SSEMA1, SSEMA2, SSEMA3-EOCT Review

SSEMA1-A.The Components of GDP Recall: GDP is total spending. Four components:

Consumption (C) Investment (I) Government Purchases (G) Net Exports (NX)

These components add up to GDP (denoted Y):

Y = C + I + G + NX

Y = C + I + G + NX

U.S. GDP and Its Components, 2007

–2,344

8,905

7,037

32,228

$45,825

per capita

–5.1

19.4

15.4

70.3

100.0

% of GDP

–708

2,690

2,125

9,734

$13,841

billions

NX

G

I

C

Y

In each of the following cases, determine how much GDP and each of its components is affected (if at all).

A. Debbie spends $200 to buy her husband dinner at the finest restaurant in Boston.

B. Sarah spends $1800 on a new laptop to use in her publishing business. The laptop was built in China.

C. Jane spends $1200 on a computer to use in her editing business. She got last year’s model on sale for a great price from a local manufacturer.

D. General Motors builds $500 million worth of cars, but consumers only buy $470 million worth of them.

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GDP and its componentsGDP and its components

A. Debbie spends $200 to buy her husband dinner at the finest restaurant in Boston.

Consumption and GDP rise by $200.

B. Sarah spends $1800 on a new laptop to use in her publishing business. The laptop was built in China.

Investment rises by $1800, net exports fall by $1800, GDP is unchanged.

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C. Jane spends $1200 on a computer to use in her editing business. She got last year’s model on sale for a great price from a local manufacturer.

Current GDP and investment do not change, because the computer was built last year.

D. General Motors builds $500 million worth of cars, but consumers only buy $470 million of them.

Consumption rises by $470 million, inventory investment rises by $30 million, and GDP rises by $500 million.

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SSEMA1-B. Gross Domestic Product (GDP)

the total value of all final goods and services produced in the US

Economic Growth Growth allows successive generations to

have more and better goods and services than their parents. An increase in standard of living

Unemployment The percentage of the nation’s labor force

that is out of work

SSEMA1-B. Consumer Price Index (CPI)

A price index determined by measuring the price of a standard group of goods meant to represent the “market basket” of a typical urban consumer

Inflation The general rise in price levels

Stagflation A decline in real GDP combined with a rise in the price level

Aggregate Supply The total amount of goods and services in the economy

available at all possible price levels Aggregate Demand

The total amount of goods and services in the economy that will be purchased at all price levels.

SSEMA1.-C. Real GDP Per Capita

Real GDP is the value of the total production of goods and services within a country during a particular period time (usually one year). The number is adjusted for inflation so one year’s production can be compared with another’s.

Per Capita GDP is the GDP figure divided by the population of the country

Real versus Nominal GDP Inflation can distort economic variables

like GDP, so we have two versions of GDP: One is corrected for inflation, the other is not.

Nominal GDP values output using current prices. It is not corrected for inflation.

Real GDP values output using the prices of a base year. Real GDP is corrected for inflation.

EXAMPLE:

Compute nominal GDP in each year:

2005: $10 x 400 + $2 x 1000 = $6,000

2006: $11 x 500 + $2.50 x 1100 = $8,250

2007: $12 x 600 + $3 x 1200 = $10,800

Pizza Latte

year P Q P Q

2005 $10 400 $2.00 1000

2006 $11 500 $2.50 1100

2007 $12 600 $3.00 1200

37.5%

Increase:

30.9%

EXAMPLE:

Compute real GDP in each year, using 2005 as the base year:

Pizza Latte

year P Q P Q

2005 $10 400 $2.00 1000

2006 $11 500 $2.50 1100

2007 $12 600 $3.00 1200

20.0%

Increase:

16.7%

$10 $2.00

2005: $10 x 400 + $2 x 1000 = $6,000

2006: $10 x 500 + $2 x 1100 = $7,200

2007: $10 x 600 + $2 x 1200 = $8,400

SSEMA1-C. Inflation etc.

Inflation: rise in general price level change in price level

Inflation rate= beginning price level x 100

Creeping inflation: 1-3% per yearGalloping inflation: intense; 100-300% per yearHyperinflation: 500% per year and above

Deflation: decrease in general price level

EXAMPLE:

The change in nominal GDP reflects both prices and

quantities.

year

Nominal

GDPReal GDP

2005 $6000 $6000

2006 $8250 $7200

2007 $10,800 $8400

20.0%

16.7%

37.5%

30.9%

The change in real GDP is the amount that GDP would change if prices were constant (i.e., if zero inflation).

