Principles of Macroeconomics: Aggregate Supply & Demand, Fiscal and Monetary Policy, and Stabilization

Comprehensive practice flashcards reviewing aggregate supply, aggregate demand, the Classical and Keynesian models, fiscal and monetary policies, banking mechanisms, and macroeconomic stabilization theories.

Aggregate Supply

The total quantity of output (real GDP) produced across an economy at each alternative price level.

Potential GDP

The sustainable level of real output an economy can produce when operating at full employment with all economic resources fully and efficiently utilized.

Aggregate Demand

The total planned real spending across an entire economy, consisting of consumer spending, business investment, government spending, and net exports.

Stagflation

An economic condition characterized simultaneously by economic stagnation (manifesting as cyclical unemployment) and rapid inflation.

Pure Competition (Classical Assumption)

A foundational assumption in the Classical model stipulating that no single buyer or seller possesses sufficient market power to influence the market price.

Flexible Wages and Prices

The Classical assumption that wage rates and prices adjust freely up and down without friction to clear markets and eliminate unemployment or surplus output.

Demand for Labor ($\text{MRP}_L$)

The firm's demand curve for labor in a competitive labor market, defined mathematically as the marginal product of labor multiplied by marginal revenue ($\text{MRP}_L = \text{MP}_L \times \text{MR}$).

Classical Credit Market Mechanism

The Classical process wherein interest rate adjustments ensure that every dollar saved by households is fully borrowed and invested by businesses, preventing persistent demand deficits.

Sticky Wages

The Keynesian proposition that nominal wages are inflexible downward due to long-term labor contracts, union agreements, social norms, and morale concerns.

Recessionary Gap

The shortfall between equilibrium real GDP and Potential GDP that emerges when Aggregate Demand is insufficient to maintain full employment.

Inflationary Gap

The amount by which real GDP exceeds Potential GDP at full employment, creating upward pressure on costs and the aggregate price level.

Cost-Push Inflation

A rise in the aggregate price level driven by a leftward shift of the Short-Run Aggregate Supply curve, often triggered by unexpected supply shocks or higher input prices.

Average Propensity to Consume (APC)

The ratio of total real consumption spending to total real disposable income, expressed as $\text{APC} = \frac{\text{Real Consumption}}{\text{Real Disposable Income}}$.

Average Propensity to Save (APS)

The ratio of total real personal saving to total real disposable income, expressed as $\text{APS} = \frac{\text{Real Saving}}{\text{Real Disposable Income}}$.

Marginal Propensity to Consume (MPC)

The proportion of an additional increment of disposable income that a household consumes, defined as $\text{MPC} = \frac{\Delta \text{Consumption}}{\Delta \text{Disposable Income}}$.

Marginal Propensity to Save (MPS)

The proportion of an additional increment of disposable income that a household saves, defined as $\text{MPS} = \frac{\Delta \text{Saving}}{\Delta \text{Disposable Income}}$.

Keynesian Expenditure Multiplier

The numerical factor by which a change in autonomous spending expands aggregate real output, calculated as $\text{Multiplier} = \frac{1}{\text{MPS}} = \frac{1}{1 - \text{MPC}}$.

Fiscal Policy

The strategic adjustment of federal government taxation and expenditure levels to influence macroeconomic goals including employment, inflation, and growth.

2022 Total U.S. Government Spending Breakdown

A distribution of U.S. government spending across major categories, led by Health Care ($23\%$), Education ($19\%$), Pensions/Social Security ($17\%$), Defense ($12\%$), and Welfare ($7\%$).

Expansionary Fiscal Policy

Fiscal actions that increase government spending or decrease taxes to shift Aggregate Demand rightward and raise real GDP.

Contractionary Fiscal Policy

Fiscal actions that decrease government purchases or increase tax collections to shift Aggregate Demand leftward to curb inflationary pressures.

Crowding-Out Effect

The phenomenon wherein debt-financed government spending raises real interest rates, reducing interest-sensitive private investment and consumer spending.

Ricardian Equivalence

The theoretical proposition that debt-financed spending and tax-financed spending have equivalent real impacts, because households save tax cuts to pay anticipated future taxes.

Automatic Stabilizers

Nondiscretionary budgetary changes, including progressive taxes and unemployment benefits, that automatically mitigate output fluctuations without new legislation.

Discretionary Fiscal Policy

Deliberate statutory interventions by lawmakers to adjust tax rates or spending levels in response to evolving economic problems.

Budget Deficit

The annual flow amount by which government outlays exceed government tax receipts within a designated fiscal year.

Net Federal Debt

The accumulated public debt owed to outside individuals, businesses, and foreign institutions, excluding debt held by internal federal trust funds.

Debt Rollover

The fiscal technique of issuing new Treasury debt obligations to redeem and pay off maturing sovereign bonds rather than using current tax revenue.

