Economic system

Capitalism & socialism

(1) Factors of production:
• Labor includes all types of work, from the part-time labor of teenagers working at
McDonald’s to the work of senior managers in large corporations.
• Capital refers to physical capital, such as computers and machine tools, that is used
to produce other goods.
• Natural resources include land, water, oil, iron ore, and other raw materials \ that are
used in producing goods.
• An entrepreneur is someone who operates a business. Entrepreneurial ability is the
ability to bring together the other factors of production to successfully produce and
sell goods and services.

(2) Market economies & planned economies

1. Productive efficiency: A situation in which a good or service is produced at the
lowest possible cost.
2. Allocative efficiency A state of the economy in which production is in accordance
with consumer preferences; in particular, every good or service is produced up to
the point where the last unit provides a marginal benefit to society equal to the
marginal cost of producing it.
3. Voluntary exchange A situation that occurs in markets when both the buyer and
the seller of a product are made better off by the transaction.
4. Centrally planned economy: An economy in which the government decides how
economic resources will be allocated. (North Koera)
5. Market economy: An economy in which the decisions of households and firms
interacting in markets allocate economic resources. (European countries, U.S.A)
6. Mixed economy: An economy in which most economic decisions result from the
interaction of buyers and sellers in markets but in which the government plays a
significant role in the allocation of resources.

(3) Economic failure of the Soviet Union

Circumstance: 1950s-1980s, economics grows rapidly, (Its strategy was to make
continuous increases in the quantity of capital available to its workers.) however
diminishing returns to capital meant that the additional factories the Soviet Union was
building resulted in smaller and smaller increases in real GDP per hour worked.
1. High cost, low quality goods and service (planned economy, communism).
2. Not take new technology. (managers wage are paid by government and short of
competitions)
3. centrally planned economy could not, in the long run, grow faster than a market
economy.

(4) Karl Marx and communism

1. According to Marx, the owners of businesses—capitalists—did not earn profits by
contributing anything of value to the production of goods or services. Instead, they
earned profits because their ownership of factories and machinery—allowed them
to exploit workers by paying them wages that were much lower than the value of
workers’ contribution to production. (the wages of workers would be driven to
levels that allowed only bare survival.)
2. small firms would be driven out of business by larger firms, forcing owners of
small firms into the working class. Control of production would ultimately be
concentrated in the hands of a few firms, which would have difficulty selling the
goods they produced to the impoverished masses. A final economic crisis would
lead the working classes to seize control of the economy and establish
Communism.
3. North Korea and Cuba

Supply and demand

(1)
1. Perfectly competitive market A market that meets the conditions of (1) many buyers
and sellers, (2) all firms selling identical products, and (3) no barriers to new firms
entering the market.
2. Law of demand: The rule that, holding everything else constant, when the price of a
product falls, the quantity demanded of the product will increase, and when the price
of a product rises, the quantity demanded of the product will decrease.
Substitution effect: The change in the quantity demanded of a good that results
from a change in price making the good more or less expensive relative to other goods
that are substitutes.
Income effect: The change in the quantity demanded of a good that results from
the effect of a change in the good’s price on consumers’ purchasing power.
3. Law of supply: The rule that, holding everything else constant, increases in price
cause increases in the quantity supplied, and decreases in price cause decreases in the
quantity supplied.

(2) Factors affecting demand

1. income 2. Price of related goods
3. Preference 4. Population and demographics
5. Expected future prices 6. government policy
7. technology 8. Weather

(3) Factors affecting demand

1. Prices of inputs 2. Technological change
3. Prices of substitutes in production 4. Number of firms in the market
5. Expected future prices
（4）surplus and shortage affect supply and demand
(5) consumer surplus
1. Consumer surplus: The difference between the highest price a consumer is willing
to pay for a good or service and the actual price the consumer pays.
2. Marginal benefit: The additional benefit to a consumer from consuming one more
unit of a good or service.

(6) Producer surplus

1. Producer surplus: The difference between the lowest price a firm would be willing
to accept for a good or service and the price it actually receives.
2. Marginal cost: The additional cost to a firm of producing one more unit of a good
or service.
3. Deadweight loss: The reduction in economic surplus resulting from a market not
being in competitive equilibrium.
4. Economic efficiency A market outcome in which the marginal benefit to
consumers of the last unit produced is equal to its marginal cost of production and
in which the sum of consumer surplus and producer surplus is at a maximum.

