Economics 102 midterm notes, Exercises of Economics

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Chapter 7: measuring GDP

How do we measure the size of the economy?

• national income accounting

VALUING AN ECONOMY

• Gross domestic product (GDP): the sum of the market values of all final goods and services produced within a

country in a given period of time.

• economists divide the goods into 4 categories (consumption, investments, government purchases, and net exports)

Market value: measured in dollars, a number measure in the local currency.

Final goods and services

• an example of this is in producing a jar of jam, suppose the blueberry farmer sells enough blueberries to make one

jar of jam to a wholesaler for 12 cents. The wholesaler then sells them to the factory for 33 cents. The jam factory sells

the jar of jam to the grocery store for $1.85. Finally the grocery story sells it to you for $3.

• how much does this contribute to GDP, if you add them up this contributed $5.80 to GDP however this is incorrect.
• to avoid double counting we should ignore the price of intermediate goods and services.
• therefore only $3.50 is contributed to the GDP

Produced within a country

• if a Canadian company owns a factory in Mexico, the value of the goods produced in that factory will count toward

Mexican GDP, not the Canadian GDP. A Canadian citizen working in France will contribute to the French GDP

• Gross national product (GNP): the sum of the market values of all final goods and services produced by a country’s

business within a given period of time. Similar to GDP except

1. Includes the worldwide value of final goods and services produced by a country’s businesses
2. Excludes production by foreign businesses within the country

Given period of time

• GDP is calculated on a quarterly basis
• December usually has more economic activity due to people buying presents and travelling

Production equals expenditure equals income

The expenditure approach

• the market value of a good or service is the price at which it is bought and sold.
• we calculate this by adding up all the money people spend buying final goods and services produced (being careful

to omit spending on intermediate goods)

• this is messing the total output by measuring total expenditure
• consumption (C) + investment (I) + government purchases (G) + net exports (NX) = total expenditure
  • consumption: spending on new goods and services by private individuals and households with the exception of

spending on new housing.

• investment: spending on productive inputs (e.g. machinery and inventories – capital goods) to use to produce

other goods rather than consuming; it includes households spending on new housing.

• government purchases: spending on goods and services by all levels of government.
• net exports: spending on goods and services produced abroad domestically – value of exports (X) minus value of

imports (M).

The income approach

• every transaction, has a buyer who spends on a good or service but also a seller who earns income from the sale,
• we measure production using the income approach by adding up everyone’s income
• national production = national expenditure = national income
• national income = wages + interest + rental income + profits

The value added approach

• what if we looked at all transactions, but only counted the value they add to the economy
• useful when looking at the services involved in the resale of existing goods

Real vs Nominal GDP

• real GDP: gdp measurement that focuses solely on output, controlling for price changes. Calculates based on goodd

and services valued at constant prices.

• nominal GDP: calculated based on goods and services valued at current prices

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GDP growth rates

• one of the most common uses of GDP is to track changes in an economy’s over time. We talk about changes in

terns of growth rate. This is often measured as the percent change in real GDP from one period to the next, typically

annually or quarterly at an annual rate, calculated as

Ex: if canadas real GDP grew from $2 trillion in one year to $2.05 trillion the next, the annual growth rate would be:

• if the economy shrinks, the growth rate will be negative

Recession: a period of significant economic decline

Depression: a particularly severe or extended recession

LIMITATIONS OF GDP MEASURES

GDP versus well-being

• GDP per capita is a good measure of the country’s average income
• quality of life can be accessed by: infant/child mortality, literacy rates, and life expectancy

Data Challenges

• home production: goods and services that are produced and consumed within one household. This is not

included in GDP

• underground economy: goods or service transactions made under the market. Black or grey market goods
• environmental externalities: pollution costs. (Green GDP: an alternative measure of GDP that subtracts the

environmental costs of production from the positive outputs normal counted in GDP)

