MACRO ECONOMIC

Define macroeconomics.

The study of the economy as a whole: the aggregate effects of choices by households, firms and governments on inflation, unemployment and growth.

What is scarcity?

Unlimited wants exceeding the limited resources available to satisfy them. It forces choices, and every choice is a trade-off.

Define opportunity cost.

The highest-valued alternative forgone to get something.

What does a PPF show, and what do points on, inside and outside it mean?

Maximum combinations of two goods with fixed resources and technology.; On = efficient · Inside = inefficient · Outside = unattainable.

Why is the PPF bowed outward?

Increasing marginal opportunity cost: each extra unit of one good requires giving up more and more of the other.

Absolute vs comparative advantage?

Absolute: produce more with the same resources.; Comparative: produce at a lower opportunity cost. Trade is based on comparative advantage.

You pick 20 apples or 20 cherries; your neighbour picks 30 apples or 60 cherries. Who specialises in what?

Your cost of 1 apple = 1 cherry; neighbour's = 2 cherries.; You → apples. Neighbour → cherries (even though they have absolute advantage in both).

Australia: 40 honey or 60 cheese. NZ: 50 honey or 50 cheese. Who has comparative advantage in cheese?

Australia (1 cheese costs ⅔ honey vs 1 honey in NZ). NZ has comparative advantage in honey.

What is the price mechanism?

In a free market, price changes signal producers to adjust output to consumer demand: the 'invisible hand' allocating scarce resources.

Define GDP.

Market value of all final goods and services produced in a country during a period of time.

Why are intermediate goods excluded from GDP?

Their value is already included in the final good; counting them would double count.

Write the expenditure identity and name each part.

Y = C + I + G + NX; Consumption, Investment (incl. new houses), Government purchases (no transfers), Net exports.

What are the three ways to measure GDP?

Production (value added), expenditure, income. All give the same answer because of the circular flow.

NDP and GNI?

NDP = GDP − depreciation.; GNI = GDP + income earned overseas by residents − income earned here by non-residents.

Two types of activity GDP leaves out?

Household production (cooking, childcare) and the underground economy.

Five ways GDP falls short as a wellbeing measure.

Ignores distribution, leisure, health/education quality, pollution, crime and social problems.

Nominal vs real GDP?

Nominal: current-year prices (moves with prices and output).; Real: base-year prices (moves with output only).

GDP deflator formula.

(Nominal GDP ÷ Real GDP) × 100

France has a shorter work week than Australia. Does GDP over- or underestimate its living standard?

Underestimate: GDP doesn't count the value of extra leisure.

Economic growth rate formula.

(Real GDP this year − Real GDP last year) ÷ Real GDP last year × 100

Rule of 70: how long to double at 2.3% growth?

70 ÷ 2.3 ≈ 30 years.

What two factors determine labour productivity?

1) Capital per hour worked (physical and human capital); 2) Technological change, the most critical.

Define potential GDP.

Real GDP when inputs are employed at the full-employment level. Actual GDP fluctuates around it.

Three services the financial system provides.

Risk sharing, liquidity, information.

Show that S = I in a closed economy.

Y = C + I + G → I = Y − C − G.; S = (Y − C − T) + (T − G) = Y − C − G. So S = I.

In the loanable funds market, who supplies and who demands?

Supply: saving by households and government.; Demand: investment by firms. Price = real interest rate.

Effect of a government budget deficit on loanable funds?

Supply shifts left → real interest rate rises → private investment falls (crowding out) → slower growth.

Technical definition of a recession.

Two consecutive quarters of negative economic growth.

Why does unemployment keep rising after a recession ends?

Discouraged workers re-enter the labour force, and firms wait before rehiring.

ABS definition of employed and unemployed.

Employed: worked 1+ hour in the reference week.; Unemployed: no work, actively searched in past 4 weeks, ready to start now.

Unemployment rate formula.

Unemployed ÷ Labour force × 100 (labour force = employed + unemployed).

Labour force participation rate formula.

Labour force ÷ Working-age population × 100

Who are discouraged workers, and how are they counted?

Available for work but stopped looking because they think no jobs exist. Not in the labour force, so the rate understates joblessness.

Why might the unemployment rate understate true joblessness?

Discouraged workers are excluded, and underemployed part-timers count as employed.

Name the four types of unemployment.

Cyclical, frictional, structural, seasonal.

Bus drivers lose jobs after a permanent fall in public transport demand. Type?

Structural.

A new graduate takes 3 months to find a job. Type?

Frictional.

What does full employment mean?

Zero cyclical unemployment; frictional and structural remain (the natural rate).

What is NAIRU?

The unemployment rate below which inflation starts rising.

How can a minimum wage cause unemployment?

If set above the equilibrium wage, labour supplied exceeds labour demanded.

Define inflation.

A sustained rise in the price level. Inflation rate = % change in the price level from one year to the next.

CPI formula.

(Cost of basket in current year ÷ Cost in base year) × 100

Four CPI biases that overstate inflation.

Substitution, quality, new product, outlet.

Beef gets expensive and people switch to chicken. Which CPI bias?

Substitution bias.

Fisher equation.

r = i − π; Real interest rate = nominal rate − inflation.

Convert $30,000 from 1990 (CPI 59) to 2016 dollars (CPI 109).

$30,000 × 109 ÷ 59 ≈ $55,424

Who wins and loses from unexpectedly high inflation?

Borrowers on fixed contracts gain; lenders and fixed-income earners lose.

Costs of anticipated inflation.

Fixed-income earners lose, cash loses value, menu costs, higher taxes on nominal income.