Twin Deficits

The concurrent occurrence of a domestic federal budget deficit and an international trade deficit financed by foreign entities investing surplus dollars into sovereign debt.

Medium of Exchange

A primary function of money whereby it is universally accepted as payment for goods, services, and debts, lowering transaction costs relative to barter.

Double Coincidence of Wants

A necessary barter prerequisite where two economic agents must each desire the precise commodity that the other possesses and is willing to exchange.

Unit of Account

A primary function of money that establishes a common monetary yardstick for denominating prices, measuring market value, and performing economic calculations.

Store of Value

A primary function of money enabling households and firms to preserve and transfer purchasing power into future time periods.

Standard of Deferred Payment

A property of money that allows future obligations, contracts, and long-term loans to be specified and settled in terms of the monetary unit.

Fiat Money

Currency declared legal tender by government decree that lacks intrinsic consumption value and is not backed by gold or precious commodities.

Liquidity

The speed and ease with which an asset can be converted into ready cash or utilized to purchase final goods and services with minimal loss of value.

M1 and M2 Money Supply

Alternative measures of the money supply; M1 comprises coins, currency in circulation, checkable deposits, and savings deposits, whereas M2 includes all of M1 plus money market mutual funds, certificates of deposit, and other time deposits.

Financial Intermediation

The process through which institutional intermediaries (such as commercial banks, savings banks, and credit unions) channel savings from ultimate lenders to ultimate borrowers.

Asymmetric Information

An imbalance of information where prospective borrowers know substantially more about their own creditworthiness, repayment intentions, and project risks than the lender.

Federal Reserve System

The central bank of the United States, governed by a Board of Governors in Washington, D.C., and divided geographically into 12 district banks.

Federal Open Market Committee (FOMC)

The chief monetary policymaking body of the Federal Reserve System tasked with overseeing open market operations to manage reserve balances and the money supply.

Fractional Reserve Banking

A banking framework in which depository institutions retain only a fraction of customer deposits in reserve while lending or investing the remaining balance.

Monetary Multiplier

The maximum ratio by which money supply expands following an initial injection of bank reserves, represented mathematically as $\text{Monetary Multiplier} = \frac{1}{\text{Reserve Ratio}}$.

Bank Run

A financial panic in which large numbers of depositors simultaneously request cash withdrawals, threatening the liquidity and solvency of a fractional-reserve bank.

Federal Deposit Insurance Corporation (FDIC)

A government agency established to protect bank depositors against financial losses by insuring deposit accounts up to $\$250{,}000$ per depositor, per insured institution.

Transactions Demand for Money

The demand to hold liquid balances to finance anticipated, planned purchases of final goods and services, which increases directly with nominal GDP.

Precautionary Demand for Money

The liquidity preference associated with holding money as a financial safeguard to manage unexpected emergencies, contingencies, and unforeseen expenses.

Asset Demand for Money

The desire to hold money as a risk-free store of wealth rather than holding interest-bearing financial assets, which varies inversely with the market interest rate.

Open Market Operations

The Federal Reserve's primary policy tool involving the purchase or sale of U.S. Treasury securities to alter depository reserves and steer short-term interest rates.

Discount Rate

The interest rate assessed by the Federal Reserve when providing emergency short-term credit directly to eligible banks through the discount window as a lender of last resort.

Federal Funds Rate

The market-driven interest rate that commercial banks charge each other for overnight unsecured loans of reserve balances held at the central bank.

Quantitative Easing

An unconventional monetary strategy whereby a central bank purchases large quantities of longer-term bonds and non-standard financial assets to inject liquidity and lower long-term yields.

Equation of Exchange

The fundamental accounting identity $MS \times V = P \times Y$, asserting that total monetary expenditures ($MS \times V$) equal the nominal gross domestic product ($P \times Y$).

Velocity of Money

The average frequency with which a unit of money turns over per year to purchase finished goods and services, calculated as $\text{Velocity} = \frac{P \times Y}{MS}$.

Phillips Curve

A macroeconomic curve demonstrating an empirical short-run trade-off between the rate of inflation and the rate of unemployment.

Natural Rate of Unemployment

The long-run benchmark unemployment rate at which the economy is operating at Potential GDP and the inflation rate remains stable.

Wage-Price Spiral

A compounding inflationary dynamic wherein expected price increases cause workers to demand higher wages, raising input costs and forcing businesses to increase output prices further.

Menu Costs

The explicit and implicit costs incurred by firms when changing, printing, and displaying updated price lists, leading to short-run price stickiness.

Active Policymaking

Discretionary policy actions that dynamically alter fiscal or monetary tools in explicit response to short-run economic shocks and fluctuations.

Passive Policymaking

A nondiscretionary stabilization approach where monetary and fiscal instruments follow predetermined, fixed rules and do not actively react to economic shifts.