Chapter 2

Question 1

Employment

Answer 1

The number of people who have a job

Question 2

Unemployment

Answer 2

The number of people who do not have a job but are looking for one

Question 3

Labor force

Answer 3

The sum of employment and unemployment

Question 4

unemployment rate

Answer 4

the ratio of the number of people who are unemployed to the number of people in the labor force u = U/L

Question 5

Current Population Survey (CPS)

Answer 5

The US survey to households to research how much unemployment there is

Question 6

Not in labor force

Answer 6

People not having a job and not looking for a job

Question 7

Discouraged workers

Answer 7

Unemployed workers that give up looking for a job

The flows in and out the labor force should not be disregarded as they give a lot of information. For example, the flow out of the labor force generally increases in periods of recession as many discouraged individuals stop looking for jobs.

Question 8

Participation rate

Answer 8

the ratio of the labor force to the total population of working age

Question 9

Inflation

Answer 9

A sustained rise in the general level of prices (the price level)

Question 10

Inflation rate

Answer 10

the rate at which the price level increases

Question 11

deflation

Answer 11

A sustained decline in the price level. Negative inflation rate.

Question 12

What determines output in the Short Run?

Answer 12

Short-run: demand side: Movements in output are generated by movements in the demand for goods. Firms adjust labor at given wage rates to match the level of demand and they can adjust prices to some extent.

Year-to-year movements in output are primarily driven by movements in demand. Changes in demand, perhaps as a result of changes in consumer confidence or other factors, can lead to a decrease in output (a recession) or an increase in output (an expansion). Output being determined by demand.

Question 13

What determines output in the Medium Run?

Answer 13

Medium-run: supply side: Output is determined by how much firms produce. This depends on their stock of capital, the size and composition of the labor force etc. These things can be adjusted, but it takes time.

The economy tends to return to the level of output determined by supply factors: the capital stock, the level of technology, and the size of the labor force. And, over a decade or so, these factors move sufficiently slowly that we can take them as given. Output being determined by the level of technology, the capital stock and the labor force.

Question 14

What determines output in the Long Run?

Answer 14

Long-run: supply side: Output is determined by deeper parameters: the structure of the economy, innovation, the laws under which firms operate, the education system etc.

Neither technology, nor capital, nor skills are given. The technological sophistication of a country depends on its ability to innovate and introduce new technologies. The size of its capital depends on how much people have saved. The skills of the people depend on the quality of the country’s education system. In conclusion it depends on factors like the education system, the saving rate, and the role of the government. Output being determined by factors like education, research, saving and the quality of the government.

Question 15

What is Okun’s law?

Answer 15

If output growth is high, unemployment will decrease. —> key to decreasing unemployment is a high enough rate of growth.

Clear relation between the change in the unemployment rate and GDP growth.

• High output growth generally associated with a decrease in the unemployment rate.
• Low output growth generally associated with an increase in the unemployment rate.

Intuition:
High output growth, increase in production, more hiring, less unemployment.

Question 16

What is the GDP deflator?

Answer 16

nominal GDP/real GDP = price level

the GDP deflator is the average price of all final goods produced in the economy

GDP Deflator: increases in GDP can come from either and increase in real GDP or an increase in prices. If we see nominal GDP increase faster than real GDP, the difference must come from an increase in prices.

Question 17

GDP as the sum of value added in the economy during a given period.

Answer 17

Value added = value of its production minus value of intermediate goods. Calculated from production side.

Question 18

GDP as the sum of incomes in the economy during a given period.

Answer 18

Value added of the income from labor and capital. Calculated from income side.
Labor income: firms’ pay to workers 
Capital income: the rest of the revenue

Question 19

GDP as the sum of incomes in the economy during a given period.

Answer 19

Value added of the income from labor and capital. Calculated from income side.

Labor income: firms’ pay to workers

Capital income: the rest of the revenue

Question 20

Nominal GDP

Answer 20

Nominal GDP is the sum of the quantities of final goods produced times their current price. Denoted with “dollar sign”Y

Question 21

Why does nominal GDP increase over time?

Answer 21

1. The production of most goods increases over time.


2. The price of most goods increase over time.

Question 22

Real GDP

Answer 22

Real GDP is the sum of the quantities of final goods times the constant prices. Weighted average of the output of all final goods. Denoted with Y.

To construct real GDP: # of cars in each year * common price from one year (base year) 
—> despite what year we use as base year, the rate of change from year to year will be the same.

Question 23

Price level

Answer 23

nominal GDP = GDP deflator (price level) * real GDP

Question 24

What is CPI?

Answer 24

CPI: representing a regular consumer’s basket. An index.

GDP and CPI move together most of the time.

Question 25

Why do economists care about inflation?

Answer 25

Pure inflation: proportional increase in all prices and wages. Doesn’t exist. Inflation creates uncertainty, makes it hard for firms to know if they’re gonna invest Unfair for example retirees that receive payments that don’t keep up with the price level.

Question 26

What is Phillips Curve?

Answer 26

Okun’s law implies that, with strong enough growth, one can decrease the unemployment rate to very low levels. But inflation suggest that, when unemployment becomes very low, the economy is likely to overheat, which might lead to an upwards pressure on inflation.

Question 27

What is Hyperinflation?

Answer 27

- if the rate of CPI inflation is higher than 50%, this is called hyperinflation - hyperinflation does not mean that everybody becomes very poor and there is mass starvation, as wages usually keep up with prices - but the problems connected with inflation that we discussed above are even more relevant here and there is risk of impoverishment of parts of society - also, hyperinflation usually goes along with severe economic and financial problems - from a practical point of view, daily life can become very tricky...

Question 28

Why do we care about unemployment?

Answer 28

employment matters for production: the more jobs, the more can be produced employment matters for consumption: the more people earn, the more they will spend employment matters for wellbeing: unemployed are less happy and have less financial means as employment is closely linked to economic growth and welfare, a main goal of policy makers is to keep unemployment low

Question 29

What does the business cycle tell us about expansionary and contractionary effects on the economy?

Answer 29

An increase in consumption, investment, government expenditure or exports has expansionary effects A decrease of all the above, as well as a tax rise or an increase in imports (if not met by increasing exports) have contractionary effects

Question 30

In what different ways can variables co-move?

Answer 30

A variable is procyclical if its cyclical component is positively correlated with the cyclical component of GDP. That is, it tends to increase in periods of expansion and decrease in periods of recession. A variable is countercyclical if its cyclical component is negatively correlated with the cyclical component of GDP. That is, it tends to decrease in periods of expansion and increase in periods of recession. A variable is acyclical if its cyclical component is not correlated with the cyclical component of GDP.