AP Macroeconomics Vocab/Formulas

GDP = C + I + G + Xn

The expenditure approach to measuring GDP correlates well with aggregate demand

GDP = W + I + R + P

The income approach to measuring GDP correlates well with aggregate supply

Calculating Nominal GDP

The quantity of various goods produced in a nation times their current prices, added together

GDP Deflator

A price index used to adjust nominal GDP to arrive at real GDP. Called the “deflator” because nominal GDP will usually overstate the value of a nation’s output if there has been inflation. The Consumer Price Index is another commonly used price index.

Absolute Advantage

A country or entity has an absolute advantage in the production of a good when the country can produce the good using fewer resources than another country or entity

Aggregate Demand (AD)

A schedule or curve that shows the total quantity demanded for all goods and services of a nation at various price levels at a given period of time

Aggregate Supply (AS)

The total amount of goods and services that all the firms in all the industries in a country will produce at various price levels in a given period of time

Appreciation

An increase in the value of one currency relative to another, resulting from an increase in demand for or a decrease in supply of the currency on the foreign exchange market

Balance of Payments

Measures all the monetary exchanges between one nation and all other nations. Includes the current account and the capital account

Bonds

A certificate of debt issued by a company or a government to an investor

Real GDP

Nominal GDP/ GDP deflator x 100

GDP Growth Rate

(Current year’s GDP - Last year’s GDP/ Last year’s GDP) x 100 The GDP growth rate is a percentage change in a nation’s real output between one year and the next

The Inflation Rate via the CPI

(This year’s CPI - Last year’s CPI/ Last year’s CPI) x 100

The inflation rate is the percentage change in the CPI from one period to the next

Budget Deficit

When a government spends more than it collects in tax revenues in a given year

Business Cycle

A model showing the short-run periods of contraction and expansion in output experienced by an economy over a period of time

Capital

Human-made resources (machinery and equipment) used to produce goods and services; goods that do not directly satisfy human wants. Sometimes separated into human capital (education, know-how) and physical capital (tools you can touch and operate)

Capital Account (also called the Financial Account)

Measures the flow of funds for investment in real assets (such as factories or office buildings) or financial assets (such as stocks and bonds) between a nation and the rest of the world

Ceteris Paribus

“Other things being equal”; used as a reminder that all variables other than the ones being studies are assumed to be constant

Circular Flow Diagram

A model of the macro-economy that shows the interconnections of businesses, households, government, banks, and the foreign sectors. Money flows in a circular direction, and goods, services, and resources flow in the opposite direction

Classical Economic Theory

The view that an economy will self-correct from periods of economic shock if left alone. Also known as “laissez-faire”

Scarcity

Something is scarce when it is both desired and limited in supply. Scarcity is the basic economic problem

Real Interest Rate

Nominal interest rate - inflation rate

Unemployment Rate

(Number of unemployed/number in the labor force) x 100

The labor force includes all non-institutionalized people of working age who are employed or seeking employment

Money Multiplier

1/RRR where RRR equals the required reserve

Comparative Advantage

When an individual, firm, or a nation is able to produce a particular product at a lower opportunity cost than another individual, firm, or nation. Comparative advantage is the basis on which nation trade with one another

Consumer Price Index (CPI)

An index that measures the price of a fixed market basket of consumer goods bought by a typical consumer. The CPI is used to calculate the inflation rate in a nation

Consumption

A component of a nation’s aggregate demand; measures the total spending by domestic households on goods and services

Contractionary Fiscal Policy

A demand-side policy whereby the government increases taxes or decreases its expenditures in order to reduce aggregate demand. Could be used in a period of high inflation to bring down the inflation rate

Contractionary Monetary Policy

A demand-side policy whereby the central bank reduces the supply of money, increasing interest rates and reducing aggregate demand. Could be used to bring down high inflation rates

Cost-Push Inflation

Inflation resulting from a decrease in AS (from higher wage rates and raw materials prices, such as the price of oil) and accompanied by a decrease in real output and employment. Also referred to as “stagflation” or “adverse aggregate supply shock”

Crowding-Out Effect

The rise in interest rates and the resulting decrease in investment spending in the economy caused by increased government borrowing in the loanable funds market. Seen as a disadvantageous side effect of expansionary fiscal policy

Quantity Theory of Money

MV = PQ = Y. A monetarist’s view that explains how changed in the money supply (M) will affect the price level (P) and/or real output assuming the velocity of money (V) is fixed in the short run.

MPC + MPS = 1

The fraction of an increase in disposable income that is spent (MPC) plus the fraction that is saved (MPS) must equal 1

Spending Multiplier

1/1-MPC or 1/MPS. This tells you how much total spending an initial injection of spending in the economy will generate.

