AP Macro Unit 2

Circular Flow Diagram

illustrates how a market economy connects households and firms across the resource and product market

Resource Market

households own the factors of production and sell them to firms in exchange for income

Product Market

firms use resources to produce final goods and services, which are sold to households in exchange for consumer spending

Gross Domestic Product

the total market value of all final goods and services produced within a nation’s borders in a given time period

Expenditures Approach to GDP

Y = C + I + G + NX

Consumer Spending (C)

household spending on goods and services

Investment Spending (I)

business spending on new physical capital, all commercial and residential construction, and change sin business inventories

Government Purchases (G)

government spending on goods and services

Net Exports (NX)

exports minus imports; exports added to domestic production and imports must be subtracted

Income Approach to GDP

adds up all income generated by producing goods; national income = wages + rent + interest + profits

Vallue-Added Approach to GDP

sums the value added by all businesses a cross every stage of production; value added = value of output - cost of intermediate goods

Not Included in GDP

intermediate goods, used goods, financial transactions, government transfer payments, non-market transactions

Unemployed

a person must be out of a job, currently available for work, and actively seeking work within the past 4 weeks

Unemployment Rate

unemployed/Labor Force * 100

Frictional Unemployment

workers who are temporarily between jobs (typically voluntary)

Structural Unemployment

results from a permanent mismatch between a worker’s skills and the requirements of available jobs (typically involuntary)

Cyclical Unemployment

directly tied to downturns in the business cycle due to deficiency in aggregate demand (involuntary)

Natural Rate of Unemployment

zero cyclical unemployment; = frictional + structural unemployment

Unemployment in Inflationary Period

actual UE rate < NRU

Unemployment in Recessionary Period

actual UE rate > NRU

Inflation

a sustained increase in the economy’s general price level; decreasing money’s purchasing power

Consumer Price Index

measures the cost of a fixed market basket in order to track inflation

CPI

cost of basket in current year/cost of basket in base year * 100

Inflation Rate

(CPI year 2 - CPI year 1)/CPI year 1 × 100

Flaws in CPI

substitution bias and quality changes

Nominal Values

measruments using current prices

Real Values

measurements adjusted for inflation

GDP Deflator

= nominal GDP/real GDP * 100

Fisher Equation

Real IR = Nomimal IR - Inflation Rate

Unanticipated Inflation

borrowers/debtors on fixed-rate loans are winners and lenders/banks on fixed-rate loans and fixed-income earners/savers are losers

Business Cycle

tracks the short-run fluctuations of Real GDP

Expansion in Business Cycle

real GDP increases, unemployment decreases, price level increases

Peak of Business Cycle

where real GDP reaches its maximum temporary capacity

Contraction in Business Cycle

real GDP decreases, unemployment increases, price level decreases

Trough in Business Cycle

lowest point of economic output