Gaps Graph

Full Employment- Full Employment Equilibrium exits where AD intersects SRAS and LRAS at the same point

Recessionary Gap- When Equilibrium occurs below Full Employment Output

Inflationary Gap- When Equilibrium occurs beyond Full Employment Output

Aggregate Supply

Aggregate Supply- The Level  of Real GDP (GDPR) that firms will produce at each price level (PL)

Long Run vs. Short Run

• Long Run
• The period of time where input prices are completely flexible and adjust to changes in the price level (PL)
• In the long run, the Level of Real GDP (GDPR) supplied  is independent of PL
• Short Run
• Period of time where input prices are sticky and do not adjust to changes in the PL
• In the short run, the GDPR supplied is directly related to the price level

Long Run Aggregate Supply (LRAS)

• The LRAS marks the level of Full Employment in the economy (can be compared to like the PPC)
• Because input prices are completely flexible in the long run, changes in PL do not change firms' real profits, and thereby do not change firms' level of output. 
• This means that the LRAS is vertical at the economy level of Full Employment.

Changes in Short Run Aggregate Supply (SRAS)

• Increase in SRAS= Shift to the Right
• Decrease in SRAS= Shift to the Left
• Key to understanding shifts in SRAS is Per Unit Cost of Production
• Per Unit Cost of Production= Total Input Cost/ Total Output

Determinants of SRAS 

• Input Prices
• Productivity
• Legal-Institutional Enviroment

Input Prices

• Domestic Resource Prices
• Wages (75% of all business costs)
• Cost of Capital
• Raw Materials (Commodity Prices)
• Foreign Resource Prices
• Market Power

Increase in Resource Prices= SRAS Shift to the Left

Decrease in Resource Prices= SRAS Shifts to the Right

Productivity

• Productivity= Total Output/ Total Inputs
• More Productivity= Lower Unit Production Cost= Shifts SRAS to the Right
• Lower Productivity= Higher Unit Production Cost= Shifts SRAS to the Left

Legal Institutional Environment

• Taxes and Subsidies
• Taxes ($ to Government) on business increase Per Unit Cost of Production= SRAS to the Left
• Subsidies ($ from Government) to business reduce Per Unit Cost of Production= SRAS to the Right
• Government Regulation 
• Government Regulation creates a Cost of Compliance= SRAS Shifts to the Left
• Deregulation reduces Compliance Costs= SRAS to the Right

Aggregate Demand

Aggregate Demand (AD)- the demand by consumers, businesses, government, and foreign countries

• C+I+G+Xn
• Changes in price level cause a move along the curve

Why is AD Downward Sloping?

1. Real-Balance Effect
• Higher price levels reduce purchasing powers of money
• Decreases the quantity of expenditures
• Lower price levels increase purchasing power and increase expenditures
2. Interest- Rate Effect
• When price level increases, lenders need to charge higher interest rates to get a real return on their loans
• High interest rates discourage consumer spending and business investment 
3. Foreign Trade Effect
• When U.S price level rises, foreign buyers purchase fewer U.S goods and Americans buy more foreign goods
• Exports fall and imports rise, causing real GDP demanded to fall (Xn Decreases)

Shifters of Aggregate Demand 

GDP= C+I+G+Xn

• Two parts to a shift in AD
• Change in C, Ig, G, and Xn
• Multiplier effect that produces a greater change than the original change in the 4 components
• Increases in AD= Shift to the Right
• Decreases in AD= Shift to the Left

Consumption

• Household Spending is affected by:
• Consumer Wealth
• More Wealth= More Spending (AD Shifts Right)
• Less Wealth= Less Spending (AD Shifts Left)
• Consumer Expectations 
• Positive Expectations= More Spending (AD Shifts Right)
• Negative Expectations= Less Spending (AD Shifts Left)
• Household Indebtedness
• Less Debt= More Spending (AD Shifts Right)
• More Debt= Less Spending (AD Shifts Left) 
• Taxes
• Less Taxes= More Spending (AD Shifts Right)
• More Taxes= Less Spending (AD Shifts Left)

Gross Private Investment 

• Investment Spending is sensitive to:
• The Real Interest Rate
• Lower Real Interest Rate= More Investment (AD Shifts Right)
• Higher Real Interest Rate= Less Investment (AD Shifts Left)
• Expected Returns
• High Expected Returns= More Investment (AD Shifts Right)
• Lower Expected Returns= Less Investment (AD Shifts Left)
• Expected Returns are Influenced by:
• Expectations of future profitability
• Technology
• Degree of Excess Capacity (Existing Stock of Capital)
• Business Taxes

Government Spending

• More Government Spending (AD Shifts Right)
• Less Government Spending (AD Shifts Left)

Net Exports

• Net Exports Are Sensitive to
• Exchange Rates (International Value of U.S Dollar)
• Strong $= More Imports and Fewer Exports (AD Shifts Left)
• Weak $= Fewer Imports and More Exports (AD Shifts Right)
• Relative Income
• Strong Foreign Economies= More Exports (AD Shifts Right)
• Weak Foreign Economies= Less Exports (AD Shifts Left)
• 
  

Inflation and Unemployment Rate

Who is Hurt and Helped by Inflation?

