Unit II

Types of Economic Systems:
1. Command - Centrally planned, the government owns land and capital, and controls labor
       - Cuba (government controls every facet)
2. Traditional - Based on rituals, habits, and customs. Most decisions are made by the elder
       - Tribes
3. Free Market - People and firms act on their own best interest. Allows buyers and sellers to exchange goods and services
      - Hong Kong
4. Mixed - Government regulates businesses to protect the public's interest
      - U.S., Canada, Mexico

3 Economic questions 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?

Markets: Institution or a mechanism, allowing buyers and sellers to make trades (borrowing or paying)

• Product Market - Buyer is usually a consumer and the seller is a firm
• Factor Market - Factor of productions (CELL)
• Most important is labor
• Buyer = firm; sellers = factor owner
• If firms/businesses demand resources = Factor Market
• Customers buying products = Products Market

Households - Person or 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 the country's borders within a given year
• Includes: All production or income earned within the U.S. by U.S. and foreign producers
• Excludes: Production outside of the U.S. even by Americans

Gross National Product (GNP)

• Total value of all final goods and services produced by Americans in a year
• Includes: Production or income earned by Americans anywhere in the world
• Excludes: Production by non-Americans even in the U.S.

 Calculating GDP

GDP = C + Ig + G + Xn

• C = Personal Consumption -  purchases of finished goods/services
• Consumption spending
• Ig = Gross Private Domestic Investment - Investment spending
• New factory equipment
• Construction of housing
• Factory equipment maintenance
• Unsold inventory of products built in a year
• G = Government Spending - gov't purchase of goods/services
• Xn = Net Exports (Exports - Imports)
• French company purchases one-year membership at Partypeople.com, U.S. based company

Items that DO NOT count in GDP

• Gifts or transfers (Scholarships)
• Stocks and bonds
• Unreported business activities (Cash tips to waiters)
• Illegal activities
• Financial transactions between banks
• Financial transactions between banks and businesses
• Intermediate goods (what you use to make a certain product)
• Non-market activities (Volunteering or baby sitting)

Expenditure Approach - Income generated from production of goods/services

• C + Ig + G + Xn

Income Approach - All income generated from production of final output

• W + R + I + P
• W = wages, R = rents, I = interests, P = profits

Both sides have to equal!

Net National Product (NNP) = GNP - Depreciation (consumption of fixed capital)

Net Domestic Product (NDP) = GDP - Depreciation

National Income (NI) - Income earned by American owned resources, whether here or abroad

1. NNP - Indirect Business Taxes (IBT)
2. CE (compensation of employees) + RI (rental income) + II (interest income) + CP (corporate profits) + PI (proprietor's income)
3. GDP - IBT - Depreciation - Net foreign factor payments

Disposable Personal Income (DPI) = NI - HT (household taxes) + GTP (government transferred payments)

Real GDP - Measures GDP in constant dollars, is adjusted for inflation, therefore it reverts to base year prices

Nominal GDP - Measures GDP in current prices, regardless of output

• P * Q = NGDP

GDP Deflate - Measure of the level of prices of all new domestically produced final goods/services in an economy

• (Nominal GDP / Real GDP) x 100

Inflation Rate - Rise in the general level of prices

• [(Price index in year 2 - Price index in year 1) / (PI in year 1)] x 100

Consumer Price Index (CPI) - Most widely used measure of the overall price level in the U.S.

• (Price of market basket in particular year / Price of same market in different year) x 100

Inflation - Rise in general price level (standard rate is 2-3%)

Deflation - Decline in general price level

Disinflation - Occurs when the inflation rate declines

Solving Inflation Problems

Inflation Rate = (current year - prior year) / prior year
Rule of 70 - How many years it will take to double inflation (70 / inflation rate)
Real Interest Rate (cost of borrowing/lending money that is adjusted for inflation
 = Nominal interest rate - inflation (unadjusted cost of borrowing and lending money)

Causes of Inflation

• Demand-pull: caused by an excess of demand over output that pulls prices upward
• Sources:
• Increases in government purchases
• Excessive increases in the money supply which creates a situation of hyper inflation (rapid rise/extremely high inflation rate)
• Rise in income as the economy approaches FE output (as workers earn more, demand increases)
• Cost-push: caused by a rise in per unit production due to increasing resource cost
• Sources:
• Supply shocks (dramatic rise in energy or raw material prices due to input shortages/growing demand for inputs)
• Price wage spiral (workers seek higher wages to offset rising consumer prices)

Effects of Inflation

• Anticipated - expecting, waiting for inflation
• Increases nominal cost of borrowing while unexpected reduces the real cost of borrowing
• Unanticipated - has stronger effects because those expecting may be able to adjust their work/spending to avoid/lessen effects
• Wages and penchants may have cost of living adjustments (COLAS) built in to offset anticipated inflation
• Hurts those with fixed incomes, savers, and lenders
• Helps borrowers (debt repaid in cheaper dollars)

Unemployment

• Unemployment - failure to use available resources
• New entrants, laid off, fired, quit, rentrants
• Employed includes self-employment
• Not included in the labor force -
• Armed forces, homemakers, students, retirees, disabled people, discouraged workers, prisoners, and mental patients
• Unemployment rate = (# of unemployed / # of total labor force) x 100
• Standard unemployment rate = 4-6%
• Four types of unemployment
1. Frictional - temporary, transitional, short-term
• In between jobs/searching for job
• Graduates, fired/quit jobs
• Signals that new jobs are available
2. Cyclical - caused by the recession phase of the business cycle
• Deficient demand for goods/services
3. Structural - technological or long-term
• Automation - due to consumer taste, jobs may become obsolete
• Creative Destruction - New jobs are created, others are lost
4. Seasonal - weather related of seasonal jobs

Full Employment (FE) = Natural rate of unemployment (NRU)

• It is equal to structural and frictional unemployment
• 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

1. Rates are lower for white collar workers
2. Teenagers have the highest rates
3. Blacks have higher rates than whites
4. Rates for males and females are comparable