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ECON 1102 - Review Part 1, Study notes of Economics

This is the first 4 chapters of ECON 1102, that I studied and created into a review. It has all material required for Midterm 1, and it also has a few sample questions dor each chapter.

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Available from 05/12/2023

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Principles of Macroeconomics
Chapter 1- Economic Issues and Concepts
What is Economics?
- Economics is the study of the use of scarce resources to satisfy unlimited human wants.
- Scarcity indicates that resources are not unlimited and that if resources were not scarce, then choices
would not have to be made.
What are the factions of production/input?
- Land: All natural endowments such as arable land, forests, lakes, crude oil, and minerals.
- Labor: The mental/physical human resources, like entrepreneurial capacity and management skills.
- Capital: All manufactured (produced) aids to production, such as tools, machinery, and buildings.
What are goods and services?
- Goods are tangible, while Services are intangible.
- The act of making goods and services is called production and the act of using them is consumption.
What is Opportunity Cost?
- It is the value of the next best alternative that is forgone when one alternative is chosen.
- It can be shown using a budget line, which is a negatively sloped line that indicates the boundary
between attainable (efficient) and unattainable (inefficient) combinations.
- The opportunity cost for a country is shown using a production possibilities boundary (PPB), a curve
showing which alternative combinations of output can be attained if all available resources are used
efficiently.
What is the law of increasing opportunity costs?
- It states that as the production of one good increases, the opportunity cost of producing an additional
unit rises.
What are the 4 key economic questions?
1. What is produced and how? Resources must be allocated among alternative uses to determine which
goods are produced, and which are not. (MICRO)
2. What is consumed? By whom? What determines how a country’s total output is distributed among its
residents? Why do some get a lot and others only a little, should governments try to alter it? (MICRO)
3. Why are resources sometimes unused? If a society is not using all of its resources, then the society is
operating inside the PPB. Why would this happen? How should governments deal with it? (MACRO)
4. Is productive capacity growing? Growth in productive capacity is shown by an outward shift of the PPB,
making previously unattainable points now attainable. (MACRO)
What is Macroeconomics?
- The study of the determination of economic aggregates such as total output, employment, and growth.
What are the characteristics of a Market Economy?
- Self-Organizing, not organized by the central authority
- Efficient, which means that the resources available are organized to produce goods and services while
using the least amount of resources.
- Focused on Incentives, buy low and sell high. Maximizing consumers and making Marginal decisions to
help them determine if they are better off producing one more/less of a good.
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Principles of Macroeconomics Chapter 1- Economic Issues and Concepts What is Economics?

  • Economics is the study of the use of scarce resources to satisfy unlimited human wants.
  • Scarcity indicates that resources are not unlimited and that if resources were not scarce, then choices would not have to be made. What are the factions of production/input?
  • Land: All natural endowments such as arable land, forests, lakes, crude oil, and minerals.
  • Labor: The mental/physical human resources, like entrepreneurial capacity and management skills.
  • Capital: All manufactured (produced) aids to production, such as tools, machinery, and buildings. What are goods and services?
  • Goods are tangible, while Services are intangible.
  • The act of making goods and services is called production and the act of using them is consumption. What is Opportunity Cost?
  • It is the value of the next best alternative that is forgone when one alternative is chosen.
  • It can be shown using a budget line, which is a negatively sloped line that indicates the boundary between attainable (efficient) and unattainable (inefficient) combinations.
  • The opportunity cost for a country is shown using a production possibilities boundary (PPB), a curve showing which alternative combinations of output can be attained if all available resources are used efficiently. What is the law of increasing opportunity costs?
  • It states that as the production of one good increases, the opportunity cost of producing an additional unit rises. What are the 4 key economic questions?
  1. What is produced and how? Resources must be allocated among alternative uses to determine which goods are produced, and which are not. (MICRO)
  2. What is consumed? By whom? What determines how a country’s total output is distributed among its residents? Why do some get a lot and others only a little, should governments try to alter it? (MICRO)
  3. Why are resources sometimes unused? If a society is not using all of its resources, then the society is operating inside the PPB. Why would this happen? How should governments deal with it? (MACRO)
  4. Is productive capacity growing? Growth in productive capacity is shown by an outward shift of the PPB, making previously unattainable points now attainable. (MACRO) What is Macroeconomics?
  • The study of the determination of economic aggregates such as total output, employment, and growth. What are the characteristics of a Market Economy?
  • Self-Organizing, not organized by the central authority
  • Efficient, which means that the resources available are organized to produce goods and services while using the least amount of resources.
  • Focused on Incentives, buy low and sell high. Maximizing consumers and making Marginal decisions to help them determine if they are better off producing one more/less of a good.

