Emad Econ Unit 2 Chapter 21

Overview 1. Three major macroeconomic goals are maintaining employment at high levels; maintaining prices at a stable level; and achieving a high rate of economic growth. 2. Concern over both unemployment and price instability led to the passage of the Employment Act of 1946, in which the United States committed itself to policies designed to reduce unemployment in a manner consistent with price stability. 3. With high rates of unemployment, society loses some potential output of goods and services. 4. The unemployment rate is the number of people officially unemployed divided by the civilian labor force. 5. The labor force is the number of people over the age of 16 who are either employed or unemployed. 6. Discouraged workers, who have not actively sought work for four weeks, are not counted as unemployed; instead, they fall out of the labor force. 7. Some people working overtime or extra jobs might be considered to be over employed. 8. The four main categories of unemployed workers include job losers (temporarily laid off or fired), job leavers (quit), reentrants (worked before and now reentering the labor force), and new entrants (entering the labor force for the first time). 9. Job losers typically account for the largest fraction of those unemployed. 10. In the short run, a reduction in unemployment 11. may come at the expense of a higher rate of inflation, especially if the economy is close to full capacity. 12. Trying to match employees with jobs quickly may lead to significant inefficiencies because of mismatches between a worker's skill level and the level of skill required for a job. 13. The duration of unemployment tends to be greater when the amount of unemployment is high and smaller when the amount of unemployment is low. 14. The percentage of the population that is in the labor force is called the labor force participation rate.

15. Frictional unemployment is short term and results from the normal turnover in the labor market. 16. Frictional unemployment tends to be somewhat greater in periods of low unemployment, when job opportunities are plentiful. 17. If individuals seeking jobs and employers seeking workers had better information about each other, the amount of frictional unemployment would be considerably lower. 18. Structural unemployment reflects the existence of persons who lack the necessary skills for jobs that are available. 19. Cyclical unemployment is the most volatile form of unemployment. 20. Most of the attempts to solve the unemployment problem have placed an emphasis on increasing aggregate demand. 21. Job retraining programs have the potential to reduce structural unemployment. 22. The natural rate of unemployment roughly equals the sum of frictional and structural unemployment when they are at a maximum. 23. One can view unemployment rates below the natural rate as reflecting the existence of a below-average level of frictional and structural unemployment. 24. The natural rate of unemployment is the median, or "typical," unemployment rate, equal to the sum of frictional and structural unemployment when they are at a maximum. 25. The natural rate of unemployment may change over time as technological, demographic, institutional, and other conditions vary. 26. When all of the economy's labor resources and other resources, such as capital, are fully employed, the economy is said to be producing its potential level of output. 27. When the economy is experiencing cyclical unemployment, the unemployment rate is greater than the natural rate. 28. The economy can temporarily exceed potential output as workers put in overtime or moonlight by taking on extra employment. 29. Without price stability, consumers and producers will experience more difficulty in coordinating their plans and decisions. 30. In general, the only thing that can cause a sustained increase in the rate of inflation is a high rate of growth in money.

31. The consumer price index is the standard measure of inflation. 32. Retirees on fixed pensions, creditors, and those whose incomes are tied to longterm contracts can be hurt by inflation because inflation erodes the purchasing power of the money they receive. 33. The uncertainty that inflation creates can discourage investment and economic growth. 34. Inflation can raise one nation's price level relative to price levels in other countries, which can lead to difficulties in financing the purchase of foreign goods or to a decline in the value of the national currency relative to that of other countries. 35. In periods of high and variable inflation, households and firms have a difficult time distinguishing changes in relative prices from changes in the general price level, distorting the information that flows from price signals. 36. Menu costs are the costs of changing posted prices. 37. Shoe-leather costs are the costs of checking on your assets. 38. The real interest rate equals the nominal interest rate minus the inflation rate. 39. In most economic decisions, it is the real rate of interest that matters, because it shows how much borrowers pay and lenders receive in terms of purchasing power. 40. The lower the interest rate, the greater the quantity of funds people will demand,

ceteris paribus; the higher the interest rate, the greater the quantity of loanable funds supplied, ceteris paribus. 41. When creditors start expecting future inflation, there will be a leftward shift in the supply curve of loanable funds. Likewise, demanders of funds (borrowers) are more anxious to borrow because they think they will pay their loans back in dollars of lesser purchasing power than the dollars they borrowed. Thus, the demand for funds increases. 42. If the inflation rate is accurately anticipated, new creditors do not lose, nor do debtors gain, from inflation. 43. Groups try to protect themselves from inflation by using cost-of-living clauses in contracts. 44. The tendency is for nominal interest rates and inflation rates to move in the same direction.

