Ap Macro Notes Unit II part B

MACRO UNIT 2
Tear Down Approach

This approach will allow us to look at how much income people have for spending purposes.

Gross Domestic Product:
should show the well being of the economy. (everything that was produced)
Problem is that it includes depreciation. Is depreciation a real payment? No.
This means we must deduct it from GDP. This will give us a more realistic picture of the production available for consumption and additions to capital stock.

This give you Net Domestic Product:
You must replace the machinery. It shows the annual output that the economy (households, business, governments, and net exports might consume without impairing our capacity to produce next year.

How is this shown in the income approach? Take out consumption of fixed capital.

National Income: all income earned by American owned resources. To get this you must look at
1) Income earned by Americans outside of the United States (this must be added in to NDP)
2) Indirect business taxes. You must subtract these taxes because this goes to the government and the government is not a resource of production. In other words, they get the tax money without adding to production.

National Income (income earned) is what it costs society to obtain its output. (Its GDP)

Looking at the income approach NI is compensation to employees, rent, interest, proprietors income and corporate profits.

Personal Income: (income received) The income actually received by people.
We pay the following so we must subtract them out:
1) social security contributions
2) corporate income taxes
3) Undistributed corporate profits

You must also add back transfer payments (unemployment compensation, welfare, disability...)
This is income received but not currently earned. (Notice that is you have to add this back because it was not originally included in GDP)

Disposable Income (DI): personal income less personal taxes.
Personal Taxes: income taxes, property taxes and inheritance taxes
(Personal Income - Personal Taxes = Disposable Income
You can then use your disposable income to either save or consume.



Macro Unit 2 Lesson 4

Prices are important because that is how we measure GDP.

Price Index: measures the combined price of a particular collection of goods and services, called a market basket, in a given period relative to the combined price of an identical or similar group of goods and services in a reference period (base year).

PI = price of market basket in a given year X 100
price of same basket in the base year

* Notice that in the base year the index will always be 100

Consumer Price Index: Best known indicator. It measures the prices of a fixed market basket of around 300 Goods and services. Measures the prices of goods and services purchased by wage earners.

Producer Price Index: measures the price level of goods and services that firms purchase from other firms.

GDP Deflator: reflects the price of goods and services but not the quantities. In other words, it will show how much prices have changed without worrying about changes in quantity.

GDP deflator = Nominal GDP/Real GDP x 100

Example: if Nominal GDP is $600 and Real GDP is $350 you get
600/350 x 100 = 171 that means prices have increased 71 percent.


When you look at GDP it is important to realize that inflation may have occurred. Does the increase in GDP arise because of an increase in Q or an increase in prices. To find out you want to adjust it for inflation.

The GDP can be adjusted for inflation or recession. In so doing we find the real GDP (adjusted) as opposed to the nominal GDP (unadjusted).

Nominal GDP = real GDP
price index

This gives us the value of total output in various years as if the prices of the products had been constant from the reference or base year throughout all the years being considered.
Inflation:

Inflation: a rising general level of prices. (The opposite would be deflation.)

Inflation makes the money in your pocket worth less. If you are on a fixed salary it also makes your salary worth less because you can buy less and less with each pay check.

The amount of real goods and services that a dollar can buy is called purchasing power. Purchasing power does not vary directly with inflation.

Nominal value of dollar is the actual value. The real value is what it can buy. If I give you a dollar today and you save it until next year its real value will be less than its nominal value.

Anticipated Inflation: inflation rate that we believe will occur
Unanticipated Inflation: inflation rate that comes at a surprise.

Unanticipated Inflation hurts those that lend money (fixed rate loan is getting paid back with inflated money that buys less.

Lenders lend money make money. They must take inflation into account. If unanticipated inflation occurs they are hurt because the interest rate they charged was not large enough.

Nominal rate of interest: rate expressed in today's dollars.
Real rate of interest: nominal rate of interest minus the anticipated rate of inflation.

Inflation causes interest rates to rise.

COLA: Cost of living adjustment: an automatic increase in income when inflation rate increases.

Stock dividends generally rise with inflation.

Inflation is measured through the price indexes. Ex. CPI, PPI

Rate of inflation is determined by subtracting last years price index (2007) from this years price index (2008) and dividing that by last years index (2007). This must all then be multiplied by 100.

Price index (2008) - Price index (2007) x 100 = Rate of Inflation
Price index (2007)

Rule of 70: a method for determining how long it will take the price level to double, given the current price level. To calculate this you divide the % annual rate of increase into 70.

Demand Pull Inflation: "too much money chasing too few goods" The economy demands more than it can produce (production possibilities curve) and this drives the prices up.

Cost-Push or Supply-Side Inflation: If the per unit cost of production increases then producers will be willing to supply less goods and services at various prices. This will drive the price up. This could result from rising wages or rising costs of materials (ex. rising oil prices).

Unit 2 Lesson 5




Peak: business activity has reached a temporary maximum.

recession: period of decline in total output, income, employment, and trade, lasting six months or longer.
depression: severe and prolonged recession

trough: recession or depression is at its lowest level

recovery: output and employment expand toward full employment

Unemployment:
Frictional Unemployment: This takes into account those workers that are between jobs. They are either searching for jobs or waiting to take jobs in the future.

Structural Unemployment: change in the demand for labor over time leads some people to become unemployed because their job is no longer needed. (ex: computers are taking the jobs of some people. ) This also includes shifts in geography. (ex: companies move their headquarters.

Cyclical Unemployment: unemployment caused by the recession phase of the business cycle.

Natural Rate of Unemployment: frictional and structural unemployment.

Full employment is achieved when the number of workers seeking jobs is satisfied by the number of jobs available. (Someone may be unemployed because the jobs that are open are not to their liking.) FULL EMPLOYMENT IS NOT 0. THEIR IS ALWAYS PEOPLE LOOKING FOR JOBS.

To find the unemployment rate you must not even consider those people under 16, those people institutionalized and those people not in the labor force (work in the home, in school, retired, have no desire to work...)

Problems with unemployment rate:
1) Part time workers are considered employed. (even if they are looking for a full time job.)

2) Discourage workers (those not actively seeking employment because they have given up.) are not counted because they are not actively seeking employment.

3) Workers employed in cash jobs will report themselves as unemployed. They may however just be employed in the underground economy.



GDP Gap: amount by which actual GDP falls short of potential GDP because of unemployment.