GDP Gap: The amount by which actual GDP 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.
- (Actual unemployment rate - NRU) x 2
- Ex: In 2012, the unemployment rate for Mexico was 7.4%. The NRU for Mexico is 6%.
- (7.4 - 6) x 2 = 2.8 (GDP gap)
Rule of 70: Used to determine how many years it takes for a value to double given a particular annual growth rate.
- 70 / yearly interest rate
- Ex: If you put $20,000 in the bank and it earns a yearly interest rate of 7%, how many years will it take for your income to double?
- Product Market: Firms sell products, and households buy products here.
- Factor (Resource) Market: Firms buy products, and housesolds sell products here.
- Households: Sell resources and buy products.
- Firms: Buy resources and sell products.
- Factors of Production: Land, labor, capital, and entrepreneurship.
- Budget: Government purchases of goods/services + government transfer payments - government tax and fee collection.
- + = Deficit and - = surplus
- Trade: Exports-Imports
- + = surplus and - = deficit
- National Income:
- Compensation of employees + Rents + Interest + Corporate profits + Proprietor's income
- GDP - Indirect business taxes - depreciation - net foreign factor payment
- Disposable Personal Income: National income - personal household taxes + government transfer payments
- Net Domestic Product(NDP): GDP - depreciation
- Net National Product(NNP): GNP - depreciation
- GNP: GDP + net foreign factor payment
- Nominal and Real GDP
- Nominal GDP: The value of output produced in current year prices.
- Price x Quantity
- Can increase from year to ear if either price or quantity increase.
- If we wanted to measure an increase in prices (inflation), use nominal GDP.
- Real GDP: The value of output produced in constant base year prices.
- Price x Quantity
- Adjusted for inflation
- Used to measure economic growth
- Can increase from year to year only if output increases.
- GDP Deflator: Price index used to adjust from nominal to real GDP.
- (Nominal GDP / Real GDP) x 100
- In the base year, the GDP deflator always equals 100.
- For years after the base year, GDP deflator > 100.
- For ears before the base year, GDP deflator < 100.
- Consumer Price Index(CPI): Most commonly used measurement of inflation.
- Measures the cost of a market basket of goods of a typical urban American family.
- (Cost of a market basket of goods in a given year / Cost of a market basket of goods in the base year) x 100
- Inflation Rate: ((Price index in year 2 - price index in year 1) / price index in year 1) x 100
- Nominal Interest Rate: % increase in money where the borrower must pay the lender for a loan.
- NOT adjusted for inflation
- Expected interest rate + inflation premium
- Unanticipated inflation
- Real Interest Rate: % increase in purchasing power where the borrower must pay the lender for a loan.
- Adjusted for inflation
- Nominal Interest Rate - inflation
- Anticipated inflation
- Who is hurt and helped by inflation?
- Hurt by inflation:
- Savers
- Lenders/creditors
- People on a fixed income (elderly, welfare)
- Helped by inflation:
- Debtors
- Cost of Living Adjustments (COLA): Automatic wage increase when inflation occurs.
- Ex: New York and California
- Unemployment: The failure to use available resources particularly labor to produce desired goods and services.
- Labor Force: Those that are above 16 years of age and are able and willing to work.
- Labor Force = employed + unemployed
- Not included in the labor force:
- Military
- Students
- Retired
- Disabled
- Homeworkers
- Mental Institutions
- Jail/Prison
- Those who are not looking for a job
- Unemployment Rate: 4-5 % = full employment or Natural Rate of Unemployment (NRU)
- Unemployment Rate = (# of unemployed / (# of employed + # of unemployed)) x 100
- Types of Unemployment:
- Frictional: Those who are searching for a job.
- Temporarily unemployed or in between jobs.
- Have transferable skills.
- Ex: high school graduate, college, laid off or left your job.
- Structural: Changes in the structure of the labor force that makes some skills obsolete.
- Do not have transferable skills.
- Have to learn new skills to get a job.
- Seasonal: Due to the time of the year and nature of the job.
- Ex: school bus-drivers, lifeguards, Santa Claus/ Easter Bunny impersonators, and construction workers.
- Cyclical: Results from economic downturns such as recessions/depressions.
- As demand for goods/services fall, demand for labor falls off and workers get laid off.
- Frictional + Structural = NRU
- Full employment means there is no cyclical unemployment.
- GDP: Market value of all final goods and services produced within a nation in a given year.
- What's not included in GDP
- Intermediate goods-something that needs further processing.
- Used/second-hand goods
- Purely financial transactions (stocks/bonds)
- Illegal activities (Ola-drugs)
- Unreported business activity (Ex. Tips)
- Non-market transactions (volunteering, babysitting)
- Transfer payments (scholarships, welfare payments, social security)
- What's included in GDP
- C-Personal Consumption Expenditures (65%)
- Ig-Gross Private Domestic Investment (17%)
- Factory equipment maintenance
- New factory equipment
- Construction of housing
- Unsold inventory of products built in a year.
- G-Government Spending (20%)
- Net exports (Xn)- Exports-imports (-2%)
- GNP- Gross National Product of all final goods and services by citizens of that country on its land or foreign land.
- Two Ways to Calculate GDP
- Expenditure Approach: Add up all the spending on final goods and services produced in a given year.
- GDP= C + Ig + G + Xn (Exports-imports)
- Most preferred method
- Income Approach: Adds up all the income that resulted from selling all final goods and services produced in a given year.
- GDP= Wages + Rent + Interest + Profit + Statistical adjustments (indirect business taxes, depreciation, and net foreign factor payment)
- Compensation of Employees: Wages, salaries, pensions, insurances, health, and welfare.
- Rent: Income received by property owners.
- Received from tenant to landlord.
- Interest: Money paid by private businesses to the suppliers of loans.
- Corporate Projects: The income of the corporation's stockholders.
- Dividends, corporate income taxes
- Proprietor's Income: Income that comes from entrepreneurs and partners.