45. Business cycles refer to the short-term fluctuations in economic activity, not to the long-term trend in output. 46. A business cycle has four phases: expansion, peak, contraction, and trough. 47. Expansion occurs when output is rising significantly, unemployment is falling, and both consumer and business confidence are high. 48. The peak is when an expansion comes to an end, that is, when output is at the highest point in the business cycle; while the trough is the point in time when output stops declining, that is, when business activity is at its lowest point in the business cycle. 49. Seasonally adjusted unemployment rates in summer months are below actual unemployment rates because unemployment is normally high in summertime as a result of the inflow of school-age workers into the labor force. 50. It can be in the best interest of the incumbent to stimulate the economy in the period leading up to an election. 51. Businesses, government agencies, and, to a lesser extent, consumers rely on economic forecasts to learn of forthcoming developments in the business cycles. 52. If the index of leading indicators increases sharply for two or three months, it is likely (but not certain) that increases in the overall level of activity will follow. 53. Even though the leading economic indicators do provide a warning of a likely downturn, they do not provide accurate information on the depth or duration of the downturn. COPYRIGHT © 2008 by Thomson South-Western.

Overview 1. National income accounting was created to provide a reliable, uniform method of measuring economic performance. 2. GDP is defined as the value of all final goods and services produced in a country in a period of time, almost always one year. 3. A final good or service is one that is ready for its designated ultimate use, in contrast to intermediate goods or services, which are used in the production of other goods.

4. The two primary ways of calculating economic output are the expenditure approach and the income approach. 5. With the expenditure approach, GDP is calculated by adding up the expenditures of market participants on final goods and services over a period of time. 6. For analytical purposes, economists usually categorize expenditures into four categories: consumption, investment, government purchases, and net exports. 7. Consumption spending is usually broken down into three subcategories: nondurable goods, durable consumer goods, and services. 8. Consumption refers to the purchase of consumer goods and services by households. 9. The most important single category of consumer durable goods is consumer vehicles. 10. Sales of nondurable consumer goods tend to be more stable over time than sales of durable goods. 11. Investment, as used by economists, refers to the creation of capital goods, whose purpose is to produce other goods. 12. The two categories of investment purchases measured in the expenditures approach are fixed investment and inventory investment. 13. When the economy is booming, investment purchases tend to increase dramatically. 14. Transfer payments are not included in government purchases because that spending does not go to purchase newly produced goods or services. 15. Imports must be excluded from GDP in order to obtain an accurate measure of domestic production. 16. The income approach to measuring GDP involves summing the incomes received by producers of goods and services. 17. Output creates income of equal value. 18. Factor payments include wages for the use of labor services, rent for land, interest payments for the use of capital goods, and profits for entrepreneurs, who put labor, land, and capital together. 19. The incomes received by persons providing goods and services are actually payments to the owners of productive resources and are sometimes called factor payments.

20. Depreciation must be subtracted from gross domestic product to get net national product (NNP). 21. Disposable personal income is the personal income available to individuals after taxes. 22. We must adjust for the changing purchasing power of the dollar by constructing a price index. 23. The best-known price index is the consumer price index, which provides a measure of the trend in the prices of goods and services purchased for consumption purposes. 24. The GDP deflator measures the average level of prices of all final goods and services produced in the economy. 25. The CPI is the price index that is most relevant to households trying to evaluate their changing financial position over time. 26. A price index is equal to the cost of the chosen market basket in the current year, divided by the cost of the same market basket in the base year, times 100. 27. While the CPI and the GDP deflator move together, the CPI tends to be more volatile. 28. The formula for converting any year's nominal GDP into real GDP (in base year dollars) is real GDP equals nominal GDP divided by the price-level index, times 100. 29. To calculate real per capita GDP, we divide real GDP by the total population to get the value of real output of final goods and services per person. 30. We do not have reliable enough information on the output of nonmarket transactions to include it in the GDP. 31. The most important nonmarket transactions omitted from GDP are services provided directly in the home. 32. The value that individuals place on leisure is omitted in calculating GDP. COPYRIGHT © 2008 by Thomson South-Western.

