Midterm Review Sheet (2011/Spring)


Macroeconomics- studies the behavior of the economy as a whole

Business Cycle-long-run economic growth and the short-run fluctuations in output and employment (ups and downs in economic growth)

Recession- when in the long run economic growth declines (lower output and living standards)

Real GDP- measures the value of all final goods and services produced within a country, and usually for one year. It also corrects for price changes so that we know if there is a change in output (rather than prices)

Nominal GDP- measures the dollar value all goods and services produced in a country using their current prices during the year that they were produced

Unemployment- when the skills and talents of people remain unused

Inflation- an increase in the overall level of prices, it reduces the purchasing power of people’s savings since with the money available they cannot buy as many goods and services as they could in the previous years (when prices were lower)

Industrial Revolution (England, 1700) - factory production and automation, output grew faster than the population, improving so the standards of living since the amount of output per person increased

Modern Economic Growth- occurred in countries that experienced the influence of the industrial revolution (in which output rises)

Global Perspective 6.1 makes three adjustments to each country’s GDP:

  1. It converts each country’s GDP from its own currency into US dollars

  2. It divides each country’s GDP measured in dollars by the size of its population ( GDP per person )

  3. Uses the purchasing power parity to adjust the fact that prices are lower in some countries, meaning that 1$ of GDP in the US represents the same amount of goods that you can purchase fro 1 $ in some other country

Savings- are generated when current consumption is less than current output, or when current spending is less than current income

Investment-current resources are devoted to increase future output

Financial Investment- when ordinary people purchase things like stocks, bonds, and real estate with the hope of having a financial gain either by selling the assets later at higher prices, or by receiving periodical payments ( such as rents), but here only the ownership is changed ( nothing new is created)

Economic Investment- the creation and expansion of business enterprises, the money is spent for newly created capital goods such as machines, factories, and warehouses

Principal sources of savings Households

Main economic investors Businesses

Expectations- for future trends affect the current economic behavior e.g. if pessimistic less current investment less future consumption

Shocks-unexpected situations, when things don’t go as planned

Demand Shocks- unexpected changes in demand for goods and services

Supply Shocks- unexpected changes in the supply of goods and services

Positive Demand Shock- demand higher than expected

Negative Demand Shock- demand lower than expected

  • Most short-run fluctuations are a result of demand shocks

In the short-run prices are inflexible or “sticky” (slow to change) leading to changes in output, in the quantity of production.

If prices are flexible than no matter what the demand is, u can still produce at a certain output (the price will adjust to the demand)

Chapter 7

National Income Accounting- measures the economy’s overall performance by:

  • Comparing levels of production at regular levels

  • Tracking the economy in the long-run (whether it has increased, stagnated, or declined)

  • Formulating policies to improve the economy

Aggregate output-the annual total output of all goods and services

  • GDP counts only final goods

Intermediate goods- are purchased for resale or further processing

Final goods-are consumption goods, capital goods that are purchased by final users

Value Added-the market value of the firm’s output less the value of the inputs the firm has bought from others

Nonproduction Transactions- don’t generate final goods and are of two types:

  • Financial transactions and

  • Secondhand sales

Financial Transactions include:

  • Public transfer payments- social security, veterans’ payment (government to households) that don’t contribute anything to current production

  • Private transfer payments- money as a gift which doesn’t produce output, only transfer of funds to another person

  • Stock market transactions- not included in GDP since they don’t create production

Secondhand Sales: excluded from GDP since they contribute nothing to current production

  • Two ways of looking at GDP: spending (expenditure approach) and income (income approach)

Expenditures approach-the sum of all money spent in buying

Income approach- the income derived or created form production

Personal Consumption Expenditures (C) - all expenditures by households on:

  • Durable goods-automobiles, refrigerators, video recorders

  • Nondurable goods-bread, milk, vitamins, pencils

  • Expenditures for services-doctors, lawyers

Gross Private Domestic Investment (Ig) includes:

  • Final purchases of machinery and equipment by businesses

  • All constructions ( residential construction, constructions of new factories)

  • Changes in inventory ( e.g. increase in inventory)

Noninvestment Transactions-paper assets, resale of tangible assets

Net Private Domestic Investment-only investment in the form of added capital

Depreciation- the amount of capital that is used up for over a year

Net investment=gross investment-depreciation

Net investment and depreciation are equal than gross investment is zero (no change in capital stock)

Gross investment minus depreciation = negative Net investment

Disinvestment- when the economy uses more capital than it is producing (capital stock shrinks)

Government purchases (G):

  • Expenditures for goods and services that it consumes for providing public services

  • Expenditures for publicly owned capital (schools, highways)

Reservoir Analogy:

Stock-Water; Gross investment-Inflow; Depreciation-outflow

Net Exports (Xn) - exports minus imports

Exports (X) - are goods and services produced within the borders the country

Imports (M) - goods and services produced outside of the country

GDP Formula

GDP= C +Ig+G+X-M

National Income includes:

  • Compensation of Employees- wage and salary supplements, welfare for workers

  • Rents- income received by households

Net Rent= gross rental income- depreciation

  • Interest- money paid to the suppliers of loans

  • Proprietors’’ Income- the net income of sole proprietorships

  • Corporate Profits- earnings of co operations

  • Corporate Income Taxes- levied on the profit of the corporate (flow to government)

  • Dividents- profits that corporations distribute to stockholders (flow to households)

  • Undistributed Corporate (Retained Earnings)- Profits-saved profits, by corporations to be later invested

  • Taxes on Production and Import-sales taxes, license fees, customs duties, and excise taxes

Net Foreign Factor Income- The difference between factor payments received from the foreign sector by domestic citizens and factor payments made to foreign citizens for domestic production. Net foreign factor income (NFFI) is the key difference between gross DOMESTIC product and gross NATIONAL product

Statistical Discrepancy- The official adjustment factor in the National Income and Product Accounts that ensures equality between the income and expenditures approaches to measuring gross domestic product. This is one of several differences between national income (the resource cost of production) and gross/net domestic product (the market value of production).

Consumption of Fixed Capital-the huge depreciation charge made against private and publicly owned capital each year

Net Domestic Product= GDP-consumption of fixed capital (depreciation)

Personal Income- all income received, whether earned or unearned

Disposable Income= Personal Income- Personal Taxes

Nominal GDP- The total market value, measured in current prices, of all goods and services produced within the political boundaries of an economy during a given period of time, usually one year.

Real GDP-that has been deflated or inflated to reflect changes in the price level

Price Index- a measure of the price of specified goods and services

Chapter 8

Economic Growth- an increase in real GDP occurring over some time period, or in GDP per capita

Real GDP per capita- Real GDP divided by the size of population

Economic growth is defined as either:

  • An increase in real GDP occurring over some time period

  • An increase in real GDP per capita occurring over some time period

Real GDP per capita:

It is found by dividing real GDP by the size of the population. The resulting number is then compared in percentage terms with that of the previous period.


If real GDP in Zorn was $200 billion last year and its population was 40 million, its real GDP per capita would be $5000. If real per capita GDP rose by $5100 this year, Zorn’s rate of growth of real GDP per capita for the year would be 2 percent: {=[($5100-$5000)/5000]x100}

Rule of 70:

The mathematical approximation called the rule of 70 provides the quantitative grasp of the effect of the economic growth. It tell us that we can find the number of years it will take for some measure to double, given its annual percentage increase, by dividing that percentage increase into the number 70.


number of years

required to double = 70 / annual percentage rate of growth

real GDP

Modern economic growth:

It is characterized by sustained and ongoing increases in living standards that can cause dramatic increases in the standard of living within less than a human lifetime.

Leader countries:

The countries that started experiencing modern economic growth earlier than other areas.

Follower countries:

Are the countries that did not experience modern economic growth as early as the leader countries.

Leader VS Follower:

If leader countries are richer it does not mean that the follower countries will not be able to catch up. Broadly speaking the richest countries today have achieved because they have more advanced technology. They have to invent new technologies to get even richer, but the period of inventing e new technology is slow and costly. By contrast, poorer follower countries can grow much faster because they simply adopt existing technologies from rich leader countries.

Supply factors:

Four of the ingredients of economic growth relate to the physical ability of the economy to expand. They are:

  • Increases in the quantity and quality of natural resources

  • Increases on the quantity and quality of human resources

  • Increases in the supply (or stock) of capital goods

  • Improvement in technology

These supply factors changes in the physical technical agents of production enable an economy to expand its potential GDP.

Demand Factor:?

To achieve the higher production potential created by the supply factors, households, businesses, and government must purchase the economy’s expanding output and goods and services.

Efficiency factor:?

To reach its full production potential, an economy must achieve economic efficiency as well as full employment.

Labor productivity:

Real GDP = hours of work x labor productivity

Labor-force participation rate- the percentage of the working –age population actually the labor force

Growth accounting infrastructure- the council of Economic Advisers uses a system called growth accounting to assess the relative importance of the supply-side elements to contribute to changes in real GDP. This system groups these elements into two main categories

  • Increases in hours of work

  • Increases in labor productivity

Human capital: The knowledge and skills that make a worker productive.

Economies of scale:The more you produce the lower the cost.

Information technology:

The combination of the computer, fiber-optic cable, wireless technology, and internet constitutes a spectacular advance in information technology.

