Unit 2

Unit 2: Economic Systems

     First, let's discuss the four types of Economic Systems. The four types are command, traditional, mixed, and free market.

1. Command
•  Command economies are centrally planned. The government decides the question of production. The government also owns land and capital and it controls labor. Cuba has this type of economic system.
2. Traditional
• A tradition economy is based on rituals, habits, and customs.The elders are the ones who make the decisions. An example would be tribes.
3. Mixed
• In mixed economies, the government regulates businesses to protect the public's interest. An example would be the United States, Canada, and Mexico.
4. Free Market
• People in firms act in their own best interest. Free markets allow buyers and sellers to exchange goods and services. Hong Kong is an example of a true Free market economy.

There are three main questions that should be answered

1. What goods and services should be produced?
2. How will these goods and services be produced?
3. Who will consume these goods and services?

Market

A market is an institution or mechanism allowing buyers and sellers to make trades. Markets are divided into two sections: Product Market and Factor market.

• Product Market: In this type of market, the buyer is usually a consumer and the seller is a firm. This is where the customers are buying products.
• Factor Market: A Factor market is also known as the Resource market. It involves C.E.L.L. (Capital, Entrepreneurship, Land, and Labor). The most important is Labor. The buyer is usually the firm and the sellers is the factor owner. The firm/business demands resources, business buys from business.

Household- person or group of people that share their income.

Firms- organization that produces goods and services from sale.

Gross Domestic Product (GDP)

• Total value of all goods and services produced within the country's borders within a given year.
• It includes all production or income earned within the United States by United States and foreign producers.
• It excludes production outside of the United States even by Americans.
• Included:
• Final goods, income earned (Wages, rents, interest, payments), interest payments on corporate bonds, current production of final goods, and unsold output (business inventories).
• Excluded:
• used/second hand goods, gifts(scholarships) or transfers(social security), stocks and securities, unreported business activities conducted in cash, illegal activities, financial transactions between banks and businesses, intermediate goods, and non-market activities.
• Expenditure Approach:
• income is generated from production of goods and services. C+Ig+G+Xn
• C= personal consumption(purchases of finished goods and services)
• Ig= gross private domestic investment (factory equipment maintenance, new factory equipment  construction of housing, and unsold inventory of products built in a year).
• G= government purchases of goods and services.
• Xn= net exports (Exports - imports)
• Income Approach
• Income generated from the production of final goods.
• W+R+I+P+statistical adjustments

Gross National Product (GNP)

• Total value of all final goods and services produced by Americans in a year
• It includes production or income earned by Americans anywhere in the world.
• It excludes production by non-Americans even in the United States.
• GNP = GDP + Net foreign factor payment

Terms

• GDP Deflator: measure of the level of prices of all new domestically produced final goods and service sin an economy. NGDP / RGDP x 100
• Inflation rate: rise in the general level of prices
• Price index in Year 2 (current year) - Price index year 1 (previous year)  x 100
•                                Price index year 1 (previous year)
• CPI(Consumer price index): widely used measure of the overall price level in the United States
• Price of the market basket in the particular year   x 100
•      Price of the market basket in base year
• National Income: income earned by American owned resources here or abroad.
• NNP - Indirect Business Taxes(IBT)
• Ce + Ri + Ii + CP + Pi
• Ce= consumption of employees
• Ri= rental income
• Ii= Interest income
• Cp= Corporate profit
• Pi= proprietors income
• Disposable personal income: after tax income available for household consumption (after bills are paid)
• Ni - Ht(household taxes) + GTP(government transfer payments)
• Net National Product: GNP - Deprecation
• Net Domestic Product: GDP - Deprecation(consumption of fixed capital)
• Nominal GDP: measure of  GDP at current price regardless of output
• Price(current) x Quantity(current)
• Real GDP: measure of GDP in constant dollars, is adjusted for inflation, therefore it reverts to base year prices.
• Price(base year) x Quantity(current)
• Deflation: decline in the general price level.
• Disinflation: occurs when the inflation rate declines.
• Rule of 70: how many years it will take to double inflation
• Current year price index - prior year price index
•                           inflation rate
• Real interest rate: cost of borrowing or lending money that is adjusted for inflation, expressed as a percentage.
• Nominal interest rate: unadjusted cost of borrowing or lending money]
• Okun's Law: describes how unemployment relates to a nation's GDP, states that for every 1% unemployment above that NRU, a negative GDP gap 2% will occur

Causes of inflation

• Demand pull: caused by an excess of demand over output that pulls prices upward.Sources:
• increases of government purchases
• excessive increase in the money supple which creates a situation of hyperinflation(rapid rise or extremely high inflation rate)
• rising incomes as the economy approaches full employment output( as workers earn more, they increase their demand for goods)
• Cost push: (supply side economic) cause by a rise in per unit production cost, due to increasing resource cost.
• Supply shocks: dramatic rise in energy or raw material prices due to input shortages or growing demand for inputs.
• Price wage spiral: workers seek higher wages to offset rising consumer prices

Effects of Inflation

• Anticipated: expecting a rise, waiting to happen
• Unanticipated: unexpected, don't know why
• Unanticipated has stronger effects because those expecting inflation may be able to adjust the work or spending activities to avoid or lessen the effects.
• Wages and pensions may have cost of living adjustments(COLA) built in to offset anticipated inflation
• Expected inflation- increases the nominal cost of borrowing while unexpected inflation reduces the real cost of borrowing
• Helped by unanticipated inflation
• Borrowers: debts will be repaid with cheaper dollars than those that were loaned out
• Hurt by unanticipated inflation
• Fixed income group (pensions, social security, real income suffers, nominal income doesn't rise with the prices).
• Savers: it takes away from the interest earned on the account
• Lenders: Debts will be repaid with cheaper dollars than those that were loaned out

Unemployment

• Failure to use available resources
• employed: self employed included
• New entrants, re entrants, laid off, lost last job, quit last job
• not in labor force_ armed forces, homemakers, students, retirees, disabled, discouraged workers, prisoners  mental institutions.

Types of unemployment

1. Frictional: temporary, transitional, short term (in between and searching for a job), grads, fired or quitters  and signals that new jobs are available.
2. Cyclical: caused by recession phase of business cycle, deficit demand for goods and services.
3. Structural: technological, long term
• automation:due to consumer tastes, jobs may become obsolete
• creative destruction: new jobs created, others are lost
4. Seasonal: weather related or seasonal jobs, construction, Santa Claus, Easter bunny, life guard, bus drivers

Full Employment

• natural rate of unemployment
• It is equal to structural and frictional unemployment
• Full employment does not mean zero unemployment

Unequal Burdens of Unemployment

1. Rates are lower for white-collar workers
2. Teenagers have the highest rates
3. Blacks have higher rates than whites
4. Rates for males and females and females are comparable

Economic Norms

• GDP growth(real):
• 2-3% per year is considered manageable growth.
• Negative GDP change is officially a "recession"
• 1-2% growth is considered weak
• Over 4% probably puts too much inflation pressure on the economy
• Unemployment %:
• 4-5% per year seems to be attainable(at least since the 1990's)
• Over 5% unemployment seems linked to recessions
• Under 4% appears to cause worker shortages and leads to wage inflation
• Inflation rate(usually measure with CPI):
• 2-3% seems attainable and "normal" for steady growth
• 1-2% inflation seems to indicate too little growth
• 4-higher %'s indicate an overheated economy:
• inflation due to too much demand
• inflation due to too little supply

Circular Flow Model