Overview

1. John Maynard Keynes was primarily concerned with explaining and reducing short-term fluctuations in the level of business activity. 2. Many would argue that in the long run, economic growth is a crucial determinant of people's well-being. 3. Economic growth is usually measured by the annual percent change in real GDP per capita. 4. How much the economy will produce at its potential output depends on the quantity and quality of an economy's resources. 5. Increases in technology can increase the economy's production capabilities. 6. A nation with greater economic growth will end up with a much higher standard of

living, ceteris paribus. 7. The Rule of 70 says that the number of years necessary for a nation to double its output is approximately equal to the nation's growth rate divided into 70. 8. Several factors have contributed to economic growth in some or all countries: (1) growth in the quantity and quality of labor resources used (human capital); (2) increase in the use of inputs provided by the land (natural resources); (3) growth in physical capital inputs (machines, tools, buildings, inventories); and (4) technological advances (new ways of combining given quantities of labor, natural resources, and capital inputs) allowing greater output than previously possible. 9. If the labor force participation rate in a country rises or if workers put in longer hours, output per capita will tend to increase. 10. It has become popular to view labor as human capital that can be augmented or improved by education and on-the-job training. 11. Capital formation has played a significant role in the economic development of nations. 12. Innovation is the adoption of a new product or process. 13. Technological advance permits us to economize on labor, land (natural resources), or even capital. 14. Generally speaking, higher levels of saving will lead to higher levels of investment and capital formation and, therefore, to greater economic growth. 15. Investment alone does not guarantee economic growth, which hinges on the quality and the type of investment as well.

16. Research and development can result in new products, management improvements, production innovations, or learning by doing. 17. Economic growth rates tend to be higher in countries where the government enforces property rights. 18. If a country's government is not enforcing property rights, the private sector must respond in costly ways that stifle economic growth. 19. Free trade can lead to greater output because of the principle of comparative advantage. 20. Accepting a reduction in current income to acquire education and training can increase future earning ability, which can raise the standard of living. 21. With economic growth, illiteracy rates fall and formal education grows. 22. Improvements in literacy stimulate economic growth by reducing barriers to the flow of information and raising labor productivity. 23. One problem in providing enough education in poorer countries is that children in developing countries are an important part of the labor force at a young age; therefore, a higher opportunity cost of education is involved in terms of forgone contributions to family income. COPYRIGHT © 2008 by Thomson South-Western.

Overview 1. Aggregate demand (AD) refers to the quantity of real GDP demanded at different

price levels. 2. Consumption is by far the largest component of AD.

3. Government purchases tend to be a less volatile category of aggregate demand than investment. 4. Models that include international trade effects are called open economy models. 5. Exports minus imports equals net exports.

6. The AD curve slopes downward, which means an inverse relationship between

the price level and real gross domestic product (RGDP) demanded. 7. Three complementary explanations exist for the negative slope of the aggregate demand curve: the real wealth effect, the interest rate effect, and the open economy effect. 8. As the price level decreases, the real value of people's cash balances rises so that their planned purchases of goods and services increase. 9. The real wealth effect can be summarized as follows: A higher price level reduced real wealth reduced purchasing power reduced RGDP demanded. 10. At higher interest rates, the opportunity cost of borrowing rises; and fewer interest-sensitive investments will be profitable, which will result in a lower quantity of RGDP demanded. 11. The interest rate effect process can be summarized as follows: A higher price level increases the demand for loanable funds increases the interest rate reduces investments reduces RGDP demanded. 12. If the prices of goods and services in the domestic market rise relative to those in global markets as a result of a higher domestic price level, consumers and businesses will buy more from foreign producers and less from domestic producers. 13. If the price level in the United States rises, U.S. exports will become more expensive, imports will become less expensive, and net exports will fall. 14. The real wealth effect, the interest rate effect, and the open economy effect all

contribute to the downward slope of the AD curve. 15. An increase in any component of GDP (C, I, G, or X - M) can cause the AD curve

to shift rightward. 16. If consumers sensed that the economy was headed for a recession or the

government imposed a tax increase, this would result in a leftward shift of the AD curve. 17. Because consuming less is saving more, an increase in savings, ceteris paribus,

would shift AD to the left. 18. A reduction in business taxes would shift AD to the right, while an increase in real

interest rates or business taxes would shift AD to the left. 19. An increase in government purchases, other things being equal, shifts AD to the

right.