What is the Circular Flow of Income and Expenditure?

  • The goods and services flow from firms through good markets to households.
  • Money payments flow from firms to individuals through factor markets.
  • Output EQUALS Income
  • The inner circle is real transactions
  • The outer circle is financial transactions What are the characteristics of production?
  • Specialization of Labor is the allocation of different jobs to different people.
  • Division of Labor is the breaking up of a production process into a series of specialized tasks. What are the types of economies?
  • Traditional, Command, and Free-Market.
  • Every economy is a mixed economy since it combines significant elements of all three systems. Sample Questions-
  1. What is the cost of one additional unit increase in an activity called?
  • Marginal Cost.
  1. Mothers Against Drunk Drivers (MADD) campaigned to increase the legal penalties of drunk driving. This successful campaign ________ of drunk driving.
  • Increased the Marginal Cost.
  1. As the circular flow model points out, a choice that households make is how…
  • Many goods and services are purchased.
  1. In the circular flow model, consumption goods are bought and sold in the…
  • Goods market.
  1. Ali decides to attend the one-hour review session for microeconomics instead of working at his job. His job pays him $10 per hour. Ali's opportunity cost of attending the review session is…
  • The $10 he could have earned at his job.
  1. The fact of increasing opportunity cost when moving on the PPB means that…
  • Increasing the production of one product requires larger and larger sacrifices for the other good.
  1. When a nation is producing on its production possibilities boundary, if more resources are used to produce one good, then the production of other goods…
  • MUST decrease!
  1. The slope of the budget line represents an opportunity cost because moving along the line,
  • a consumer must give up some of one good in order to get more of the other.
  1. An increase in a consumer's budget…
  • Increases consumption possibilities.

What are the types of Employment?

  • When the economy is at POTENTIAL GDP (Y*), there is full employment. Although, even at full employment, some unemployment exists.
  1. Frictional Unemployment is caused by natural turnover in the labor market, it is short-term.
  2. Structural Unemployment is caused by a mismatch between jobs and workers, it is long-term.
  3. Cyclical Unemployment is when REAL GDP is less than POTENTIAL GDP (Y < Y). Zero when Y = Y.
  • Actual Unemployment = Frictional + Structural + Cyclical What are some Unemployment Rate Trends?
  • The Unemployment Rate rises during recessions and falls during expansions.
  • Unemployment (especially long-term), represents lost potential output due to unused resources, which can incur social costs.
  • Workers who are unemployed for a long time leave the Labor Force, becoming discouraged workers.
  • The Labor Force grows, because of a higher birth rate, more immigrants, and women entering the LF. What is productivity?
  • Productivity is a measure of the amount of output that the economy produces per unit of input.
  • Labor Productivity is the level of REAL GDP divided by the level of employment (total hours worked).
  • GDP per person/capita is GDP divided by POP. What are Price Levels and Indexes?
  • Price Level is the average level of all prices in the economy expressed as an index (relative to 100) number, Inflation is a rise in the average level of all prices.
  • Consumer Price Index (CPI) is an index of the average prices of goods and services commonly bought by households.
  • It is based on the price of a “typical” consumption basket, relative to the price in a base year.
  • CPI = (price of the 2002 basket in the CURRENT year / price of the basket in the base year) X 100
  • Inflation Rate = {(CPI CURRENT Year – CPI PREVIOUS Year) / CPI PREVIOUS Year} X 100
  • If CPI goes UP, it is inflation. If CPI goes DOWN, it is deflation. What is the Purchasing Power of Money?
  • It is the amount of goods and services that can be purchased with a unit of money.
  • Inflation matters because it reduces the purchasing power of money and reduces the REAL (adjusted for inflation) value of any sum fixed in NOMINAL (dollar) terms, like a bank account.
  • If households and firms anticipate inflation, they will be able to adjust many NOMINAL prices and wages to maintain their REAL values. Unanticipated inflation leads to more changes. What is an Interest Rate?
  • Interest rate is the price paid per dollar borrowed per period of time.
  • NOMINAL Interest rate (i) is the price paid per dollar borrowed per period of time.
  • REAL Interest rate (r) is the rate of interest adjusted for the change in the purchasing power of money, which is equal to the NOMINAL Interest Rate minus the Rate of Inflation (), r = i -  AND i = r +  What is an Exchange Rate?
  • It is the number of units of domestic currency required to purchase one unit of foreign currency.
  • Foreign Exchange refers to foreign currencies or claims on foreign currencies, payable in foreign money
  • A RISE in the exchange rate means it takes more CAD to buy a unit of foreign currency. Depreciation!
  • A FALL in the exchange rate means it takes less CAD to buy a unit of foreign currency. Appreciation!

