Macroeconomics Final Exam Review Flashcards

Key macroeconomics concepts, definitions, applications, and common exam traps for the final exam, focused on understanding Units 5–9.

Goods-market equilibrium

When output equals planned expenditure, meaning Y = PE.

Planned expenditure

The total amount households, firms, government, and foreigners plan to spend.

Keynesian-cross equilibrium

The point where the planned expenditure line crosses the 45-degree line.

45-degree line

Shows all points where output equals planned expenditure.

If output is greater than planned expenditure

Firms produce more than people buy, so inventories increase.

Firm response when Y > PE

Firms reduce production because goods are piling up.

If output is less than planned expenditure

People want to buy more than firms produced, so inventories fall.

Firm response when Y < PE

Firms increase production because demand is higher than output.

Unplanned inventory accumulation

Extra goods pile up because firms produced more than customers bought.

Actual investment when Y > PE

Actual investment is greater than planned investment because inventories rise.

Government purchases increase

Planned expenditure shifts upward, causing output to rise.

Government purchases decrease

Planned expenditure shifts downward, causing output to fall.

Tax increase

Disposable income falls, consumption falls, planned expenditure falls, and output falls.

Tax cut

Disposable income rises, consumption rises, planned expenditure rises, and output rises.

Multiplier effect

An initial change in spending creates a larger total change in output.

Why output falls by more than a decrease in G

Lower government spending lowers income, which lowers consumption, causing more rounds of reduced spending.

MPC

The marginal propensity to consume; the fraction of extra income people spend.

Higher MPC

Creates a larger multiplier because people spend more of each extra dollar.

Lower MPC

Creates a smaller multiplier because people save more of each extra dollar.

Government spending multiplier

The total change in output caused by a change in government purchases.

Tax multiplier

The total change in output caused by a change in taxes.

Why the tax multiplier is smaller

Taxes affect spending indirectly through consumption, while government spending affects planned expenditure directly.

Balanced budget increase

When government purchases and taxes both increase by the same amount.

Effect of increasing G and T equally

Output increases because the government spending effect is stronger than the tax effect.

IS curve

Shows combinations of interest rates and output where the goods market is in equilibrium.

Interest rate rises

Investment falls, planned expenditure falls, and output falls.

Interest rate falls

Investment rises, planned expenditure rises, and output rises.

Movement along the IS curve

Caused by a change in the interest rate.

Fall in interest rate on IS graph

Causes movement down along the IS curve and higher output.

Rise in interest rate on IS graph

Causes movement up along the IS curve and lower output.

IS curve shifts right

Planned expenditure rises at every interest rate.

IS curve shifts left

Planned expenditure falls at every interest rate.

Increase in government purchases and IS curve

Shifts the IS curve right.

Decrease in government purchases and IS curve

Shifts the IS curve left.

Tax cut and IS curve

Shifts the IS curve right.

Tax increase and IS curve

Shifts the IS curve left.

Investment demand increase

Shifts the IS curve right.

Investment demand decrease

Shifts the IS curve left.

IS curve trap

A change in interest rate causes movement along the IS curve, not a shift.

Fed Rule

The idea that the Fed changes interest rates in response to output and inflation.

FR curve

Shows the interest rate the Fed sets at each level of output.

Why the FR curve slopes upward

When output rises, the Fed raises interest rates to prevent overheating and inflation.

FR curve shifts downward

The Fed sets lower interest rates at every level of output.

Fed becomes more concerned about unemployment

The Fed may set lower interest rates, shifting the FR curve downward.

Federal funds rate decreases

Overall interest rates usually fall.

Lower interest rates and investment

Investment may increase because borrowing becomes cheaper for firms.

GDP

The market value of final goods and services produced within a country during a period of time.

Final goods and services

Goods and services sold to the final user, not used as inputs for another product.

GDP counts production based on location

GDP counts production inside a country’s borders.

Government spending

Government purchases of final goods and services.

What counts as government spending

New military aircraft, roads, schools, and government services.

What does not count as government spending

Transfer payments like Social Security, unemployment benefits, and interest payments on debt.

Transfer payment

A government payment where no new good or service is purchased.

Government spending trap

Social Security and unemployment benefits are transfer payments, not government purchases.

Gross private domestic investment

Spending by firms and households on capital, inventories, and residential construction.

Examples of gross private domestic investment

Residential construction, increased inventories, and machinery bought by firms.

GDP vs GNP

GDP is production inside a country; GNP is income earned by a country’s residents or nationals.

Foreign-owned factory in the U.S.

Counts in U.S. GDP, but not U.S. GNP.

Why GDP is not a perfect measure of well-being

It misses leisure, household production, income distribution, and quality of life.

Nominal GDP

GDP measured using current-year prices.

Real GDP

GDP measured using base-year prices.

If prices rise but quantities stay the same

Nominal GDP rises, but real GDP stays the same.

Real GDP trap

Real GDP does not rise if only prices rise.

GDP deflator

A price index for all domestically produced final goods and services.

GDP deflator includes

Domestically produced consumer goods, investment goods, government goods, and exports.

GDP deflator excludes

Imports.

GDP deflator vs CPI

GDP deflator covers domestic production, while CPI covers a fixed consumer basket.

GDP deflator and investment goods

GDP deflator includes investment goods.

GDP deflator import trap

GDP deflator does not include imports.

CPI

The Consumer Price Index; measures the cost of a fixed basket of consumer goods and services.

CPI and imports

CPI includes imports if imported goods are part of the consumer basket.

Imported electronics price increase

Shows up in the CPI, but not the GDP deflator.

CPI import trap

CPI includes imports if consumers buy them.

CPI fixed basket problem

CPI may overstate inflation because it does not fully account for substitution.

New goods and CPI

CPI understates the improvement in consumer well-being from new goods.

Inflation

A general increase in the price level.

Unexpected inflation

Inflation that is higher or lower than people expected.

If actual inflation exceeds expected inflation

Borrowers gain and lenders lose.

Why borrowers gain from unexpected inflation

They repay loans with dollars that are worth less than expected.

Why lenders lose from unexpected inflation

The money they are repaid has less purchasing power than expected.

Unexpected inflation trap

Unexpected inflation helps borrowers and hurts lenders.

Nominal interest rate

Interest rate before accounting for inflation.

Real interest rate

Interest rate adjusted for inflation.

Real interest rate formula

Real interest rate is approximately nominal interest rate minus inflation.

Shoe-leather costs

Time and effort people spend trying to avoid holding cash during inflation.

Menu costs

Costs of changing prices.

Relative-price distortion

When inflation makes it harder to compare prices accurately.

Unemployment rate

The percentage of the labor force that is unemployed.

Labor force

People who are employed plus people who are unemployed and actively looking for work.

Labor force participation rate

The percentage of the working-age population that is in the labor force.

Discouraged workers

People who want a job but stopped looking.

Are discouraged workers counted as unemployed?

No, because they are not actively looking for work.

What happens when discouraged workers stop looking?

Labor force participation falls, and unemployment may look lower than the economy really is.

Unemployment rate trap

Discouraged workers can leave the labor force and make unemployment look better.

Employment-population ratio

The share of the working-age population that is employed.

Frictional unemployment

Short-term unemployment from people searching for jobs.

Structural unemployment

Unemployment from skill mismatch, location mismatch, or wage rigidity.

Cyclical unemployment

Unemployment caused by recessions or weak demand.

Seasonal unemployment

Unemployment caused by predictable seasonal changes.

Natural rate of unemployment

Frictional unemployment plus structural unemployment.