UNIT 2 Notes

UNIT 2:

Type of Economic Systems

• Command, Traditional, Mixed, Free Market

• C - Centrally planned, government decides questions of production. Government owns land and capital and controls labor.
• ex: Cuba
• T - based on rituals, habits, and customs. 
• ex: Tribes
• FM - People and firms act in their best interest. Allows buyers and sellers to exchange goods and services.
• ex: Hong Kong
• Mixed -Government regulating businesses to product the public's best interest
• ex: US, Canada, Mexico

Three economic questions

1) What goods and services should be produced?

2) How will these goods and services will be produced?

3) Who will consumer these goods and services?

Market - institution or mechanisms allowing buyers and sellers to make trades

Product v. Factor Market.

P- Buyer is usually a consumer, seller is a firm

F- Factors of production. Most important factor is labor. The buyer is usually the firm, the seller is the factor owner. 

Firm / Business - demanding resources -> Factor market  "think cell" 

Customer buying products -> Product market

Household - Person or a group of people that share their income

Firms - organization the produces goods or services for sales

GDP - Total value of all final goods and services produced withing the country's border within a given year. Includes all production or income earned within the U.S by U.S and foreign producers. Excludes production outside of the U.S even by Americans.

GNP - Total value of all final goods and services produced by Americans in a year. Includes all production or income earned by Americans anywhere in the world. Excludes productions by non-Americans even in the U.S  

GDP = C + Ig + G + Xn

• C - Personal consumption  - 67%
• purchases of final goods and services
• IG - Gross domestic private investment
• factory equipment maintenance
• new factory equipment
• construction of housing
• unsold inventory of products built in a year
• G - Government spending
• government purchases of goods and services
• Xn - Net Exports
• Exports - Imports

GDP

INCLUDED:

1) Final goods and services

2) Income earned (W.R.I.P)

3) Interest payments on corporate bonds

4) Current production of goods and services

5) Unsold output ( business inventory)

6) Factory equipment maintenance

7) New factory equipment

8) Construction of housing

9) Unsold inventory of products built in a year

EXCLUDED:

1) Used / Secondhand goods

2) Gifts/Transfers

3) Stocks

4) Unreported business activities

5) Illegal activities

6) Financial transactions between bonds and businesses

7) Intermediate goods

8) Non-market activities (volunteering, babysitting)

CLIFF NOTES:

1. Consumption expenditures: Personal consumption expenditures on goods and services comprise the largest share of total expenditure. Consumption good expenditures include purchases of nondurable goods, such as food and clothing, and purchases of durable goods, such as appliances and automobiles. Consumption service expenditures include purchases of all kinds of personal services, including those provided by barbers, doctors, lawyers, and mechanics.
   Investment expenditures: Investment expenditures can be divided into two categories: expenditures on fixed investment goods and inventory investment. Fixed investment goods are those that are useful over a long period of time. Expenditures on fixed investment goods include purchases of new equipment, factories, and other nonresidential housing as well as purchases of new residential housing. Also included in fixed investment expenditures is the cost of replacing existing investment goods that have become worn out or obsolete. The market value of all investment goods that must be replaced in a single year is referred to as the depreciation for that year. Inventory goods are final goods waiting to be sold that firms have on hand at the end of the year. The year-to-year change in the market value of firms' inventory goods is considered an investment expenditure because these inventory goods will eventually yield a flow of consumption or production services.
   Government expenditures: Government expenditures on consumption and investment goods and services are treated as a separate category in the expenditure approach to GDP. Examples of government expenditures include the hiring of civil servants and military personnel and the construction of roads and public buildings. Social security, welfare, and other transfer payments are not included in government expenditures. Recipients of transfer payments do not provide any current goods or services in exchanges for these payments. Hence, government expenditures on transfer payments do not involve the purchase of any new goods or services and are therefore excluded from the calculation of government expenditures.
   Net exports: Exports are goods and services produced domestically but sold to foreigners, while imports are goods and services produced by foreigners but sold domestically. In the expenditure approach to GDP, expenditures on exports are added to total expenditures, while expenditures on imports are subtracted from total expenditures. Alternatively, one can calculate net exports, which is defined as expenditures on exports minus expenditures on imports, and add the value of net exports to the nation's total expenditures. 

