Define GDP and distinguish between a final good and an intermediate good. Provide examples.

Define GDP

GDP or gross domestic product, is the market value of the final goods and services produced within a
country in a given period.

Market value- the prices at which items are traded in markets

Final goods and services- items that are bought by their final user during a specific period.

Within a country- Only goods and services that are produced within a country count as part of that
country’s GDP.

In a Given Time Period-GDP MEASURES THE value of production in a given period which is either
quarterly or annually

Final Good

It is an item that is bought by its final user during a specific period. Final goods an items that are ready
for consumption or use by an individual or business. Examples are cars, smartphones, and houses.

Intermediate Good

Is an item that is produced by one firm, bought by another firm, and used as a component of a final
good or service. They are not meant for final consumption but rather contribute to the production
process. Examples are raw materials like steel, wood, and plastic.

Why does GDP equal aggregate income and also equal aggregate expenditure?

GDP is a measure of the value of total production. GDP can be measured in two ways by the total
expenditure on goods and services or by the total income earned producing goods and services.

GDP =Aggregate Income + Aggregate Expenditure

Aggregate Income

GDP can be calculated by summing up the total amount paid for the services of the factors of
production used to produce. Final goods and services. This includes wages, interest, rent, and profit.

Aggregate Expenditure

GDP can also be calculated by summing up all expenditures in the economy. This includes consumption
expenditure, investment, government expenditure, and net exports.

This equality is based on the principle that every transaction in an economy involves both a buyer and
a seller. When someone spends money (expenditure), someone else earns that money as income.
Therefore, the total value of all expenditures must equal the total income generated in the economy.
What are the distinctions between domestic and national, and gross and net?

Domestic product is produced within a country. For example, the Gross Domestic Product (GDP)
measures the economic output within a country’s borders, including both domestic and foreign-
owned factors of production. In comparison, National product is the value of goods and services
produced anywhere in the world by the residents of a nation. National indicators, such as Gross
National Product (GNP), consider the production by factors of production owned by a country’s
residents, regardless of whether the production occurs within the country’s borders or abroad.

Gross refers to the total or whole, without deductions. For instance, Gross Domestic Product (GDP)
represents the total market value of all goods and services produced within a country’s borders
without subtracting depreciation of capital. In comparison, Net means after subtracting the
depreciation of capital. For example, Net Domestic Product (NDP) is GDP minus the depreciation of
capital.

What is the expenditure approach to measuring GDP?

The expenditure approach is one of the methods used to calculate the Gross Domestic Product (GDP)
of a country. The expenditure approach calculates GDP by summing up consumption expenditure (C),
investment (I), government expenditure on goods and services (G), and net exports of goods and
services (X-M).

What is the income approach to measuring GDP?

The income approach is another method used to measure Gross Domestic Product (GDP) by summing
the incomes that firms pay households for the services of the factors of the production they hire. This
includes wages for labor, interest for capital, rent for land, and profit for entrepreneurship.

What adjustment must be made to total income to equal GDP?

The adjustment involves adding depreciation to total income to obtain a more accurate measure of
the total value of goods and services produced in an economy. The reason for this adjustment is to
ensure that GDP reflects the total value of goods and services produced in an economy, considering

1. Distinguishing between Real GDP and Potential GDP

Real GDP (Gross Domestic Product)

Real GDP is the value of final goods and services produced in a given year. Real GDP provides a
snapshot of a country's economic output, accounting for changes in prices over time.

Potential GDP
Potential GDP maximum level of real GDP that can be produced while avoiding shortages of labor,
capital, land, and entrepreneurial ability that would bring rising inflation. Potential GDP is not affected
by short-term fluctuations or cyclical variations.
Growth Over Time

Real GDP Growth

It reflects the actual expansion or contraction of a country's economy over time. Economic growth
occurs when real GDP increases, usually driven by factors such as increased productivity, population
growth, technological advancements, and investment.

Potential GDP Growth

This represents the growth in an economy's productive capacity over the long term. It is influenced
by factors like population growth, capital accumulation, technological progress, and efficiency
improvements. Sustainable economic growth aligns with the growth in potential GDP.

2. How does the growth rate of real GDP contribute to an improved standard of living?
As real GDP grows, a country's standard of living tends to improve. This is because economic growth
allows for an increase in the production of goods and services, leading to higher income levels,
improved employment opportunities, and enhanced purchasing power for individuals. Overall, a
growing real GDP is indicative of an expanding economy, contributing to an improved standard of
living for the population.

3. What is a business cycle and what are its phases and turning points?
- A business cycle is a periodic but irregular up-and-down movement of total production and other
measures of economic activities.

