Macroeconomics: Core Principles, Measurement, and Dynamics

Comprehensive vocabulary flashcards covering macroeconomics topics including GDP measurement, economic growth, unemployment, inflation, money, consumption, saving, and investment.

Gross Domestic Product (GDP)

The market value of all final goods and services produced within a country in a year.

Circular Flow Diagram

A visual model of the economy illustrating how households and businesses are linked through matching, offsetting flows of real resources (inputs and outputs) and flows of money (spending and income).

Intermediate Goods

Goods and services used as inputs in the production of other goods; their value is embodied in the final good's price and they are omitted from GDP to avoid double counting.

Value Added

The amount by which the market value of an item is increased at each stage of production, calculated as total sales minus the cost of intermediate inputs.

Transfer Payments

Government payments that reallocate income from one group to another (such as Old Age Security or GST credit cheques) without demanding a good or service in return, and which are excluded from GDP.

Net Exports ($NX$)

The expenditure component of GDP calculated as spending on exports (domestically produced goods purchased by foreign buyers) minus spending on imports (foreign-produced goods bought domestically).

Shadow Economy

Economic activity purposefully conducted outside the view of government authorities—including black markets, illegal trade, and cash transactions used to evade taxes—that is excluded from GDP.

Nominal GDP

A measure of total economic output evaluated using the actual prices prevailing in the year in which the output was produced.

Real GDP

A measure of total economic output evaluated in constant base-year prices, thereby isolating physical changes in output by removing the distorting effects of price changes.

Rule of 70

A rule of thumb stating that the number of years required for an economic variable to double equals roughly $70$ divided by its annual percentage growth rate ($\text{Years to double} \approx \frac{70}{\text{Annual growth rate}}$).

Production Function

The mathematical relationship or economic 'recipe' linking the quantity of productive inputs used (labour $L$, human capital $H$, and physical capital $K$) to the maximum total output ($Y$) that can be produced ($Y = f(L, H, K)$).

Labour ($L$)

An essential input in the aggregate production function measured as the total number of hours worked across the entire economy.

Human Capital ($H$)

The accumulated knowledge, skills, and expertise that workers acquire through formal education, on-the-job training, and experience, making them more productive.

Physical Capital ($K$)

The human-made tools, machinery, equipment, factory buildings, and public infrastructure that serve as productive inputs in creating goods and services.

Labour Productivity

The quantity of goods and services produced by an average worker in one hour of work, acting as a fundamental determinant of living standards.

Constant Returns to Scale

A property of a production process where scaling all inputs up by a given proportion causes total output to increase by the exact same proportion.

Law of Diminishing Returns to Capital

The economic principle stating that holding other inputs constant, successive increases in physical capital per worker lead to progressively smaller increments in output per worker.

Catch-Up Growth

The rapid growth experienced by a relatively low-income country with low starting capital, where each additional dollar of physical capital yields large gains in output per worker.

Solow Model

A neoclassical model of long-run economic growth analyzing how capital accumulation, saving, depreciation, and technological progress interact to determine output over time.

Technological Progress

The advancement in ideas and production techniques that allows an economy to produce more output from a given set of inputs, shifting the production function upward.

Property Rights

Legally enforced authority over tangible and intangible assets that gives owners the security and incentive to maintain, invest, and trade their property.

Working-Age Population

Civilian, noninstitutionalized individuals aged $15$ and older who are legally and physically available to participate in the labour market.

Employed

Working-age individuals who currently hold a paid job, including full-time workers, part-time workers who worked at least one hour in the reference week, the self-employed, and those on temporary leave.

Unemployed

Individuals in the working-age population who do not currently have a job, are actively searching for work, and are immediately available to accept employment.

Labour Force

The total pool of individuals within the working-age population who are actively engaged in the economy, computed as the sum of employed and unemployed individuals ($\text{Labour force} = \text{Employed} + \text{Unemployed}$).

Not in the Labour Force

Working-age individuals who are neither working nor actively looking for work, such as retirees, full-time students, homemakers, and those unable to work.

Labour Force Participation Rate

The percentage of the working-age population that belongs to the labour force, expressed as: $\frac{\text{Labour force}}{\text{Working-age population}} \times 100$.

Unemployment Rate

The percentage of the total labour force that is without a job and actively seeking employment, calculated as: $\frac{\text{Unemployed}}{\text{Labour force}} \times 100$.

Equilibrium Unemployment Rate

The long-run natural rate of unemployment toward which the macroeconomy naturally returns once short-run cyclical fluctuations subside.

Discouraged Searcher

A person who wants a job but is classified as outside the labour force because they have ceased active job-hunting after coming to believe no suitable work is available.

Underemployed

An individual who has a job but is working fewer hours than desired or whose current role does not fully utilize their skills and educational qualifications.

Involuntarily Part Time

Workers who are employed part-time because they are unable to secure a full-time position despite wanting one.

Frictional Unemployment

Temporary unemployment arising from the unavoidable time and search frictions required for job seekers to match with compatible job openings.

Structural Unemployment

Unemployment resulting from real wages being held persistently above the market-clearing equilibrium wage, creating a long-term excess supply of labour.

Cyclical Unemployment

Unemployment that fluctuates in response to swings in the business cycle, rising during macroeconomic recessions and falling during expansions.

Efficiency Wage

A wage intentionally set above the competitive market equilibrium by an employer to boost worker effort, improve retention, and decrease turnover costs.

Hysteresis

The economic condition where a prolonged period of high cyclical unemployment leads to an enduring increase in the structural or equilibrium unemployment rate.

Inflation

A broad, ongoing rise in the overall price level across the entire economy, corresponding to a decline in the purchasing power of money.