Start-up firms:

Increasing returns: is a situation in which a given percentage increases in the amount of input a firm uses leads to an even larger percentage increase in the amount of output the firm produces.

Network effects: is the increase in the value of the product to each user, including existing users as the total number of users rises

Learning by doing: tasks that initially may have taken firms hours may take them only minutes once the methods are perfected.

Chapter 9

Business Cycles- are alternating rises and declines in the level of economic activity, over several years

Individual Cycles- one “up” followed by one “down”

Peak- a temporary maximum, full employment, level of output close to the economy’s capacity, price may rise

Recession- a period of decline in total output, income, and employment, unemployment rises

Trough-output and employment “bottom out” at their lowest levels

Expansion- real GDP, income, and employment rise

The cycles are not regular as implied; therefore we refer to them as “Business Fluctuations”

Causes of business cycles:

  1. Shocks : supply shocks, shocks to productivity

  2. Monetary phenomena- e.g. inflationary boom

  3. Unexpected financial bubbles and bursts

  4. Unexpected political events such as 9/11

More affected by the recession

Immediate cause- is the unexpected changes in the level of total spending

Capital goods- housing, commercial buildings, heavy equipment

Consumer durables- automobiles, personal computers, and refrigerators

Non-durable goods e.g. services

Main problems of B. cycle-unemployment and recession

Labor force- people who are able and willing to work

Unemployment rate- percentage of the labor force unemployed


Unemployment rate= Labor force x 100

Discouraged workers- are excluded from unemployment because they are not actively seeking for a job

There are three types of unemployment:

  1. Frictional( wait, search unemployment)-workers that are between jobs

  2. Structural-decline in the demand for certain workers or skills ( e.g. French teacher)

  3. Cyclical-caused by a decline in total spending

Full employment- the economy is experiencing only frictional and structural unemployment

Natural rate of unemployment- the economy is producing its potential output.

Operating above the NRU a country is producing at some point inside its possibilities curve.

GDP gap- the difference between actual and potential GDP

GDP gap=actual GDP-potential GDP

GDP gap is negative when actual GDP is lower than potential GDP

GDP gap is positive when actual GDP is higher than potential GDP

  • The higher the unemployment rate the larger the GDP gap.

Okun’s law- indicates that for every 1 percentage point by which the actual unemployment rate exceeds the natural rate, a negative GDP gap of about 2 % occurs.

Unequal Burdens- the cost of unemployment is not equally distributed as in differences of:

Occupation, Age, Race and ethnicity, gender, education, and duration

Non-economic costs-idleness, loss of skills, loss of self-respect, family disintegration, socio-political unrest

Consumer Price Index- main measure of inflation

CPI= price of the most recent market (basket in a particular year)/ price estimate of the market basket X 100

Types of Inflation:

Demand-pull Inflation- an increase in the price levels as a result of excessive spending

Cost-push Inflation-prices increase as e result of rising prices in terms of factors that raise per-unit production and the main source are the supply shocks

Per-unit production costs=total input/units of output

Real Income= nominal income/price index (in hundreds)

Unanticipated inflation- hurts fixed-income recipients, savors, and creditors

Real interest rate- the percentage increase in purchasing power from borrower to the lender

Nominal interest rate- the percentage increase in money from borrower to the lender

Deflation- declines in the price level

Hyperinflation- rapid inflation

Chapter 10-Consumption and Savings

45 (degree) line consumption schedules-a line along which the value of GDP (measured horizontally) is equal to the value of aggregate expenditures (measured vertically)

Saving schedule- shows the amounts that households plan to save (plan not to spend for consumer goods) at different levels of disposable income

Break-even income-the level of disposable income at which households plan to consume (spend) all their income and to save none of it

Average propensity to consume (APC)-fraction (or percentage) of disposable income that households plan to spend for consumer goods and services; the consumption divided by the disposable income

Average propensity to save (APS) - the percentage of disposable that households that households save; saving divided by disposable income

Marginal propensity to consume (MPC)-the fraction of any change in disposable income spent for consumer goods; equal to the change in consumption divided by the change in disposable income

Marginal propensity to save (MPS)-the fraction of any change in disposable income that households save; equal to the change is saving divided by the change in disposable income

Wealth effect-shifts the consumption schedule upward and the saving schedule downward

Expected rate of return-the increase in profit a firm anticipates it will obtain by purchasing capital

Investment demand curve-shows the amounts of investment demanded by an economy at a series of real interest rates

Multiplier-the ratio of a change in the equilibrium GDP to the change in investment or in any other component of aggregate expenditures or aggregate demand, the number by which a change in any such component must be multiplied to find the resulting change in the equilibrium GDP

Kudos to Teuta Avdimetaj!!

Unknown user,
Apr 13, 2011, 12:59 PM