(7) Reservation price

1. Price discrimination: sell the same product to different people with different price;
Block of information flow among clients;
Prevent its sale

(8) Monopoly
1. China: anti-monopoly 2. America: antitrust law
 National income
(1)
1. Gross domestic product (GDP): The market value of all final goods and services
produced in a country during a period of time, typically one year.
2. Inflation rate: The percentage increase in the price level from one year to the next.

(2) Components of GDP

1. Personal Consumption Expenditures, or “Consumption”
2. Gross Private Domestic Investment, or “Investment”
3. Government Consumption and Gross Investment, or “Government Purchases”
4. Net Exports of Goods and Services, or “Net Exports”

(3) An Equation for GDP and Some Actual Values

1. Y = C + I + G + NX.
C: consumption I: investment G: government purchases NX: net exports

(5) Shortcomings in GDP as a Measure of Total Production

1. Household Production: Household service are not accounted in the GDP
2. The Underground Economy: Buying and selling of goods and services that is
concealed from the government to avoid taxes or regulations or because the goods
and services are illegal.
3. The Value of Leisure Is Not Included in GDP: (The consultant’s well-being has
increased, but GDP has decreased.)
4. GDP Is Not Adjusted for Pollution or Other Negative Effects of Production
5. GDP Is Not Adjusted for Changes in Crime and Other Social Problems: divorce
rates, drug addiction, or other factors that may affect people’s well-being.
6. GDP Measures the Size of the Pie but Not How the Pie Is Divided Up

(6) Real GDP versus Nominal GDP

1. Nominal GDP: calculated by summing the current values of final goods and
services
2. Real GDP: calculated by designating a particular year as the base year and then
using the prices of goods and services in the base year to calculate the value of
goods and services in all other years.
3. At base-year, Real GDP= Nominal GDP; before base-year, Real GDP > Nominal
GDP; after base-year, Real GDP＜Nominal GDP.

(7) The GDP Deflator

1. (measure price level change)

2. Both prices and production usually increase each year, but the more prices
increase relative to the increase in production, the more nominal GDP increases
 relative to real GDP, and the higher the value for the GDP deflator. Increases in
the GDP deflator allow economists and policymakers to track increases in the
price level over time.

(8) Gross National Product

(9) National Income

(10) Disposable Personal Income

(11) The Division of Income

 Unemployment

(1)
1. Unemployed: In the government statistics, someone who is not currently at work
but who is available for work and who has actively looked for work during the
previous month.
2. Labor force: The sum of employed and unemployed workers in the economy.
3. Unemployment rate: The percentage of the labor force that is unemployed.
4. Discouraged workers: People who are available for work but have not looked for a
job during the previous four weeks because they believe no jobs are available for
them.
5. The unemployment rate: Number of unemployed/Labor force * 100
6. The labor force participation rate: Labor force/Working-age population * 100
7. The employment–population ratio: Employment/Working-age population * 100

(2) Problems with Measuring the Unemployment Rate

1. Distinguishing between the unemployed and people who are not in the labor force.
2. During an economic recession, previous unemployment workers may not look for
the job and they also are not accounted as unemployed.
3. part-time job accounted employment.
4. work in illegal industry or people who want to refuse hand in tax may accounted as
unemployment.

(3) Trends in Labor Force Participation

1. Labor force participation: important, because it determines the amount of labor that
will be available to the economy from a given population. The higher the labor force
participation rate, the more labor that will be available and the higher a country’s
levels of GDP and GDP per person.
2. In the shorter term, the decline is due to the severity of the 2007–2009 recession
and the weak recovery that followed the recession.

(4) Unemployment Rates for Different Groups

(5) How Long Are People Typically Unemployed?

1. The longer a person is unemployed, the greater the hardship.
2. A typical unemployed person stays unemployed for a relatively brief period of time,
although that time lengthens significantly during a severe recession.

(6) How Unusual Was the Unemployment Situation Following the 2007–2009
Recession?
1. Unemployment rate are not nearly reduced.
2. Unemployment was so persistent and widespread.
(7) The Establishment Survey: Another Measure of Employment
1. The data on employment from the establishment survey can be subject to
particularly large revisions over time.