GDP growth

rate =

GDPyear2-GDPyear

1

X 100 %

GDP year

I

$ 2. 05 trillion^

• (^) $ 2. 0 trillion

GDP growth

rote = $ 2.^0 trillion

X100 = (^2). 5 %

CHAPTER 8: the cost of living

Definitions

Market basket: a list of specific goods and services in fixed quantities

Price index: a measure showing how much the cost of a market basket has risen or fallen relative to the cost in a

base period or location

Consumer price index(CPI): a measure that tracks changes in the cost of a basket of goods and services purchased

by a typical Canadian household as calculated by statistics Canada

Inflation rate: the size of the change in the overall price level

All-items inflation: measure of inflation that includes all the goods that the average consumer buys: also known as

the headline inflation

Core inflation: measure of inflation that excludes goods with historically volatile prices

Indexing: a practice of automatically increasing payments as the cost of living increases

Purchasing power parity(PPP): the theory that price levels in different countries should be the same when stated

in a common currency

PPP adjustment: recalculating economic statistics to account for differences in price levels across countries

Real values of goods and services are determined by the economy

Nominal price changes occur when the value of money changes

8.1 MEASURING PRICE CHANGES OVER TIME

The market basket

• the goal of creating a market basket is to see how the cost of buying the goods or services on the list changes

over time, to achieve this economists keep the goods and quantities included in the market basket relatively

constant.

Ex.

If we want to know how much the cost of your groceries rose, we need to know ones consumptions amount. Say

you typically buy a loaf of bread, a litre of milk, three kilograms of beef and a kilogram of carrots:

This is the basket approach, it measures changes in the cost of your shopping basket, assuming that you buy the

same items in the same quantities.

Consumer price index (CPI)

• to summarize the changes in the cost of living we construct a price index

Ex: suppose that the annual cost of the market basket was $40000 in 2022 (base year) and $40400 in 2023. To

find the index for 2023 relative to 2022 use the following formula

price

last year

($) (^) price this^ year

($) (^) (x

Xi)

X 100 %

Bread 2. 60 2.^73

XI

Milli (^3). (^00 3). 06

So the^ change

in (^) the price

of (^) bread is

Beef (^4). 08 4. 16

• $ 2 . 60)x100% (^) = 5

$ (^2). 60

carrots (^1). 00 1.^25

Cost last (^) year =^ ($ 2.^60 x1)

< $^8.^00 x^ 1) +^ ($^4.^00 x^ 3)^

• (^) ($ 1. 00x1) =^ $^18.^60

Cost this (^) year =^ /$ 2.^73 x^11

($ 3.^06 x^ 1)^

(55%.^16

x

3. +^ /$ 1.^

25 x^ 1) = $ (^19). 52

price

increase =

($ 19. 52 -$^18. 60!^ x100% (^) = 4. 95 %

&

5. 18.^60

& ost of base (^) year basket^ in^ desired-year prices

CPI

= ↓

100

cost of base^ year

basket in^ base-year prices

baske 2. 023 $ 10400 x 100 =^101 CPI =

basket 2022

X 100 =

$ 40000

Accounting for price differences across places

Purchasing Power Parity (PPP)

• in theory goods ought to cost the same everywhere after translating currency
• May not hold due to (1) transacton costs, (2) non-tradable, (3) trade restrictions
  1. Transactions costs: transportation, time
  2. Non-tradable: some goods can’t be taken from place to place easily
  3. Trade restrictions: international trade isn’t free, tariffs or trade restrictions

Purchasing Power Indexes (PPI)

• fins a market basket of goods and services you can compare across countries and measure the price of the

goods in the basket in each country and calculate the overall cost of purchasing them in each country. For

example, think of burgers. In the US, the price of a burger in 2021 is $5.65; in Mexico, it was 64 pesos. The

exchange rate between pesos and US dollars hold be 11.33 pesos per dollar (64 pesos / $5.65). In reality the

exchange rate was 20.52 pesos per dollar

The negative bae means that the price levels in Mexico are lower than wed expect in PPP held true. As a result,

real purchasing power is higher in Mexico than it is in the US

PPP adjustment

• involves recalculating economic statistics to account for differences in price levels across countries.

