Unit II

• Types of Economic Systems:
1. Command:
• Also known as centrally planned
• The government decides questions of production
• The government owns land and capital
• The government controls labor
• Ex: Cuba
2. Traditional:
• Based on rituals, habits, and customs
• Most decisions are made by the elders
• Ex: Indian tribes, African tribes
3. Free Market:
• People and firms act in their own best interest
• Allows buyers and sellers to exchange goods and services
• Only one true free market in the world: Hong Kong
4. Mixed:
• Have government regulating businesses to protect the public's interest
• Ex: U.S., Canada, Mexico
• Three Economic Questions that every society must answer:
1. What goods and services should be produced?
2. How will these goods and services be produced?
3. Who will consume these goods and services?
• Market: an institution or mechanism allowing buyers and sellers to make trades
• Product Market: the buyer is usually a consumer, and the seller is a firm
• Factor Market (Resource Market): you have your factors of production
• Most important factor is labor
• The buyer is usually the firm, the seller is the factor owner
• Firms/Businesses demanding resources - Factor Market (Think "CELL")
• CIRCULAR FLOW

• Household: a person or a group of people that share their income
• Firms: organization that produces goods and services for sell
• Gross Domestic Product (GDP): total value of all final goods and services produced within a country's borders within a given year
• GDP includes all production or income earned within the U.S. by U.S. and foreign producers
• It excludes production outside of the U.S. even by Americans
• Gross National Product (GNP): it is the total value of all final goods and services produced by Americans in a year
• It includes production or income earned by Americans anywhere in the world
• It excludes production by non-Americans even in the U.S.
• GNP = GDP + Net foreign factor payment
• Formula to Calculate GDP
• C + Ig + G + Xn
• C = Personal Consumption (67%)
• Purchases of finished goods and services
• Ig = Gross Private Domestic Investment
• Factory equipment maintenance, new factory equipment, construction of houses, unsold inventory of products built in a year
• G = Government Purchases of Goods and Services
• School buses, medicine, aircraft
• Xn = Net Exports (Exports - Imports)
• Gross Private Domestic Investment = Net private domestic investment + Depreciation
• EXAMPLES

• What's Included in GDP:
• Final goods and services
• Income earned (wages, rents, interest, profits)
• Interest payments or corporate bonds
• Current production of final goods
• Unsold output (business inventories)
• What's Excluded in GDP:
• Used goods/secondhand
• Gifts or transfers (scholarship, social security worked for)
• Stocks and securities
• Unreported business activities conducted in cash (waiter, waitresses)
• Illegal activities (drugs, black market)
• Financial transactions between banks and businesses
• Intermediate goods (avoid double counting, used in production of final goods)
• House market activities (babysitting)
• Expenditure Approach: income generated from production of goods and services
• Formula: C + Ig + G + Xn
• Income Approach: income generated from the production of final output
• Formula: W + R + I + P + Statistical adjustments
• Net National Product (NNP)
• Formula: GNP - Depreciation
• Net Domestic Product (NDP)
• Formula: GDP - Depreciation
• Depreciation (Consumption of Fixed Capital)
• National Income (NI): income earned by American-owned resources whether here or abroad
• NNP - Indirect Business Taxes (IBT)
• CE + RI + II + CP + PI
• Consumption of employees + rental income + interest income + corporate profits + proprietor's income
• GDP - IBT - Depreciation - Net foreign factor payment
• Disposable Personal Income (DPI): after tax income available for household consumptions
• Formula: NI - household taxes + GTP (government transfer payments)
• Nominal GDP (NGDP): it measures GDP in current dollars regardless of the output
• Formula: price x quantity OR p x q = NGDP
• Real GDP (RGDP): it measures GDP in constant dollars; it is adjusted for inflation, therefore, it reverts to base year prices
• EXAMPLE

For a walkthrough of how to do an example of a Real GDP and Nominal GDP problem, I recommend you to watch this video:

• GDP Deflator: a measure of the level of prices of all new domestically produced final goods and services in an economy
• Formula: nominal GDP/real GDP x 100
• Inflation Rate: a rise in the general level of prices
• [(Price Index in Year 2 - Price Index in Year 1)/Price Index in Year 1] x 100
• Consumer Price Index (CPI): most widely used measure of the overall price level in the U.S.
• (Price of the market basket in the particular year/Price of the same market basket in another year) x 100
• ECONOMIC NORMS (RATES)

