AP Macroeconomics: Unit 2 Complete Review

Gross Domestic Product (GDP)

Total market value of all final goods and services produced within a country’s borders in one year.

Final Goods

Goods purchased by the end user; counted in GDP.

Intermediate Goods

Goods used to produce final goods; excluded from GDP to avoid double counting.

Nominal GDP

GDP measured using current prices; not adjusted for inflation.

Real GDP

GDP adjusted for inflation; reflects actual output.

GDP Deflator

A price index used to convert nominal GDP into real GDP.

Real GDP per Captita

Real GDP divided by population; measures average standard of living.

Expenditure Approach

GDP = C + I + G + (X – M).

Consumption (C)

Household spending on goods and services; largest component of GDP.

Investment (I)

Business spending on capital goods, inventories, and new construction.

Government Spending (G)

Government purchases of goods and services; excludes transfer payments.

Net Exports (X - M)

Exports minus imports; can be positive or negative.

Transfer Payments

Payments where no good or service is exchanged; not counted in GDP.

Value - Added Approach

Measures GDP by summing the additional value created at each stage of production.

Non-Market Transactions

Economic activity not recorded in markets (e.g., household labor); excluded from GDP.

Underground Economy

Unreported or illegal economic activity; causes GDP to underestimate true output.

Inventory Investment

Changes in unsold goods; counted as part of Investment (I).

Real GDP Growth Rate

Percentage change in real GDP from one year to the next.

Circular Flow Model

Diagram showing how money and goods/services move between households, firms, government, and foreign sector.

Product Market

Where households buy goods/services and firms sell them.

Factor Market

Where firms buy resources (land, labor, capital) from households.

Household Sector

Provides resources to firms and receives income in return.

Firm Sector

Produces goods/services and pays households for resources.

Leakages

Money leaving the circular flow (savings, taxes, imports).

Injections

Money entering the circular flow (investment, government spending, exports).

GDP and Quality of Life

GDP does not measure happiness, leisure, or well‑being.

Environmental Costs

GDP ignores pollution and resource depletion.

Income Distribution

GDP does not show how income is divided among individuals.

Non-Market Production

Household labor and volunteer work are excluded from GDP.

Unemployment Rate

Percentage of the labor force that is unemployed and actively seeking work.

Labor Force

People 16+ who are working or actively seeking work.

Not in Labor Force

People not working and not seeking work (students, retirees, discouraged workers).

Discouraged Workers

Individuals who stop looking for work; not counted in unemployment.

Underemployment

Workers employed below their skill level or part‑time but wanting full‑time.

Frictional Unemployment

Temporary unemployment due to job search or transitions.

Structural Unemployment

Unemployment caused by technological change or skills mismatch.

Cyclical Unemployment

Unemployment caused by downturns in the business cycle.

Natural Rate of Unemployment (NRU)

Unemployment rate at full employment; includes frictional + structural.

Full Employment

Occurs when cyclical unemployment is zero.

Labor Force Participation Rate

Percentage of the adult population in the labor force.

Marginally Attached Workers

People who want work but have not searched recently.

Natural Rate vs Actual Rate Gap

Difference between actual unemployment and the natural rate.

Okun’s Law

For every 1% unemployment above NRU, GDP falls about 2%.

Inflation

General increase in the price level.

Deflation

General decrease in the price level.

Disinflation

A reduction in the rate of inflation.

Consumer Price Index (CPI)

Measures average price of a fixed basket of consumer goods.

Market Basket

Collection of goods used to track price changes.

Inflation Rate

Percentage change in the price level.

Demand - Pull Inflation

Inflation caused by excessive spending.

Cost - Push Inflation

Inflation caused by rising production costs.

Hyperinflation

Extremely rapid inflation that destroys currency value.

Shoe - Leather Costs

Costs of reducing money holdings during inflation.

Menu Costs

Costs of changing prices due to inflation.

Unexpected Inflation

Redistributes wealth between borrowers and lenders.

Core Inflation

Inflation excluding food and energy prices.

Substitution Bias

CPI overstates inflation because consumers switch to cheaper goods.

Quality Bias

CPI may overstate inflation because it doesn’t fully adjust for improved quality.

New Product Bias

CPI may miss price changes of new goods.

Nominal vs Interest Rate

Real interest rate = nominal interest rate – inflation rate.

Fisher Effect

Nominal interest rates rise with expected inflation.

Business Cycle

Recurring pattern of expansion and contraction.

Expansion

GDP rises, unemployment falls.

Peak

Highest point before a downturn.

Contraction

GDP falls, unemployment rises.

Recession

Two consecutive quarters of declining real GDP.

Depression

Severe and prolonged recession.

Trough

Lowest point before recovery.

Recovery

GDP begins rising after a trough.

Leading Indicatiors

Predict future economic activity.

Coincident Indicators

Move with the economy.

Lagging Indicatiors

Change after the economy changes.

Output Gap

Difference between actual real GDP and potential GDP.

Potential Output

GDP the economy can produce at full employment.

Countercyclical Indicators

Move opposite the business cycle (e.g., unemployment).

Procyclical Indicators

Move with the business cycle (e.g., GDP).

Productivity Shock

Sudden change in technology or resources that shifts long‑run growth.