Page 191 - Krugmans Economics for AP Text Book_Neat

Section 3 Summary

Disposable income, total household income minus different groups in the population; it is typically higher
taxes plus government transfers, is allocated to con- for younger workers and for workers near retirement age
sumer spending (C) in the product markets and pri- than for workers in their prime working years.
vate savings. Via the financial markets, private savings 6. The unemployment rate is affected by the business cycle.
and foreign lending are channeled to investment spend- The unemployment rate generally falls when the growth
ing (I), government borrowing, and foreign borrowing. rate of real GDP is above average and generally rises
Government purchases of goods and services (G) are when the growth rate of real GDP is below average.
paid for by tax revenues and government borrowing.
7. Job creation and destruction, as well as voluntary job
Exports (X) generate an inflow of funds into the country
separations, lead to job search and frictional unem-
from the rest of the world, but imports (IM) lead to an
ployment. In addition, a variety of factors such as mini-
outflow of funds to the rest of the world. Foreigners can
mum wages, unions, efficiency wages, and government
also buy stocks and bonds in the U.S. financial markets.
policies designed to help laid -off workers result in a sit-
2. Gross domestic product, or GDP, measures the value uation in which there is a surplus of labor at the market
of all final goods and services produced in the econ- wage rate, creating structural unemployment. As a re-
omy. It does not include the value of intermediate sult, the natural rate of unemployment, the sum of
goods and services, but it does include inventories frictional and structural unemployment, is well above
and net exports (X − IM). It can be calculated in three zero, even when jobs are plentiful.
ways: add up the value added by all producers; add up
8. The actual unemployment rate is equal to the natural
all spending on domestically produced final goods and
services, leading to the equation GDP = C + I + G + X − rate of unemployment, the share of unemployment that
is independent of the business cycle, plus cyclical un-
IM, also known as aggregate spending; or add up all
employment, the share of unemployment that depends
the income paid by domestic firms to factors of pro-
on fluctuations in the business cycle.
duction. These three methods are equivalent because in
the economy as a whole, total income paid by domestic 9. The natural rate of unemployment changes over time,
firms to factors of production must equal total spend- largely in response to changes in labor force characteris-
ing on domestically produced final goods and services. tics, labor market institutions, and government policies.
3. Real GDP is the value of the final goods and services 10. Inflation does not, as many assume, make everyone
produced calculated using the prices of a selected base poorer by raising the level of prices. That’s because if
year. Except in the base year, real GDP is not the same as wages and incomes are adjusted to take into account a
nominal GDP, the value of aggregate output calculated rising price level, real wages and real income remain
using current prices. Analysis of the growth rate of aggre- unchanged. However, a high inflation rate imposes
gate output must use real GDP because doing so elimi- overall costs on the economy: shoe- leather costs,
nates any change in the value of aggregate output due menu costs, and unit -of-account costs.
solely to price changes. Real GDP per capita is a measure 11. Inflation can produce winners and losers within the econ-
of average aggregate output per person but is not in itself omy, because long -term contracts are generally written in
an appropriate policy goal. U.S. statistics on real GDP are dollar terms. Loans typically specify a nominal interest
always expressed in “chained dollars,” which means they rate, which differs from the real interest rate due to in-
are calculated with the chain-linking method of averag- flation. A higher-than-expected inflation rate is good for
ing the GDP growth rate found using an early base year borrowers and bad for lenders. A lower-than-expected in-
and the GDP growth rate found using a late base year. flation rate is good for lenders and bad for borrowers.
4. Employed people currently hold a part-time or full- 12. It is very costly to create disinflation, so policy makers
time job; unemployed people do not hold a job but are try to prevent inflation from becoming excessive in the
actively looking for work. Their sum is equal to the first place.
labor force, and the labor force participation rate is 13. To measure the aggregate price level, economists cal-
the percentage of the population age 16 or older that is culate the cost of purchasing a market basket. A price
in the labor force. index is the ratio of the current cost of that market bas-
5. The unemployment rate, the percentage of the labor ket to the cost in a selected base year, multiplied by 100.
force that is unemployed and actively looking for work, 14. The inflation rate is the yearly percent change in a
can overstate or understate the true level of unemploy- price index, typically based on the consumer price
ment. It can overstate because it counts as unemployed index, or CPI, the most common measure of the aggre-
those who are continuing to search for a job despite hav- gate price level. A similar index for goods and services
ing been offered one (that is, workers who are friction- purchased by firms is the producer price index, or
ally unemployed). It can understate because it ignores PPI. Finally, economists also use the GDP deflator,
frustrated workers, such as discouraged workers, mar- which measures the price level by calculating the ratio
ginally attached workers, and the underemployed. In of nominal to real GDP times 100.
addition, the unemployment rate varies greatly among
Summary 149