Expenditure approach:

• Income generated from production of goods and services
• C+Ig+G+Xn

Income Approach:

• Income Generated from the production of final goods and services
• W+R+iT+P + statistical adjustments

Net National Product ( NNP)

• GNP - Depreciation

Net Domestic Product ( NDP )

• GDP - Depreciation
• consumption of fixed capital

National Income (NI)

1. NNP - Indirect business taxes
2. CE + RI + II + CP +PI
3. GDP - IBT - Depreciation - net foreign factor payment

CE- compensation of employees

RI - Rental income

II - Interest income

CP - Corporate Profits

PI  - Proprietor's Income

Disposable Personal Income 

NI - HT + GTP

HT - Household Taxes

GTP - Government transfer payments

Nomial GDP - Measures GDP in current prices regardless of the output 

• P*Q

Real GDP - Measures GDP in constant dollars, it is adjusted for inflation, therefore it reverts to base year prices

• P*Q

GDP Deflator

• Measure of level of prices of all new domestically produced final goods and services in an economics
• NGDP / RGDP x 100
• (Prices index in year 2 - Price index in year 1) / (Price year 1)

CPI ( Consumer Price Index)

• Widely used measure of the over all price level in U.S.
• Price of market basket / Price of the market basket in _____ x100

1) Inflation - rise in the general price level

2) Deflation - decline in the general price level

3) Disinflation - it occurs when the inflation rate declines

4) Solving inflation problems

Rule of 70

• How many years will it take to double inflation

Okun's law 

• describes how unemployment relates to a nation’s GDP. For every 1% unemployment above the NRU, a negative GDP gap of 2% will occur.

5) Finding real interest rates

• Real interest rate = Nominal interest rates - Inflation
• Real Wages
• Cost of borrowing or lending money that is adjusted for inflation
• %

Nominal interest rate - unadjusted cost of borrowing or lending money

6) Causes of inflation

• Demand - Pull
• Caused by an excess of demand over output that pulls prices upward
• Sources of Demand Pull
• Increase in government purchases
• Excessive increases in the money supply which creates a situation or hyper inflation
• Hyperinflation - rapid rise or extremely high inflation rate 
• Rise in income as the economy approaches full employment output
• as workers earn more, they increase their demand for goods
• Cost - Push (supply side economics)
• caused by a rise in per unit production cost due to increasing resource cost
• 2 sources
• Supply shocks - dramatic rise in energy or raw material prices due to input shortages or growing demand for inputs
• price wage spiral - worker seeks higher wages to offset rising consumer prices

7) Effects of inflation

• Anticipated vs Unanticipated
• Unanticipated - don't know why or when but it happens
• stronger effect because those expecting inflation may be able to adjust their work or spending activities to avoid or lessen the affects
• Wages and pensions may have cost of living adjustments (COLAS) built in to offset anticipated inflation.
• Anticipated - increases the nominal cost of borrowing while unexpected inflation reduces the real cost of borrowing. 

HURT

1. Fixed Income Group

2. Savers

3. Lenders

Helped

1. Borrowers

Unemployment

• failure to use available resources (labor)

Employed

• includes those that are self employed

Unemployed

• New entrants
• Laid off
• Quit last job
• Reentrants
• Lost last job

Not in the labor force

• Armed forces
• Homemakers
• Students
• Retirees
• Disabled people
• Dislocated worker
• Prisoners
• Mental institution

Unemployment rate: # of unemployed/ Labor force x 100

Four types of unemployment

• Frictional
• temporary, transitional, short term, graduates, fired/quit, in between jobs, searching for a job, signals new jobs are available
• includes people who are temporarily between jobs. They may have quit one job to find another, or they could be they could be trying to find the best opportunity after graduating from high school or college.
• Cyclical
• Caused by recession phase of business cycle
• deficient demand for goods and services
• Includes people who are not working because firms do not need their labor due to lack of demand or a downturn in the business cycle. For Example, if people are not buying many goods and services, workers are laid off.
• Structural
• Technological or long term
• automation due to consumer taste, jobs become obsolete
• creative destruction, new jobs created, others lost
• Involves mismatches between job seekers and job openings. Unemployed people who lack skills or do not have sufficient education are structurally unemployed.
• Seasonal
• Seasonal Unemployment
• Weather related, construction jobs, Santa Clause, eastern bunny, life guard, bus drivers

Economic Norms:

GDP growth (real) : 2 to 3% per year is considered manageable growth. 

Unemployment - 3 to 5%

Inflation Rate - 2 to 3%