What are Net Exports?

  • Net Exports (NX) are the difference between exports (X) and imports (I), also called trade balance.
  • Canada’s Imports (I) are the goods and services Canada buys from other countries.
  • Canada’s Exports (X) are the goods and services Canada sells to other countries. Is it Growth or Fluctuation?
  • Long-term trends of increases in both total output and in-output per person mean that average living standards are rising.
  • Long-term growth receives less attention, however, it has more importance for a society’s living standards from decade to decade. Sample Questions-
  1. The real rate of interest is equal to the nominal interest rate…
  • Minus the rate of inflation.
  1. Unemployment arising from a persistent mismatch between the skills and characteristics of workers and the requirements of jobs is called…
  • Structural Unemployment.
  1. Potential GDP is defined as
  • The level of GDP is attained when all firms are producing at capacity.
  1. What is the potential or full-employment output?
  • The GDP that would be produced if the economy's resources were fully employed at a normal intensity of use.
  1. The reference base period is 2002. A consumer price index of 122 in 2018 means that
  • The average of prices paid by urban consumers for a fixed market basket of consumer goods and services was 22 percent higher in 2018 than it was on average during 2002.
  1. If the inflation rate is negative, the price level in an economy is…
  • Falling
  1. In general, productivity is a measure of…
  • The amount of output that the economy produces per unit of input.
  1. Suppose a country has an unemployment rate of 20%. If we know that the population is 38 million and the labor force is 25 million, then the number of people unemployed is…
  • 5 million.
  1. Which of the following causes the unemployment rate to understate the true extent of joblessness?
  • Discouraged workers are not counted as unemployed.
  1. An upward trend in real national income over an extended period of time is called…
  • Economic growth.

What does GDP look like from the Expenditure Side?

  • GDP (Y) for a given year is calculated from the expenditure side by adding up the expenditures needed to purchase the final output produced in that year:
  • Consumption Expenditure, Investment Expenditure, Government Purchases, and Net Exports.
  1. Consumption Expenditure (C) is household expenditure on all goods and services, both durable (cars, furniture) and non-durable (gasoline, food), as well as services (haircuts, education).
  2. Investment Expenditure (I)is expenditure on the production of goods not for present consumption capital goods like factories and machinery, residential housing, and inventories.
  • Inventories are stocks of raw materials, goods in process, and finished goods held by firms to mitigate the effect of short-term fluctuations in production or sales. The economy’s total quantity of capital goods is called capital stock. The process of creating new capital goods is called fixed investment.
  • The total investment that occurs in the economy is called Gross Investment.
  • Net Investment is Gross Investment less depreciation, which is the amount of capital stock depleted, throughout the production process.
  1. Government Purchases (G) are all federal, provincial, and municipal government expenditures on currently produced goods and services, except for government transfer payments like social assistance.
  2. Net Exports (NX) is the value of total exports minus the value of total imports. (X – IM)
  • Imports (IM) are the value of all goods and services purchased from firms, households, or governments in other countries. Imports do NOT reduce GDP! NX goes DOWN, but C goes UP.
  • Exports (X) are the value of all Canadian-made goods and services sold to firms, households, and governments in other countries.
  • GDP = ACTUAL (a) total expenditure on domestically produced output. GDP = Y = Ca + Ia + Ga + NXa What does GDP look like from the Income Side?
  • The calculation of GDP from the income side involves adding up the factor incomes (payments to labor/capital/land) and other claims on the value of output until all of that value is accounted for.
  • Factor Incomes: wages and salaries (payments to labor), interest, business profits (other payments)
  • Non-Factor Payments: indirect taxes minus subsidies, and depreciation. Indirect taxes are taxes on the production and sale of goods and services. Subsidies act like negative taxes and are payments from governments to firms. Portions of current output replace worn-out physical capital, thus depreciation.
  • GDP is the sum of factor incomes + indirect taxes (net of subsidies) + depreciation.
  • National Income and National Expenditure should sum to the same number because they are measured with slight error. Included in the measuring process is Statistical Discrepancy, which makes sure that the independent measures of income and expenditure come to the same total. What are some issues with National Income Accounting?
  • Total GDP valued at current (this year) prices is called NOMINAL GDP.
  • GDP valued at base-period prices (constant dollars) is called REAL GDP, which is more suitable to use.

