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macroeconomics chapter two


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Gross domestic product (GDP)
Gross Domestic Product (GDP) is the market value of all final goods and services produced within an economy in a given period of time.
For the economy as a whole, income must equal expenditure.
GDP measures the flow of dollars in this economy.
Gross national product (GNP)
To obtain gross national product (GNP), we add receipts of factor
income (wages, profit, and rent) from the rest of the world and
subtract payments of factor income to the rest of the world.
GNP = GDP+Factor Payments from Abroad -Factor Payments to Abroad
Whereas GDP measures the total income produced domestically, GNP
measures the total income earned by nationals (residents of a nation).
Consumer Price Index (CPI)
The Consumer Price Index (CPI) turns the prices of many goods and services into a single index measuring the overall level of prices.
Unemployment Rate
The unemployment rate tells us the fraction of workers who are unemployed.
Value added
Value added of a firm equals the
value of the firm’s output less the value of the intermediate goods
the firm purchases.
Imputed value
Some goods are not sold in the marketplace and therefore don’t
have market prices. We must use their imputed value as an estimate
of their value. For example, home ownership and government services.
Nominal versus real GDP
The value of final goods and services measured at current prices is called nominal GDP. It can change over time either because there is a change in the amount (real value) of goods and services or a change in the prices of those goods and services. Hence, nominal GDP Y = P ´ y, where P is the price level and y is real output– and remember we use output and GDP interchangeably. Real GDP or, y = Y¸P is the value of goods and services measured using a constant set of prices.
GDP deflator
The GDP deflator, also called the implicit price deflator for GDP,
measures the price of output relative to its price in the base year. It
reflects what’s happening to the overall level of prices in the economy.
GDP deflator vs CPI
The GDP deflator measures the prices of all goods produced, whereas the CPI measures prices of only the goods and services bought by consumers. Thus, an increase in the price of goods bought by firms or the government will show up in the GDP deflator but not in the CPI.
Also, another difference is that the GDP deflator includes only those goods and services produced domestically. Imported goods are not a part of GDP and therefore don’t show up in the GDP deflator.
The final difference is the way the two aggregate the prices in the economy. The CPI assigns fixed weights to the prices of different goods, whereas the GDP deflator assigns changing weights.
National income accounts identity
Y = C + I + G + NX
(Consumption, Investment, Government Purchases, Net Exports)
Labor force, Labor-force participation rate
The labor force is defined as the sum of the employed and unemployed, and the unemployment rate is defined as the percentage of the labor force that is unemployed.
The labor force participation rate is the percentage of the adult population who are in the labor force.
Okun’s Law
The negative relationship between unemployment and GDP is called
Okun’s Law, after Arthur Okun, the economist who first studied it.
In short, it is defined as:
Percentage Change in Real GDP =
3% - 2 ´ the Change in the Unemployment Rate
If the unemployment rate remains the same, real GDP grows by
about 3 percent. For every percentage point the unemployment rate
rises, real GDP growth typically falls by 2 percent. Hence, if the
unemployment rate rises from 6 to 8 percent, then real GDP growth
would be:
Percentage Change in Real GDP = 3% - 2 ´ (8% - 6%) = - 1%

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