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ECN 302 Exam 1
Terms and ideas
100
Economics
Undergraduate 2
10/04/2009

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Term
GDP
Definition
measures total income of everyone in the economy (adjusted for price level change)
Term
inflation rate
Definition
measures how fast prices are rising
Term
unemployment rate
Definition
fraction of labor force that is out of work
Term
endogenous variables
Definition
those variables that a model tries to explain (output of model)
Term
exogenous variables
Definition
those variables that the model takes as a given (input of model)
Term
Purpose of model
Definition
to show how the exogenous variables affect the endogenous variables
Term
Market clearing
Definition
the assumption that supplied and quantity demanded will fall into balance, or equilibrium, through price adjustments to where the curves intersect
Term
The reason market clearing is viewed as naive...
Definition
The issue of sticky versus flexible wages and prices.  Market clearing voids this issue, which can play a major role in certain markets.  Continuous market clearing is not realistic for some markets, as some prices/wages are only adjusted periodically (ie magazine prices), and are consequently "sticky", while market clearing assumes flexible wages/prices. 
Term
Central principle of microeconomics
Definition
all households/firms operate to maximize/optimize utility
Term
GDP is computed every three months by:
Definition
The Bureau of Economic Analysis
Term
The two ways to view GDP are:
Definition

1. As the total income of everyone in the economy

2. As the total expenditure on the economy's total output of goods and services

 

Term
GDP
Definition
the market value of all goods and services produced within an economy in a given period of time
Term
Imputed value
Definition
an estimation of the value of goods and services that do not have a market value (ie housing owned, not rented, or government services)
Term
GDP is an imperfect measure of economic activity because (2):
Definition

1. imputations are approximate

2. there are many values of goods and services that are left out altogether

Term
Nominal GDP
Definition

the value of goods and services measured at current prices

**Can increase either because prices rise or quantities rise

Term
Real GDP
Definition
a tally of the economy's output without being influenced by changes in prices; the value of goods and services measured using a constant set of prices (aka base year prices)
Term
GDP deflator =
Definition
nominal GDP/real GDP
Term
The GDP deflator...
Definition
reflects what is happening to the overall level of prices in the economy
Term
The four components of expenditure are:
Definition

1. Consumption

2. Investment

3. Gov't purchases

4. Net exports (IM-EX)

Term
Consumption
Definition

Goods and services bought by households; includes:

-nondurable goods (food & clothing)

-durable goods (cars & TVs)

-services (restaurants)

Term
Investment
Definition

Goods bought for future use; includes:

-business fixed investment (purchase of new plant/equipment by firms)

-residential fixed investment (purchase of new housing by households and landlords)

-inventory investment (increase in inventory for firms and businesses)

Term
Net exports
Definition
exports minus imports
Term
Letting Y stand for GDP, Y = ?
Definition

C + I + G + NX

(this is aka the national income accounts identity)

Term
GNP (Gross national product) =
Definition
GDP + factor payments from abroad - factor payments to abroad
Term
NNP (net national product) =
Definition

GNP - depreciation of capital

*In the national income accounts, depreciation is called consumption of fixed capital

Term
Disposable personal income =
Definition
personal income - personal tax and nontax obligations (ie parking ticket)
Term
We are interested in disposable personal income because...
Definition
it tells us how much households and noncorporate businesses have to spend after satisfying their tax obligations to the government
Term
Consumer Price Index (CPI)
Definition
the price of the basket of goods purchased by a typical consumer relative to the price of the same basket in a base year
Term
Producer Price Index (PPI)
Definition
the basket of goods typically consumed by firms rather than consumers
Term
Core inflation
Definition
measures the change in price of consumer basket excluding those goods that fall under food and energy (because food and energy products exhibit substantial short-run volatility)
Term
GDP deflator measures the prices of all goods and services produced, whereas CPI measures...
Definition
the prices of only the goods and services bought by consumers
Term
An increase in price of the goods and services bought only by firms or the government will show up in ______, but not in _______.
Definition
Firm and government product inflation will show up in GDP deflator, but not the CPI
Term
GDP deflator includes only those goods produced...
Definition
domestically.
Term
An increase in price of a foreign good....
Definition
could affect CPI, but not the GDP deflator
Term
The _______ assigns fixed weights to the prices of different goods, whereas the _______ assigns changing weights.
Definition
The CPI assigns fixed weights, while the GDP deflator assigns changing weights.
Term
Laspeyres index
Definition
A price index with a fixed basket of goods
Term
Paasche index
Definition
A price index with a changing basket of goods
Term
A Laspeyres index ignores consumers' ability to __________, so it tends to overstate inflation.
Definition
substitute more expensive goods for less expensive alternatives
Term
Unemployment rate =
Definition
# unemployed/# in labor force
Term
Labor-force participation rate =
Definition
# in labor force/# in adult population
Term

What determines the total production of goods and services (2)?

 

Definition

1. Quantity of inputs (called factors of production)

2. Ability to turn input into output

Term
Factors of Production
Definition

the inputs used to produce goods and services

The two most important:

1. Capital (K)

2. Labor (L)

Term

The Production Function:

 

Definition
Y = F(K,L)
Term
Marginal product of labor (MPL)
Definition

the extra amount of output gained from one extra unit of labor

MPL = F(K, L + 1) - F(K, L)

Term
Diminishing Marginal Product
Definition
holding the amount of capital fixed, the product of labor decreases as the amount of labor input increases
Term
Marginal Product of Capital (MPK)
Definition

the amount of extra output the firm gets from an extra unit of capital, holding the amount of labor constant

 

MPK = F(K+1, L) - F(K, L)

