ECON 1150 Honors Macroeconomics Fall 2013 Midterm I review sheet

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1 ECON 1150 Honors Macroeconomics Fall 2013 Midterm I review sheet Midterm parts 1 and II: Part one of the midterm will be worth 10 points, multiple choice and diagram related questions (the PPF and the Supply and demand diagrams) and one part with the short answer questions (no diagrams). Part I will be taken in class for 45 minutes this Monday Sept. 30th. I will also distribute the Part II short answer questions the same day. Part II of the midterm (5 points) is due within 24 hours of getting the exam on turnitin.com (if you need another couple of hours, let me know). These Part II short answer questions should be submitted on turnitin.com, typed. You should not need diagrams or tables. These questions will be similar to the short answer questions on the quizzes and to LDQ (see class calendar). There will likely be 2-4 required questions and one optional questions, once you have Part II, you are on your own to some extent, except for questions of clarification which we can answer on the class calendar. Important: to review with this midterm which is more or less a double quiz, I suggest reviewing quizzes 1 and 2, including the short answer questions (but not the Coase theorem). Then I would look at the review sheets for both quizzes (and your homework questions). For Chapter 10 there is no quiz, so see my notes below and comments on the HW assignment you submitted on turnit.com. Many of the questions for review and the quick quizzes are useful for review as well. 2nd Midterm Review session first 25 minutes of class Monday: Since we have decided to separate the two parts of the midterm (see above) minutes at the beginning of the class to answer additional questions. Chapter 10 Nominal vs. Real GDP: we did not have a quiz on this chapter, but there will be short answer questions on the Midterm. I would use the chapter summary as a good guide to what you need to know, see also the terms below. You will not need to do compute deflators and real GDP as in Table 2 (Hot Dogs and Hamburgers) or P&A #4 or #6 but there could be a small table constructed just from the P and Qs as in QFR #7. We went over #1 in class, you need to know the basic how and why of what counts toward GDP. The GDP deflator and real GDP as well as the inflation rate are defined on pages 205 and 206, you need to memorize these formulas (see below, and recall the crude shorthand we used in class, Y = P*Q where Q is real GDP. You should know roughly how large the U.S. GDP (we have to get used to trillions) and the major components of GDP listed in Table 1 (see a little more detail on net exports below, everyone focuses on imports, but we sell lots of soybeans, cars, planes and iphone to China, exports are almost as important as imports these days (as a component of NX = X IM where IM are imports, we are saving M for money later on). Per capita GDP is just real GDP divided by population, one of our best metrics of economic progress as nation (macroeconomics is about nations, microeconomics is about how firms and people (consumers & workers) deal with and are affected by market forces. The title of Chapter 10 is measuring a nation s income it should be current income and employment (see P&A #1 page 214). See the definition of macroeconomics below. Most of the little quick quizzes and Question for Review (QFR) #1-3,5-8 as well as P and A 1-3, 6 (see below) and #10 on women in the labor force, which is a great PPF question as well (all on pages 214 to 215 at the end of Chapter 10). 1 1 P&A Question 9 on page 214 is interesting but it is not entirely accurate: home production is counted as income when computing poverty lines and poverty rates in India, home production is valued using local market prices. Similarly, we compute incomes that include the imputed value of homes owned by the elderly for example, even though these homes are not rented so do not add to GDP directly. In other words, we can measure and value some types of home production (literally in this case). Just under 70% of Americans own their own homes, the imputed rents generated by these homes are not part of GDP, whether this income is greater or less than own consumption in India is debatable.

2 Miscellaneous Questions for review related to Chapter 10: 1. Why should policy makers care about real and nominal GDP? (see page 212). Which of the measures discussed in this chapter are likely to be most correlated with employment? If our focus is employment, why should we focus most on valued created in the current year (not past years) and to some extent ignore depreciation (the difference between net and gross national product). 2. Health and GDP: Look at the first two columns of Table 3 on page 212 (pasted in below) what is the relationship between health (longevity) and real GDP? There does seem to be a correlation between health (longevity) and real GDP (see this graphic). Does real GDP cause health, or does good health lead GDP growth? On this see Hans Rosling, both the four minute and six minute versions are good, but best to watch watch 6 minute version and then use 4 minute version as a crib notes. 3. A major deficiency of standard GDP is that they leave out environmental damage (and enhancements, such as a cleaner Hudson River (you can swim in it but don t eat fish from the Hudson more than once a month, never is OK too). Sometimes the relationship between GDP and the environment seems perverse, the more coal we mine the warmer the planet, while environmental disasters such as Sandy, Katrina and the Gulf oil spill create billions of dollars in new GDP as damaged homes, businesses and sand dunes are rebuilt. But from a macroeconomic point of view, why is GDP not misleading useful in this context? How from a longer term perspective might higher real GDP in this context be misleading? 4. In Table 1A below, why in column F is per capita nominal GDP lower in 2009 than in 1999 and just reverse in 1999? Hint: what was the GDP deflator in 2005? 5. Per person and per capita are the same thing, and often they are what matters. Real GDP per person is the most important indicator, why? From 1999 to 2009 real GDP per person grew at.9% per year (same with 1999 to 2012). How fast did real GDP per capita grow from 1964 to 2012? Compare the inflation rates during these two periods, inflation per person and per unit of GDP are the same (see below) why is this? (next chapter we get the CPI, a better price index for computing real wages for example). The CPI gives us real consumption spending, where Y = C + I + G + NX. Ultimately, the goal of all economic activity is to consume more and to have longer, happier (healthier?) lives. If this is the case why is GDP per capita a slightly more comprehensive measure of well-being, especially net national income (think I and domestic).