(8) Revisions in the Establishment Survey Employment Data: How Bad Was the
2007–2009 Recession?
1. The recession of 2007–2009 turned out to be much more severe than economists
and policymakers realized at the time.

(9) Job Creation and Job Destruction over Time

1. The U.S. economy creates and destroys millions of jobs every year. (technology
change)

(10) 3 Types of unemployment

1. Frictional unemployment: Short-term unemployment that arises from the process
of matching workers with jobs. Some because seasonal factors, such as weather or
fluctuations in demand for some products or services during different times of the
year. (stores located in beach resort areas)
2. Structural Unemployment: Unemployment that arises from a persistent mismatch
between the skills or attributes of workers and the requirements of jobs.
(technology change, job replaced by machine, retraining; have addictions to
alcohol or other drugs)
3. Cyclical unemployment: Unemployment caused by a business cycle recession.
Economy moves into recession, companies fire workers. And economy get better,
companies hire the workers again.
4. Full Employment: As the economy moves through the expansion phase of the
business cycle, cyclical unemployment eventually drops to zero;
The unemployment rate will not be zero because of frictional and structural
unemployment;
When the only remaining unemployment is structural and frictional
unemployment, the economy is said to be at full employment.

(11) Factors determine the unemployment rate.

1. Government Policies:
Decrease: Pursuing policies that help speed up the process of matching unemployed
workers with unfilled jobs. (frictional unemployment); Implementing policies that aid
worker retraining. (structural unemployment) Example: the federal government’s
Trade Adjustment Assistance program offers training to workers who lose their jobs as
a result of competition from foreign firms.
Increase: Increasing the time workers devote to searching for jobs; Providing
disincentives for firms to hire workers, Keeping wages above their market level.
2. Minimum wage law
3. Labor Unions
4. Efficiency Wages: An above-market wage that a firm pays to increase workers’
 productivity.

Inflation
(1)
1. Price level: A measure of the average prices of goods and services in the economy.
2. Inflation rate: The percentage increase in the price level from one year to the next.
3. Consumer price index (CPI): A measure of the average change over time in the
prices a typical urban family of four pays for the goods and services they purchase.
CPI=Expenditures in the current year/Expenditures in the base year * 100
Inflation rate= (CPI of next year-CPI of current year)/ CPI of current year * 100

(2) Four biases that cause changes in the CPI to overstate the true inflation rate
1. Substitution bias: BLS assumes that each month, consumers purchase the same
amount of each product in the market basket. In fact, consumers are likely to buy
fewer of those products that increase most in price and more of those products that
increase least in price (or fall the most in price). Therefore, the prices of the market
basket consumers actually buy will rise less than the prices of the market basket the
BLS uses to compute the CPI.
2. Increase in quality bias
3. New product bias: BLS updated the market basket of goods used in computing the
CPI only every 10 years. If the market basket is not updated frequently, these price
decreases are not included in the CPI.
4. Outlet bias: short of the date of online selling
Overall, biases cause changes in the CPI to overstate the true inflation rate by 0.5
percentage point to 1 percentage point.

(3) The Producer Price Index(PPI)

1. The Producer Price Index: An average of the prices received by producers of goods
and services at all stages of the production process. Changes in the PPI can give an
early warning of future movements in the CPI.

(4) Using Price Indexes to Adjust for the Effects of Inflation

1. Suppose your mother received a salary of $25,000 in 1987. By using the CPI, we
can calculate what $25,000 in 1987 was equivalent to in 2012. The CPI is 114 for
1987 and 230 for 2012. Because 230/114 = 2.0, we know that, on average, prices were
twice as high in 2012 as in 1987. We can use this result to inflate a salary of $25,000
received in 1987 to its value in terms of 2012 purchasing power:

(5) Nominal Interest Rates versus Real Interest Rates

1. Nominal interest rate: The stated interest rate on a loan.
Real interest rate = Nominal interest rate - Inflation rate.
2. Deflation：A decline in the price level.

