Principles of Macroeconomics: Final Exam Review

Major Goals of Economic Policy

1) Reduce Unemployment

2) Reduce inflation

3) Adequate economic growth

4*) Equitable income distribution

Real GDP

Measures GDP utilizing the constant prices of a base year and GDP deflator

Nominal GDP

Measures GDP utilizing the current prices of all final goods and services

Macroeconomic Tools

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Why do we bother to calculate real GDP if we already have nominal GDP?

Real GDP provides a better understanding of the actual growth in the volume of output by removing price changes (inflation)

GDP Deflator

Nominal / Real x 100

Inflation Rate

New price - old price / old price x 100

GDP

Gross Domestic product- the total monetary value of all final goods and services produced in a country within a year's time

Two methods of calculating GDP

1) Government asks the firms to inform through receipts and invoices

2) income approach asks households once a year their wages, rent, profit

MPC

Marginal propensity to consume- portion of additional income that an individual consumes instead of saves. Change in C / Change in Y (income)

MPS

marginal propensity to save- portion of additional income that an individual saves. Change in S / change in Y (income)

APC

C / Y (income)

APS

S / Y (income)

The questions that an economy needs to answer and the ways in which they can be answered.

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Budget Policy

Governments decide where and how they will obtain and then allocate revenue, through expenditure or reserves.

Monetary Policy

Governments set the interest rate in order to control the flow of money in and out of the economy. In democratic states this role belongs to the Central Bank.

Income Policy

Governments decide to intervene in order to distribute income in an equal way.

Aggregate Demand

The demand of all products being produced within a country

GDP Components

(C) Household consumption

(I) Investments (firms)

(G) Government expenditure

(X) Net exports

GNP

Gross national product- what nationals produce outside of their country of origin

Investment is affected by...

1) Revenue

2) Costs

3) Expectations

Growth Rate % Change

New - old / old x 100

Shift Aggregate Demand by...

1) Fiscal policy variables

2) Exogenous variables

3) Monetary policy variables

Multiplier of (G) government expenditures

1 / MPS

Multiplier of (T) taxation

MPC / MPS

Multiplier of an open economy

1 / MPS + MPM

MPM

Change in imports / Change in income

M1 (most liquid form of money)

Metal coins, paper money, checking accounts

M2 (broad money)

M1, saving accounts, certificate of deposit

What affects Investment?

Maturity, risk, liquidity, administrative costs

Interest rate

New price - old price / old price x 100

Demand for money

1) Medium of exchange

2) Store of value

3) Unit of account

Objectives of a Central Bank

1) Stable prices

2) Low unemployment

3) Rapid growth of real GDP

Okun's Law

For every 2% of real GDP below potential GDP, the unemployment rate increases by 1%

Activity rate

Workforce / overall population

Unemployment rate

Unemployed / workforce

Types of unemployment

1) Frictional

2) Structural

3) Cyclical

CPI

Consumer price index- checks the prices that are being payed by the consumers on specifically selected commodities

PPI

Producer price index- checks the prices of goods upon their release from production

Types of inflation

1) Moderate (0-9%)

2) Galloping (10-99%)

3) Hyper

3 Causes of inflation

1) Demand - pull inflation

2) Costs - push inflation

3) ?

Stagflation

Rising unemployment and lack of growth in consumer demand and business activity.

COLA

Cost of leading adjustment- adjusts salaries based on changes in a cost-of-living index (an index that measures differences in the price of goods and services, and allows for substitutions with other items as prices vary)

Inflation

A sustained increase in the general price level of goods and services in an economy over a period of time

3 Ways to calculate inflation

1) GDP Deflator

2) Change in CPI

3) Change in PPI

Reserve Requirement

the minimum fraction of customer deposits and notes that a bank must hold as reserves. 1 / RR