20. If major trading partners are experiencing economic slowdowns, then they will

demand fewer imports from the United States, shifting AD to the left. 21. The aggregate supply curve is the relationship between the total quantity of final goods and services that suppliers are willing and able to produce and the overall price level. 22. The two aggregate supply curves are a short-run aggregate supply curve and a(n) long-run aggregate supply curve. 23. The short-run relationship refers to a period when output can change in response to supply and demand, but input prices have not yet been able to adjust. 24. In the short run, the aggregate supply curve is upward sloping. 25. In the short run, at a higher price level, producers are willing to supply more real output, and at lower price levels, they are willing to supply less real output. 26. The two explanations for why producers would be willing to supply more output when the price level increases are the profit effect and the misperception effect. 27. When the price level rises in the short run, output prices rise relative to input prices (costs), raising producers' short-run profit margins. 28. If the price level falls, output prices fall, producers' profits will fall, and producers will reduce their level of output. 29. If the overall price level is rising, producers can be fooled into thinking that the relative price of their output is rising and as a result supply more in the short run. 30. The long run is a period long enough for the price of all inputs to fully adjust to changes in the economy. 31. Along the LRAS curve, two sets of prices are changing: the prices of outputs and

the prices of inputs. 32. The level of RGDP producers are willing to supply in the long run is not affected by changes in the price level. 33. The vertical LRAS curve will always be positioned at the natural rate of output.

34. The long-run equilibrium level is where the economy will settle when undisturbed and all resources are fully employed. 35. Long-run equilibrium will only occur where AS and AD intersect along the long-

run aggregate supply curve. 36. The underlying determinant of shifts in short-run aggregate supply is production costs.

37. Higher production costs will motivate producers to produce less at any given price level, shifting the short-run aggregate supply curve leftward. 38. A permanent increase in the available amount of capital, entrepreneurship, land,

or labor can shift the LRAS and SRAS curves to the right. 39. A decrease in the stock of capital will reduce real output in the short run and

reduce real output in the long run, ceteris paribus. 40. Investments in human capital would cause productivity to rise. 41. A decrease in the amount of natural resources available would result in a leftward

shift of both SRAS and LRAS. 42. An increase in the number of workers in the labor force, ceteris paribus, tends to

depress wages and increase short-run aggregate supply. 43. Lower output per worker causes production costs to rise and potential real output

to fall, resulting in a leftward shift in both SRAS and LRAS. 44. A reduction in government regulations on businesses would lower the costs of

production and expand potential real output, causing both SRAS and LRAS to shift to the right. 45. The most important of the factors that shift SRAS but do not impact LRAS are a

change in input prices and natural disasters. 46. If the price of steel rises, it will shift SRAS left, while the LRAS will not shift as

long as the capacity to make steel has not been reduced. 47. A fall in input prices, which shifts SRAS right, shifts LRAS right only if potential

output has risen, and this situation only occurs if the supply of those inputs is increased. 48. Adverse supply shocks, such as natural disasters, can increase the costs of production. 49. Only a short-run equilibrium that is at potential output is also a long-run equilibrium. 50. The short-run equilibrium level of real output and the price level are determined by the intersection of the aggregate demand curve and the short-run aggregate supply curve. 51. The long-run equilibrium level of RGDP changes only when the LRAS curve

shifts. 52. Economists call unexpected shifts in supply or demand shocks.

53. When short-run equilibrium occurs at less than the potential output of the economy, it results in a recessionary gap. 54. Demand-pull inflation occurs when the price level rises as a result of an increase in aggregate demand. 55. Demand-pull inflation causes an increase in the price level and an increase in

real output in the short run, illustrated by a movement up along the SRAS curve. 56. Demand-pull inflation causes an inflationary gap. 57. When AD increases, real (adjusted for inflation) wages fall in the short run. 58. In response to an inflationary gap in the short run, real wages and other real

input prices will tend to rise, which is illustrated by a leftward shift in the SRAS curve. 59. Stagflation is the situation in which lower economic growth and higher prices occur together. 60. An increase in input prices can cause the SRAS curve to shift to the left, resulting

in higher price levels, lower real output, and higher rates of unemployment in the short run. 61. With the economy initially at full-employment equilibrium, a sudden increase in oil prices would result in higher unemployment and in real output less than potential output in the short run. 62. Falling oil prices would result in a rightward shift in the SRAS curve. 63. Holding AD constant, falling oil prices would lead to lower prices, greater output,

and lower rates of unemployment in the short run. 64. An economy can self-correct from a recessionary gap through declining wages and prices. 65. The long-run result of a fall in aggregate demand is an equilibrium at potential output and a lower price level. 66. Wages and prices may be sticky downward because of long-term labor contracts, a legal minimum wage, employers paying efficiency wages, and menu costs. 67. If the economy is currently in an inflationary gap, with output greater than potential output, the price level is higher than workers anticipated. 68. The interdependence of the AD and AS curves makes the AD/AS analysis less

than completely satisfactory.