(6) The problems that inflation causes

Nominal incomes generally increase with inflation.
1. Inflation Affects the Distribution of Income: Incomes rising more slowly than the
rate of inflation. Purchasing power may decrease.
2. The Problem with Anticipated Inflation
Winners: Consumers - does not reduce the affordability of goods and services to the
average consumer
Losers: Firms - incur menu costs and have to change the price of goods and services
Paper money - loses some of its value
3. The Problem with Unanticipated Inflation
When people borrow, it is usually at a fixed rate of interest that had some expected
level of inflation built into it. If higher than expected inflation occurs, then the real
value of the borrower's debt is reduced. Therefore, lenders lose because they will not
have built into interest rates a sufficient allowance of inflation.
If it turns out lower, borrow will lose, and lender will gain

Relationship between Inflation & Unemployment

In the short-run, Lower unemployment rates can result in higher inflation rates;
In the long-run, The unemployment rate is independent of the inflation rate.
(1) The Discovery of the Short-Run Trade-off between Unemployment and
Inflation
1. Phillips curve: A graph showing the short-run relationship between the
unemployment rate and the inflation rate. (inverse relationship between
unemployment and inflation)

2. AD-AS model (Lower unemployment rates can result in higher inflation rates)
3. Short-run Phillips curve:
long-run aggregate supply curve was vertical (a point we discussed in Chapter
13). If this observation were true, the Phillips curve could not be downward
sloping in the long run.
4. Long-run Phillips curve:
Natural rate of unemployment: The unemployment rate that exists when the
economy is at potential GDP.
Potential GDP: The level of real GDP in the long run.
The long-run aggregate supply curve is a vertical line at the potential real GDP,
and the long-run Phillips curve is a vertical line at the natural rate of
unemployment. (the unemployment rate is always equal to the natural rate in the
long run.)
5. The Role of Expectations of Future Inflation

6. Short-run Phillips curve and long-run Phillips curve

7. Expectations of the Inflation Rate and Monetary Policy: Low inflation; Moderate
but stable inflation; High and unstable inflation (1973-1982)
 Aggerate expenditure and output in the short-run
(1)
1. Aggregate expenditure (AE): Total spending in the economy: the sum of
consumption, planned investment, government purchases, and net exports.
2. Aggregate expenditure model: A macroeconomic model that focuses on the short-
run relationship between total spending and real GDP, assuming that the price level is
constant.
3. Consumption function: The relationship between consumption spending and
disposable income.
4. Marginal propensity to consume (MPC): The slope of the consumption function:
The amount by which consumption spending changes when disposable income
changes.

4. Autonomous expenditure: An expenditure that does not depend on the level of

GDP.

5. Multiplier: The increase in equilibrium real GDP divided by the increase in

autonomous expenditure.

7. Multiplier effect: The process by which an increase in autonomous expenditure

leads to a larger increase in real GDP.
8. Marginal propensity to save (MPS): The amount by which saving changes when
disposable income changes.

OR

(2) Aggregate Expenditure(AE)

1. Components of aggregate expenditure:
Consumption (C); Planned investment (I); Government purchases (G); Net exports
(NX)
2. AE = C + I + G + NX.
(3) Real investment & planned investment
1. An unplanned increase in inventories, actual investment spending will be greater
than planned investment spending;
An unplanned decrease in inventories, actual investment spending will be less
than planned investment spending;
No unplanned change in inventories, actual investment will equal planned
investment

(4) Macroeconomic Equilibrium

1. When AE=GDP, it will has macroeconomic equilibrium

(5) Determining the Level of Aggregate Expenditure in the Economy

1. Consumption (Current disposable income; Household wealth; Expected future
income; The price level; The interest rate)
a) Current disposable income: Consumption to increase when the current disposable
income of households increases and to decrease when the current disposable
income of households decreases.
b) Household wealth
c) Expected future income
d) The price level: the price of level decrease, consumption will increase
e) The interest rate: The interest rate increase, lead to save increases, then
consumption decrease

f) Income, Consumption, and Saving

a) National income = Consumption + Saving + Taxes. (C+S+T)
Y = C + S + T.
2. Planned Investment (Expectations of future profitability; The interest rate; Taxes;
Cash flow)

Fiscal policy
(1)
1. Fiscal policy: Changes in federal taxes and purchases that are intended to achieve
macroeconomic policy goals.
2. Automatic stabilizers: Government spending and taxes that automatically increase
or decrease along with the business cycle.
3. Crowding out: A decline in private expenditures as a result of an increase in
government purchases.
4. Cyclically adjusted budget deficit or surplus: The deficit or surplus in the federal
government’s budget if the economy were at potential GDP.
5. Tax wedge: The difference between the pretax and posttax return to an economic
activity.

