for at least 2 successive quarters

An expansion ends and recession begins at a business cycle peak, which is the highest level that
real GDP has attained up to that time. A recession ends at a trough, when real GDP reaches a
temporary low point and from which the next expansion begins.

PPP = Purchasing Power Parity

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Standard of Living Across Countries

• Should converted into the same currency unit as the real GDP
• Good/Service in both countries must be valued at the same price

Limitations of Real GDP (Not included ,Underestimate production and overestimate the growth rate)
• Household Production: child caring
• Underground Economic Activity: Illegal, avoid taxes
• Leisure Time: working time is valued as part of GDP, but leisure time is not
• Environment Quality: nature resources, pollution

Ch5 Unemployment
Unemployment is a problem:
• Lost income and production
• Lost human capital

Working-age-population: age>=15 => Labour Force (employed + unemployed)

Not in Labour Force = not employed and not unemployed

Unemployed:
• On temporary layoff with an expectation of recall
• Without work but has looked for work in the past four weeks
• Has a new job to start within four weeks

Unemployment Rate:
1. ⬆ as recession deepens, reaches a peak value after recession end, ⬇ as expansion
gets underway

2. Not included:
• Discouraged searchers(A person who currently is neither working nor looking for
work)
• Long-term future starts(Someone with a job that starts more than four weeks in the
future is classi ed as not in the labour force)
• Involuntary part-timers(Part-time workers who would like full-time jobs)
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3. Most Costly = Long-term unemployment

Involuntary Part-Time Rate:

• People work part time but want full-time jobs

Labour Force Participation Rate

• the percentage of the working-age population who are members of the labour force

Employment Rate
• the percentage of people of working age who have jobs

Frictional Unemployment:
• The unemployment that arises from the normal labour turnover - from people entering and
leaving the labour force and from the ongoing creation and destruction of jobs
• a permanent and healthy phenomenon in a dynamic, growing economy
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Structural Unemployment:
• arises when changes in technology or international competition change the skills needed
• usually lasts longer than frictional unemployment

Cyclical Unemployment
• higher-than-normal unemployment at a business cycle trough and the lower-than-normal
unemployment at a business cycle peak
• Laid off when recession and rehired when expansion

Natural Unemployment
• Unemployment rate equals the natural unemployment rate when full-employment.
• Equals to “Frictions unemployment + Structural unemployment” when there is no cyclical
• Natural unemployment rate = Natural unemployment/Labour Force
• Important Factors:
• The age distribution of the population: An economy with a young population has a
large number of new job seekers and has a high level of frictional unemployment.
(Aging population has low level of frictional unemployment)
• The scale of structural change: technology change
• The real wage rate
• Unemployment bene ts

Full Employment:
• Unemployment Rate = Natural Unemployment Rate
• unemployment rate = natural unemployment rate & real GDP = potential GDP => output gap =
0
• Unemployment rate < natural unemployment rate => real GDP > potential GDP & output gap
>0
• Unemployment rate > natural unemployment rate => real GDP < potential GDP & output gap
<0

Output Gap:
• real GDP uctuates around potential GDP. The gap between real GDP and potential GDP is
called the “Output gap”
• As the output gap uctuates over the business cycle, the unemployment rate uctuates around
the natural unemployment rate.
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Price Level: average level of price

In ation:
• persistently rising price level
• Real GDP rises above potential GDP and the unemployment rate falls below the natural rate
for temporary

De ation:
• persistently falling price level, in ation rate is negative
• Businesses and households that are in debt (borrowers) are worse off and they cut their
spending. A fall in total spending brings a recession and rising unemployment

In ation => De ation => Stagnation => Recession

Hyperin ation: in ation rare of 50% or higher

Problems of In ation and De ation:

• Redistribute Income: Workers and employers sign wage contracts that last for a year or more.
An unexpected burst of in ation raises prices but doesn’t immediately raise wages.
• Redistribute Wealth: People enter into loan contracts that are xed in money terms and that
pay an interest rate agreed as a percentage of the money borrowed and lent. With an
unexpected burst of in ation, the money that the borrower repays to the lender buys less than
the money originally loaned.
• Lower GDP and Employment
• Diverts Resources from Production: Unpredictable in ation or de ation turns the economy
into a casino and diverts resources from productive activities to forecasting in ation.

