Gross Domestic Product (GDP) - the market value of

all final goods and services produced and expanded

upon within a nations borders (money spent on
domestically produced final goods/services)
-Expenditure Approach (Nominal GDP)
-National income identity: Y = C + I + G + (Ex
Im)
-C: personal consumption spending on
(non)durable goods/services
-I: gross private investment spending on
fixed investment, (non)residential
-G: gov. consumption expenditures on
private goods/services produced by marketplace,
st./local, gross gov. investment
-Exports: goods produced domestically but
sold abroad
-Imports: purchases of foreign-produced
goods/services
-Doesnt provide adequate info on
contribution of each sectors or distribution of
income payments
-Only concerned with value of final
goods/services produced using final quantities and
prices
-Value Added Approach GDP = (Price)(Quantity)
-To be considered value adding, must be a
transformational process employed
-Value added = total firm sales cost of
intermediate goods used
-GDP = summation of value added at each
stage
-Value added in nation income accounts
refers to the difference in the final price and the
value of inputs purchased
-Factors Payments Approach
-GDP = sum of all factor payments made =
wages + interest + rent + profit
Personal consumption expenditures accounted for a
little more than 68% of GDP
-if all prices increase, nominal GDP will increase
-if prices of goods rise faster than the rise in
quantities of those goods produced, nGDP has
increased but purchasing power of economys
output has been eroded all inflation
-Real GDP- total value of all final goods produced in
economy during given year, calculated using prices
of selected base year (accounts for inflation) (same
as inflation-adjusted GDP)
-Inflation adjusted measure of aggregate output
typically used by economists
-rGDP = (P1)(Q1) + (P2)(Q2) +
-rGDP per capita=best available measure of
standard of living in country
real wage = nominal wage adjusted for inflation
Inflation- overall rising trend in the measure price
level at the national, regional, state, and local level
-can be measured by the % change in the CPI
-can be positive indicator of good growth that is
demand driven (bad in sense that it eroded

purchasing power)
inflation rate = (new-old)/old
-Inflation rate- yearly % change in a price index,
typically based upon the Consumer Price Index
(CPI), the most common measure of the aggregate
price level
-CPI measures the cost of the market basket of a
typical urban American family
-most important factor affecting interest rates over
time is changing expectations about future inflation
-this shifts both the supply and the demand
for loanable funds (reason why int. rates lower
today than in 70s/80s)
-when rates decrease, demand and price for
commercial and residential real estate will decrease
-real interest rate = nominal interest rate inflation
rate (nominal rate specified because dont know
what future rate will be when deal is made)
Price level- a weighted measurement in which prices
of goods and services serve as weights for
corresponding quantities produced
Price index = market value of basket of goods
(output) for current year /
base year x 100
-ratio of the current cost of that market basket to
the cost in a base year
Economic aggregates = consumption spending,
investment spending, gov. spending, trade balance
Aggregate output- economys total quantity of
output of final goods
-Examples included in calculation = value of
Firestone tires sold at local garage/value of new
shower installed in recently purchased 1920s house,
value of CD player installed to replace the factory
mounted radio cassette player in new car (NOT
value of tires installed on brand new Volvo cars)
Aggregate price level- measure of the overall level
of prices in the economy (to measure, calculate the
cost of purchasing a market basket
Aggregate spending- total spending on domestically
produced final goods/services in economy
-if both aggregate output and aggregate price level
increase, nGDP will increase faster than rGDP
GDP per capital: growth rate of real GDP =
(GDP/size of population), equivalent to the average
GDP per person (incomplete measure of a countrys
standard of living)

If increase in consumer spending/decrease in

imports/increase in investment spending increase
in nominal GDP
Decrease in consumer spending increase in the
unemployment rate
Decrease in exports/increase in imports decrease
in nominal GDP
If prof wins lottery, GDP isnt affected
GDP tends to understate our economic wellbeing
because it: excludes the value of leisure
Included in GDP: purchase of a ticket to a Rolling
Stones concert; mom buys 100 shares of Nike stock;