Good

Price Quantity Price Quantity Apples $1.00 100 $1.50 110 Oranges $0.60 200 $0.75 240 What is the GDP Deflator?

  • It is an index number derived by dividing NOMINAL GDP by REAL GDP. Its change measures the average change in the price of all the items in GDP.
  • Therefore, it must also be true that NOMINAL GDP = REAL GDP X GDP Deflator
  • The CPI and the GDP Deflator are both measures of prices, but the Deflator does not change in line with changes in CPI, since they are measuring two different things.
  • Movements in CPI measure the change in the average price of consumer goods, some are imported.
  • Movements in the Deflator echo the change in average price of all goods & services produced in CAD. Sample Questions-
  1. In macroeconomics, the term "capital goods" refers to…
  • Human-made factors of production, such as tools, machines, and factory buildings.
  1. Classify the following: Item 1. A DVD bought by a household Item 2. A new airplane bought by WestJet
  • Item 1: A final good that is consumption expenditure; Item 2: A final good that is an investment
  1. Which of the following would be classified as "investment" in the national income and product accounts?
  • The construction of a new factory.
  1. In the circular flow model,…
  • Firms are sellers of goods and services in goods markets.
  1. One major reason that GDP is an inaccurate measure of the true level of economic activity is that…
  • It does not include non-market activities.
  1. The GDP deflator is the…
  • The ratio of nominal GDP to real GDP is multiplied by 100.
  1. Which of the following would be directly counted in GDP in 2020?
  • Kitchen cabinets purchased from Home Depot in 2020 to be installed in a house built in 2010
  1. Intermediate goods are…
  • Produced by one firm, bought by another firm, and used as a component of a final good or service. Nominal GDP 2018 = ($1.00 X 100) + ($0.60 X 200) = $ Nominal GDP 2019 = ($1.50 X 110) + ($0.75 X 240) = $ Real GDP 2018 = ($1.00 X 100) + ($0.60 X 200) = $ Real GDP 2019 = ($1.00 X 110) + ($0.60 X 240) = $

What is Desired Investment Expenditure?