Consumer Price Index(CPI)

• average prices paid by urban consumers for a xed basket of goods and services
• The value of money
• CPI Reference base period = 100
• CPI Basket:
• contains the goods and services represented in the index
• the budget of an average urban household
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In ation Rate

Price Level vs In ation Rate

Price level rises rapidly(slowly) => in ation rate is high(low)

Price level falls => in ation rate is negative = de ation

Biased CPI:
• New goods bias: high tech puts an upward bias into the CPI and In ation Rate
• Quality change bias: better quality => higher price
• Commodity substitution bias: people will choose substitution when the price is high
• Outlet substitution bias: different discount in different stores

Consequence of Bias: The bias in the CPI distorts private contracts and increases government
outlays.

GDP De ator:
• GDP de ator is an index of the prices of all the items included in GDP and is the ratio of
nominal GDP to real GDP
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Chained Price Index for Consumption:

• an index of the prices of all the items included in consumption expenditure in GDP and is the
ratio of nominal consumption expenditure to real consumption expenditure

Core In ation: the in ation rate excluding volatile elements, attempts to do just that and reveal
the underlying in ation trend.

Ch6 Economic Growth

Real GDP growth rate:

Standard of Living = Real GDP Per Person(per capita real GDP) = Real GDP/
Population
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Real GDP Increase with 2 reasons:

• economy might be returning to full employment in an expansion phase of the business cycle
• potential GDP might be increasing.

The growth rate of potential GDP measures the pace of expansion of production possibilities and
smoothes out the business cycle uctuations in the growth rate of real GDP
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Rule of 70(70/annual percentage growth):

• A rule that states that the number of years it takes for the level of any variable to double is
approximately 70 divided by the annual percentage growth rate of the variable

The quantity of labour employed is the only variable factor of production.

Quantity of Labour = number of workers employed * average hours per worker

Real GDP:
• Produce by labour, capital, land, and entrepreneurship
• Qty of real GDP produced by productivity of factors of production

Growth Rate of Real GDP = Real GDP grew - Population Grew

Potential GDP = Real GDP when full-employment => labour market equilibrium

Aggregate Production Function:

• the relationship that tells us how real GDP changes as the quantity of labour changes, when
all other in uences on production remain the same
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The demand for labour is the relationship between the quantity of labour demanded and the real
wage rate.

Real Wage Rate = Money Wage Rate/ Price Level => if ⬇ labour demand ⬆ , if ⬆
labour supply ⬆

Potential GDP per hour o labour, which is potential GDP divided by labour hours.

Labour Market Equilibrium

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Potential GDP Grow with:

• Growth of the supply of labour: supply of labour curve ship rightward, quantity of labour at
a given peak wage rate increases(In the long run, the working-age population grows at the
same rate as the total population)
• Growth of labour productivity: Labour is more productive and more labour is employed.

Effect of an Increase in Population:

• Lowers the real wage rate
• Increase the full-employment quantity of labour
• Increase potential GDP, decrease potential GDP per hour of labour
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The Effects of an Increase in Labour Productivity

• The quantity of real GDP that any given quantity of labour can produce increases
• Demand of labour increase
• Wage rate and quantity of labour supplied increase with no change in the supply of labour

Precondition for Labour Productivity Growth

• Physical capital growth
• Human capital growth
• Technological advances
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Ch7 Financial Market

Financial Capital: The fund used to buy investment

Gross Investment: total spent on new capital

Net Investment = Gross Investment - Depreciation: the change in quantity of capital

