Macroeconomics Exam 2

Phases of the Business Cycle

expansion, peak, contraction (recession), trough

How do you calculate the unemployment rate?

(number of unemployed / number of labor force) x 100

What makes up the unemployed rate

people actively looking for work

what makes up the labor force

people working and people looking for work

What is CPI

The consumer price index

what does the consumer price index (CPI) measure

the average change over time in the prices of a fixed basket of goods and services

what is nominal income

the raw, unadjusted dollar amount you earn

what is real income

the amount you earn adjusted for inflation to reflect your actual purchasing power

what is says law

a core principe in classical economics which states that the production of goods and services creates its own demand

what is the classical theory

argues that free markets are self-regulating and tend toward full employment

what is the keynesian theory

emphasizes the role of aggregate demand and suggests government intervention can stabilize a fluctuating economy

marginal propensity to consume (MPC)

the proportion of an additional dollar of income that a consumer spends on goods and services

MPC formula

(change in consumption)/(change in disposable income)

marginal propensity to save (MPS)

the proportion of an extra dollar of income that is saved rather than spent

MPS formula

(change in savings)/(change in income)

what is the consumption function

shows the relationship between total consumption and disposable income

consumption function formula

c = a - bY

c= total amount of consumption spending

a= autonomous consumption (level of consumption that occurs when disposable income is zero)

b= the marginal propensity to consume (how much consumption increases by)

Y= disposable income

why is investment unstable

because it is volatile and influenced by many factors that change rapidly such as business profits, interest rates, and future expectations

recessionary gaps

occurs when an economy’s actual output is below its potential output, leading to high unemployment

inflationary gap

when actual output is above potential, characterized by low unemployment and rising prices

what do recessionary and inflationary gaps represent

deviations from the economy’s long-run equilibrium

aggregate expenditures curve

plots the total spending in an economy against real GDP and represents the sum of household consumption, investment, gov. spending, and net exports

saving vs. dissaving

setting money aside for future use vs. spending more than your income

autonomous expenditures

spending that does not depend on a country’s current income level

closing a recessionary gap

using expansionary fiscal or monetary policy to boost aggregate demand, which shifts the aggregate demand curve to the right

closing an inflationary gap

implementing contractionary fiscal policy (increasing taxes, reducing gov. spending) and/or monetary policy (raising interest rates), shifting the aggregate demand curve to the left

the tax cut multiplier

measures the total change in aggregate demand resulting from an initial change in tax revenue, operating inversely to a tax increase