Macroeconomics and Business Cycle: Key Concepts and Indicators

Macroeconomics

Study of the economy as a whole—looks at GDP, unemployment, inflation, growth, and trade.

Business Cycle

Recurring pattern of expansion, peak, recession, and trough in real GDP over time.

Expansion

Period of rising output, employment, and income.

Peak

Highest point before a downturn.

Recession

At least two consecutive quarters of declining real GDP.

Trough

Lowest point before recovery begins.

GDP (Gross Domestic Product)

Total dollar value of all final goods and services produced within a country's borders in a specific time.

Real GDP

Adjusted for inflation → true output.

Nominal GDP

Uses current prices → can rise from inflation alone.

Requirements to Be Unemployed

1️⃣ Without a job 2️⃣ Able and willing to work 3️⃣ Actively seeking work.

Economic Investment

Buying new capital (machines, buildings).

Financial Investment

Buying existing assets (stocks, bonds).

Demand Shock

Sudden change in desire to buy goods.

Supply Shock

Sudden change in ability to produce goods.

Sticky Prices

Prices don't change quickly in short run → cause recessions and business cycles.

Final Goods

Products ready for consumption; counted in GDP.

Intermediate Goods

Used to make other goods; not counted separately.

Value Added

= Output Value - Input Value; prevents double counting.

Expenditure Approach

GDP = C + Ig + G + Xn; C = consumption Ig = investment G = gov't purchases Xn = exports - imports.

Net Investment

= Gross Investment - Depreciation. If positive → economy's capital stock grows.

Disposable Income (DI)

= Personal Income - Taxes = C + S. Money households can spend or save.

What's Excluded from GDP

Transfer payments, non-market work, used goods, financial transactions, imports.

Economic Growth

Increase in real GDP or real GDP per capita over time.

Real GDP Per Capita

= Real GDP ÷ Population → best measure of living-standard change.

Labor Productivity

= Total Output ÷ Hours of Work.

Real GDP Formula

= Labor Productivity × Hours of Work.

5 Factors Raising Productivity

1 Tech advances (≈ 40%) 2 Capital per worker 3 Education/training 4 Economies of scale 5 Better resource use.

Economies of Scale

Larger production lowers per-unit cost.

Human Capital

Skills + knowledge of workers that raise productivity.

Network Effects

Value of a product increases as more people use it (e.g., social media).

Increasing Returns

% output rise > % input rise.

Labor Force

= Employed + Unemployed (excludes discouraged workers, retirees, students).

Unemployment Rate

= (Unemployed ÷ Labor Force) × 100.

Frictional Unemployment

Temporary—between jobs or entering workforce.

Structural Unemployment

Skills no longer match job demand (automation, new industries).

Cyclical Unemployment

Caused by downturns or recessions.

Natural Rate of Unemployment

Frictional + Structural (~4-5%); economy at potential output.

GDP Gap

= Potential GDP - Actual GDP. Large gap → underused resources & high unemployment.

Inflation

Average rise in price levels.

Demand-Pull Inflation

"Too much money chasing too few goods."

Cost-Push Inflation

Higher input costs push prices upward.

Core Inflation

CPI change excluding food & energy; used by Fed.

Real vs. Nominal Income

%Δ Real Income ≈ %Δ Nominal Income - %Δ Price Level. Example: If income ↑ 5% & prices ↑ 3% → real income ↑ 2%.

Main Determinant of Consumption

Income.

MPC (Marginal Propensity to Consume)

ΔC ÷ ΔY. If MPC = 0.6, you spend $0.60 per extra $1 earned.

MPS (Marginal Propensity to Save)

ΔS ÷ ΔY. MPC + MPS = 1.

APC (Average Propensity to Consume)

C ÷ Y (total consumption ÷ total income).

Dissaving

Spending more than current income (using savings or debt).

45° Line

Where C = Y; above = dissaving, below = saving.

Investment Rule

If Expected Return (r) > Interest Rate (i) → Invest. Otherwise don't.

Real Interest Rate

= Nominal Rate - Inflation Rate.

Multiplier Formula

= 1 ÷ (1 - MPC) or 1 ÷ MPS. Example: MPC = 0.75 → Multiplier = 4.

Change in GDP

= Multiplier × Initial Spending Change.

Why Actual Multiplier Smaller

Imports, taxes, and inflation leak spending out of economy.

Key Assumption

Prices are fixed (sticky).

Equilibrium Condition (Private Closed)

C + Ig = GDP.

Equilibrium Condition (Mixed Open)

C + Ig + Xn + G = GDP.

Leakages vs. Injections

Leakages: S, M, T. Injections: Ig, X, G. Equilibrium when Leakages = Injections.

Unplanned Inventories Rule

At equilibrium, no unplanned inventory changes.

Below Equilibrium GDP

C + Ig > GDP → inventories fall → firms increase production.

Above Equilibrium GDP

C + Ig < GDP → inventories rise → firms cut production.

Government Spending Multiplier Effect

If G ↑ by $20B & multiplier = 4 → GDP ↑ by $80B.

Tax Effect on GDP

Tax × MPC = ΔC; then multiply by multiplier to find ΔGDP.

Government vs. Tax Impact

Gov't spending has bigger impact per dollar than tax cuts.

Recessionary Expenditure Gap

Aggregate spending too low → GDP < potential → unemployment.

Inflationary Expenditure Gap

Aggregate spending too high → demand-pull inflation.

Keynesian Solution to Recession

↑ Government spending or ↓ Taxes to close gap.

Say's Law vs. Keynesian View

Say's Law: "Supply creates its own demand." Keynes: Spending can be too low; gov't should stabilize economy.