Wealth(Net Worth):
• Householders or rms: owns - owes
• Financial Institutions: lent - borrowed

National Wealth(in the end of year) = National Wealth(Start in the year) + saving(in the
year) => saving = income - consumption expenditure

Saving: Income - paid in taxes - spent on consumption => add to wealth

Capital Gains: Wealth increases when the market value of assets rises

Make Real GDP⬆ : Saving & wealth => investment & capital
(transferred into)

Types of Fund for Financial Markets:

• Loan: like mortgage

• Bond: promise make speci ed payment on speci ed date

• Coupon Payment: pay interest
• Redemption Payment: nal payment on speci ed date
• Terms to Maturity: term of a bond
• Yield Curve: relationship between term of bond and interest rate (longer term with
higher interest)

• Stock: certi cate of ownership and claim to the rm’s pro ts

• Stock Market: nancial market in which shares of stocks of corporations are
traded
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Financial Institutions:
• a rm that operates on both sides of the markets for nancial capital
• borrower in one market and a lender in another

Key Financial Institutions:

• Banks
• Trust and loan companies: provide services similar to banks and the largest ones are owned
by banks
• Credit unions and caisses populaires: banks that are owned and controlled by their
depositors and borrowers, regulated by provincial rules, and operate only inside their own
provincial boundaries. (Large number and small size)
• Mutual funds: nancial institutions that buy bonds and stocks using funds provided by
individual savers.
• Pension funds: nancial institutions that receive the pension contributions of rms and
workers
• Insurance companies

Financial Assets: Stocks, bonds, short-term securities, and loans

Source of Founds: saving

Investment nance comes from three sources:

1. Household saving
2. Government budget surplus
3. Borrowing from the rest of the world
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Y: Households’ income, C: spent on consumption goods and services, S: saved, T: paid in net
taxes

Y=C+S+T
Y=C+I+G+X-M

I+G+X=S+T+M
I = S + (T - G) + (M - X)

Net Taxes: taxes paid to government - cash transfer received from government
Investment I is nanced by household saving S.
Government budget surplus (T - G).
Browsing from the rest of the world (M - X).
Sum of private saving S.
Government saving (T - G).
National Saving => S + (T - G)
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Real Interest Rate = Nominal Interest Rate - In ation Rate

• Opportunity Coast of Loanable Funds, Borrowed Funds

• Forgone when funds are used on consumptions or invest new capital

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Loanable Funds Markets: aggregate of all individual nancial markets, stable in long run

Demand of Loanable Funds(⬇ when interest rate is high):

• Relationship between quantity of loanable funds demanded and read interest
rate(when all other in uences same)
• Change when expected pro t changes

Supply of Loanable Funds(⬆ (saving increase as well) when increase in disposable

income, a decrease in expected future income, a decrease in wealth, or a fall in
default risk):
• Relationship between quantity of loanable funds supplied and read int rate( when
all other in uences same)
• Disposable income: income - net taxes

Interest Rate is High => quantity of supply is high, quantity of demand is low
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Loanable Market:
• Firms expect earn increase, demand shift rightward=> real interest rate and quantity
of supply ⬆
• Saving increase, Supply shift rightward => real interest rate⬇ , investment⬆

Government in the Loanable Market:

• Government enters the market when its has budget surplus or budget de cit
• Budget surplus: Increase supply => real interest rate & saving &qty of private
funds ⬇ => lower real interest rate increase quantity of demand and investment
• Budget De cit: Increase demand => real interest rate ⬆ => saving & quantity of
private funds ⬆ =>higher real interest rate decrease quantity demand and
investment

Crowding-Out Effect: The tendency for a government budget de cit to raise the real
interest rate and decrease investment
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Ricardo-Barro Effect: private supply of loanable funds increases to match the quantity
of loanable funds demanded by the government=> budget de cit has no effect on either
the real interest rate or investment

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