Unit 2 Economics

1/26/16

Unit 2

Circular Flow Diagram

v  Represents the transactions in an economy

1.    Product Market: this is where firms sell goods and services that they produce to the household

2.    Factor Market: it is the place where households sell their resources & businesses buy those resources

Firms

v  It is an organization that produces goods & services for sale

Household

v  A person or group of people that share their phone

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Gross Domestic Product (GDP)-

v  It is the market value of all final goods & services produced within a nation in a given year

What’s not included?

1.    Intermediate Goods- something that needs further processing

2.    Used or Second-hand Goods- has been counted before

3.    Purely Financial Transactions- stocks, bonds, etc.

4.    Illegal Activities- drugs money, etc.

5.    Unreported Business Activity- tips

6.    Nonmarket Activities/Transactions- volunteering, babysitting

7.    Transfer Payments- scholarships, welfare payments, social security

What’s included?

C- Personal Consumption Expenditures (65% Americans spend on)

Ig- Gross (Total) Private Domestic Investment (17%)

1.    Factory Equipment Maintenance

2.    New Factory Equipment

3.    Construction of Housing

4.    Unsold Inventory or Products built in a Year

G- Government Spending (20% of American economy)

Xn- Net Exports (2%) (Exports-Imports)

Gross National Product (GNP)-

v  Total market value of all final goods & services by citizens of that country on it’s land or foreign land

Two Ways to Calculate GDP

1.    Expenditure Approach

-       Add up all of the spending on final goods & services produced in a given year formula:

GDP= C+Ig+G+Xn

“expenditure”- to spend

2.    Income Approach

-       It adds up all the income that resulted from selling all final goods & services produced in a given year formula:

W +R +I+ P+ statistical adjustments

W- wages

R- rents

I-  interests

P- profits

Statistical Adjustments

1.            Indirect Business Taxes

2.            Depreciation AKA Consumption of Fixed Capital

3.            Net Foreign Factor Payment

Compensation of Employees

v  Wages & salaries, could also include pensions, insurance, health & welfare

Rents

v  Income received by property owners

Interest

v  Money paid by private businesses to the suppliers of loans

Corporate Profits

v  It is the income of the corporation’s stockholders Ex. Dividends & corporate income taxes

Proprietor’s Income

v  income that comes from entrepreneurships & partners in a business

Formulas:

§  Budget Surplus/Deficit =

Gov. Purchases of Goods & Services + Gov. Transfer Payments – Gov. Tax & Free Collection

§  Trade Surplus/Deficit =

Exports – Imports

§  National Income =

1.    Compensation of Employees + Rents + Interests + Corporate Profits + Proprietor’s Income

2.    GDP – Income Business Taxes – Depreciation – Net Foreign Factor Payment

§  Disposable Personal Income =

National Income – Personal Household Taxes + Gov. Transfer Payments

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§  Net Domestic Product (NDP):

GDP – Depreciation

§  Net National Product (NNP):

GDP + Net Foreign Factor Payment

Nominal GDP	Real GDP
o   (price × quantity) o   The value of output produced in current year prices o   Used to measure an increase in prices o   Can increase from year to year if either price or quantity increases	o   (base yr. price × current yr. quantity) o   The value of output produced in constant base year prices o   ADJUSTED for inflation o   Used to measure economic growth o   Can increase from year to year only if output increases

 

GDP Deflator:

§  It is a price index used to adjust from nominal to real GDP

Nominal GDP ×100                                    Nominal Interest Rate ×100

   Real GDP                                                   Real Interest Rate

§  In base year, GDP Deflator ALWAYS equals 100

§  For years after the base year, GDP deflator is greater than 100

§  For years before the base year, GDP deflator is less than 100

Consumer Price Index (CPI):

§  Most commonly used measurement of inflation

§  It measures the cost of a market basket of goods of a typical urban American family

(cost of a market basket of goods & services in a given year) ×100

(cost of a market basket of goods in a base year)

Inflation Rate:

New Price Index – Old Price Index

Old Price Index

2/2/16

Nominal Interest Rate:

§  The percentage increase in money, the borrower must pay a lender for a loan

§  It is NOT adjusted for inflation

Real Interest Rate (RIR):

§  The percentage increase in purchasing power, the borrower must pay the lend for a loan

§  It IS adjusted for inflation

Formulas:

RIR= Nominal Interest Rate – Inflation                          Unanticipated Inflation

Nominal Interest Rate= Expected Interest Rate + Inflation Premium           Anticipated                                                Inflation *Fisher Effect*

Hurt by Inflation	Helped by Inflation
►   Savers ►   Lenders/Creditors ►   People who are on a Fixed Income Ex. Elderly, welfare	►   People who Owe Money Ex. Debtors

C.O.L.A.

o   Cost of living adjustments

o   It is where you get an automatic wage increase when inflation occurs

2/4/16

Unemployment:

§  It is the failure to use available resources, particularly labor, to produce desired goods & services

Underemployment:

§  Working less than 12 hours

Part-time:

§  Working 12-15 hours

People in the Labor Force:

§  Above 16 years of age

§  Able & willing to work

Not Included in Labor Force:

1.    Military

2.    Students

3.    Retired

4.    Disabled

5.    Homemakers

6.    Mental Institutions

7.    Jail/Prison

8.    Those Who Aren’t Looking for a Job

Unemployment Rate:

4 to 5%= Full Employment or Natural Rate of Unemployment (NRU)

How to Calculate Unemployment Rate:

               # of unemployed               ×100

(# of employed + # of unemployed)

Types of Unemployment

Frictional	Structural	Seasonal	Cyclical
v  Those who are searching for a job v  Temporary unemployed or in between jobs v  Have transferable skills v  Ex. College//high school graduates, laid off from your job or you leave or job	v  Changes in the structure of the labor force that make some skills obsolete v  DO NOT have transferable skills v  Has to learn new skills to get a job	v  Due to the time of year and nature of the job v  Ex. School bus drivers, lifeguards, Santa Claus/Easter Bunny impersonators, construction workers	v  As demand for goods and services falls, demand for labor falls & workers are laid off

* Frictional + Structural Unemployment= NRU

* Full Employment means there is NO cyclical unemployment

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GDP Gap:

§  The amount by which actual falls short of potential GDP

Okun’s Law:

§  For every 1% in which the actual unemployment rate exceeds the NRU a GDP gap of about 2% occurs

Ex. In 2012, the unemployment rate for Mexico was 7.4%, the NRU for Mexico is 6%

(7.4-6.4) ×2=2

(actual unemployment rate – NRU) ×2

Rule of 70:

§  It is used to determine how many years it takes for a value to double given a particular annual growth rate

Ex. If you put $20,000 in the bank and it earns a yearly interest of 7%, how many years for your income to double?

70/7=10 years

70/interest rate= # of years