GDP and Economic Indicators
What does GDP measure?
The total value of all final goods and services produced in a country in a given year
What is the labor force?
People who are working or are actively searching for work
Who makes fiscal policy decisions?
The government (Congress + president)
What is the role of the Federal Reserve?
To conduct monetary policy and stabilize the economy
What is a trade deficit?
When imports exceed exports
Are intermediate goods counted in GDP?
No, to avoid double-counting
What type of unemployment is caused by people moving between jobs?
Frictional unemployment
What is the goal of expansionary fiscal policy?
Increase aggregate demand to reduce unemployment
What is the discount rate?
The interest rate the Fed charges commercial banks for loans
What happens to exports when a country’s currency depreciates?
Exports increase because they become cheaper for foreigners
Why doesn’t GDP accurately reflect the standard of living between countries?
It doesn’t account for income distribution, non-market transactions, or environmental factors
How can the unemployment rate fall even if fewer people are working?
Some people stop actively seeking work and become discouraged workers, meaning they are no longer counted in the labor force or as unemployed
Why might expansionary fiscal policy cause interest rates to rise in the loanable funds market?
Increased government borrowing increases the demand for loanable funds, which results in a higher real interest rate
Why might lowering the reserve requirement increase the money supply?
Banks can loan out more money, creating more deposits through the money multiplier
Explain the relationship between interest rates and currency value in the foreign exchange market.
Higher interest rates attract capital inflows, increasing the demand for the currency
If nominal GDP rises but real GDP falls, what does this indicate about the economy?
Output fell while prices rose (possibly stagflation)
If actual unemployment is 6% and the natural rate is 4.5%, what type of unemployment is present, and what does it imply about the economy’s output relative to potential?
The 1.5% difference is cyclical unemployment, which means the economy is producing below potential output (recessionary gap)
Why are automatic stabilizers considered more timely than discretionary policy?
They take effect immediately as economic conditions change; no new legislation is needed
The Fed sells bonds in the open market. Explain the effect on the nominal interest rate, investment spending, and aggregate demand.
Selling bonds decreases the money supply, raising the nominal interest rate. Higher interest rates reduce investment, decreasing aggregate demand
Country X has a capital account surplus. What does this imply about its current account and why?
The country must have a current account deficit, because the balance of payments must equal 0
A country increases production, but also causes major environmental change. How is GDP affected, and what limitation does this reveal?
GDP increases, but it ignores negative externalities, overstating economic well-being
Why is an increase in the minimum wage likely to increase structural unemployment?
It raises the wage above the equilibrium, making the quantity demanded of labor less than the quantity supplied of workers, which leads to an excessive number of workers available
How can contractionary fiscal policy reduce GDP while also decreasing interest rates?
It reduces GDP by reducing aggregate demand. It lowers interest rates because reduced government borrowing decreases the demand for loanable funds, which lowers the real interest rate
If the Fed unexpectedly raises the federal funds target rate during a period of full employment, explain the likely short-run effects on real output, price level, and unemployment.
Higher interest rates reduce investment and consumer spending, shifting aggregate demand left. In the short run, real output decreases, the price level falls, and unemployment rises above the natural rate.
If the U.S. dollar appreciates, what happens to the aggregate demand curve in the short run? Why?
It decreases/shifts left, because appreciation means these individuals will have higher income so they will import more, decreasing net exports