Macroeconomics: Key Concepts and Definitions

Vocabulary flashcards covering key terms and concepts across Macroeconomics chapters including Short-Run Economic Fluctuations, Measuring National Income, Measuring the Cost of Living, Production and Growth, Saving and Investment, and Unemployment.

Business cycles

Fluctuations in economic activity over time, consisting of expansion and contraction phases.

Recession

A significant decline in economic activity across the economy lasting more than a few months, typically visible in GDP.

Aggregate Demand (AD) components

The total spending across an economy, comprising Consumption ($C$), Investment ($I$), Government Spending ($G$), and Net Exports ($NX$).

Impact of consumer confidence on Aggregate Demand

Higher consumer confidence increases household consumption spending, shifting the Aggregate Demand ($AD$) curve to the right.

Short-Run Aggregate Supply (SRAS) vs. Long-Run Aggregate Supply (LRAS)

SRAS represents total production across price levels in the short run, while LRAS represents full-capacity output independent of the price level.

Factors that shift Short-Run Aggregate Supply (SRAS)

Changes in nominal wages, raw material input prices, and external supply shocks.

Equilibrium in the AD-AS model

The point of intersection between Aggregate Demand ($AD$) and Short-Run Aggregate Supply ($SRAS$), determining output and the price level.

Stagflation

A situation of stagnant economic growth, high unemployment, and inflation occurring simultaneously.

Fiscal policy response to downturns

Combating economic downturns by increasing government spending or reducing taxes to stimulate Aggregate Demand.

Monetary policy

Economic policy managed by a central bank that involves regulating the money supply and interest rates to influence economic activity.

Nominal GDP

The total market value of all final goods and services produced in a country in a given year, measured in current prices.

Real GDP

Nominal GDP adjusted for inflation, reflecting the true volume of goods and services valued at constant base-year prices.

GDP per capita

Total GDP divided by the national population, indicating the average economic output per person.

Four components of GDP

Consumption ($C$), Investment ($I$), Government Spending ($G$), and Net Exports ($NX$).

GDP deflator formula

$$\text{GDP Deflator} = \frac{\text{Nominal GDP}}{\text{Real GDP}} \times 100$$

Income approach vs. expenditure approach to GDP

The income approach totals all factor incomes earned across the economy, whereas the expenditure approach totals spending on final goods and services.

Importance of adjusting GDP for inflation

Accurately represents physical economic growth without distortion from shifting price levels.

Effect of increased government spending on GDP

Directly raises GDP through an immediate increase in the government expenditure ($G$) component.

Role of net exports in GDP calculation

Increases or decreases GDP based on whether exports exceed imports ($NX = \text{Exports} - \text{Imports}$).

Gross National Product (GNP)

The total income earned by a nation's permanent residents, regardless of whether production takes place domestically or abroad.

Consumer Price Index (CPI)

A measure examining the average change over time in prices paid by consumers for a fixed market basket of goods and services.

Calculation method for CPI

Tracking price changes for each item in a predetermined consumer basket and calculating a weighted average relative to a base year.

Difference between CPI and GDP deflator

CPI measures the price level of a representative consumer market basket, while the GDP deflator reflects prices of all domestically produced final goods and services.

Primary limitations of the CPI

It can overstate the rise in living costs due to substitution bias, introduction of new goods, and unmeasured quality changes.

Inflation rate

The percentage increase in the overall price level from one period to the next, often calculated using CPI.

Significance of the market basket in CPI

Represents the typical purchasing bundle of an average urban household to measure real shifts in consumer living expenses.

Substitution bias

A limitation of the CPI that occurs when the index fails to capture consumers switching toward cheaper substitute goods as relative prices rise.

Effect of quality changes on CPI

Improvements in product performance increase value, causing standard price tracking to overestimate genuine inflation if quality gains are unadjusted.

Core inflation

A measure of inflation that excludes volatile food and energy components to provide a clearer indicator of underlying long-term price trends.