Consumer Price Index (CPI)

A price index measuring the average cost over time of a representative, fixed market basket of goods and services typically bought by urban households.

Inflation Rate

The annual percentage change in a chosen price index over time: $\text{Inflation rate} = \frac{\text{Price level this year} - \text{Price level last year}}{\text{Price level last year}} \times 100$.

Deflation

A sustained, generalized drop in the overall price level of goods and services throughout an economy.

Substitution Bias

A distortion in fixed-basket price indexes like the CPI that overstates increases in the cost of living because it ignores consumers substituting toward goods whose prices rise relatively less.

Core Inflation

An inflation measure that strips out notoriously volatile categories—namely food and energy—or isolates median price changes to monitor the underlying trend in price levels.

Producer Price Index (PPI)

A price index tracking changes in the prices paid by firms for raw materials and wholesale intermediate inputs utilized in production.

GDP Deflator

A broad price index measuring the price level of all final goods and services produced domestically, given by: $\frac{\text{Nominal GDP}}{\text{Real GDP}} \times 100$.

Money Illusion

The tendency of individuals to interpret values and price changes in nominal dollar amounts rather than adjusting for changes in purchasing power (real values).

Medium of Exchange

The core function of money as an asset generally accepted in payment for goods, services, and debts, circumventing the need for barter.

Unit of Account

The function of money as a standard common unit in which market prices, financial accounts, and debt obligations are quoted and recorded.

Store of Value

The function of money that enables individuals to transfer purchasing power and wealth from the present into the future.

Hyperinflation

An extraordinarily rapid and disruptive inflation rate that causes the currency to collapse as a reliable store of value and medium of exchange.

Menu Costs

The real resource and administrative costs incurred by firms whenever they update and reprint their posted prices.

Shoe-Leather Costs

The time, effort, and inconvenience people expend trying to minimize their cash balances to avoid holding money during times of inflation.

Inflation Fallacy

The mistaken belief that inflation naturally erodes real living standards permanently, which overlooks the reality that nominal incomes and wages typically increase alongside general prices.

Consumption

Household expenditure on new final goods and services, constituting the largest single spending category in GDP.

Consumption Function

A graphical curve or mathematical function illustrating how aggregate consumer spending varies at different levels of disposable income.

Marginal Propensity to Consume (MPC)

The proportion of an extra dollar of disposable income that a household allocates to consumption rather than saving, defining the slope of the consumption function ($\text{MPC} = \frac{\Delta \text{Consumption}}{\Delta \text{Income}}$).

Saving

The portion of current income that is not spent on consumption during a specific timeframe ($\text{Saving} = \text{Income} - \text{Consumption}$).

Dissaving

Spending more on consumption in a given period than current disposable income provides, requiring a reduction in savings or an increase in borrowing.

Rational Rule for Consumers

The principle directing an individual to consume an additional dollar today if its marginal benefit exceeds or matches the marginal benefit of saving that dollar and spending it with accrued interest in the future.

Consumption Smoothing

The practice of using borrowing and saving to maintain a stable, uniform level of consumption across high- and low-income periods of life due to diminishing marginal benefit.

Permanent Income

An individual's best estimate of their average sustainable lifetime income, used as the benchmark for establishing long-run consumption plans.

Permanent Income Hypothesis

The theory stating that consumers base their spending on their long-run permanent income rather than on transient variations in their current income.

Credit Constraints

Limits imposed by lenders on the total amount an individual or household can borrow, restricting their ability to smooth consumption over time.

Hand-to-Mouth Consumers

Individuals who spend virtually all of their current income as soon as it arrives ($\text{MPC} = 1$), leaving their consumption dependent on current income rather than permanent income.

Precautionary Saving

Funds set aside to build an emergency buffer against unpredictable future events, such as job loss, medical emergencies, or unanticipated costs.

Macroeconomic Investment

Expenditure by businesses, individuals, and governments on new capital goods—including machinery, nonresidential structures, intellectual property, and new housing—that expand productive capacity.

Capital Stock

The total physical quantity of productive capital equipment, facilities, and structures existing in the economy at a specific point in time.

Depreciation

The reduction in the physical value and productive capacity of a capital asset caused by wear and tear, physical obsolescence, accidental damage, or passage of time.

Business Investment

Spending by private enterprises on newly produced capital goods, including industrial equipment, structures, software, and research and development.

Housing Investment

Spending devoted to constructing brand new residential structures or significantly renovating existing homes, which increases shelter capacity and rental potential.

Compounding

The process by which an investment grows over time because accrued interest earns interest in subsequent periods ($\text{Future value in } t \text{ years} = \text{Present value} \times (1 + r)^t$).

Discounting

The financial calculation used to convert future values into equivalent present values, accounting for the opportunity cost of interest ($\text{Present value} = \text{Future value in } t \text{ years} \times \frac{1}{(1 + r)^t}$).

Rational Rule for Investors

The rule guiding capital investment decisions: a project should be pursued if the present value of expected future stream of revenues exceeds the up-front capital cost ($\frac{\text{Next year's revenue}}{r + d} > C$).

User Cost of Capital

The annual cost of using an extra unit of capital for one year, calculated as the sum of forgone interest and physical depreciation: $(r + d) \times C$.

Market for Loanable Funds

The financial market in which savers supply loanable funds and borrowers demand funds to finance investment projects, with the equilibrium price set by the real interest rate.

Neutral Real Interest Rate

The equilibrium real interest rate that equates the supply of and demand for loanable funds when the macroeconomy is operating at potential output.

Crowding Out

The decline in private capital investment that results when increased government borrowing drives up the real interest rate in the market for loanable funds.