Macroeconomics Core Concepts and Measurement Techniques

Macroeconomics

The study of the 'whole' economy, focusing on aggregate economic activity.

Production Possibilities Curve (PPC)

A curve that shows the possible combinations of goods and services an economy can efficiently produce, given its available resources and technology.

PPC (Significance)

The line represents the maximum level of production possible, which reflects scarcity of resources.

PPC Downward Slope

Reflects the trade-offs and opportunity costs of converting production.

Economic Growth (PPC)

Illustrated by a shifting of the production possibilities curve outward.

Opportunity Cost

The next best alternative given up to gain something.

Factors of Production (Resources)

The inputs required for production: Labor, Capital, Land, and Entrepreneurship.

Labor

The quantity and quality of human resources who have the skills to produce goods and services.

Capital

Refers to the final goods used to produce other goods (e.g., completed buildings, machines, and tools, a tractor, a computer purchased for a secretary, or a factory).

Land

Refers to the ground but also all natural resources, including crude oil, water, air, and minerals.

Entrepreneurship

The assembling of resources to produce new or improved products and technologies.

Market Mechanism / Invisible Hand

The essential feature is the price signal; consumers respond to prices and producers respond to prices and sales volume.

Economic Growth

An increase in output (real GDP) or the expansion of production possibilities.

Best Measure of Economic Growth

An increase in real GDP per capita.

Per Capita GDP

The dollar value of GDP divided by the population; considered a measure of average living standards.

Worker Productivity

Output per worker hour; related to the development of human capital.

Production Function

The relationship between the quantity of output produced and the quantity of inputs used to produce it.

Capital Deepening

Occurs when the economy experiences an increase in the amount of capital stock per worker.

Participants of Markets

Consumers, business firms, and government.

Circular Flow Diagram

The diagram that shows the flow of income, spending, goods and services between markets. A major lesson is that total income in the economy must always equal total spending.

Factor Markets

Households supply inputs (resources), which firms demand. The buyers of labor in the labor market are the firms.

Law of Demand

An inverse relationship between the price of a product and the quantity demanded in a given time period, ceteris paribus.

Ceteris Paribus

The assumption that nothing else is changing.

Determinants of Demand

Factors assumed to remain unchanged under ceteris paribus (Tastes, Income, Other goods, Expectations, and Number of buyers).

Substitute Goods

When the price of good X rises, the demand for the substitute good Y will rise.

Complementary Goods

Goods frequently consumed in combination; when the price of good X rises, the demand for good Y falls.

Market Demand

The horizontal sum of individual demands, representing the total quantities people are willing and able to buy at alternative prices in a given time period.

Market Supply

The horizontal summation of individual supplies, representing the total quantities sellers are willing and able to sell at alternative prices in a given time period, ceteris paribus.

Optimal Outcomes

The best possible outcomes given our incomes and scarce resources (not necessarily perfect, nor do they make everyone happy).

GDP (Gross Domestic Product)

The total market value of all final goods and services produced within a country's borders over a given time period, usually one year.

Final Goods and Services

Goods and services included in GDP (e.g., the economics class you are taking or the popcorn you bought before a movie).

Intermediate Goods

Goods produced for the purpose of producing other goods (e.g., coffee beans Starbucks purchases).

Avoiding Double Counting

Achieved by not counting the value of intermediate goods in GDP.

Value Added Approach to GDP

The increase in market value of a product that takes place at each stage of the production process.

Expenditure Approach to GDP

GDP = Consumption + Investment + Government Purchases + Net Exports (Exports - Imports).

Consumption Subcategory

May include durables (longer-term consumables like refrigerators, autos, furniture).

Transfer Payments

Payments from the government (like welfare payments) that are part of Personal Income but not National Income because they are a payment for which no goods or services are exchanged.

Net Exports (NX)

The value of exports minus the value of imports. If net exports is negative, imports exceed exports.

Nominal GDP

Measures the value of all goods and services in current dollars.

Real GDP

Gross domestic product measured using the prices of a specified base year. It is more accurate than nominal GDP because nominal GDP may change simply because of price changes over time.

Base Year (GDP)

The year specified for price measurement; real GDP in the base year is equal to the nominal GDP.

NDP (Net Domestic Product)

GDP minus Depreciation.

Depreciation

The consumption of capital in the production process (a loss of productive capability).

