Principles of Macroeconomics Review 1: Chapters 1, 16-18

What is the Cost-Benefit Principle? An individual should take an action if, and only if, the extra benefits from taking the action are at least as great as the extra costs How does macroeconomics differ from microeconomics? The study of the performance of national economies and the policies that governments use to try to improve that performance

What is the definition of GDP? The market value of all final goods and services produced in a country in a given time period. You buy a used car in Does that purchase count towards GDP in 2011? No, the used car was counted towards GDP when it was first purchased as a new car. You work in London for 6 months in Does your work count towards GDP in 2011? No, since your work was done outside of our country’s borders, it does not count towards GDP. A foreign-owned Honda plant in Iowa produces $10 million worth of goods in Does this count towards GDP in 2011? Yes, since the goods were produced within our country, it does count towards GDP.

Find GDP, given the following data: -Consumption = $9 billion -Investment = $2 billion -Government Spending = $3 billion -Imports = $ 4 billion -Exports = $2 billion GDP = C + I + G + NX: GDP = (2-4) = $12 billion What is the difference between real and nominal GDP? Real GDP values output in the current year using the prices from the base year. Nominal GDP values output in the current year using prices from the current year.

What are some shortcomings to the current GDP measure? Values only market transactions (excludes illegal activity, volunteer work, household production); no value placed on leisure; does not take into account impact of production on environment, resource depletion, or social issues, income inequality.

If a basket of goods cost $500 in the base year and $700 in the current year, what is the value of the CPI for the current year? CPI = current year prices/base year prices $700/$500 = 1.40 If the CPI were 2.3 in 2009 and 2.6 in 2010, what is the inflation rate? Inflation rate = (current year CPI – previous year CPI)/previous year CPI ( )/2.3 = 13% If a candy bar cost $0.05 in 1925 with a CPI value of 0.15 and the same candy bar cost $1.00 in 2010 with a CPI value of 2.05, what is the real cost of the candy bar in 1925 and in 2010? Real Value = Nominal Value/CPI 1925: 0.05/0.15 = $ : 1.00/2.05 = $0.49

Explain the substitution bias in the CPI measure. When the price of a good increases, consumers will buy less of that good and switch to less expensive goods. This is not taken into account in the CPI and can overstate inflation. If the nominal interest rate is 7% and the rate of inflation is 2%, what is the real interest rate? Real Interest Rate = Nominal Interest Rate – Inflation 5% = 7% - 2%

What two factors affect the demand for labor? Productivity of workers and the price of the worker’s output If the price for a good increases, will the demand for labor in that industry increase or decrease? Increase If the productivity of workers increases, will the demand for labor in that industry increase or decrease? Increase

What factor affects the aggregate labor supply curve? Size of the working-age population How do economists explain the increase in real wages over the last century? Increased demand for labor, brought on by an increase in productivity. Productivity increased due to advancements in technology and capital. How do economists explain the increase in wage inequality in the U.S.? Globalization has made some sectors of the U.S. economy nearly obsolete, causing wages in these industries to fall. High-skill industries within the U.S. have benefited from globalization, causing wages in these industries to increase.

Find the unemployment rate given the following information: Employed: 100 million Unemployed: 10 million Unemployment Rate = unemployed/labor force 10% = 10 million/110 million Who is considered not in the labor force? A person is not in the labor force if they have not worked in the past week and did not look for work in the past four weeks. What are three types of costs of unemployment? Economic, Psychological, and Social Costs

What are discouraged workers? What are involuntary part-time workers? How do they affect the current unemployment measure? Discouraged workers are those who would like to have a job but they have not looked for work in the past four weeks. Involuntary part-time workers are people who would like to work full-time but cannot find a full-time job. Since neither group is factored into the unemployment rate, some argue that the unemployment rate understates the true level of unemployment. Explain the three types of unemployment. Frictional – workers are between jobs; person is taking time to find suitable employment Cyclical – unemployment caused by economic downturns Structural - long-term, chronic unemployment in a well-functioning economy; caused by lack of skills, discrimination, language barriers