Study Questions Circular Flow Model Definitions Consumption Expenditures Investment the purchase of final goods by businesses that

at are used in the production of other goods plus the purchase of new homes by individuals. Private Saving Public Saving National Saving public savings plus private savings Net Taxes taxes minus transfer payments; the net flow of cash from household to government Net Exports the value of exports minus the value of imports Lists The three uses of income by households: private savings, tax payments, and consumption expenditures. The four sectors in the complete circular flow model: households, firms, government, and rest of the world. The four types of expenditures in the complete circular flow model: government spending, investment, imports, consumer. Visual Representation Draw a two sector circular flow model

Draw a four sector circular flow model

Explanations Why are expenditures and income equal to each other? When one receives income, they either spend it or save it. The firms do not hold onto any of the money in the economy since all things are owned by the household. Thus, if money is spent on something in the economy, that money serves as income for someone else, not as savings by a firm. Thus, expenditures always equals income. If net taxes increase, must government spending increase? Why or Why not? Study Questions Price Level & Inflation Definitions Price Level the change of prices in general Price Index an index allows one to measure changes in a numerical series. A price index shows how prices, in general, change from a reference year. Inflation a sustained increase in the general level of prices. Deflation a sustained decrease in the general level of prices. Nominal Price a price expressed in current dollars. Relative (Real) Price the relative price of a good is its nominal price adjusted for changes in the general level of prices. Consumer Price Index (CPI) The CPI is a type of price index. It measures the change in prices for goods and services frequently bought by households. It is reported monthly by the US governments Bureau of Labor Statistics. Core Consumer Price Index the section of the CPI that measures all items less food and energy; provides a better depiction of the CPI from a consumer point of view. Chained GDP Price Index measures the value of new stuff produced in economy. Lists Three price indices: The gross domestic product (GDP) chain-type price indexes measure changes in the U.S. economy The consumer price index (CPI) measures price changes in consumer purchases The producer price index (PPI) measures changes in the selling price of material goods Three differences between the CPI and the chained GDP price index:

1. The CPI measures only increases in the price of goods paid by consumers. An increase in the price of thermonuclear reactors will not show up in the CPI but it will in the GDP deflator (as long as they are produced). 2. The CPI includes also goods produced abroad but the GDP deflator does not. An increase in the price of Toyotas will show up in the CPI but it will not in the GDP deflator. 3. In the CPI the basket is held constant in the GDP deflator is not. Three costs of inflation: menu (use of resources in one area vs. another; change prices, takes resources to change price of things), shoe leather (the time effort put into one thing vs. another; could be doing something more productive), bracket creep (prices set by the government in nominal terms; changing the terms takes a lot of effort; doesnt change, so behavior changes since real price changes). Calculations

IR09 = CPI08-09 / CPI08 = (214.303 214.537) / 215.303 =

Explanations When would it be more appropriate to use the CPI for all items and when would it be appropriate to use the CPI for all items less food and energy? It is better to use the CPI for all items when evaluating income or household ability to buy. This is because households require all items for daily life (usually). If one were wanting to evaluate the economy, one would use the core CPI. This is because the core CPI measures items that tend to not fluctuate as much (e.g. gas and agricultural products), and thus gives a less deviated depiction of the economy as a whole. Explain why a general decline in the purchasing power of income is not a cost of inflation.

General decline in purchasing power of income doesnt change, change in distribution, not a cost of inflation since no $ changes as economy as whole doesnt lose income. Data Look at Table A in the most recent consumer price index news release (there is a link to this news release on the MyGateway site for this course). What is the inflation rate for all items for the 12 months ending December 2011? 3 % What is the inflation rate for all items less food and energy for the 12 months ending December 2011? 2.2 % (You may want to print out a copy of the data table from the MyGateway site for this course and add these numbers to this table.) Examine the graph of the inflation rate based on the CPI for all items (there is a link to this graph on the MyGateway site for this course). Would you consider the current inflation rate to be high, moderate, or low compared to inflation rates since 1948? When was the inflation rate high? What were the approximate inflation rates during these time periods? Study Questions Gross Domestic Product Definitions Gross Domestic Product The market value of all final goods and services produced in an economy during a given period. Nominal Gross Domestic Product Real Gross Domestic Product Real GDP is calculated by adjusting nominal GDP by changes in price level. Lists List the 4 major expenditure categories of GDP. Which is the largest?
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. 1. 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. 2. 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. 3. 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.