Example: calculate the PPP_adjusted GDP per capita in Canada and Mexico, in 2017, nominal GDP per capita in

Canada was $43,258; in Mexico it was $8347, the Canada the figure is 5.2x larger

(.^

33 - 20. (^) 52) x

A hamburger

in Mexico

=

20. 52

= -

9. 19X = -^45 %

(^20). 52

1

PPP-adjusted

GDP

= GDP in nominal value

country

A

(11 + (^) price-level adjustment country

PPP-adjusted GDP^

= $ 8 , (^) 347x(s)

,

268. 38

Chapter 9: unemployment and the labour market

Key terms

Unemployment: situation in which someone wants to work but cannot find a job

Labour force: people who are in the working-age populate and are either employed or unemployed

Unemployment rate: the number of unemployed people divided by the number of people in the labour force

Labour-force participation rate: the number of people in the labour force divided by the working-age population

Discouraged workers: workers who have looked for work in the past year but have given up looking because of the

condition of the labour market

Underemployed: workers who are either working less than they would like to or are working in jobs below their skill level

Labour demand curve: a graph showing the relationship between the wage rate and the total labour demanded from all

the firms in the economy

Labour supply curve: a graph showing the relationship between the total labour supplied in the economy and the wage

rate

Natural rate of unemployment: the minimum level of unemployment that is unavoidable in a dynamic economy

Frictional unemployment: unemployment caused by workers who are changing location, job or career

Structural unemployment :unemployment due to a mismatch between the skills workers can offer and the skills in

demand

Real-wage or classical unemployment : unemployment that results when wages are high than the market-clearing level

Cyclical unemployment : unemployment resulting from changes in GDP

Labour unions: groups of employees who join together to bargain with their employers over salaries and work conditions

Efficiency wages :wages that are deliberately set above their market rate to increase worker productivity

Employment insurance money paid by the government to people who are unemployed.

Defining and measuring unemployment

• in general, unemployment occurs when someone wants to work but cannot find a job.
• there are many reasons for unemployment: lack of relevant skills and ambitions

Definition: persons aged 15 years and older who during the reference week were without paid work or without self-

employment work and were available to work and had actively looked for paid work in the past four weeks

• in addition people who were on temporary layoffs and expected to return to their jobs and people who had definite

arrangements to start a new job in 4 weeks or less

• this data comes from household surveys (labour force survey)

Measuring unemployment

• working age population: civilian, non-institutionalized population aged 15 or over, except those in the army
• we don’t count students or stay at home parents or disabled or inherently wealthy individuals or retirees. These

categories are not included in the labor force.

labour force = employed + unemployed

The unemployment rate

Month

April 2020

October 2021

Working age pop. (Non-institutionalized (^) Labor force employed unemployed

# of unemployed

unemployment

rate =

labour Force

X 100%

unemployed

=>

(employed

unemployed)

• 100%

unemployment

rate , April

2020 :^2. 422 ,

900

x 100 %^ =^13 %

(^18) , 568 , 700

unemployment

rate (^) , October^2021

: (^1) , 395 ,

700

x 100 %

= (^6). 8 %

20 ,

(^537) , 400

Categories of unemployment

Natural rate of unemployment

• all economies experience some level of unemployment regardless of how well or badly the economy is doing in

the short term. This is referred to as a normal level of unemployment that persists in an economy in the long run as the

natural rate of unemployment. This is also referred to as the equilibrium rate of unemployment.

• three contributors lead to hte natural rate of unemployment
  1. Frictional
  2. Structural
  3. Real-wage (classical) unemployment

1. Frictional unemployment

• unemployment caused by workers who are changing location, job or career
• how long it takes depends on these factors: job openings, how picky they are about waiting, what resources

they can draw on to support them

2. Structural unemployment
   • unemployment due to a mismatch between the skills workers can offer and the skills in demand
   • skills that may have been in demand last year may not be in demand this year. (Changing economy)
   • example: travel agent then, now there is numerous websites that can do that for you.
3. Real wage (classical) unemployment

-unemployment that results when wages are higher than the market-clearing level.

• anything that acts like a price floor in the labor marker will create a surplus in labor which we call

unemployment.

• explanations include: minimum wage laws, bargaining by unions, and strategic choices by employers to pay ages

above the equilibrium rate.

The common theme amongst these contributors to the natural rate of unemployment is that they reflect underlying

feature’s of the economy. These features can change over time.

Cyclical unemployment

• unemployment caused by these short-term economic fluctuations.
• as the economy goes through ups and downs (business cycle) this maters for unemployment because it affects the

demand for labor

-imagine the effect if an economic slowdown as a reduction in the total demand for labor at any wage, the labor

demand curve shifts to the left. Why don’t wages simply fall during a cyclical slowdown, so that the market still clears

and cyclical unemployment is zero?