Hence, real GDP is corrected for inflation.

SSEMA1-C. Who is “Unemployed?”

Three criteria: Available for work & made specific effort to find a job

in the past month Worked for pay < 1 hour in the

past week (people with part-time jobs are considered employed)

SSEMA1-C. Unemployment

unemployment rate calculation:

Number of unemployed individualsTotal # of persons in civilian labor

force

How the CPI Is Calculated

1. Fix the “basket.”The Bureau of Labor Statistics (BLS) surveys consumers to determine what’s in the typical consumer’s “shopping basket.”

2. Find the prices.The BLS collects data on the prices of all the goods in the basket.

3. Compute the basket’s cost.Use the prices to compute the total cost of the basket.

How the CPI Is Calculated

4. Choose a base year and compute the index.The CPI in any year equals

5. Compute the inflation rate.The percentage change in the CPI from the preceding period.

100 xcost of basket in current year

cost of basket in base year

CPI this year – CPI last year

CPI last year

Inflationrate

x 100%=

EXAMPLE basket: {4 pizzas, 10 lattes}

$12 x 4 + $3 x 10 = $78

$11 x 4 + $2.5 x 10 = $69

$10 x 4 + $2 x 10 = $60

cost of basket

$3.00

$2.50

$2.00

price of latte

$122009

$112008

$102007

price of pizza

year

Compute CPI in each year

2007: 100 x ($60/$60) = 100

2008: 100 x ($69/$60) = 115

2009: 100 x ($78/$60) = 130

Inflation rate:

15%115 – 100

100x 100%=

13%130 – 115

115x 100%=

using 2007 base year:

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CalculatCalculate the CPIe the CPI

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CPI basket: {10 lbs beef, 20 lbs chicken}

The CPI basket cost $120 in 2004, the base year.

A. Compute the CPI in 2005.

B. What was the CPI inflation rate from 2005-2006?

price of

beef

price of

chicken

2004 $4 $4

2005 $5 $5

2006 $9 $6

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A. Compute cost of the 2006 household basket.

($9 x 5) + ($6 x 25) = $195

CPI basket: {10# beef, 20# chicken}

Household basket in 2006:

{5# beef, 25# chicken}

beef chickencost of CPI

basket

2004 $4 $4 $120

2005 $5 $5 $150

2006 $9 $6 $210

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B. Compute % increase in cost of household basket over 2005-6, compare to CPI inflation rate.

Rate of increase: ($195 – $150)/$150 = 30%

CPI inflation rate from previous problem = 40%

CPI basket: {10# beef, 20# chicken}

Household basket in 2006:

{5# beef, 25# chicken}

beef chickencost of CPI

basket

2004 $4 $4 $120

2005 $5 $5 $150

2006 $9 $6 $210

SSEMA1-D.Types of unemployment Frictional: Unemployed people don’t always take the very first job they

can find. They often wait to find a job that fits their talents and preferences. While they search for a job that is a good fit, these people are frictionally unemployed. Other people sometimes purposefully decide to leave a job and look for one that better fits their interests and abilities. These job seekers are also considered frictionally unemployed. Overall, frictional unemployment is not entirely bad for an economy because it gives people time to find a job that suits their needs.

Structural: Structural unemployment occurs when you have job skills that no one wants, or when a company wants to hire somebody but can’t find anyone who has the necessary requirements. Suppose you worked at a company that made old-fashioned phones with dials. Almost no one wants these phones anymore, so once your company closes there is no place for you to use your old-fashioned-phone-making skills. At the same time, suppose that a local company needs people who can design computer networks, but no one in the community has experience in this area. This type of mismatch is a typical example of structural unemployment.

Unemployment- continued Cyclical: Most economies encounter

cyclical periods of growth and recession. During boom years, unemployment drops dramatically as companies hire new workers to match the higher demand. However, boom periods often overreach, and these are followed by recessions. People who are laid off as a result of a contracting economy are cyclically unemployed.