3 Table 1A: Consider the following data on U.S. GDP: Nominal GDP GDP Deflator (in billions of $U.S. current or 2005 Prices See Table 1 page 203 A B C D E F Nominal GDP Real Total Per Capita Per Capita Year Line # GDP Deflator GDP Pop Real GDP Nominal GDP , ,772 $42,332 $46, , ,295 $38,581 $33, Years (N) 3 Growth* 4.3% 2.4% 1.9% 0.9% 0.9% 3.3% annual p. 15, , ,914 $43,296 $49, Years (N) 5 *Annual 4.1% 2.2% 1.8% 0.90% 0.89% 3.1% Growth Rate , ,889 $17,663 $3, Years (N) 7 Growth Rate 6.8% 3.8% 2.9% 1.0% 1.9% 5.7% Online Tables: Data Source: Council of Economics advisors (2013) Economic Report of the President ECON 1150 Macroeconomics GDP Lecture Notes 1. Handy shorthand for GDP real and Nominal, Real GDP = Nominal GDP/ GDP Deflator (suppose Q is real GDP) GDP Deflator = Nominal GDP Real GDP or P = P Q Q Real GDP = Nominal GDP GDP Deflator Real GDP GDP Deflator = Nominal GDP or P*Q = Y 2. When thinking about how we define GDP (especially real GDP our main macro indicator) recall the books discussion of what macroeconomics is about: Macroeconomists address diverse questions: Why is average income high in some countries while it is low in others? Why do prices sometimes rise rapidly while at other times they are more stable? Why do production and employment expand in some years and contract in others? What, if anything, can the government do to promote rapid growth in incomes, low inflation, and stable employment? These questions are all macroeconomic in nature because they concern the workings of the entire economy. Mankiw, Chapter 10 Page 196. Amazon Digital Services.

4 Context sensitive macroeconomics: Employment may or may not appear most often in the above discussion, but emerging from the Great Recession inflation remains low (too low for Chairman Bernanke) and unemployment is too high. Sometimes and in some countries it is the revers, inflation is the problem, employment is less of a problem, but right now employment (high unemployment) is the major macroeconomic challenge we face. 3. Thinking about GDP vs. GNP and net exports. Y = C + I + G + NX were NX = X M Where Y is GDP, Gross Domestic Product, final sales of new products (expenditure) or total incomes paid, does not include previous year s production (sales from inventory) or depreciation (this is what makes it Gross) and only includes good and services produced within the U.S. (not matter who produces them). GNP includes production of U.S. citizens wherever they live or own businesses U.S. capital. Assets abroad are mainly equity stakes and companies (Foreign Direct Investment). Recently, the U.S. has accumulated debt owed to foreigners in the form of U.S. Treasury bonds, right now these foreign owned bonds pay very little interest, but if interest rates rise in the future debt service (interest payments) could reduce our GNP. In 2012, U.S. GDP was about $16.25 trillion while GNP was about $16.5 trillion. Than is GNP was $261B or 1.6% larger than GDP. 4. If the U.S. is a net debtor nation (which it not annual borrowing added to NX is our current account balance, that is CA = NX r*d + π*f where D is total external debt, and π*f is the profits U.S. firms earn abroad. We can only be a net borrower if we import more goods and services than we export (including financial payments for current but not past factor contributions). 5. How might current account imbalances have contributed to the Great recession, how might they have mitigated the Great Recession as well (hint Chimerica). Answer: this is similar to the Walmart question: we had a large trade deficit heading into the recession, largely with China and largely financed by borrowing (and printing) dollars. Generally large and negative NX reduces employment, but during the 2008 recession China embarked on a massive stimulus program building high speed trains, offices, roads, airports etc. This massive spending reduced their CA surplus and our trade deficit, helping the U.S. recover from recession by creating a market for our exports (we will discuss this more the upcoming open economy chapter 18, but perhaps not until November).

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