NI (National Income)

The income earned by the factors of production in producing GDP. Calculated as NDP + net foreign income - statistical discrepancy.

DI (Disposable Income)

Personal income minus personal taxes. Also defined as consumption plus savings.

Saving

Income that is not consumed.

Recession (Traditional Definition)

A decline in real GDP lasting for at least two consecutive quarters.

Depression

Commonly defined as a severe recession.

Labor Force

The sum of the employed plus the unemployed. Increases if a worker loses a job and immediately starts looking for another job.

Unemployed

A labor force participant actively searching for and unable to find a job.

Requirement to be Counted as Unemployed

People must be actively looking for work.

Unemployment Rate

(Unemployed / Labor Force) * 100 = % change.

Labor Force Participation Rate

(The labor force / Working-age population) * 100 = % change.

Not in the Labor Force

A worker who currently is not working, but is not looking for a job.

Discouraged Workers

Do not actively seek employment although they desire to be employed; they are not considered part of the labor force.

Frictional Unemployment

Temporary unemployment that occurs when people are searching for another job (e.g., a man searching after being fired for being late).

Structural Unemployment

The portion of unemployment due to the mismatch between skills required for a job and the skills of job seekers.

Cyclical Unemployment

Changes in unemployment that occur as the economy expands and contracts. Directly affected when the economy slows down and real GDP falls.

Seasonal Unemployment

Unemployment that occurs due to seasonal changes in employment (e.g., a snow ski instructor's unemployment during the summer months).

Natural Rate of Unemployment (NRU)

The long-term unemployment rate determined by frictional and structural forces in labor and product markets. It is the sum of the frictional unemployment and structural unemployment rates.

Full Employment

The lowest rate of unemployment compatible with price stability. Occurs when the unemployment rate equals the natural rate of unemployment.

Unemployment at Full Employment

Around 4 to 6 percent. Cyclical unemployment is assumed to be zero when the economy's unemployment rate equals the natural rate.

Macro Consequence of Unemployment

Lost output for the economy.

Okun's Law

The observation that a 1 percent increase in unemployment tends to lead to approximately a 2 percent decrease in real output.

Inflation

An increase in the average price level of goods and services. A sustained increase in the average prices of all goods and services.

Price Stability

Inflation of 3% or less. This goal was officially set by Congress in the Full Employment and Balanced Growth Act of 1978.

Deflation

Falling prices. Occurs if the price index in one year is lower than the previous year. It is a great economic problem because prices and wages fall but debts remain the same.

Core Rate of Inflation

The inflation measure that excludes energy and food prices.

Nominal Income

The amount of income received in a given time period, measured in current dollars.

Real Income

Nominal income adjusted for inflation (implied by the distinction from nominal income).

Real Rate of Interest

The nominal interest rate minus the anticipated rate of inflation. It is the inflation-adjusted rate of interest.

Inflation and Borrowers/Lenders

Borrowers can benefit from inflation, and lenders can be harmed. Fixed rate contracts help borrowers pay back debt using 'cheaper' dollars, while inflation cheapens the money received by lenders.

Deflation and Borrowers/Lenders

Lenders win, and borrowers lose when entering fixed rate contracts.

Redistributive Effects of Inflation

Micro consequences that include Price effects, Income effects, and Wealth effects.

Macro Consequences of Inflation

Uncertainty (makes long-term decisions difficult), Speculation (investing in non-productive assets like houses, precious metals, and commodities), and Bracket creep (movement of taxpayers into higher income tax brackets as nominal income grows).

Demand-Pull Inflation

Occurs if consumers attempt to buy more goods than the economy can produce.

CPI (Consumer Price Index)

The index used most often to measure prices paid by households. It includes a fixed basket of goods.

GDP Deflator

A measure of the average price level of goods and services.

Price Index Overstatement

Both the CPI and the GDP chain index overstate actual changes in the cost of living due to the difficulty of measuring quality improvements.

Relative Price

The price of one good in comparison with the price of other goods. Changes in relative prices may occur in periods of stable prices or in periods of inflation or deflation.

COLA (Cost-of-Living Adjustment)

An automatic adjustment of nominal income to the rate of inflation.

Auction Prices

Prices that adjust quickly.

Custom Prices (Sticky Prices)

Prices that adjust slowly. Also known as sticky prices. Steel rod prices are an example of custom prices.