• the explanation is that wages are sticky in the real world, meaning that they are SLOW to respond to shifts in

the economy.

• reasons for wage stickiness: difficult to change contracts, employers may chose not to raise and lower wages

all the time. Actual wages are temporarily above the market-clearing level which causes cyclical unemployment.

in general unemployment tends to be higher when GDP growth is low, although nit always true. Unemployment

tends to lag behind overall GDP growth, meaning it will change soon after but not at the same time as GDP growth

changes.

Public policies and other influences on unemployment

factors that may stop wage rates from falling.

1. minimum wage
   • the lowes wage a firm is legally allowed to pay its workers
   • when minimum wage is set above the equilobrium wage then unemployement occurs, when the wage is set below

the equilibrium it has no effect, this is called a non-binding minimum wage

2. unions and bargaining
   • strikes are made possinle by labor unions
   • if labor unions drive a hard bargain, wage rates can rise above the equilibrium level, then unemployment may

occur

• unions may be good for its own members but hurtful to the unemployed

3. efficiency wages

• firms may want to oay their workers more than minimum because a higher wage makes workers less likely to quit

and workers are more lilely to fear losing thier jobs and will work harder

• the idea is to give positive incentives to maximize porductivity.

UnEmployment insurance

• money paid by the government to’ people who are unemployed, the main goal is to provide insurance against a

major loss of income

• amount and duration of employment insurance varys widely.
• the maximum duration of employment insurance regular benefits is 45 weeks, it can be extended.
• taxes on wage income are important as well.

Chapter 10: Economic growth

10.1: calculate the growth rate of real GDP per capita, accounting for changes in price levels and population

Real GDP per capita describes the change in actual purchasing power for each person.

Real GDP per capita growth rate = nominal GDP growth rate - inflation rate

To get a sense of an annual growth rate, here’s how to calculate the Canadian real GDp per capita in 2021 ($54,154) and

the level in 2020 ($53,889). Then subtract to find the absolute change, an increase of $268. The growth rate is then

calculated as the absolute change between 2020 and 2021 expressed as a percent in 2020.

Compounding and the rule of 70

• compounding results in total changes in GDP over time that are larger than the annual growth rate would at first

suggest. The base from which growth is measured gets bigger each year*.

• if the economy is growing at 2% per year in 2001, GDP will be (Canadian GDP in 2020 = Y)

A different way to calculate the implications of steady growth is to use the rule of 70. It states that the number of years it

will take for income to double at a given annual growth rate is approximately equal to 70 divided by the annual growth

rate

Thinking of growth in terms of years to double makes it easier to appreciate how small differences in growth rates can

add up to huge difference in income over time.

• for example: if the growth rate in Canada increased from around 2% to about 3.5%. A growth rate of 2% incomes

double every 35 years. So over 70 years, incomes doubles and then doubles again. At a growth rate of 3.5% income

doubles every 20 years instead of 35. So starting at $18700 in 1961 instead of earning an average of $61, 355 by 2021

(2% growth per year). Canadians would be earining $147,320 about $85,965 more a year thanks to a 3.5% growth rate

Determinants of Productivity

Productivity drives growth

• productivity can be measured in various ways but its typically measured as output per worker
• the more a country produces the more it can consume. In the short term, it can temporarily push consumption

higher than production by borrowing money. But in the long run, debts have to be paid, and the only way to get to

consume more is by producing more.

• the standard of living in a country is driven by the average productivity of its peoples
• increases in productivity per person lead to increases in per capita income which we call economic growth

Components of productivity

10.2: describe the relationship between productivity and growth and list the factors that determine productivity

Physical Capital: a stock of equipment and structures that allow for production of goods and services

• we can calculate the amount of physical capital in an aconomy by adding up all the value of all tools, equipment

and structures.

,

=

xIOOV =^0. 50%

GDP2ool

= Y +

(

. 02 x y)

= (^1). 02Y

GDP0O2 =^1. (^) 02XGDP200l

= (^1) .02x

1. 02Y =^ (1. 02/2Y GDPyearA

= GDPyearBX (^

growth

rate)

(A-B)

GDP 2003

= (^) (1. 0213Y

years

until income doubles=

annual towth rate

Production function: an equation capturing relationship between quantity of inputs and quantity of outputs

Y= Af(K,L,N)

• even if countries differ in their rates of savings population growth and other feature, they will still converge at the

same growth rate although no the same level of income.

