FINAL REVIEW Essay

1. Explain the problem of moral hazard and give examples from the insurance and the employment context.
Moral hazard – refers to the reduced incentive to exercise care once you purchase insurance, arises from information asymmetry and hidden actions. Employees will shirk after they are hired (Principal – Agent Problem)

2. Explain how incentive contracts can solve the moral hazard problem.
These contracts keep people from perusing risky actions by keeping their interests aligned with those of the other party. (Bonuses, Commissions, etc.)

3. Define GDP.
GDP represents the total value of all goods and services produced in a country over a period of time. Long-run what country produce and consume are identical. (Consumption + Savings + Gov’t Spending + Net Exports); only counts final goods and services

4. Explain the difference between nominal and real GDP.
Real GDP has been adjusted to account for inflation, in contrast nominal figures have not been adjusted.

5. Explain how the fact that home production is not counted in GDP may affect GDP trends over time.
Work done at home is not counted toward the nation’s official output. During periods of recession where more work is done at home to save money GDP will drop more precipitously.

6. Explain the difference between potential GDP and actual GDP.
The potential GDP is a country's maximum, ideal production with high employment across all sectors of the economy while maintaining currency and price stability. Real GDP is the actual measured economic output for a country over a given interval. The GDP gap or output gap is considered a measure of a wasteful economic model. Inefficiencies, unemployment and economic crises dampen actual GDP figures.

7. Explain why GDP forecasts are likely to have large confidence intervals.
They are forecasting the probability that different occurrences will happen. They have a range that encompasses a wide possibility of outcomes and then determine which ones are most likely, usually with a normal or bell shaped distribution. These intervals are so large due to the many possible outcomes that can occur.

8. Explain the advantages and disadvantages of using GDP as a measure of a country’s well - being.
1) Pros: Simple measure of economic wellbeing from year to year, GDP per capita makes it easy to compare different nations to determine how well off each nation’s individuals are, in long-run GDP per capita will be an accurate measure of how much each individual will consume (can’t consume more than you produce)

Cons: GDP does not take into account any economic activity that is not paid for (like work done at home), GDP does not account for pollution or environmental degradation, GDP per capita does not take into account distribution of incomes (can mask income disparities)

9. Describe how the Consumer Price Index is constructed.
Five steps: Fix the basket, find the prices, compute the basket’s cost, choose a base yaer and compute the index, compute the inflation rate
CPI = (P Basket in current year / P Basket in base year) * 100
Inflation = (CPI year 2 – CPI year 1) / CPI year 1

10. Describe the difference between nominal interest rate and the real interest rate.
Nominal interest rate = the change in dollar amounts, the real interest rate is corrected for inflation. Nominal tell you how fast the number of dollars rises over time, whereas the real tell you how fast the purchasing power rises over time.

11. Define the unemployment rate and the labor force participation rate.
Labor force = # of people employed + # of people unemployed
Unemployment rate % of labor force that is unemployed = (# of unemployed / labor force) * 100
Labor-force participation rate % of adults in LF = (Labor force / Adult population) * 100

12. Explain why the unemployment rate and the labor force participation rate are necessary to give a full picture of the state of the labor market.
It is necessary to study both numbers in order to get a full picture.

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