  • Investment Expenditure is the most volatile component of GDP, and changes in Investment Expenditure are strongly associated with aggregate economic fluctuations.
  • Categories of investment: new plant & equipment, residential construction, inventory accumulation.
  • The most important determinants of Desired Investment Expenditure are the real interest rate, change in the level of sales, and business confidence.
  • The real interest rate reflects the opportunity cost associated with the investment. The higher the rate, the higher the opportunity cost of investment, and the lower the amount of desired investment.
  • The higher the level of sales, the larger the desired stock of inventories.
  • Investment also depends on firms’ expectations about the future state of the economy, optimism leads to more desired investment, while pessimism leads to less desired investment. What is the Aggregate Expenditure Function?
  • It relates the level of desired aggregate expenditure to the level of ACTUAL National Income, it is equal to desired consumption plus desired investment. AE = C + I
  • AE = C + I = 200 + 0.8Y (C) + 100 (I). AE = 300 + 0.8Y
  • The desired Aggregate Expenditure function is upward sloping, with a positive intercept (autonomous spending) and a slope between 0 + 1. What is Equilibrium National Income?
  • In equilibrium, there is no tendency for a change in Y. ACTUAL National Income (Y = GDP) must equal what agents in the economy desire to spend (desired aggregate expenditure, AE, C + I). AE = Y = C + I
  • If desired aggregate expenditure exceeds actual income, inventories are falling (signal), firms increase production (response), causing pressure for actual income to rise. AE > Y
  • If desired aggregate expenditure is less than actual income, inventories are rising (signal), firms decrease production (response), causing pressure for actual income to fall. AE < Y
  • The equilibrium condition, Y = AE, is a 45-degree line. If output is below the line, AE is greater than Y. If the output is above the line, Y is greater than AE.
  • The slope of the AE function is the Marginal Propensity to Spend. Change in AE / Change in Y. How is Equilibrium Income found?
  • C = 200 + 0.8Y = Consumption
  • I = 100 = Investment
  • AE = C+ I = Desired Aggregate Expenditure
  • Y = AE = Equilibrium Condition
  • AE = 300 + 0.8 Y
  • Y = AE
  • Y = 300 + 0.8Y
  • 1Y – 0.8Y = 300
  • 0.2Y = 300
  • Y = 300/0.
  • Y = 1500

What are Changes in Equilibrium National Income?

  • The equilibrium level of National Income occurs where the AE Function intersects the 45-degree line.
  • A parallel shift in the AE Function occurs due to changes in autonomous expenditure. o A shift UP leads to an increase in Equilibrium National Income o A shift DOWN leads to a decrease in Equilibrium National Income
  • A change in the slope of the AE Function occurs due to a change in the Marginal Propensity to Spend. o An Increase in the Marginal Propensity to Spend steepens the function and increases E-Income.
  • If desired investment changes, there will be a change in output that is greater than the change in investment. This “multiple” effect on output is called the Multiplier.
  • The Multiplier is equal to the ratio of the final change in Equilibrium National Income to the initial changes in autonomous spending (Change in Y / Change in A).
  • So, suppose investment spending rises, making the output of investment goods rise. When the output rises, the income of those producing the investment good also rises, which increases their consumption spending. The output of consumption goods rises, leading to a further rise in income. Effects of the Marginal Propensity to Spend
  • Suppose, Desired investment increased by $10M, causing households to consume $8M and save $2M.
  • Then, using the $8M to consume, they consume $6.4M and save $1.6M.
  • Then, using the $6.4M to consume, they consume $5.12M and save $1.28M. And so on.
  • The increase in output is smaller because the increase in output in each round is equal to the increase in output in the previous round multiplied by the Marginal Propensity to Spend (0.8)
  • Change in I is 10, so I 2 = 110, making AE 2 = 310 + 0.8Y. Y = 310 + 0.8Y. 1Y – 0.8Y = 310. Y 2 = 1550
  • Since the change in Y is 50 when change in I = 10, then the change in Y/change in I = 50/10 = 5.
  • The formula for the simple multiplier is change in Y / change in A = 1 / (1-z), where “z” is the Marginal Propensity to spend out of National Incomes and the change in A is autonomous expenditure.
  • The larger the Marginal Propensity to spend, the steeper the AE function and the larger the multiplier.
  • Changes in desired Aggregate Expenditure leads to changes in National Income, this link between expectations and national income suggests that expectations about a healthy economy can actually produce a healthy economy, making it a self-fulfilling prophecy. Sample Questions-
  1. If an increase in investment spending of $20 million results in a $200 million increase in equilibrium real GDP, then… the multiplier is 10.
  2. The vertical distance between the consumption function and the 45° line measures… saving / dissaving
  3. If there is an unplanned increase in inventories, aggregate planned expenditure is… less than real GDP and firms decrease production.
  4. Consider the simplest macro model with a constant price level and demand-determined output. In such a model, an upward shift of the saving function causes the equilibrium national income to… fall because the AE function shifts downward simultaneously.
  5. A decrease in the marginal propensity to spend out of national income will cause… a decrease in the slope of the AE curve, which rotates it downward.