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Overview 1. Keynes believed that total spending was the critical determinant of the overall level of economic activity. 2. In the simple Keynesian model, we assume that the price level is constant as output changes. 3. Consumption spending is the largest component of the demand for final goods and services. 4. The autonomous factors affecting consumption are those that do not depend on income. 5. A decrease in real wealth would decrease autonomous consumption. 6. A higher interest rate today tends to make items purchased on credit more expensive and reduces expenditures on those items. 7. Either lower interest rates or lower household debt would tend to increase autonomous consumption. 8. An increase in consumer confidence would tend to increase consumption spending. 9. Personal consumption spending depends most importantly on your current disposable income. 10. Your marginal propensity to consume is equal to the change in consumption spending divided by the change in disposable income. 11. The more you spend out of any given increase in income, the greater your marginal propensity to consume. 12. Your marginal propensity to save is equal to the change in savings divided by the change in disposable income. 13. The MPC and MPS must add up to 1. 14. The MPC is equal to the slope of the consumption function. 15. Consumption spending is partly autonomous, or independent of income, and partly induced, or dependent on income.

16. Income and output are always the same in the economy. 17. Aggregate expenditures equal output when the economy is in equilibrium. 18. In the Keynesian model, if output were lower than its equilibrium level, inventories would fall below desired levels and producers would increase output. 19. When inventories rise above desired levels, output will fall. 20. When aggregate expenditures exceed output, output will rise. 21. In addition to consumption, the major components of aggregate expenditures are investment, government purchases, and net exports. 22. Only in equilibrium do aggregate expenditures equal output. 23. One reason that investment contributes to the business cycle is that planned investment responds dramatically to perceptions about future changes in business activity. 24. When unplanned inventory investment is positive, output will tend to fall. 25. In equilibrium, unplanned business investment equals zero. 26. An increase in autonomous government purchases by $2 billion will increase output by more than $2 billion in the simple Keynesian model. 27. The expenditure multiplier is equal to 1 divided by (1 - MPC), when consumption is the only component of aggregate expenditures. 28. When autonomous investment increases, the level of consumption will increase as a result. 29. The smaller is MPC, the smaller is the expenditure multiplier. 30. As well as autonomous consumption, changes in investment, government purchases, and net exports can also change autonomous expenditures. 31. When an economy grows rapidly, its imports rise, so that its net exports fall. 32. When components of aggregate expenditures other than consumption change with income, the multiplier equals 1/(1 - MPAE), which is the marginal propensity of aggregate expenditures. 33. MPAE increases when the marginal propensity to consume or the marginal propensity to invest out of income increases, or the marginal propensity to import decreases. 34. Lump-sum taxes are taxes that do not depend on income.

35. Equilibrium output will tend to move in the same direction as a change in government purchases and in the opposite direction as a change in lump-sum taxes. 36. The multiplier for changes in lump-sum taxes is less than that for changes in government purchases. 37. The balanced-budget multiplier is always equal to 1. 38. According to the paradox of thrift, an autonomous increase in saving could reduce an economy's equilibrium output. 39. In the Keynesian model, an increase in autonomous saving yields no benefit to the economy, but reduces real output. 40. The government can raise aggregate expenditures by increasing its spending, but for real output to increase, something must cause an increase in aggregate supply. 41. To go from the Keynesian-cross to aggregate demand, we need to add how the price level affects each of the aggregate expenditure components. 42. Consumption, investment, and net exports all increase as a result of a fall in the price level. 43. In terms of the Keynesian expenditure model, a fall in the price level shifts the aggregate expenditures curve up. 44. Changes in any of the components of aggregate expenditures for any reason other than a change in the price level or income will also shift the aggregate demand curve. 45. When the aggregate expenditure curve shifts up for reasons other than changes in the price level, the aggregate demand curve shifts right. 46. The aggregate supply curve must be vertical in the long run. 47. If the short-run aggregate supply curve slopes upward, an increase in aggregate demand will increase real output less than aggregate expenditures in the short run. 48. If wages and prices are sticky and the economy has sufficient excess capacity, the short-run aggregate supply curve would be flat over that range of output. 49. Price and wage inflexibility, when aggregate demand fell, played a significant part in Keynesian theory. 50. The Keynesian model could not explain the stagflation of the 1970s.

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