Term
Real rental price of capital
Definition
The cost of capital measured in units of goods, rather than in dollars
Term
Marginal Propensity to Consume (MPC)
Definition
the amount by which consumption changes when disposable income increases by $1
Term
Interest rate
Definition
measures the cost of funds used to finance investment
Term
Nominal interest rate
Definition
the interest rate as usually reported; it is the rate of interest that investors pay to borrow money
Term
Real interest rate
Definition
the nominal interest rate adjusted for inflation; nominal interest rate - inflation rate
Term
These are not made in exchange for the economy's output of goods and services, so they are NOT calculated in the variable "G" (government spending).
Definition
Transfer payments (social security or welfare)
Term
Transfer payments are the opposite of....
Definition
taxes.
Term
National saving (S)
Definition
S = Y - C - G; the output that remains after the demands of consumers and the gov't have been satisfied
Term
Private saving =
Definition
Y - T - C (disposable income minus consumption)
Term
Public saving =
Definition

T - G (T = taxes - transfer payments)

*(government revenue - government spending)

Term
National saving is the sum of...
Definition

Private and public saving

 

SO,

 

S = (Y-T-C) + (T-G)

Term
Government purchases are said to _________ _________ investment.
Definition
"crowd out"
Term
Reasons investment demand changes (2):
Definition

1. An increase could occur through technological innovation

2. Government encouragement/discouragement through tax laws

Term
Net exports =
Definition
output - domestic spending
Term
In terms of investment and national saving, S =
Definition
Investment + Net Exports
Term
Another name for net exports is:
Definition
trade balance
Term
With the equation S - I = NX, the left side of the equation is also referred to as:
Definition
Net capital outflow, or net foreign investment
Term
Net capital outflow (S - I) =
Definition
trade balance (NX)
Term
Balanced trade:
Definition
when S - I = NX
Term
Starting from balanced trade, a fiscal policy that reduces national saving (increase in G or decrease in T to stimulate consumption) leads to a:
Definition
trade deficit
Term
If S - I and NX are positive, we have a:
Definition
trade surplus
Term
Net capital outflow is the difference between...
Definition
domestic saving and domestic investment
Term
Policies that increase investment or decrease saving tend to...
Definition
cause a trade deficit
Term
Policies that decrease investment or increase saving tend to cause a...
Definition
trade surplus
Term
A trade deficit could be a reflection of:
Definition
low saving
Term
Nominal exchange rate
Definition
the relative price of the currencies of two countries
Term
Appreciation is:
Definition
the strengthening of a currency
Term
Depreciation is:
Definition
the weakening of a currency
Term
Real exchange rate:
Definition
the relative price of the goods of two countries; also known as "terms of trade"
Term
Real exchange rate =
Definition

(nominal exchange rate)(price of domestic good)

/

(price of foreign good)

Term
If the real exchange rate is high, foreign goods are:
Definition
relatively cheap
Term
If the real exchange rate is low, foreign goods are:
Definition
relatively expensive
Term
If the real exchange rate is low, the quantity of our net exports demanded will be...
Definition
high.
Term
If the real exchange rate is high, the quantity of our net exports demanded will be...
Definition
low.
Term
Net exports are a function of...
Definition
the real exchange rate.
Term
When the real exchange rate is lower, ___________ are less expensive relative to ____________, and _____________ are greater.
Definition
domestic goods are less expensive relative to foreign goods, and net exports are greater.
Term
The trade balance must equal the....
Definition
net capital outflow.
Term
Saving is fixed by (2):
Definition
the consumption function and fiscal policy.
Term
Investment is fixed by (2):
Definition
the investment function and the world interest rate.
Term
What happens if the US gov't reduces national saving by increasing spending or cutting taxes?
Definition
The reduction in S lowers S - I, and thus NX, creating a trade deficit.  Change in policy shifts saving to the left, lowering supply of dollars, which causes the equilibrium real exchange rate to rise, making the dollar more valuable.  Domestic goods are, therefore, more expensive relative to foreign goods.
Term
What happens to the real exchange rate if foreign governments increase spending or cut taxes?
Definition
This change in fiscal policy reduces world saving and raises the world interest rate.  The raise in the world interest rate reduces investment I, which raises S-I, and thus NX.  The raise in the world interest rate causes a trade surplus.  This change in policy shifts the saving line to the right, raising the supply of dollars to be invested abroad.  The equilibrium real exchange rate falls, so the dollar becomes less valuable, making domestic goods less expensive relative to foreign goods.
Term
Tariff
Definition
a tax on foreign imports
Term
Quota
Definition
restricting the amount of goods and services that can be imported
Term
Protectionist policies diminish:
Definition
gains from trade.
Term
International trade benefits...
Definition
all countries.
Term
Given the real exchange rate, if the domestic price level rises, P, then the nominal exchange rate, e, will...
Definition
fall.
Term
Nominal exchange rate =
Definition
real exchange rate x (foreign price level)/(domestic price level)
Term
One consequence of high inflation is:
Definition
a depreciating currency.
Term
Just as growth in the amount of money raises the price of domestic goods, it also raises the price of:
Definition
foreign curreny in terms of the domestic currency.
Term
% change in nominal exchange rate, e =
Definition
% change in real exchange rate + (change in foreign inflation rate - change in domestic inflation rate)
Term
The law of one price
Definition
a famous hypothesis in economics which states that the same good cannot sell different prices in different locations at the same time
Term
Arbitrageurs
Definition
people who specialize in buying low in one market and selling high in another
Term
Purchasing-power parity
Definition
the law of one price applied to the international marketplace; this states that if international arbitrage is possible, then a dollar (or any other currency) must have the same purchasing power in every country
Term
Purchasing-power parity does not provide a perfectly accurate description of the world because (2):
Definition

1. Many goods are not easily traded

2. Even tradable goods are not always perfect substitutes

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