Seasonal: due to changes in weather or change in demand for certain products

You might find a question like the following on the EOCT:

Peggy, a recent college graduate, decides

to look for a job instead of going tograduate school. If she is unable to find ajob that suits her interests right away,what type of unemployment is she MOSTlikely experiencing?A structuralB seasonalC frictionalD cyclical

Answer to sample question

While Peggy may be experiencingcyclical unemployment because of adownturn in the economy, the questionnotes that she is trying to match herskills with a job that she wants.Therefore she is experiencing frictionalunemployment (choice C).

SSEMA1-E.Cycle Phases Recession & Depression Recession: real GDP decreases for 2

quarters (6 months) in a row Depression: severe recession w/3

more elements Very high unemployment Acute shortages Excess manufacturing capacity (idle or

partially unused factories)

SSEMA1-E.Cycle Phases As GDP increases,

there is expansion. When expansion reaches a peak, recession begins. Recession ends at the trough, and expansion (and recovery) begin at that point.

The British call the peak a boomWe call the line above the trend line.

SSEMA1-F National Debts and Government Deficits

What is the difference between national debt and government deficits?

National debt is all the money the gov’t owes to bondholders

Gov’t deficits is when the gov’t spends more than it raises in revenues

Total Public Debt:

SSEMA2 The student will explain the role and functions of the Federal Reserve System.

a. Describe the organization of the Federal Reserve System.

b. Define monetary policy. c. Describe how the Federal Reserve

uses the tools of monetary policy to promote price stability, full employment, and economic growth.

SSEMA2-What is the Fed?hat is the Fed?

The nation’s first true The nation’s first true centralcentral bank bank Created in 1913Created in 1913 National banks required to be National banks required to be

membermember State banks eligible to be a memberState banks eligible to be a member Privately owned Publicly operated Privately owned Publicly operated Federal Reserve Notes (gold standard Federal Reserve Notes (gold standard

1913-1934)1913-1934)

a. Describe the organization of the Federal Reserve System.

The Federal Reserve System consists of: Board of Governors

(7 members), located in Washington, DC

12 regional Fed banks, located around the U.S.

Federal Open Market Committee (FOMC), includes the Bd of Govs and presidents of some of the regional Fed banks The FOMC decides monetary policy.

Structure of the FedStructure of the Fed

Board of Governors Board of Governors (regulatory and supervisory (regulatory and supervisory group)group)

14 year terms14 year terms

General policiesGeneral policies

Annual Report to CongressAnnual Report to Congress

Monthly Public BulletinMonthly Public Bulletin

Structure of the FedStructure of the Fed 12 Districts, 25 Branches12 Districts, 25 Branches

Structure of the FedStructure of the Fed

Federal Open Market Committee Federal Open Market Committee (FOMC)(FOMC)

(the Fed’s primary monetary policy body)(the Fed’s primary monetary policy body)

How does the money supply grow?How does the money supply grow? Where are interest rates set?Where are interest rates set?

12 voting members12 voting members

Responsibilities of the FedResponsibilities of the Fed

State Member banksState Member banks Monitor reserves Monitor reserves

Bank Holding CompaniesBank Holding Companies

International OperationsInternational Operations Foreign banks own about 20% of US banking Foreign banks own about 20% of US banking

assetsassets Approx. 800 branches of US banks abroadApprox. 800 branches of US banks abroad

Member bank mergersMember bank mergers

b. Define monetary policy.

Actions by the Federal Reserve Actions by the Federal Reserve System to expand or contract System to expand or contract the the money supplymoney supply in order to in order to affect the cost and availability affect the cost and availability of goodsof goods

c. Describe how the Federal Reserve uses the tools of monetary policy to promote price stability, full employment, and economic growth.

The Fed’s 3 Tools of Monetary Control1.Open-Market Operations (OMOs): the purchase

and sale of U.S. government bonds by the Fed.

To increase money supply, (recession) Fed buys govt bonds, paying with new dollars. …which are deposited in banks, increasing reserves…which banks use to make loans, causing the money supply to expand.

To reduce money supply, (inflationary period) Fed sells govt bonds, taking dollars out of circulation, and the process works in reverse.

The Fed’s 3 Tools of Monetary Control1.Open-Market Operations (OMOs): the purchase

and sale of U.S. government bonds by the Fed.

OMOs are easy to conduct, and are the Fed’s monetary policy tool of choice.

The Fed’s 3 Tools of Monetary Control2.Reserve Requirements (RR):

affect how much money banks can create by making loans.

To increase money supply, (recession) Fed reduces RR.

