Macroeconomics Unit 2: The Circular Flow, GDP, Unemployment, and Inflation

Vocabulary practice flashcards covering Unit 2: The Circular Flow, GDP, Unemployment, Price Indices, Inflation, Real vs. Nominal GDP, and the Business Cycle.

The Circular Flow

A model that illustrates the continuous movement of resources, goods, services, and money between households and businesses across resource and product markets.

Gross Domestic Product (GDP)

The total dollar value of all final goods and services produced within a country's borders during a specific time period, avoiding intermediate goods.

Income Approach

A method of calculating GDP by adding all income earned in production.

Value-Added Approach

A method of calculating GDP by summing the value added by each firm or industry at every stage of the production process.

Expenditure Approach

A method of calculating GDP by adding up all spending: $\text{GDP} = C + I + G + (X - M)$.

Consumption ($C$)

Spending by households on goods and services.

Investment ($I$)

Spending by businesses on capital goods.

Government Spending ($G$)

Spending by federal, state, and local governments on public goods and services.

Net Exports ($X - M$)

The component of GDP representing exports minus imports.

Nonmarket Activities

Productive tasks such as household activities that are excluded from GDP calculations.

Underground Economy

Economic activities that are hidden to avoid taxes and regulation, which are not captured in GDP.

Labor Force

People aged 16 and older who are either employed or actively seeking work; it excludes those not looking for work, full-time students not looking for work, and discouraged workers.

Unemployment Rate

The percentage of the labor force without a job, calculated as: $\left(\frac{\text{\# of unemployed}}{\text{total labor force}}\right) \times 100$.

Labor Force Participation Rate

The share of the working-age population that is either employed or actively seeking employment, calculated as: $\left(\frac{\text{Labor Force}}{\text{Working Age Population}}\right) \times 100$.

Underemployment

A situation where individuals work part-time but prefer full-time employment, which is not captured by the standard unemployment rate.

Discouraged Workers

Individuals who have stopped looking for work and are therefore excluded from the labor force and the unemployment rate.

Frictional Unemployment

Short-term unemployment experienced by workers who are temporarily between jobs or entering the workforce for the first time as part of the job search process.

Structural Unemployment

Unemployment resulting when workers lack the skills required for available jobs due to declining industries or obsolete skills, requiring retraining to find employment.

Cyclical Unemployment

Unemployment caused by economic downturns when businesses reduce production and lay off workers due to decreased demand; it rises during recessions and falls when the economy expands.

Natural Rate of Unemployment (NRU)

The level of unemployment present when only structural and frictional unemployment exist ($\text{NRU} = \text{Frictional} + \text{Structural}$, roughly $3\text{--}5\%$ in the U.S.).

Inflation

A rise in the general price level in an economy over time, which decreases the purchasing power of money.

Price Index

A measure that tracks inflation by assigning a numerical value to the price level relative to a base year (which always has an index value of 100).

Consumer Price Index (CPI)

A price index measuring the cost of a fixed market basket of goods and services that represent typical household purchases (e.g., food, housing, clothing).

Inflation Rate

The percentage change in the price level from one year to the next.

Disinflation

A situation where the general price level continues to rise, but at a slower rate than before.

Deflation

A decrease in the overall price level, which can be harmful because consumers may delay purchases.

Hyperinflation

An economic condition where prices rise extremely quickly and money rapidly loses its value.

Substitution Bias

A limitation of the CPI that overstates inflation because it fails to account for consumers purchasing cheaper alternative goods when relative prices change.

Menu Costs

The costs incurred by businesses from frequently having to update their prices during periods of inflation.

Shoe Leather Costs

The costs and effort incurred when people reduce cash holdings and make more frequent trips to the bank due to inflation.

Unit of Account Costs

The cost of inflation making money less reliable for comparing the relative prices of goods and services.

Nominal GDP

The value of production evaluated at the current prices that exist during the year the goods and services are produced, reflecting changes in both price and quantity.

Real GDP

A measure of output adjusted for inflation by valuing production using constant prices from a base year, allowing comparison without price distortion.

GDP Deflator

A price index measuring the price level of all goods and services included in GDP (including business and government purchases), calculated as: $\left(\frac{\text{Nominal GDP}}{\text{Real GDP}}\right) \times 100$.

Business Cycle

The recurring pattern of economic expansion and contraction over time, reflecting fluctuations in production, employment, and income.

Expansion

A phase of the business cycle characterized by increasing economic activity, more goods and services produced, rising employment, and higher real GDP.

Peak

The highest point of economic activity in the business cycle, characterized by high consumer confidence and strong business investment.

Contraction

A period of declining economic activity where production slows, and businesses reduce hiring or lay off workers.

Recession

A decline in economic activity lasting for at least two consecutive quarters of negative real economic growth.

Depression

A prolonged and severe recession.

Trough

The lowest point of the business cycle, after which economic activity recovers and enters an expansion phase.

Negative Output Gap (Recessionary Gap)

A condition where actual GDP is less than potential GDP ($\text{Actual GDP} < \text{Potential GDP}$), leading to underutilization of resources and high unemployment.

Positive Output Gap (Inflationary Gap)

A condition where actual GDP is greater than potential GDP ($\text{Actual GDP} > \text{Potential GDP}$).