Policy implications when unemployment and inflation rise together

Policymakers face a difficult trade-off, because expansionary measures risk accelerating inflation, while contractionary policy deepens unemployment.

Four factors of production

The essential inputs utilized in production: land, labor, capital, and entrepreneurship.

Production function

A mathematical relationship specifying the maximum quantity of output that can be produced per unit of physical and human inputs.

Diminishing returns to scale

An economic principle stating that adding additional units of an input while holding others constant yields progressively smaller increases in output.

Impact of technological advancements on growth

They elevate productive efficiency, enabling firms to produce greater output using the same amount of inputs.

Human capital

The cumulative knowledge, skills, education, and health possessed by individuals that contribute to their economic productivity.

Standard metric for economic growth

The annual percentage increase in Real GDP or Real GDP per capita over time.

Unintended consequences of rapid economic growth

Potential environmental degradation, rapid depletion of natural resources, and widening income disparities.

Methods for countries to increase productivity

Directing capital into technological innovation, worker education, workforce training, and physical infrastructure.

Innovation (economics)

The development and implementation of novel products, services, or production processes that boost efficiency and productivity.

Role of infrastructure in economic growth

Facilitates commerce, lowers transport and logistics costs, improves productivity, and enhances market access.

Saving

The portion of disposable income that is not consumed or spent on current goods, set aside as deferred consumption.

Difference between saving and investment

Saving is unspent income set aside for the future, while investment is the expenditure on capital goods and assets to generate wealth.

Primary role of financial markets

Institutions that channel loanable funds from surplus savers to borrowers seeking capital for consumption or investment.

Relationship between national saving and investment

National saving provides the financial pool necessary to fund capital accumulation and investment in an economy ($S = I$ in a closed economy).

Relationship between interest rates and investment spending

An inverse relationship: lower interest rates reduce the cost of borrowing and encourage investment, whereas higher rates discourage investment.

Macroeconomic benefits of a high savings rate

Furnishes greater capital for business investment, accelerating physical capital deepening and long-run economic expansion.

How commercial banks create money

Through fractional reserve banking by issuing loans against customer deposits while retaining only a mandatory fraction in reserve.

Government policies to encourage saving

Offering tax incentives such as individual retirement accounts, lowering capital gains taxes, and sponsoring financial education programs.

Risks associated with financial market investments

Asset price volatility, default or credit risks, macroeconomic recessions, and the potential loss of invested principal.

Contribution of the stock market to economic growth

Enables corporate enterprises to raise equity capital from investors to fund expansion, technological development, and job creation.

Frictional unemployment

Short-term unemployment experienced by individuals who are transitioning between jobs or newly entering the labor market.

Structural unemployment

Long-term joblessness resulting from persistent imbalances between worker skill sets or geographic locations and employer requirements.

Cyclical unemployment

Unemployment directly attributable to economic downturns, recessions, and insufficient Aggregate Demand across the macroeconomy.

Natural rate of unemployment

The baseline rate of unemployment determined entirely by structural and frictional dynamics, independent of cyclical business variations.

Unemployment rate formula

$$\text{Unemployment Rate} = \frac{\text{Number of Unemployed}}{\text{Labor Force}} \times 100$$

Labor force participation rate

The percentage of the working-age population that is actively employed or registered as actively seeking work.

Economic implications of high unemployment

Depressed household spending, foregone real GDP output, reduced tax revenues, and inflated government expenditures on social welfare.

Government policies to address unemployment

Providing vocational retraining initiatives, direct employment subsidies, job search assistance, and countercyclical fiscal stimulus.

Seasonal unemployment

A form of joblessness that recurs predictably throughout the year due to weather variations, holiday cycles, or seasonal demand shifts.

Social consequences of sustained high unemployment

Increased crime rates, deteriorating mental and physical health, erosion of occupational skills, and widespread community distress.