Unit II

• 4 types of Economic Systems- Command, Traditional, Free Market, Mixed Economy
• Command Society (Centrally Planned) – government owns capital and land, and controls labor
• Ex.: Cuba
• Traditional Society – Habits, Rituals, Customs
  Decisions made by the elders and discourage new idea and technologies
• Ex.: tribes
• Free Market – people and firms act in their own best interest. Buyers and sellers exchange goods and services.
• Ex.: Hong Kong
• Mixed Economy – government regulates businesses to protect the public’s interests
• Ex.: Canada, U.S., and Mexico
• Three Economic Questions

1. What goods and services should be produced?
2. How should these goods and services be produced?
3. Who will consume these goods and services?

• Market – institution allowing buyers and sellers to trade
• Product Vs. Factor Market
• Product – usually the buyer is the consumer, the seller is a firm
• Factor (Resource) – Factor of Production, the buyer is usually the firm and the seller is the factor owner.
• Household – person or a group of people that share an income
• Firms- Organization that produces goods or services for sale
• Gross Domestic Product (GDP) – total value of all final goods and services produced in the U.S. in 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, including income earned by Americans anywhere in the world.
• Includes: production or incomes earned by Americans anywhere in the world.
• Excludes: production by non-Americans even in the U.S.

• Formula for GDP : C + Ig + G + Xn
• C - Personal Consumption-67%
• Purchases of finished goods and services
• Ig - Gross Private Domestic Investment
• New factory equipment
• Construction of housing
• Factory equipment maintenance
• Unsold inventory of products build in a year
• G - Government Spending
• Government purchases of goods and services
• Xn - Net Export (Exports – Imports)
• GDP Items Excluded
• Used or second hand goods
• Gifts or transfers 
• Stocks and bonds
• Unreported business activities 
• Illegal activities
• Financial transactions between banks
• Financial transactions between banks and businesses
• Intermediate goods 
• Non-market activities 

• Expenditure approach Vs. Income approach
• Expenditure approah:
• income generated from production of goods and services
• C + Ig + G + Xn
• Income approach
•  we’re going to add all the income generated from the production of final output 
• W + R + I + P
• W = wages
• R = rents
• I = interests
• P = profits
• + Statistical Adjustments

Both sides have to equal out 

• Net Domestic Product (NDP) 
• GDP – Depreciation
• consumption of fixed capital
• National Income (NI) – income earned by American owned resources whether it is here or abroad

1. NNP  – Indirect Business Taxes (IBT)
2. CE + RI + II + CP + PI
3. GDP – IBT – Depreciation  - Net foreign factor payment

• CE = Compensation of employee 
• RI = rental income
•  II = interest income
• CP = corporate profit
•  PI = Proprietor’s income
• Personal Income (PI) - Income received by households regardless of the source
• Disposable Personal Income (DPI) 
• NI – HT + GTP
• HT- Household Taxes
• GTP-Government transfer payments
• Formula for trade:  exports – imports
• Nominal GDP (NGDP) – measures GDP in current prices regardless of  the output 
• P * Q 
• Real GDP (RGDP) – measures GDP in constant dollars and is adjusted for inflation
• reverts to base year prices
• P*Q

• GDP Deflator: 
• the measure of level of prices of all new domestically produced final goods and services in an economy
• NGDP/RGDP x 100
• (Price index in year 2) - (Price index in year 1) / (Price year 1)
• CPI – Consumer Price Index
• Widely used measure of the over all price level in U.S.

1. Inflation Rate – a rise in the general level of prices
2. Deflation – A decline in the general price level.
3. Disinflation – occurs when the inflation rate itself declines.
4. Solving inflation problems: 2-3% inflation

• Rule of 70 – how many years will it take to double inflation.
• Okun's Law- describes how a nation's GDP relates to unemployment. States that every 1 % unemployment about NRU, a negative GDP gap of 2% will happen.
• Finding real interest rates:

• Real Interest Rate = Nominal interest rate – Inflation
• Real wages
• Percents
• cost of borrowing or spending money that is adjusted for inflation
• Nominal interest rate – it is an unadjusted cost of borrowing or lending money. Always in percentages.
• Causes of inflation:
• Demand-Pull – 
• caused by an excess of demand over output that pulls prices upward
• Sources of Demand Pull:
1. increase in government purchases
2. excessive increases in the money supply creating a condition called hyperinflation – a rapid rise or extremely high inflation rate

                          3. rising incomes as the economy approaches full employment output

• Cost-push  (supply side economics) –
•  caused by a rise in per unit production cost due to increasing resource cost
• 2 sources :
1. Supply shocks – dramatic rise in energy or raw material prices due to input shortages or growing demand for inputs
2. Price wage spiral – workers seek higher wages to offset higher consumer prices.
• Effects of inflation:
• Anticipated Vs. Unanticipated –
• Unanticipated inflation - don't know why or when it happens and have stronger effects because those expecting inflation may be able to adjust their work or spending habits to avoid or lessen the effects. 
• Wages and pensions may have cost of living adjustments (Cola) built in to offset anticipated inflation
• Anticipate inflation - increases the nominal cost of borrowing while unexpected inflation reduces the real cost of borrowing.
• Hurt:
1. Fixed income group - because their real income suffers because their nominal income does not rise with prices.
2. Savers –  by unanticipated inflation because inflation takes away from the interest earned on the account
3. Lenders – by unanticipated inflation because debts will be repaid with cheaper dollars than the ones that were loaned out 
• Helped:

1. Borrowers- by unanticipated inflation

• GNP = GDP + Net foreign factor payment
• Net Private Domestic Investment + Depreciation = Gross Private Domestic Investment
• Unemployment:
•  Failure to use unavailable resources
• Employed:
• Includes those that are self-employed
• Unemployed:
• Laid off
• New entrants
• Re-entrants
• Quit last job
• Lost last job
• Not in the labor force:
• Armed forces
• Home makers 
• Students
• Retirees
• Disabled people
• Dislocated people
• Prisoners
•  Unemployment rate= (Number of unemployed) / (Labor force) x 100
• 
• Four Types of unemployment:
• Frictional –  temporary, short term, transitional, graduates, fired, quit, in between jobs, searching for a job, signals new jobs are available. Include people temporarily between jobs that might have quit one job to look for another.
• Cyclical – 
• caused by a recession phase of business cycle
• deficient demand for goods and services
• Includes people who are not working because their labor is not needed due to lack of demand or downturn in the business cycle.
• Structural – technological or long termed
• Automation
• Creative destruction as jobs are created others are lost
• Change in skills
• Seasonal - seasonal unemployment
• Life guard, Santa clause, Easter bunny, Construction workers (weather)
• Full Employment (FE) = natural rate of unemployment (NRU)
• It is equal to structural + frictional unemployment
• Full employment does not mean zero unemployment
• 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