• simply: countries that start out poor should initially grow faster than ones that start out rich, but eventually slow

down to the same rate.

Growth and Public policy

10.6: discuss policies that could promote growth and relate them to productivity

• investment trade-off: a reduction of current consumption or investment in physical capital for future production.

Savings that pay for capital investment can come either from within a country or from outside it.

Investment funds within a country

• domestic savings: savings for capital investments that come from within a country; equals domestic income minus

consumption spending

• come from 3 sources: private households earning more than they spend, corporations earning profit beyond

what they give to shareholders as dividends and government generating surplus (that is, government revenues exceeding

government spending)

• foreign direct investment (FDI): an investment that occurs when a firm runs part of its operation abroad or invests

in another company abroad. Many governments try to attract FDI. When foreign companies invest in local firms, they

can transfer human capital to local managers and workers

Public Policy

10.7: explain how good governance and economic openness lay the foundation for growth.

Education and health

• free availability of high-quality public education for all children is one of the most important ways a country can

increase its stock of human capital

Infrastructure and industrial policy

Technological development

Laying the groundwork: good government, property tights, and economic openness

The juggling act

• most countries can’t afford all of the things that may promote growth in the economy.
• how a country decides how they spend their money on things that promote growth.

Chapter 11: Aggregate expenditure

The great crash

• stock markets crash, unemployment (Great Depression)
• john Maynard Keynes introduced price frictions into a model of the economy. The model showed that rather than

freely adjusting, prices were actually “sticky” and rarely decreased enough during recessions to restore demand

• this revolutionary idea placed the focus of aggregate demand.
• the model explains how widespread unemployment can persist, even when people are able and willing to work

The components of aggregate expenditure

• aggregate expenditure (Y) includes consumption, government spending, net exports, and actual investment by

firms

• aggregate expenditure can be divided into four primary components of spending: consumptions (C), investment

(I), government spending (G), and net exports (NX)

Y = C+I+G+NX

• this tells us everything that was produced must have been purchased by a combination of households (C), firms

(I), the government (G) and foreigners (NX)

Consumption (C)

• makes up one half of two thirds of GDP in most countries
• consider four factors when it comes to consumption
  1. current income (increase C)

marginal propensity to consume (MPC): the amount that consumption increases when after-tax income

increases by $

MPC =

2. wealth (increase C)
   • money held in savings and chequing account, holding of stocks, bonds and mutual funds, the value of

your house. From those assists are subtracted the amount of debt, mortgages and student loans

3. expected future income (increase C)
   • trying to keep spending fairly steady even when their income rises and falls. This is

referred to as the desire to “smooth consumption” over time). As a result, expected future income influences

current consumption in much the same way that current income does

4. The interest rate (decrease C)
   • the price of money typically expressed as a percentage per dollar per unit of time
   • for savers, it is the price received for letting a bank use their money for a specified period of time.
   • for borrowers, it is the price of using money for a specified period of time.
   • interest rate determines the financial return on savings and the cost of borrowing
   • a higher interest rate encourages savings, decreasing consumption and discourages peoples from

borrowing, this also decreases consumption.

Investment (I)

Expected profitability (decrease I)

• there is a positive relationship between expected profitability and the current level of aggregate investment

The Interest Rate (increase I)

• a big way that businesses invest is by borrowing financial capital
• the cost of borrowing, when the cost of borrowing decreases, the amount of borrowing increases
• therefore there is a negative relationship between the interest rate and the amount of aggregate investment

Business taxes (decrease I)

• business taxes reduce profits. When business taxes rise, firms have less incentive to invest and vice versa

Government spending (G)

• government spending is different from the other components of aggregate expenditure because the government

chooses how much to spend based on beliefs about what citizens need

• therefore in the short run, government spending is not directly affected by standard macroeconomics factors
• transfer payments include spending on unemployment insurance and social benefits - payments the federal

government makes to households without receiving any goods or services in return

Change in consumption

Changing in disposable income