Chapter 4 - Economic Principles

Question 1

What are the three main groups that interact with the economy?

Answer 1

1. Consumers (maximize satisfaction/well-being)
2. Firms (max profits)
3. Governments

Question 2

What is the Expenditure Approach of measuring GDP?

Answer 2

Looks at total spending on “final goods” and services:

GDP = C + G + I + (X - M)

Question 3

What is the Income Approach to measuring GDP?

Answer 3

Looks at total income from producing goods & services:

• Wages for Labour
• Rent for land
• Interest for Capital goods
• Profits for entrepreneurs

Question 4

What 3 factors can lead to GDP growth?

Answer 4

• Increases in population
• Increases in capital stock (equipment and education)
• Technological improvement

Question 5

What leads to increased output per worker?

Answer 5

Higher savings (increased capital stock) and technology.

Question 6

What phase has stable inflation, strong stock market activity, and increasing profits, inventories, and jobs?

Answer 6

Expansion

Question 7

In what phase does demand outstrip supply, and has high inflation and interest rates?

Answer 7

Peak

Question 8

What phase has declining economic activity, reduced production and falling employment?

Answer 8

Contraction

Question 9

What phase has falling interest rates (along with a bond rally), falling inflation and stock price rally?

Answer 9

Trough

Question 10

What phase has high but flat unemployment, and increasing production?

Answer 10

Recovery

Question 11

Money supply, average work week hours and commodity prices are what type of infocator?

Answer 11

Leading

Question 12

The inflation rate, business loans and interest, and private sector plant/equipment spending are what type of indicator?

Answer 12

Lagging

Question 13

Personal income, GDP, industrial productions and retail sales are what type of indicators?

Answer 13

Coincident

Question 14

Manufacturers’ new orders, stock prices and housing starts are what type of indicator?

Answer 14

Leading

Question 15

What is a “soft landing” vs a recession?

Answer 15

Recession is major decline in GDP, while soft landing has significantly slowed growth (but not negative).

Question 16

What is the “participation rate”?

Answer 16

The share of working-age population in the workforce.

Question 17

What factors can cause the unemployment rate to rise?

Answer 17

Number of employed falls or number of people entering the workforce rose (or both).

Question 18

What type of unemployment is part of a healty economy?

Answer 18

Frictional

Question 19

What type of unemployment means workers cannot find jobs due to lack of skills?

Answer 19

Structural

Question 20

What type of unemployment rises when the economy weakens and falls when the economy strengthens?

Answer 20

Cyclical

Question 21

What 5 factors determine interest rates?

Answer 21

1. Demand/Supply of capital
2. Default risk of central Gov
3. Foreign interest and exchange rates
4. Central bank creditability
5. Inflation

Question 22

What are the 3 functions of money?

Answer 22

1. Medium of exchange
2. Unit of account (price)
3. Store of value

Question 23

What is the formula for inflation rate?

Answer 23

100 x (Current CPI - Previous CPI) / Previous CPI

Question 24

What is the “output gap”?

Answer 24

Difference between real GDP and potential GDP.

Question 25

What is potential GDP?

Answer 25

The maximum level of real GDP that the economy can maintain without increasing inflation.

Question 26

What is a negative output gap? And how does it affect inflation?

Answer 26

When actual output is below potential output. There is "spare capacity". Inflation falls or stays the same.

Question 27

What is a positive output gap and how does it affect inflation?

Answer 27

Occurs when actual output is above potential, increasing inflation. (Scarce labour)

Question 28

What is demand-pull inflation?

Answer 28

When there is a positive output gap there is strong consumer demand for goods which increases inflation.

Question 29

What is cost-push inflation?

Answer 29

When the cost to produce output increases. (Such as higher inputs and wages).

Question 30

What does the Phillips curve say about disinflation?

Answer 30

When unemployment is low, inflation is high. | When unemployment is high (or growth is slow) inflation is low.

Question 31

What is the sacrifice ratio?

Answer 31

The extent to which GDP must be reduced in order to see a 1% decrease in inflation.

Question 32

What is deflation vs disinflation?

Answer 32

Deflation occurs when change in CPI is negative year over year. Disinflation is a slowing in the rate of inflation.

Question 33

What are the two components of a country's balance of payments?

Answer 33

Current account - exchange of goods and services between citizens and foreigners, plus foreign aid. Capital & financial account - investment flow between citizens and foreigners.