Expansion: This is a period during which real GDP increases.

Peak: The highest level that real GDP has attained up to that time

Recession: A Period during which real GDP decreases and its growth rate is negative

Trough: is when real GDP reaches a temporary low point and From which the next expansion begins.

Turning Points are the transition periods between phases, signaling shifts from expansion to
contraction or vice versa.

4. What is PPP and how does it help us to make valid international comparisons of real
GDP?
PPP (Purchasing Power Parity) is a theory that adjusts exchange rates between countries to ensure
that a similar basket of goods and services has the same relative price. It helps make valid international
comparisons of real GDP by accounting for differences in price levels and cost of living. By using PPP-
adjusted GDP, analysts can more accurately assess and compare the economic well-being of different
nations.
5. Explain why real GDP might be an unreliable indicator of the standard of living.

- Real GDP does not account for income distribution, meaning it may not accurately reflect the
distribution of wealth within a population.

- It does not consider non-market activities (e.g., household work) or the underground economy,
leading to an incomplete picture of economic activity.

- Quality of life factors such as healthcare, education, and environmental conditions are not
directly captured by real GDP.

- Real GDP can be influenced by factors like income inequality, which may not accurately represent
the standard of living for the entire population.
 Employment and Unemployment
What determines if a person is in the labor force?
The labor force is a sum of the employed and the unemployed. The employed is a person who
is currently working and has jobs which either a full-time or a part-time job. An unemployed
is a person who must be available for work and must be in one of three categories which are
a person without work but has made specific efforts to find a job within the previous four
weeks, a person who is waiting to be called back to a job from which he or she has been laid
off, a person who is waiting to start a new job within 30 days.
What distinguishes an unemployed person from one who is not in the labor force?
An unemployed person is a person who must be available for work and must be in one of
three categories which are a person without work but has made specific efforts to find a job
within the previous four weeks, a person who is waiting to be called back to a job from which
he or she has been laid off, a person who is waiting to start a new job within 30 days. At the
same time, the person who is not in the labor force is an individual in the working-age
population who is neither employed nor unemployed. They are not considered part of the
labor force because they are not actively participating in the job market.
Describe the trends and fluctuations in the US unemployment rate from 1980 to 2014.
The average unemployment rate from 1980 to 2014 was 6.5 percent. The unemployment rate
increases in a recession, peaks after the recession ends, and decreases in an expansion. The
peak unemployment rate during a recession was on a downward trend before the 2008-2009
recession, with each successive recession having a lower unemployment rate. The severe
recession of 2008-2009 broke this trend.
Describe the trends and fluctuations in the U.S employment-to-population ratio and labor
force participation rate from 1980 to 2014
The trend in the labor force participation rate and the employment-to-population ratio is
upward before 2000 and downward after 2000. The employment-to-population ratio
fluctuates more than the labor force participation rate over the business cycle and reflects
cyclical fluctuations in the unemployment rate. The fall in both measures was steep during
2008 and 2009.
Describe the alternative measure of unemployment.
U-1 focuses on individuals who have been unemployed for 15 weeks or longer. It provides
insight into the extent of long-term unemployment. U-2 includes individuals who have lost
their jobs or have completed temporary jobs. It captures those who experienced involuntary
separations. U-3 is the official unemployment rate widely reported in the media. It includes
individuals who are unemployed and actively seeking employment, divided by the total labor
force. U-4 expands on U-3 by adding discouraged workers. Discouraged workers are those
who have stopped looking for employment because they believe no jobs are available. U-5 is
a broader measure that includes not only discouraged workers but also all other marginally
attached workers. Marginally attached workers are those who are not currently in the labor
force but have looked for work in the past 12 months. U-6 is the broadest measure of labor
underutilization. It includes the total unemployed, all marginally attached workers, and those
working part-time for economic reasons. Part-time for economic reasons refers to individuals
who work part-time but would prefer full-time employment.
Why does unemployment arise and what makes some unemployment unavoidable?
Unemployment can arise for various reasons. The economy may experience frictions,
structural change, and cycles.
Frictional unemployment is about job search and matching. People may be temporarily
unemployed while searching for a new job or waiting to be matched with a suitable
employment opportunity. It is a permanent and healthy phenomenon in a dynamic, growing
economy.
Structural unemployment happens when the unemployment that arises when changes
in technology or international competition change the skills needed to perform jobs or change
the locations of jobs. It usually lasts longer than frictional unemployment because workers
must retrain and possibly relocate to find a job.
Cyclical unemployment is when a worker is laid off because the economy is in a
recession and gets rehired some months later when the expansion begins.
While some unemployment is inevitable, certain factors can exacerbate the problem,
including Insufficient Aggregate Demand, Inadequate Education and Training, and Policy
Issues.
Insufficient Aggregate Demand is when the overall demand for goods and services is low,
businesses may reduce production and cut jobs, leading to cyclical unemployment.
Inadequate Education and Training are rapid changes in technology and the economy
can result in a gap between the skills workers possess and those required by employers,
contributing to structural unemployment.
Policy issues are inappropriate economic policies, such as overly restrictive monetary or
fiscal policies, which can hinder economic growth and exacerbate unemployment.