Tax Multiplier

\-MPC/MPS. This tells you how much total spending will result from an initial change in the level of taxation. It is negative because when taxes decrease, spending increases, and vice versa. The tax multiplier will always be smaller than the spending multiplier.

Current Account

Measures the balance of trade in goods and services and the flow of income between one nation and all other nations. It also records monetary gifts or grants that flow into or out of a country, Equal to a country’s net exports, or its exports minus its imports.

Cyclical Unemployment

Unemployment caused by a fall in aggregate demand in a nation. Not included in the natural rate of unemployment. When a nation is in a recession, there will be cyclical unemployment.

Deflation

A decrease in the average price level of a nation’s output over time.

Demand Deposit

A deposit in a commercial bank against which checks may be written. Also known as a “checkable deposit"

Demand-Pull Inflation

Inflation resulting from an increase in AD without a corresponding increase in AS

Depreciation

A decrease in the value of one currency relative to another, resulting from a decrease in demand for, or an increase in the supply of, the currency on the foreign exchange market

Devaluation

When a government intervenes in the market for its own currency to weaken it relative to another currency. Usually achieved through direct intervention in foreign exchange (forex) market or through the use of monetary policy that affects interest rates, and thereby affects international demand for the currency

Discount Rate

One of the three tools of monetary policy, it is the interest rate that the federal government charges on the loans it makes to commercial banks

Economic Growth

An increase in the potential output of goods and services in a nation over time

Economic Resources

Land, Labor, capital, and entrepreneurial ability that are used in the production of goods and services. They are “economic” resources because they are scarce (limited in supply and desired). Also known as “factors of production”

Excess Reserves

The amount by which a bank’s actual reserves exceed its required reserves. Banks can lend excess reserves; when they do, they expand the money supply. The amount of excess reserves in the banking system determines equilibrium interest rate

Exchange Rate

The price of one currency in terms of another currency, determines in the forex market

Exports

The spending by foreigners on domestically produced goods and services. Counts as an injection into a nation’s circular flow of income

Federal Funds Rate (FFR)

The interest rate banks charge one another on overnight loans made out of their excess reserves. The FFR is the interest rate targeted by the Fed through its open-market operations

Fiscal Policy

Changes in government spending and tax collections implemented by government with the aim of either increasing or decreasing aggregate demand to achieve the macroeconomic objectives of full employment and price-level stability

Floating Exchange Rate System

When a currency’s exchange rate is determined by the free interaction of supply and demand in international forex markets

Forex Market (Foreign Exchange Market)

The market in which international buyers and sellers exchange foreign currencies for one another to buy and sell goods, services, and assets from various countries. It is where a currency’s exchange rate relative to other currencies is determined

Fractional Reserve Banking

A banking system in which banks hold only a fraction of deposits as required reserves and can lend some of the money deposited by their customers to other borrowers

Frictional Unemployment

Unemployment of workers who have employable skills, such as those who are voluntarily moving between jobs or recent graduates who are looking for their first job

Full Employment

When an economy is producing at a level of output at which almost all the nations resources are employed. The unemployment rate when an economy is at full employment equals the natural rate, and includes only frictional and structural unemployment. Full-employment output is also referred to as “potential output”

GDP

The total market value of all final goods and services produced during a given time period within a country’s borders. Equal to the total income of the nation’s households or the total expenditures on the nation’s output

GDP Deflator

The price index for all final goods and services used to adjust the nominal GDP into real GDP

Human Capital

The value skills integrated into labor through education, training, knowledge, and health. An important determinant of aggregate supply and the level of economic growth in a nation

Imports

Spending on goods and services produced in foreign nations. Counts as a leakage from a nation’s circular flow of income

Inflation

A rise in the average level of prices in the economy over time (percentage change in the CPI)

Inflationary Gap

The difference between a nation’s equilibrium level of output and its full employment level of output when the nation is overheating (producing beyond its full employment level)

Inflationary Spiral

The rapid increase in average price level resulting from demand-pull inflation leading to higher wages, causing cost-push inflation

Interest Rate

The opportunity cost of money. Either the cost of borrowing money or the cost of spending money (e.g., the interest rate is what would be given up by not saving money). Conversely, this is the price a lender is paid for allowing someone else to use money for a time

Investment

A component of aggregate demand, it includes all spending on capital equipment, inventories, and technology by firms. This does not include financial investments, which is the purchase of financial assets (stocks and bonds). Also includes household purchasing of newly constructed residences

Law of Increasing Opportunity Cost

As more of a particular product is produced, the opportunity cost, in terms of what must be given up of other goods to produce each unit of the product, increases. Explains the convex shape of a nation’s production possibilities curve

Loanable Funds Market

The market in which the demand for private investment and the supply of household savings intersect to determine the equilibrium real interest rate

Long Run

The period over time over which the wage rate and price level of inputs in a nation are flexible. In the long run, any changes in AD are cancelled out due to the flexibility of wages and prices and an economy will return to its full employment level of output.

