Economics Honors Unit 2: Macroeconomics, AD/AS & Fiscal Policy

Aggregate Demand (AD)

The total quantity of all final goods and services demanded across the entire economy at various price levels ($AD = C + I + G + NX$).

Aggregate Supply (AS)

The total quantity of final goods and services that firms in an economy are willing and able to produce at various price levels.

Gross Domestic Product (GDP)

The total dollar value of all final goods and services produced within a nation's geographical borders in a given year.

Real GDP per Capita

Real GDP divided by total population. Adjusted for inflation, it measures average economic output per person and serves as the primary gauge for standard of living.

Inflation

A general, sustained increase in the overall price level over time (lowers purchasing power).

Deflation

A general, sustained decrease in the overall price level over time (increases purchasing power).

Hyperinflation

Out-of-control inflation (typically >50% per month) that rapidly devalues currency and collapses trust in money.

Demand-Pull Inflation

Driven by excess aggregate demand ('too much money chasing too few goods'); $AD$ shifts right.

Cost-Push Inflation

Driven by an abrupt increase in production costs (e.g., resource supply shocks); $SRAS$ shifts left.

Recession

A significant decline in economic activity lasting at least two consecutive quarters (6 months), marked by falling Real GDP and rising unemployment.

Depression

An acute, prolonged recession characterized by severe GDP contraction, mass unemployment, and broad economic collapse over several years.

Underemployed Worker

An individual who is working part-time for economic reasons (wants full-time work but cannot find it) or works at a job below their skill or education level.

Discouraged Worker

An individual who has stopped searching for work because they believe no jobs are available for them in the current market.

Full Employment

The economy operates where cyclical unemployment is zero. The economy produces at potential output ($Y_p$).

Natural Rate of Unemployment (NRU)

Typically sits around 4%-5%.

Infrastructure (Capital)

Physical capital networks (roads, power grids, ports, water systems, telecom) that reduce production/transport costs and increase business productivity.

Economic Growth

Steady, long-term expansion of Real GDP.

Full Employment (Goal)

Keep unemployment near NRU (4-5%).

Price Stability

Maintain low, predictable inflation (~2%).

Inflationary Gap

Actual Output ($Y$) > Potential Output ($Y_p$). Overheating economy; $AD$ to right of $LRAS$. Low unemployment, high PL.

Recessionary Gap

Actual Output ($Y$) < Potential Output ($Y_p$). High unemployment, reduced PL/output.

Components of GDP

Expenditure Approach: GDP = C + I + G + NX.

Consumption (C)

Total spending by households on final consumer goods and services.

Investment (I)

Business spending on physical capital, non-residential structures, equipment, inventory, and new residential housing.

Government Spending (G)

Total spending by federal, state, and local governments on goods/services.

Net Exports (NX)

Value of exports ($X$) minus imports ($M$). Reflects net foreign spending on domestic production.

Civilian Labor Force Criteria

At least 16 years of age, civilian non-institutionalized (not active military, in prison, or long-term care).

Frictional Unemployment

Temporary unemployment during job transitions.

Structural Unemployment

Unemployment due to skill mismatches or technological changes.

Seasonal Unemployment

Unemployment that occurs at certain times of the year.

Cyclical Unemployment

Unemployment correlated with the business cycle.

Nominal GDP

Measured using current-year market prices. Unadjusted for inflation/deflation.

Real GDP

Measured using constant base-year prices. Removes distortion of inflation to reveal actual physical output.

Expansion

Voluntary transition; time delay in matching qualified workers with open jobs.

Contraction

Directly tied to economic downturns and contractions in the business cycle.

Aggregate Demand (AD) Determinants

Factors influencing consumer spending, investment, and government spending.

Consumer Spending ($C$)

Influenced by consumer wealth, tax cuts, income, confidence, household debt.

Investment ($I$)

Affected by real interest rates, business tax rates, future expectations.

Government ($G$)

Includes federal infrastructure and public project spending.

Short-Run Aggregate Supply (SRAS) Determinants

Factors affecting resource prices, government actions, productivity, net exports, and expectations.

Resource Prices

Costs of labor (wages), raw materials, energy/oil.

Actions by Government

Includes business taxes, subsidies, environmental regulations.

Productivity

Influenced by technological advancements, worker efficiency/education.

Net Exports ($NX$)

Affected by foreign income levels and exchange rates (dollar strength).

Expectations

Anticipated future inflation rates on input costs.

Consumer Confidence Effect

High confidence boosts spending, low confidence increases savings.

Market Basket & CPI

Sample of ~80,000 goods/services purchased by urban households, tracked by BLS for CPI.

CPI Base Year Index Value

ALWAYS 100.

Unexpected Inflation Winners

Fixed-rate borrowers and asset holders are helped.

Unexpected Inflation Losers

Fixed-rate lenders, fixed income, real return < inflation are hurt.

Social Security

Retirement, disability, and survivor benefits (FICA).

The Great Recession of 2008

Real GDP contracted by over 4%, the deepest drop since the Great Depression.

Subprime Housing Crash

Triggered a severe credit crunch, shifting Aggregate Demand left.

Unemployment Rate During Great Recession

Spiked to 10%.

TANF

Financial aid & work grants for low-income families.

CHIP

Health insurance for kids above Medicaid eligibility.

SNAP

Supplemental Nutrition Assistance Program (Food Stamps).