Define frictional unemployment, structural unemployment, and cyclical unemployment.

Give examples of each type of unemployment.
Frictional unemployment is about job search and matching. People may be
temporarily unemployed while searching for a new job or waiting to be matched with a
suitable employment opportunity. It is a permanent and healthy phenomenon in a dynamic,
growing economy. For example, a person who voluntarily leaves their job to search for a
better one also contributes to frictional unemployment.
 Structural unemployment happens when the unemployment that arises when changes
in technology or international competition change the skills needed to perform jobs or change
the locations of jobs. It usually lasts longer than frictional unemployment because workers
must retrain and possibly relocate to find a job. For example, workers who are skilled in
manual labor may face unemployment as their skills become less relevant in a more
technologically advanced economy.
Cyclical unemployment is when a worker is laid off because the economy is in a
recession and gets rehired some months later when the expansion begins. For instance, in the
2008 financial crisis, many industries, including construction and finance, experienced cyclical
unemployment as economic activity contracted.
What is the natural unemployment rate?
Natural unemployment is the unemployment that arises from friction and structural change
when there is no cyclical unemployment. When all the unemployment is frictional and
structural. Natural unemployment as a percentage of the labor force is called the natural
unemployment rate.
How does the natural unemployment rate change and what factors might make it change?
Natural unemployment is the unemployment that arises from friction and structural change
when there is no cyclical unemployment. It consists of structural and frictional unemployment
and excludes cyclical unemployment. The natural unemployment rate is influenced by various
factors, and changes in these factors can lead to shifts in the natural rate.
Changes in the age distribution of the population
An economy with a young population has a large number of new job seekers every year and
has a high level of frictional unemployment. An economy with an aging population has fewer
new job seekers and a low level of frictional unemployment.
The scale of structural change
Advances in technology can alter the demand for certain skills, leading to structural
unemployment. If technology replaces certain jobs or changes the skill requirements in the
labor market, workers may face challenges finding suitable employment, contributing to an
increase in the natural unemployment rate.
The real wage rates
The natural unemployment rate is influenced by the level of the real wage rate. Real wage
rates that bring unemployment are a minimum wage and an efficiency wage.
Unemployment benefits
Unemployment benefits increase the natural unemployment rate by lowering the
opportunity cost of job search.
Why is the unemployment rate never zero, even at full employment?
The concept of “full employment” in economics does not mean zero unemployment. Full
employment is defined as a situation in which the unemployment rate equals the natural
unemployment rate. Several reasons contribute to the unemployment rate never reaching
zero even at full employment:
1. Frictional unemployment
Frictional unemployment is about job search and matching. People may be
temporarily unemployed while searching for a new job or waiting to be matched with
a suitable employment opportunity. It is a permanent and healthy phenomenon in a
dynamic, growing economy.

2. Structural employment
Structural unemployment happens when the unemployment that arises when
changes in technology or international competition change the skills needed to
perform jobs or change the locations of jobs. It usually lasts longer than frictional
unemployment because workers must retrain and possibly relocate to find a job.
Achieving a zero unemployment rate is practically unattainable due to the inherent dynamics
and complexities of the labor market, human behavior, and the ongoing changes in the
economy.
What is the output gap? How does it change when the economy goes into recession?
The output gap is the gap between real GDP and potential GDP. There are three possible
situations regarding the output gap.
1. Output gap = 0
When the economy is at full employment, the unemployment rate equals the natural
unemployment rate. Real GDP equals potential GDP. Therefore, the output gap is zero.
2. Output gap = +ve
When the unemployment rate is less (<) than the natural unemployment rate. Real
GDP is greater (>) than potential GDP. Therefore, the output gap is +ve.
3. Output gap = -ve
When the unemployment rate is greater (>) than the natural unemployment rate.
Real GDP is less (<) than potential GDP. Therefore, the output gap is -ve.
In recessions, cyclical unemployment increases, and the output gap becomes negative. At
business cycle peaks, the unemployment rate falls below the natural rate and the output gap
becomes positive. Therefore, the natural unemployment rate decreases.
How does the unemployment rate fluctuate over the business cycle?