student has pizza delivered to dorm room, value of

Firestone tires sold at local garage, value of
Goodyear tires purchased by US SS, value of
Michelin tires purchased by Canadian car collectors
If growth rate of GDP is above its historical average,
then there is a tendency for the unemployment rate
to fall
GDP: aggregate output, total production of final
goods/services, grows during expansion
If nGDP from one yr to next: either output or prices
or both must have fallen from one yr to next
Included in this years GDP: production of a TV
show, hiring of a new school teacher, purchase of a
new hybrid truck (NOT purchase of neighbors house
that was built in 1994)
Official unemployment rate ignores discouraged
workers who have given up looking for a job
Investment spending- spending on productive
physical capital (Ex: spending on inventories, new
residential construction, purchase of
machinery/other productive physical capital)
-Ex: the purchase of a freezer by an ice
cream parlor, GM builds new plant to manufacture
cars
Stock- a share in the ownership of a company held
by a shareholder
Bond- borrowing in form of an IOU that pays interest
Dividend- the portion of a firms profit paid to the
owner of one share of its stock
Ex of government transfer=social security payment
During the 1929-1939 period in the US, nGDP
declined but rGDP increased
Inventory investment is counted as investment
because inventory is a source of future sales
Producer price index: the producer price index
measures the cost of a basket of goods typically
purchased by producers (used to measure changes
in the prices that firms pay for goods)
Major diff b/t CPI & producer price index = PPI is
based on cost of a basket typically purchased by
producers. CPI based on cost of a basket typically
purchased by consumers
Ex of intermediate good: steel purchased by aircraft
manufacturers; tires purchased from Goodyear by
GM for newly produced electric cars
You read in the newspaper that the CPI in 2011 was
120. You conclude that a typical market basket in
2011 would have cost: 20% more than the same
market basket purchased in the baseyr
Human Development Index (HDI)-used by UN to
compare nations by measures other than rGDP per
capita

Unemployment rate- % of total # of qualified

workers who are unemployed and actively seeking a
job as a percentage of the labor force = (total # of
workers unemployed/labor force) x 100
-Unemployment- varies according to season of the
year/course of business cycle
-Labor force participation rate- % of the population
16+ thats in labor force = (labor force/pop 16+) x
100
Real income per capita = real GDP / population
Savings and Investment Identity
total output = total output demanded GDP = C +
I +G
Domestic investment spending: I = GDP C G
I =investment spending=national savings+capital
inflow in open economy=net savings in closed
economy
- I = NS (in closed economy)
- I = GDP - C G
- I = SPriv + SGov + (Im-Ex) = NS+KI (KI= net
capital inflow = net imports = Im - Ex) = (GDP-C-G)
+ (Im-Ex)
Sprivate = GDP + transfer payments(TR)
taxes(T) C (output (income) thats left over after
consumption spending and taxes paid)
SGov = T TR G
NS = Spriv + SGov = GDP C G
National Savings(NS)- sum of private savings among
households/firms + public servings treated as govs
budget balance that can be budget surplus or deficit
-national savings reflects output that remains after
the demand of consumers and gov has been
satisfied
-national saving equals investment at eq. interest
rate
With total output fixed and national savings
unrelated to int. rate:
-in gov purchases equilibrium interest rate
- in taxes, eq. rate/ investment
Loanable funds market-hypothetical market that
examines the market outcome of the demand for
funds generated by borrowers and the supply of
funds provided by lenders
-savers supply funds
-demand curve: lower the interest rate, the
greater the quantity of loanable funds demanded
- increase in demand will cause increase
in amount of expected business opportunities
-shifts in curve: changes in perceived
business opportunities; changes in the govs
borrowing
-Crowding out: occurs when a
government deficit drives up the interest rate and
leads to reduced investment spending where an
increase in the governments budget deficit causes
the overall investment spending to fall
-supply curve shifts: changes in private
savings behavior; changes in capital inflows

Interest rate- the price, calculated as a percentage

of the amount borrowed, charged by the lender to a
borrower for the use of their savings for one year
Financial System
-households wealth is the value of its accumulated
savings
-Financial asset- paper claim that entitles the buyer
to future income from the seller (paper claims that
provide the buyer of the claim future income from
the seller of the claim)
-in financial markets, purchased by households
-Physical asset- claim on the tangible object that
gives the owner the right to dispose of the object as
he or she wishes
-Liability- requirement to pay income in the future
-Transaction costs- expenses of negotiating and
executing a deal (cost of making a deal)
-Financial risk- uncertainty about future outcomes
that involve financial losses and gains
-3 tasks of financial system: reducing transaction
costs and financial risk and providing liquid assets
-Liquid assets (liquidity): assets that can be
quickly converted into cash without much loss of
value (opposite=illiquid)
4 main types of financial assets: loans, bonds,
stocks, bank deposits
Loan-a liability for the borrower and an asset for the
lender
Physical capital-consists of human made resources
(buildings, machines)
Households indirectly own the physical capital used
by firms through stocks
When a bond becomes more attractive as an asset
because of a rise in interest rate: price of stock, a
substitute asset, will fall
Borrowers who cant be served by stock and bond
markets can use banks for their financing needs
Rule of 70- most useful in estimating the doubling
time of real GDP for a given growth rate (applies to
any growth rate)
(70/rate) = years to
double
-if country experiences avg. growth rate of 7%,
rGDP per capita will double in 10 years
-A checking account with $500 is more liquid than a
persons new car
-Rate of return on a business project = [(revenue
from project cost of project)/cost of project] x 100
-Savings-investment spending identity savings
and investment spending are always equal for the
economy as a whole
-National savings = private savings + budget
balance
Government an increase savings by: taxing more
than it spends