(2) Automatic Stabilizers & Discretionary Fiscal Policy

1. ARRA in 2009: The American Recovery and Reinvestment Act of 2009 (ARRA)
Save existing jobs and create new ones as soon as possible. Other objectives
were to provide temporary relief programs for those most affected by the recession
and invest in infrastructure, education, health, and renewable energy.

(3) An Overview of Government Spending and Taxes

1. Besides, purchases, three other categories of federal government expenditures:
interest on the national debt, grants to state and local governments, and transfer
payments.

(4) The Effects of Fiscal Policy on Real GDP and the Price Level
1. Expansionary policy: involves increasing government purchases or decreasing
taxes.
Contractionary fiscal policy: involves decreasing government purchases or
increasing taxes. Policymakers use contractionary fiscal policy to reduce increases in
aggregate demand that seem likely to lead to inflation.
(6) The Government Purchases and Tax Multipliers
1.

2. The Effect of Changes in the Tax Rate:

(1) A cut in the tax rate increases the disposable income of households, which leads
them to increase their consumption spending,
(2) A cut in the tax rate increases the size of the multiplier effect.
3. Taking into Account the Effects of Aggregate Supply
4. The Multipliers Work in Both Directions

(7) The Limits of Using Fiscal Policy to Stabilize the Economy

1. Spend more time
2. Government invest increase which leads to decrease private input

(8) The Effects of Fiscal Policy in the Long Run

a)
1. Individual income tax.
2. Corporate income tax.
3. Taxes on dividends and capital gains.
b) Tax Simplification
c) The Economic Effect of Tax Reform

Money, Banks, Central Bank

(1)
Money: Assets that people are generally willing to accept in exchange for goods
and services or for payment of debts.
Asset: Anything of value owned by a person or a firm.
Commodity money: A good used as money that also has value independent of its
use as money
Federal Reserve: The central bank of the United States.
Fiat money: Money, such as paper currency, that is authorized by a central bank
or governmental body and that does not have to be exchanged by the central bank for
gold or some other commodity money.
M1: The narrow definition of the money supply: the sum of currency in
circulation, checking account deposits in banks, and holdings of traveler’s checks.
M2: A broader definition of the money supply: It includes M1 plus savings
account deposits, small-denomination time deposits, balances in money market
deposit accounts in banks, and noninstitutional money market fund shares.
Reserves: Deposits that a bank keeps as cash in its vault or on deposit with the
Federal Reserve.
Required reserves: Reserves that a bank is legally required to hold, based on its
checking account deposits.
Required reserve ratio: The minimum fraction of deposits banks are required by
law to keep as reserves.
Excess reserves: Reserves that banks hold over the legal requirement.
Simple deposit multiplier: The ratio of the amount of deposits created by banks to
the amount of new reserves.

(2) The Functions of Money

1. Medium of Exchange
2. Unit of Account
3. Store of Value
4. Standard of Deferred Payment

(3) What can serve as Money

1. The good must be acceptable to (that is, usable by) most people.
2. It should be of standardized quality so that any two units are identical.
3. It should be durable so that value is not lost by spoilage.
4. It should be valuable relative to its weight so that amounts large enough to be
useful in trade can be easily transported.
5. It should be divisible so that it can be used in purchases of both low-priced and
high-priced goods.

(4) Narrow definition of M1

1. Currency, which is all the paper money and coins held by households and firms
(not including currency held by banks)
2. The value of all checking account deposits in banks
3. The value of traveler’s checks (Because this last category is so small—typically
less than $4 billion—relative to the other two categories, we will ignore it in our
discussion of the money supply.)

(5) Function of Central Bank

1. control money supply
2. bank supervision
3. last resort
4. hold and manage reserves
5. formulation and implementation monetary policy

Monetary Policy
(1)
Monetary policy: The actions the Federal Reserve takes to manage the money supply
and interest rates to achieve macroeconomic policy goals

(2) Goals of Monetary policy

1. Price stability
2. High employment
3. Stability of financial markets and institutions
4. Economic growth

(3)