Long Run Aggregate Supply

The level of output to which an economy will always return in the long run. The LRAS curve intersects the horizontal axis at the full employment or potential level of output

M1

A component of the money supply including currency and checkable deposits

M2

A more broadly defined component of the money supply. Equal to M1 plus savings deposits, money-market deposits, mutual funds, and small-time deposits

M3

The broadest component of the money supply. Equal to M2 plus large time deposits

Macroeconomics

The study of entire nations’ economies and the interactions between households, firms, government, and foreigner

Macroeconomic Equilibrium

The level of output at which a nation is producing at any particular period of time

Managed or Fixed Exchange Rate System

When a government or central bank takes action to manage or fix the value of its currency relative to another currency on the forex market

Marginal Analysis

Decision-making which involves a comparison of marginal (extra) benefits and marginal costs

Marginal Propensity to Consume (MPC)

The fraction of any change in income spent on domestically produced goods and services; equal to the change in consumption divided by the change in disposable income

Marginal Propensity to Save (MPS)

The fraction of any change in income that is saved; equal to the change in savings divided by the change in disposable income

Market Economic System

A system of resource allocation in which buyers and sellers meet in markets to determine the price and quantity of goods, services, and productive resources

Microeconomics

The study of the interactions between consumers and producers in markets for individual products

Monetarism

The macroeconomic view that the main cause of changes in aggregate output and the price level are fluctuation in the money supply

Monetary Policy

The central bank’s manipulation of the supply of money aimed at raising or lowering interest rates to stimulate or contract the level of aggregate demand to promote the macroeconomic objectives of price-level stability and full employment

Money

Any object that can be used to facilitate the exchange of goods and services in a market

Money Demand

The sum of the transaction demand and the asset demand for money. Inversely related to the nominal interest rate

Money Market

The market where the supply of money is set by the central bank; includes the downward-sloping money-demand curve and a vertical money-supply curve. The “price” of money is the nominal interest rate

Money Supply

The vertical curve representing the total supply of excess reserves in a nation’s banking system. Determined by the monetary policy actions of the central bank

Multiplier Effect

The increase in total spending in an economy resulting from an initial injection of new spending. The size of the multiplier effect depends upon the spending multiplier

Natural Rate of Unemployment (NRU)

The level of unemployment that prevails in an economy that is producing at its full employment level of output. Includes structural and frictional unemployment

Net Exports (Xn)

A component of aggregate demand that equals the income earned from the sale of exports to the rest of the world minus expenditures by domestic consumers on importsn

Official Reserves

To balance the two accounts in the balance of payments (current and financial accounts), a country’s official foreign exchange reserves measures the net effect of all the money flows from the other accounts

Open-Market Operations

The central bank’s buying and selling of government bonds on the open market from commercial banks and the public. This is aimed at increasing or decreasing the level of reserves in the banking system and thereby affects the interest rate and the level of aggregate demand

Opportunity Cost

What must be given up to have something else. Opportunity costs are not necessarily monetary costs, but rather include what you could do with the resources you use to undertake any activity or exchange

Phillips Curve (Long-Run)

A model that demonstrates that after inflation expectations have been adjusted, there is no trade-off between inflation and unemployment, as it is vertical and equal to the NRU

Phillips Curve (Short-Run)

A model that demonstrates the inverse relationship between unemployment (horizontal) and inflation (vertical axis)

Production Possibilities Curve (PPC)

A graph that shows the various combinations of output that the economy can produce given the available factors of production and the available production technology

Productivity

The output per unit of input of a resource. An important determinant of a level of aggregate supply in a nation

Protectionism

The use of tariffs, quotas, or subsidies to give domestic producers a competitive advantage over foreign producers. Meant to protect domestic production and employment from foreign competition

Rational Expectation Theory

The hypothesis that business firms and households expect monetary and fiscal policies to have certain effects on the economy and take, in pursuit of their own self-interests, actions which make these policies ineffective at changing real output

Recession

A contraction in total output goods and services in a nation between two periods of time. Could be caused by a decrease in aggregate demand or in aggregate supply

Recessionary Gap

The difference between an economy’s equilibrium level of output and its full employment level of output when an economy is in recession

Required Reserves

The proportion of a bank’s total deposits it’s required to keep in reserve with the central bank. Determined by the required reserve ratio