Which of the following items would be included in measuring the U.S. GDP for 2009? A households purchase of a new domestic car. o A households purchase of a new imported car. o A households purchase of a used domestic car. A firm's purchase of new Microsoft word processing software. o A firm's purchase of 20 reams of paper for their printers.

o The value of teaching services produced by a public school teacher measured using their salary. o The value of painting services when a homeowner paints a room in their house. The value of painting services when a homeowner hires a painter to paint a room in their house.

Explanations Explain the difference between nominal GDP and real GDP. GDP is the amount of production/exporting of product that any given country does in a set amount of time (in dollar amounts). This reflects how well a country's economy is doing at the time; so naturally, countries that are doing poorly may want to tweak the impression given off by their GDPs. If a country's economy isn't doing well and inflation is high, products cost more to sell and produce; more money is being spent and by looking solely at GDP, the country appears to be doing well. Real GDP is a measure of the Gross Domestic Product of a country that is not affected by inflation. They are essentially the same thing, although real GDP is a truer reflection of a nation's economy. Explain why real GDP in preferred when comparing GDP across time.
Nominal GDP uses current prices and thus may over- or understate true changes in output. Real GDP takes into account the inflation rate and thus is more accurate at recording the actual increase in production activities. Real GDP is a better measure of economic well-being. Because Real GDP is not affected by changes in prices, changes in real GDP reflects only changes in the amount being produced.

Data What is the average growth rate of real GDP since World War II (1947). 3.2 % Look at the most recent gross domestic product news release (there is a link to this news release on the MyGateway site for this course). What is the advance estimate of the seasonally adjusted annualized growth rate of real GDP? 2.8 % (You may want to add this number to the data table from the MyGateway site for this course.)

Using nominal GDP for 2011 (available on Table 3 of the news release), what percentage of GDP is consumption (personal consumption expenditures)? Using nominal GDP for 2011, what percentage of GDP is investment (gross private domestic investment)? Using nominal GDP for 2011, what percentage of GDP is government spending (government consumption expenditures and gross investment)? Using nominal GDP for 2011, what percentage of GDP is net exports (net exports of goods and services)?

Study Questions Unemployment Definitions Unemployment Rate Labor Force Participation Rate Employment-Population Ratio Frictional Unemployment Structural Unemployment Cyclical Unemployment Natural Rate of Unemployment Potential Output/GDP (Full Employment Output/GDP)

Lists List the 3 types of unemployment: Frictional, Structural, and Cyclical.

Short Answer For each of the following, indicate the type of unemployment that best describes the situation: A store clerk loses their job in the New Orleans because the store was destroyed in the flooding following Hurricane Katrina. Structural A movie theatre worker loses their job due to decreased demand for movies because of a recession. Cyclical

A movie theatre worker loses their job due to people substituting watching movies at home on DVDs for watching movies in theatres. Cyclical A sales person losses their job when the mall store where they worked closes due to a change in consumers preferences. Cyclical

Explanations Explain the natural rate of unemployment changes over time. Data Look at the most recent employment situation news release (there is a link to this news release on the MyGateway site for this course). What is the seasonally adjusted civilian unemployment rate for January 2012? 8.3 % (You may want to add this number to the data table from the MyGateway site for this course.) What is the seasonally adjusted civilian labor force participation rate for January 2012? 63.7 % What is the seasonally adjusted employment-population ratio for January 2012? 58.5 % According to what I said in class, the natural rate of unemployment is currently in what range? Is the current unemployment rate above, near, or below the current natural rate of unemployment? Examine the graph of the civilian unemployment rate (there is a link to this graph on the MyGateway site for this course). For the past two years, has the unemployment rate been rising, falling, or staying about the same?

Examine the graph of the civilian labor force participation rate (there is a link to this graph on the MyGateway site for this course). For the past 10 years, has the labor force participation rate been rising, falling, or staying about the same? Examine the graph of the civilian employment-population ratio (there is a link to this graph on the MyGateway site for this course). For the past two years, has the employment-population ratio been rising, falling, or staying about the same?