Holding everything else constant, when the

government uses an expansionary policy in the
presence of a deficit, it will result in: an increase in
the equilibrium interest rate in the loanable funds
market
-in a simple closed economy, all investment
spending must come from savings
Gov saves when it has a budget surplus (gov
spending less than net taxes)
NASDAQ: index that includes smaller companies,
often in the technology sector
If NASDAQ is down + Dow Jones is higher on
particular day: investors are pessimistic about the
technology sector and about the old economy sector
-Human capital- refers to the education or training
which workers possess (ex:rising HS graduation
rates)
-generally increased by economies with higher
growth rates
-refers to improvement in labor by
education/knowledge in workforce
-computers started to become more common in the
70s in US. From this time until mid-90s: very little
happened to productivity
Convergence hypothesis-idea that relatively poor
nations should have higher rates of growth of rGDP
per capita than relatively rich nations
-fits the data only when the factors that affect
growth are held equal across countries. These
factors include: education, infrastructure, favorable
policies and institutions
-international differences in GDP per capita tend to
narrow over time
- not wrong, but education, infrastructure, and the
rule of law are not equal among nations
-explains why the income of high-income and lowerincome countries get closer
-efficient markets hypothesis: stock prices embody
much public information and therefore arent
overpriced or underpriced
-average worker in the US today produces more
than their counterpart a century ago because: the
modern worker is better educated, has more
physical capital and technology to work with
-from economic growth standpoint, banks are
important to: channel savings into investment
Natural resources = less reliable/significant
indicators of productivity today than they were a
century ago
If GDP doubles in 12 yrs, its average annual growth
rate is approx. 6%
Bubble: an increase in asset prices driven by
unrealistic expectations about future prices

The dollar amount of a future payment is more than

its present value

Aggregate production function depends on: the

quantity of physical capital per worker, human
capital per worker, the state of technology

$100,000 worth of stock in 10 companies in 5

industries = portfolio most diversified in terms of
risk
-common strategy to reduce potential of large
financial loss so that risks of failure are unrelated

2010, median US household income approx.

$50,000

Present value of $1 realized one year from now = $1

x (1+r)

Long-run economic growth: higher in countries with

a strong rule of law and political stability
-sustainable if it can continue in face of limited
supply of nat. resources/ impact of growth on
environment

Ex of investing physical asset: buying a new factory

that produces IBM handheld devices
Capital inflows = the net inflow of funds into a
country (capital inflow into country associated w/
Imports exceeding exports)
-positive inflow country is borrowing more than
its lending to foreigners
-negative inflow country lending more than its
borrowing from other countries
Economists are optimistic that growth can continue
in face of resource scarcity prices of scarce
resources rise and provide incentives to find
alternative energy sources
Adv. to recipient of foreign investment: foreign
companies often bring new technology to that
country which increases productivity
Diminishing returns to physical capital means that
when the amount of human capital per worker and
the state of technology are held fixed, each increase
in the amount of physical capital per worker leads
to: a smaller increase in the marginal product of
labor
-d. returns to physical capital= as more and more
PC is combined with fixed amount of human
capital+fixed technology, eventually, additions to
aggregate output or rGDP decline
Goods produced in a particular period but not sold in
that period are included in investment
Financial slump that began in US in 07 was result of
a sharp fall in housing prices
Greenhouse gas emissions = example of a negative
externality
-cost of reduction by 60% -80% by 2050 estimated
to be 1-2% of rGDP per capita

Property rights=important factor for economic

growth

Factors that influence productivity and therefore

growth: physical/human capital per worker and
technological advances
During 1900s, low oil prices encouraged consumers
to buy larger cars/SUVs that were less fuel efficient
Shifts
-all other things unchanged, a general increase in
the amount of government borrowing will typically:
shift the loanable funds demand curve to the right
and increase interest rates
-an increase in loanable funds demand would most
likely be caused by: an increase in the amount of
government borrowing
-it took India more than 40 yrs to exhibit high
economic growth after it gained independence from
Britain in 1947. This faster rate of growth resulted
from: a reduction in the burden of corruption
-throughout 20th century, nations in Latin America
experienced disappointing growth rates primarily
due to: low rates of national savings, political
instability, little emphasis on education
-main reason S. Korea has grown so rapidly is that it
was so poor, it could ski forward (leapfrog) to use
new generation technology as it developed
In the popular press we see many pictures of
affluent people in Chinese cities. Yet the average
person in China today is poorer than the average
person in America was in: 1900
Between which of the following pairings of
economies would you expect to see convergenceFrance and Germany