Why is deflation harmful?

Raises real debt burdens and the real interest rate, lowers asset values, discourages investment.

Demand-pull vs cost-push inflation.

Demand-pull: AD grows faster than output can respond.; Cost-push: negative supply shock (input costs, disasters).

What is a wage-price spiral?

Prices rise → workers demand higher wages → firms raise prices again → repeat.

Condition for short-run equilibrium in the AE model.

Y = C + planned I + G + NX, with no unplanned change in inventories.

Define MPC and MPS.

MPC = ΔC ÷ ΔY; MPS = ΔS ÷ ΔY. MPC + MPS = 1.

Which AE component is most volatile?

Investment.

What happens when AE > Y on the 45° diagram?

Inventories fall unexpectedly, so firms raise output: the economy expands toward equilibrium.

What happens when AE < Y?

Unplanned inventory build-up, so firms cut output and employment.

Expenditure multiplier formula.

1 ÷ (1 − MPC)

a = 50, MPC = 0.8, I = 100, G = 150, NX = 0. Equilibrium Y?

Multiplier 5 × autonomous 300 = $1,500b.

MPC = 0.8 and investment rises $500b. Change in equilibrium GDP?

5 × 500 = +$2,500b.

What is the paradox of thrift?

If everyone saves more, AE and income fall, so total saving may not rise (Keynes).

Three reasons AD slopes downward.

Wealth effect, interest-rate effect, international-trade effect.

Movement along AD vs shift of AD?

Price-level change = movement along. Policy, expectations or foreign factors = shift.

Why is LRAS vertical?

In the long run wages and input prices adjust fully, so output sits at potential GDP whatever the price level.

Why does SRAS slope upward?

Input prices (wages) are sticky and menu costs keep some prices fixed, so higher output prices raise profitability.

Four factors that shift SRAS.

Expected price level, past expectation errors, unexpected input prices, potential GDP.

What shifts both SRAS and LRAS?

A technological advance (or more labour and capital).

Short-run and long-run equilibrium in AD–AS?

Short run: AD = SRAS. Long run: AD, SRAS and LRAS all meet at potential GDP.

Negative demand shock: short run and long run?

SR: output and prices both fall (recessionary gap).; LR: expected prices fall, SRAS shifts right back to potential at a lower price level.

What is stagflation and what causes it?

Inflation plus recession, caused by a negative supply shock (SRAS left), e.g. 1970s oil shocks.

Dynamic AD–AS: when does the price level rise?

When AD shifts right by more than LRAS (or SRAS shifts right less than LRAS).

Four functions of money.

Medium of exchange, unit of account, store of value, standard of deferred payment.

Buying a car today and paying in the future uses which function?

Standard of deferred payment.

Double coincidence of wants?

In barter, each person must want what the other has.

Commodity vs fiat money.

Commodity: has value apart from use as money (gold).; Fiat: no intrinsic value; legal tender by government decree.

What is M1? What does M3 add?

M1 = currency + demand deposits.; M3 = M1 + all other deposits with banks.

Is a loan an asset or a liability for a bank?

Asset. Deposits are liabilities.

Simple deposit multiplier formula.

1 ÷ reserve ratio

$1,000 deposit, 10% reserve ratio. Maximum total rise in deposits?

$1,000 × 10 = $10,000.

Why is the real-world deposit multiplier smaller?

Banks hold excess reserves and people hold some cash instead of depositing.

Equation of exchange.

M × V = P × Y

Nominal GDP $13t, money $6.5t. Velocity?

2: each dollar is spent twice on final goods and services.

Quantity theory: what causes inflation with constant velocity?

Money supply growing faster than real GDP.

Define monetary policy.

RBA actions to manage interest rates in pursuit of macroeconomic objectives.

RBA inflation target.

2–3% per year on average over the business cycle (since 1993).

What is the cash rate?

Interest rate on overnight loans between banks.

Effect of an RBA open market purchase?

More reserves in the system → cash rate falls, money supply rises.

Why does money demand slope downward?

The interest rate is the opportunity cost of holding money.

What shifts money demand right?

Higher real GDP or a higher price level.

Money supply curve shape under interest rate targeting vs monetary targeting?

Interest rate targeting: horizontal at the target.; Monetary targeting: vertical.

How does a lower cash rate raise AD?

Lower rates raise consumption, investment and net exports (lower $A).

Real GDP below potential: which policy and cash rate move?

Expansionary; lower the cash rate.

Limits of monetary policy.

Lags of 12–18 months, incomplete pass-through, weak in recessions, uneven effects on savers and borrowers.

Case for and against RBA independence.

For: avoids inflationary government financing and pre-election rate cuts.; Against: not accountable to voters; power concentrated in unelected people.

Define fiscal policy.

Changes in federal government taxes and purchases to achieve macroeconomic objectives.

Expansionary vs contractionary fiscal policy.

Expansionary: ↑G or ↓T (recession).; Contractionary: ↓G or ↑T (high inflation).

Government purchases multiplier.

ΔY ÷ ΔG = 1 ÷ (1 − MPC)

Tax multiplier.

ΔY ÷ ΔT = −MPC ÷ (1 − MPC). Smaller in size than the G multiplier.

Two main limits of fiscal policy.

Timing lags and crowding out.

Financial vs resource crowding out.

Financial: deficit borrowing raises interest rates, cutting private spending.; Resource: government competes for labour and inputs, pushing up prices.

Budget deficit vs government debt.

Deficit: spending > revenue in one year. Debt: accumulated borrowing to finance deficits.