Key Concepts in Macroeconomic Policy and Theory

Economic Growth

Sustained increase in real GDP over time.

Full Employment

Using the labor force efficiently; minimal cyclical unemployment.

Price Stability

Low, predictable inflation.

Equitable Income Distribution

Reducing inequality through policy.

Sustainable Trade Balance

Avoiding large trade deficits/surpluses.

Scarcity

The basic economic problem: limited resources and unlimited wants.

Law of Demand

As price decreases, quantity demanded increases (inverse relationship).

Law of Supply

As price increases, quantity supplied increases (direct relationship).

Market Equilibrium

Occurs where supply and demand curves intersect. Price and quantity stabilize at this point.

Demand Curve Shifts - Right

At the same price, more is demanded

higher equilibrium price and quantity

Demand Curve Shifts - Left

Income falls, preferences drop, substitute price falls, complement price rises, population shrinks.

Supply Curve Shifts - Right

Input costs fall, technology improves, more sellers enter market, subsidies increase.

Supply Curve Shifts - Left

Input costs rise, taxes increase, fewer sellers, bad weather or natural disasters.

Production Possibilities Frontier (PPF)

A graph showing all possible combinations of goods/services that can be produced using available resources.

Per Capita GDP

GDP divided by the population. Indicates the average output per person and is often used as a rough measure of a country's standard of living.

Unemployment Rate

% of labor force without a job but actively seeking one.

Types of Unemployment - Frictional

Unemployment occurring between jobs.

Types of Unemployment - Structural

Unemployment due to skills and employer needs mismatch

Types of Unemployment - Cyclical

Unemployment due to recession.

Rationale for Government Policies

Governments intervene to correct market failures, promote equity and growth, stabilize the economy, provide public goods, and address externalities (e.g., pollution).

Automatic Stabilizers

Fiscal tools that automatically counter economic fluctuations, such as progressive taxes and unemployment benefits.

Trade Deficit

Occurs when a country imports more than it exports, potentially leading to currency depreciation or increasing foreign debt.

Trade Surplus

Occurs when a country exports more than it imports, which can boost GDP and strengthen the currency.

International Trade

Exchange of goods and services across borders, promoting efficiency, comparative advantage, access to a wider variety of goods, and economic growth.

Budget Deficit

Government spends more than it collects in revenue.

Budget Surplus

Government collects more than it spends.

Government Borrowing

The government borrows by issuing bonds and Treasury securities, which helps finance deficits but can increase future interest payments and debt levels.

Crowding Out

When government borrowing (ex. bonds) increases demand for loanable funds, it can raise interest rates and reduce private investment.

Progressive Tax

Rate increases with income (e.g., federal income tax).

Regressive Tax

Takes a larger share of income from low earners (e.g., sales tax).

Proportional Tax

Flat rate for all incomes (e.g., some payroll taxes).

Impact of Government Borrowing on Interest Rates

Large-scale borrowing increases demand for money, which can raise interest rates. Higher rates may reduce business investment and consumer borrowing.

Monetary Policy

Central bank uses tools to manage the money supply and influence the economy.

Expansionary Monetary Policy

Increases money supply, lowers interest rates.

Contractionary Monetary Policy

Decreases money supply, raises interest rates.

Central Bank

A national institution (e.g., the Federal Reserve in the U.S.) that controls the money supply, regulates banks, and implements monetary policy.

Federal Reserve

The U.S. central bank. It supervises commercial banks, manages inflation and employment through monetary policy, and ensures financial stability.

Federal Open Market Committee (FOMC)

A committee within the Fed that makes key decisions about open market operations and sets short-term interest rate targets.

Open Market Operations (OMOs)

The Fed buys or sells government securities.

Reserve Requirements

The % of deposits banks must hold and not loan out. Lowering requirements boosts lending; raising them restricts it.

Discount Rate

The interest rate the Fed charges commercial banks for loans. Lowering the rate makes borrowing cheaper, encouraging economic activity.

Federal Funds Rate

The rate banks charge each other for overnight loans. The Fed influences this rate to steer economic conditions.

Required Reserves

The portion of deposits banks must hold in reserve (not lent out). Helps ensure banks have enough funds to meet withdrawals.

Fiscal Policy

Government decisions on taxing and spending to influence the economy.

Expansionary Fiscal Policy

Increases spending or cuts taxes to stimulate growth.

Contractionary Fiscal Policy

Reduces spending or raises taxes to slow inflation.

Inflation

A sustained increase in the general price level.

Demand-pull Inflation

demand increases faster than the economy’s ability to produce, leading to higher prices

Cost-push Inflation

cost of production rises, so does consumer prices

Human Capital

Skills, education, experience, and health of the workforce. Investment in human capital boosts productivity and economic growth.

Capital

In economics, capital refers to physical tools, machinery, and buildings used to produce goods—not money.

Money

Functions of money: 1. Medium of exchange 2. Store of value 3. Unit of account.

Bonds

A financial instrument representing a loan to a government or corporation. The bondholder receives regular interest payments and repayment at maturity.

Globalization

The increasing economic interdependence of countries through trade, investment, technology, and labor markets.

Exports

Goods sold to other countries.

Imports

Goods bought from other countries.

Marginal Analysis

Decision-making by comparing additional (marginal) benefits vs. additional costs.

Factors of Production

The resources used to make goods and services.