Macroeconomics: Basic Economic Concepts

Circular Flow Model

A model showing the flow of goods and services between households and firms.

Households

People who consume products and own the factors of production (land, labor, capital).

Firms

Organizations that use resources to make and sell products to consumers.

Factor/Resource Market

Where firms purchase factors of production from households.

Product Market

Where goods and services made by firms are sold to households.

Gross Domestic Product (GDP)

The dollar value of the final goods and services produced in a country's borders in a given year.

GDP Growth

Signals economic expansion.

Recession

Two consecutive quarters of negative GDP growth.

Intermediate Goods

Resources used to make a final product.

Used Items

Not involved in the production of new goods and services.

Non-Productive Transactions

Transactions that do not create a new product, thus adding nothing to GDP.

Transfer Payments

Government redistribution of wealth (e.g., welfare, unemployment).

Non-Market Activities

Activities with no exchange of money for goods and services.

Expenditures Approach

C + I + G + Xn = GDP, representing total spending in the economy.

C (Consumption Spending)

Money that consumers spend on products.

I (Investment Spending)

Money that businesses spend on products.

G (Government Spending)

Money that government spends on products.

Xn (Net Exports)

The difference between exports and imports.

ΔGDP

Rate of change in GDP.

Nominal GDP

Calculated as P x Q, does not account for inflation.

Real GDP

Calculates present year's production in base year terms, removing inflation as a variable.

GDP Per Capita

Calculated as GDP / Population, providing a measure of economic output per person.

GDP Deflator

Used to adjust Nominal GDP to Real GDP by accounting for inflation.

GDP per capita

GDP / Population

GDP deflator

GDP Deflator = Nominal GDP / Real GDP x 100

GDP Deflator of 100

No change.

GDP Deflator of 110

10% increase.

GDP Deflator of 90

10% decrease.

NeRD method

Anytime you have 2 of the 3, you can find out the other.

Limitations of GDP

1. Black Market - illegal and legal sales that aren't reported to the government aren't reflected in a country's GDP. 2) Negative externalities - any effects that aren't economic aren't counted. 3) Quality of life - money is not the only thing that makes people happy, but it is the only thing that counts for GDP!

Inflation

A rise in the general level of prices of goods and services.

Quantity Theory of Money Equation

M x V = P x Y

M

Money supply, the amount of money in circulation.

V

Velocity, how quickly people spend and re-spend money.

P

Price Level.

Y

Quantity of output.

Demand-Pull Inflation

A positive demand shock causes demand to increase, but supply to stay the same, leading to higher prices.

Cost-Push Inflation

A negative supply shock causes input costs to increase, but demand stays the same, leading to higher prices.

Consumer Price Index (CPI)

CPI = Current Year Market Basket / Base Year Market Basket x 100.

Market Basket

A collection of goods and services whose prices are examined and compared to earlier years.

Base Year CPI

The base year's CPI will always be 100; the US uses 1982 as its base year CPI.

ΔCPI

NOOO (New - Old OVER Old).

Target inflation rate

2% is the target inflation rate.

Wage-Price Spiral

An overall increase in wages is not always a good thing; to gain real wealth, a worker must see a larger increase in wages than prices.

Nominal vs Real Inflation

Lenders loan money to borrowers with the goal of earning a profit through interest payments.

Nominal Interest Rates

The percentage increase in money that the borrower pays not adjusting for inflation.

Real Interest Rates

The percentage increase in purchasing power that a borrower pays, adjusted for inflation.

Real ir

Nominal interest rate - inflation.

Winners of Inflation

Borrowers - People who take out fixed-rate loans and people looking for work (unemployment usually decreases when prices increase).

Losers of Inflation

Lenders - People who loan out money (at fixed interest rates), people with fixed incomes, and savers.

Cost-of-Living-Adjustment (COLA)

An automatic adjustment to keep up with inflation for many salaried positions and government transfer payments.

Disinflation

Prices are still rising, but not as fast, e.g., going from 10% inflation to 5% inflation.

Deflation

Negative CPI growth indicating falling prices, usually indicating falling demand and often leads to recession.

Hyperinflation

When prices rise at out of control levels, often caused by printing money to pay for war or political turmoil, making money practically worthless.

Adult Population

Individuals 16 years old or older, not retired and who are not military/institutionalized.

Labor Force

The total number of adults who are either employed or unemployed.

Employed

The number of adults who are currently working either full or part time.

Unemployed

The number of adults who are not working but are actively seeking work.

Not in Labor Force

People not in the adult population category, or who are not working or not looking for work, usually military, institutionalized, retired, or voluntarily not working.

Underemployed

A person who is working part-time but wants full time employment or is overqualified for their job, still considered to be employed.

Labor Force Participation Rate

How many adults are actually in the labor force, calculated as Labor Force/Adults x100.

Unemployment Rate

How many of those in the labor force are unemployed, calculated as Unemployed/Labor Force x100.

Frictional Unemployment

When people change jobs, take time to find the right job after schooling, or take time off for various reasons.

Structural Unemployment

When the jobs available don't match the skills of the workers, often due to technological advances.

Cyclical Unemployment

Unemployment based on changing economic conditions, such as workers laid off due to a recession.

Natural Rate of Employment

The unemployment rate considered normal in a properly functioning economy, typically around 5 percent.

Full Employment

The level of employment reached when there is no cyclical unemployment.

Business Cycle

Measures the relationship between Real GDP and Time.

Expansion

Growth in Real GDP.

Peak

The eventual turning point in the business cycle.

Recession

A decline in Real GDP.

Trough

The eventual turning point after a recession.

Positive Output Gap

When a country is outperforming, referred to as an inflationary gap.

Negative Output Gap

When a country is underperforming, referred to as a recessionary gap.