• Inflation: a rise in the general price level
• Deflation: a decline in the general price level
• Disinflation: it occurs when the inflation rate declines
• Solving inflation problems:
• Rule of 70: how many years will it take to double inflation
• Formula: 70 divided by inflation rate
• Inflation rate: [(current year price index - prior year price index)/prior year price index] x 100
• Finding real interest rates
• Real Interest Rate: the cost of borrowing or lending money that is adjusted for inflation
• Real interest rate = nominal interest rate - inflation
• Real interest rate is expressed as a percentage (%)
• Nominal Interest Rate: the unadjusted cost of borrowing or lending money
• Causes of Inflation:
• Demand-pull: caused by an excess of demand over output that pulls prices upward
• Sources of Demand-pull:
• Increases in government purchases
• Excessive increases in the money supply which creates a situation of hyperinflation
• Hyperinflation: where you have a rapid rise or extremely high inflation rate
• Rising incomes as the economy approaches full employment output
• (This is what it means): As workers earn more, they increases their demand for goods
• Cost-push (supply side economics): caused by a rise in per unit production cost due to increasing resource cost
• Sources of Cost-push:
• Supply shocks: dramatic rise in energy or raw material prices due to input shortages or a growing demand for inputs
• Price Wage Spiral: workers seek higher wages to offset rising consumer prices
• Effects of Inflation (Anticipated vs. Unanticipated)
• Anticipated: expecting/waiting for inflation to happen
• Unanticipated: you don't know what happens or when it happens
• Unanticipated inflation has stronger effects, because those expecting inflation may be able to adjust their work or spending activities to avoid or lessen the effects
• Wages and pensions may have cost of living adjustments (COLAs) built in to offset anticipated inflation
• Expected inflation increases the nominal costs of borrowing while unexpected inflation reduces the real cost of borrowing
• HURT:
• Fixed income groups: they will be hurt because their real income suffers, because nominal income does not rise with the prices
• grandparents, pension people, social security (they getting COLAs)
• Savers: hurt by unanticipated inflation, because inflation takes away from the interest earned on the account
• Lenders: can be hurt by unanticipated inflation, debts will be repaid with cheaper dollars than those that were locked out
• HELP/GAIN:
• Borrowers: can be helped by unanticipated inflation, debts will be repaid with cheaper dollars than those that were loaned out
• EXAMPLE

• Unemployment: failure to use available resources (labor)
• 3 main groups:
• Employed: includes those that are self-employed
• Unemployed
• New entrants
• Re entrants
• Laid off
• Lost last job (fired)
• Quit last job
• Not in the work/labor force
• Armed forces
• Home makers
• Students
• Retirees
• Disabled people
• Discouraged workers
• Those that are in prison
• Those that are in mental institutions
• Unemployment rate: (# of unemployed/total labor force) x 100
• Total labor force = # of unemployed + # of employed

For an example of a problem in finding the unemployment rate, I recommend you watch this video:

• Standard unemployment rate: 4 to 6%
• Lower than 4% = great
• Higher than 6% = you have an issue
• Four Types of Unemployment:
• Frictional: temporary, transitional, short-term
• Characterized as in between jobs and they're searching for a job
• Graduates, people who get fired or quit their jobs
• It signals that new jobs are available
• Will not work for minimum wage
• Cyclical: caused by the recession phase of the business cycle
• Means there is deficient demand for goods and services
• If you're laid off due to recession, that job will come back (advantage)
• Structural: described as technological or long-term
• Due to (reasons):
• Automation: due to consumer taste, jobs may become obsolete
• Creative Destruction: as new jobs are created, others are lost
• When the new jobs come, your skills are no longer transferrable
• Seasonal: weather-related or seasonal jobs
• Ex: construction jobs, Santa Claus, Easter Bunny, Life Guard, school bus drivers
• EXAMPLE

• Full Employment (FE) = natural rate of unemployment (NRU)
• It is equal to structural and frictional employment
• Full employment does not mean zero unemployment
• Okun's Law: describes how unemployment relates to a nation's GDP
• States that for every 1% unemployment above the NRU, a negative GDP gap of 2% will occur
• Unequal burdens of unemployment:
• Rates are lower for white-collar workers
• Teenagers have the highest rates
• Blacks have higher rates than whites
• Raters for males and females are comparable