Banks make more loans from each dollar of reserves, which increases money multiplier and money supply.

To reduce money supply, (inflationary period) Fed raises RR, and the process works in reverse.

Fed rarely uses reserve requirements to control money supply: Frequent changes would disrupt banking.

The Fed’s 3 Tools of Monetary Control3.The Discount Rate:

the interest rate on loans the Fed makes to banks

When banks are running low on reserves, they may borrow reserves from the Fed.

To increase money supply, (recession) Fed can lower discount rate, which encourages banks to borrow more reserves from Fed.

Banks can then make more loans, which increases the money supply.

To reduce money supply, (inflationary period) Fed can raise discount rate.

The Fed’s 3 Tools of Monetary Control3.The Discount Rate:

the interest rate on loans the Fed makes to banks

The Fed uses discount lending to provide extra liquidity when financial institutions are in trouble, e.g. after the Oct. 1987 stock market crash.

If no crisis, Fed rarely uses discount lending – Fed is a “lender of last resort.”

Here is what a question for this standard might look like:

The Federal Reserve wants to reduce thenation’s money supply. This could beaccomplished by doing all of the followingEXCEPTA decreasing the discount rateB increasing the reserve requirementC selling securities on the open marketD making banks hold a reserve for all types of

deposits

Answer to sample question

Decreasing the discount rate willencourage banks to borrow money fromthe Federal Reserve and make loans.This will increase the money supply, sochoice A is the correct answer. All otherchoices reduce the nation’s moneysupply.

SSEMA3 The student will explain how the government uses fiscal policy to promote price stability, full employment, and economic growth.

a. Define fiscal policy. b. Explain the government’s taxing

and spending decisions.

a. Define fiscal policy.

The use of gov’t spending and revenue collection to influence the economy

Federal Taxation

Revenue Collections

Individual Income Taxes Social Insurance Taxes Corporate Income Tax

(revenue tax) Excise Taxes Estate and Gift Taxes Customs Duties Tariffs

Revenue Spending

Social Security National Defense Medicare Debt Payments Transportation Agriculture Education Health and Human Svcs

b. Explain the government’s taxing and spending decisions.

Fiscal Policy Tools

Expansionary Tools (recession)

1.Increase gov’t spending

2.cutting taxes

Contractionary Tools (inflationary period)

1.decreasing gov’t spending

2.raising taxes

Sample Questions for Macroeconomics

1 What problem might policymakers betrying to address MOST if they increasefunding for training programs covering skills such as computer repair,programming, and networking?A frictional unemploymentB structural unemploymentC cyclical unemploymentD seasonal unemployment

Answer to 1

1. Answer: B Standard: Key Economic Indicators

The policymakers are attempting toaddress the question of matchingemployee skills to available jobs. This is a direct reference to structuralunemployment.

Question 2

2 Monetary policies the FederalReserve can adopt include all of thefollowing EXCEPTA raising the discount rateB buying government bondsC lowering the reserve requirementD raising personal income tax rates

Answer to 2

2. Answer: D Standard: Role of the Federal Reserve

Choices A, B, and C are important FederalReserve monetary policies that directly affectthe money supply. Choice D is the correctanswer because Congress, not the FederalReserve, establishes income tax rates.

Question 3

3 Over a two-year period, the nation ofParthia experiences a steep decline inunemployment rate, a rise in real GDP,and a stabilized price level. Parthiaappears to beA at the start of a recessionB in the middle of a depressionC stagnating economicallyD in the middle of a boom period

Answer to 3

3. Answer: D Standard: Key Economic Indicators

All three economic indicators arepositive. Unemployment is down, theeconomy is growing, yet price levelshave not moved. These good timestranslate to a boom, choice D.

Question 4

4. If the unemployment rate isrising and the GDP is falling, thefiscal policy that the federal governmentshould MOST likely follow isA decreasing taxesB decreasing spendingC decreasing the money supplyD decreasing the reserve requirement

Answer to 44. Answer: A Standard: Fiscal policy and the federal

governmentChoices C and D are monetary policies, so neither ofthese options is correct. Fiscal policy is a tool that thegovernment uses to regulate the speed of the economy.When the unemployment rate is rising and the GDP isfalling, the government should speed up the economy. Decreasing taxes, choice A, would be onepossible way to achieve that goal. Decreasing spending,choice B, would slow down the already sluggish economy.