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Terms Definitions
real gross domestic product (GDP)
the market value of final goods and services produced in an economy, stated in the prices of a given year
business cycle
the upward or downward movement of economic activity, or real GDP, that occurs around the growth trend
Keynesians
in favor of activist government policies because they believe input prices are sticky and when the economy is in a recession government intervention is necessary to shift the AD curve back up
Classicals
favor laissez-faire or nonactivist government policies - prices flexible in both directions
recession
a decliine in real output that persists for more than two consecutive quarters of a year
downturn
the phenomenon of economic activity starting to fall from a peak
boom
very high peak, representing a big jump in output
peak
the top of a business cycle
trough
the bottom of a business cycle
depression
a large recession (>12% unemployment for one year)
expansion
an upturn that lasts at least two consecutive quarters of a year
unemployment rate
the percentage of people in the economy who are willing and able to work but who are not working
cyclical unemployment
unemployment resulting from fluctuations in economic activity (affected by retractions/recessions)
structural unemployment
natural unemployment caused by the institutional structure of an economy or by economic restructuring making some skills obsolete - "creative destruction"
frictional unemployment
natural unemployment caused by people entering the job market and people quitting a job just long enough to look for and find another one - increases because of regulations (France) decreases because of information (monster.com)
natural rate of unemployment (u* or target rate of unemployment)
the lowest sustainable rate of unemployment that policy makers believe is achievable given existing demographics and the economy's institutional structure - no cyclical unemployment exists, only structural and frictional
labor force
those people in an economy who are willing and able to work
labor force participation rate
measures the labor force as a percentage of the total population at least 16 years old
employment-population ratio
the number of people who are working as a percentage of people available to work
potential output
the output that would materialize at the target rate of unemployment and the target rate of capacity utilization
okun's rule of thumb
a 1 percentage point change in the unemployment rate will be associated with a 2 percent change in output in the opposite direction
inflation
a CONTINUAL rise in the price level
deflation
a CONTINUAL fall in the price level
price index
a number that summarizes what happens to a weighted composite of prices of a selection of goods (often called a market basket of goods) over time
GDP deflator
an index of the price level of aggregate output, or the average price of the components in total output (or GDP) relative to a base year
consumer price index (CPI)
measures the prices of a fixed basket of consumer goods, weighted according to each component's share of an average consumer's expenditures
personal consumption expenditure (PCE) deflator
measure of prices of goods that consumers buy that allows yearly changes in the basket of goods that reflect actual consumer purchasing habits
producer price index (PPI)
index of prices that measures average change in the selling prices RECEIVED by domestic producers of goods and services over time
real output
the total amount of goods and services produced, adjusted for price-level changes
nominal output
total amount of goods and services produced measured at current prices
formula to translate nominal output to real output
nominal output/price index x 100
hyperinflation
when inflation hits triple digits - 100% or more per year
gross domestic product (GDP)
the total market value of all final goods and services produced in an economy in a one-year period
the four expenditure categories
1) consumption2) investment3) government spending4) net exports
consumption
spending by households on goods and services (food, shampoo, televisions, furniture, services of doctors and lawyers, etc.)
investment
spending for the purpose of additional production (business spending on factories and equipment for production, the change in business inventories, purchases of factories, tractors, computers, etc...NOT STOCKS AND BONDS, THEY ARE CONSIDERED SAVING)
government spending
goods and services that government buys (TRANSFER PAYMENTS NOT INCLUDED)
transfer payments
payments to individuals that do not involve production by those individuals (Social Security, unemployment insurance, etc.)
net exports
spending on goods and services produced in the US that foreigners buy (exports) minus goods and services produced abroad that US citizens buy (imports)
wealth accounts
a balance sheet of an economy's stock of assets and liabilities
final output
goods and services purchased for their final use
intermediate products
products used as input in the production of some other product
value added
the increase in value that a firm contributes to a product or service
depreciation
the decrease in an asset's value
net domestic product (NDP)
GDP minus depreciation - accounts for production used to replace worn-out plant and equipment that is not available for purchase for consumption, investment, or government spending
net investment
gross investment minus depreciation
gross national product (GNP)
the aggregate final output of citizens and businesses of an economy in a one-year period
net foreign factor income
the income from foreign domestic factor sources minus foreign factor income earned domestically - we must add the foreign income of our citizens and subtract the income of residents who are not citizens to calculate GNP
4 sources of aggregate income
1) compensation of employees2) rents (income from property received from households, not firms)3) interest4) profits
first "rotunda point"
voluntary trade helps both sides
factors that influence demand
1) price (inverse - causes a change in quantity demanded)2) substitues price (direct)3) complements (inverse)4) consumer income (normal vs. inferior goods)5) sales taxes (inverse)6) consumer preferences (depends)
factors that influence supply
1) price (direct - change in quantity supplied)2) resource prices (inverse)3) technology (direct)4) regulations (inverse)5) weather (natural disasters)
3 effects of high GDP
1) higher literacy rates2) lower infant mortality3) more women's rights
3 economic conditions measured by GDP
1) living standards2) economic growth3) business cycles
GDP growth rate of the last 50 years
3.3%
GDP growth rate of the last 10 years
2.9%
long run unembloyment average (last 50 years)
5.9%
unemployment rate from December 2008
7.2%
full employment output (Y*)
the output level when unemployment is equal to the natural rate (u=u*)
current seasonally adjusted unemployment rate for 2009
7.6%
second "rotunda point"
inflation is a monetary phenomenon
signal extraction problem
caused by inflation, leads firms to be unsure whether an increase in price is due to an increase in demand or an increase in inflation and whether or not they should expand their output in response
money illusion
when people irrationally interpret nominal changes as real changes
future price level uncertainty
the value of future dollars is affected by inflation, making wage contracts and loan agreements difficult and riskier in the long-term (you don't know how the interest rate will hold up in response to normal inflation in the future)
basis of the loanable funds market
every dollar borrowed requires a dollar saved
3 effects on supply of loanable funds (savings)
1) interest rate - higher prices/rates mean a higher quantity supplied2) time preference - goods and services are more valuable the sooner they are delivered3) consumption smoothing - people like smooth consumption patterns (we save in the middle of our life when income is high and use our savings when income fails at retirement or in emergencies)
3 effects on the demand for loanable funds (investment)
1) price2) capital productivity - if capital tools are more productive, firms are willing to pay more for loanable funds3) consumption smoothing
examples of direct finance
stocks and bonds
examples of indirect finance
banks
3 key pieces of information on a bond
1) borrower2) date of maturity3) value at maturity (face value)
default risks
the risk that the borrower or seller of a bond will default and not be able to pay back the bond (rated by Moody's, S&P, and Fitch into AAA, BBB, BB....D)
jumk bonds
bonds with a very high default risk (and therefore higher interest rate) ex: Ford
relationship between bond price and interest rate
move oppositely (one indicates the other and vice versa)
securitization
bundling financial assets together to form a new combined security (provides diversification and marketability)
subprime mortgage
a high risk home loan in which teh home buyer (low-income) is more likely to default - FNMA and FHLMC
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