• Hurt
• Savers
• Lenders/ Creditors
• People on a Fixed Income (Elderly, Welfare)
• Helped
• Debtors

Cost of Living Adjustments (COLA)- Automatic wage increase when inflation occurs

• Ex- California

Unemployment- The failure to use available resources, particularly labor to produce desired goods and services

Labor Force- Those that are above 16 years of age and are able and willing to work

• Labor Force= Employed + Unemployed
• Not included in the Labor Force:
• Military
• Students
• Retired
• Disabled
• Homeworkers
• Mental Institutions
• Jail/ Prisons
• Those who are not looking for a job

Unemployment Rate- 4-5% = Full employment or Natural Rate of Unemployment (NRU)

• Unemployment Rate= (# of unemployed/ (# of employed + # of unemployed)) x 100

Types of Unemployment- 

• Frictional- Those who are searching for a job
• Temporarily Unemployed
• In Between Jobs
• Have Transferable Skills
• Ex- High School Graduate, College Graduate, Laid off Workers
• Structural- Changes in the structure of the labor force that makes some skills obsolete
• Doesn't have transferrable skills
• Have to learn new skills to get a job
• Seasonal- Due to the time of the year and nature of the job
• Ex- Lifeguard, Construction workers, Santa Claus/ Easter Bunny impersonators 
• Cyclical- Results from economic downturns such as recessions/ depressions
• As demand for goods and service decrease, demand for labor falls off and workers get laid off

Frictional + Structural = NRU

Full Employment means there is no cyclical unemployment

Calculating GDP

Budget- Government purchases of goods/ services + government transfer payments- government tax and fee collection.

• Postie= Deficit
• Negative= Surplus

Trade- Exports - Imports

• Positive= Surplus 
• Negative= Deficit

National Income

• Compensation of Employees + Rents + Interest + Corporate Profits + Proprietor's income
• GDP - Indirect Business Taxes - Depreciation - net Foreign Factor Payment

Disposable Personal Income: National Income - Personal Household Taxes + Government Transfer Payments

Net Domestic Product (NDP): GDP - Depreciation 

Net National Product (NNP): GNP - Depreciation

GNP: GDP + net Foreign Factor Payment

Nominal and Real GDP

• Nominal GDP: The value of output produced in current year prices
• Price x Quanity
• Can increase from year to year if either price or quantity increase
• If we wanted to measure an increase in prices (inflation), use nominal GDP
• Real GDP
• Price x Quanity
• Adjusted for Inflation
• Used to measure economic growth
• Can Increase from year to year only if output increases

GDP Deflator- Price index used to adjust from nominal to real GDP

• (Nominal GDP/ Real GDP) x 100
• In base year, GDP deflator always =100
• For years after base year, GDP Deflator > 100
• For years before base year, GDP Deflator < 100

Consumer Price Index(CPI)- Most commonly used measurement of inflation

• Measures the cost of a market basket of goods of typical urban American family
• (Cost of a Market Basket of goods in a given year/ Cost of a Market Basket of goods in the base year) x 100

Inflation Rate- ((Price Index in year 2 - Price Index in year 1)/ Price Index in year 1) x 100

Nominal Interest Rate-% increase in money where the borrower must pay the lender for a loan

• NOT adjusted for inflation
• Expected interest rate + Inflation premium
• Unanticipated Inflation 

Real Interest Rate- % increase in purchasing power where the borrower must pay the lender for a loan

• Adjusted for inflation
• Nominal Interest Rate - Inflation
• Fisher Effect
• Anticipated Inflation

GDP (Gross Domestic Product)

Gross Domestic Product (GDP)- Market product of all final goods and services produced within a country's border in a given year.

Gross National Product (GNP)- Total value of all final goods and services by citizens of that country on its land/foreign land.

What's Included in GDP?

• C- Personal Consumption Expenditures (Wages, Salaries) 
• Ig- Gross Private Domestic Investment:
• New Factory Equipment
• Factory Equipment Maintenance 
• Construction of Housing
• Unsold Inventory (Of Products built in a year)
• G- Government Spending
• Xn- Net Exports (Exports-Imports)

What's not Included in GDP?

• Intermediate Goods- Goods that require further processing before they are ready for final use
• Used/Secondhand Goods- To avoid Double Counting
• Purely Financial Transaction- Ex. (Stocks and Bonds)
• Illegal Activities
• Unreported Business Activity (Unreported tips)
• Transfer Payment
• Public (SS, Welfare, VA)
• Private (Scholarships)
• Non-Market Activity- Volunteer work or work that you do by yourself

2 Ways to Calculate GDP

• Expenditure Approach- Add up all the spending on final goods and services produced in a given year.
• GDP= C + Ig + G + Xn (Exports-imports)
• Most preferred method
• Income Approach- Adds up all the income that resulted from selling all final goods and services produced in a given year.
• GDP= Wages + Rent + Interest + Profit + Statistical adjustments (indirect business taxes, depreciation, and net foreign factor payment)

Compensation of Employees- Wages, salaries, pensions, insurances, health, and welfare.

Rent- Income received by property owners.

• From tenant to landlord

Interest: Money paid by private businesses to the suppliers of loans.

• Mortgage, stocks/bonds

Corporate Projects- The income of the corporation's stockholders.

• Dividends, corporate income taxes

Proprietor's Income- Income that comes from entrepreneurs and partners.

Circular Flow Diagram

Circular Flow Diagram- Represents the Transactions in an Economy

Product Market: 

• Households sell resources and businesses buy resources
• Ex- Goods and Services

Factor/Resource Market: 

• Factors of Production- Land, Labor, Capital, & Entrepreneurship
• Place where Households sell resources & business buys resources

Firms- An organization that produces goods and services for sale

Household- A person or group of people that share their income