Macroeconomics Final Exam (FAll2025)

circular flow of income (ignoring taxes) two principles

1. In every economic exchange, the seller receives exactly the same amount that the buyer spend

2. goods/services flow in 1 direction, and money payments flow in the other

Product Markets

transactions in which households buy goods

Buyers: households

Sellers: businesses

Factor Markets

transactions in which businesses buy resources

Buyers: Businesses

Sellers: Households

Total Income

- total of all individuals income

- the yearly amount earned by nation's resources

- wages, rent, interest payments, profits from workers, landowners, capital owners, entrepreneurs

Final Goods and Services

goods and services sold to the final, or end, user

example: wheat ordinarily is not considered a final good bc it is usually used to make a final good bread

example: bread

national income accounting

measurement of the national economy's performance, dealing with the overall economy's output and income

Gross Domestic Product (GDP)

- A measurement of the total goods and services produced within a country during a year

- GDP measures dollar value final output

- GDP measures dollar value of final goods and services produced per year by factors of production located within a nation's borders

Value Added

Gross value of the product minus the cost of raw materials and energy (intermediate goods)

Total Value

total value added is equal to sum of all income payments

Gross output

A measure of total sales volume at all stages of production

Financial Transactions (nothing to do w/ production of goods/services)

securities:

stocks and bonds

Government transfer payments (nothing to do w/ production of goods/services)

social security

unemployment compensation

Private transfer payments (nothing to do w/ production of goods/services)

individual gifts

corporate gifts

Expenditure Approach

adding up dollar value at current market prices of all final goods and services

Y = C + I + G + X

Income Approach

The method that adds all the income generated by the production of final goods and services to measure the gross domestic product.

(wages, rents, profits, interest)

CIGX explained

C = Consumer expenditure

I = Investment expenditure

G = Government expenditures

X = net eXports

Consumption Expenditure

- Durable consumer goods (C)

items that last more than 3 yrs

(automobiles, furniture)

- Nondurable consumer goods

goods that are used within 3 yrs

(gasoline, food)

- Services

mental or physical help

Gross private domestic investment ( I )

investment refers to additions to productive capacity (factories/machines)

Fixed investment

business purchases of capital goods, such as machinery and factories, and purchases of new residential housing

Inventory Investment

Changes in the stock of finished unsold goods and raw materials held during a period.

Government expenditures (G)

State, local, and federal (VALUED AT COST)

Net Exports (foreign expenditures)

Net exports (X) = total exports - total imports

Net Domestic Product (NDP)

- Allowing for depreciation (capital consumption allowance)

- the amount that businesses would have to save in order to repair/replace deteriorating machines

GDP by expenditure approach

Gross Domestic investment - estimate of wear and tear on the existing capital stock

capital stock

total shares of ownership in a corporation over a one year period

Gross Domestic Income (GDI)

The sum of all income (wages, interest, rent, and profits) paid to the four factors of production

- wages: salaries/labor income

- rent: farms/houses/stores

- interest: interest received (savings) minus interest paid (mortgages)

- profits: gross corporate profits, proprietors income

deriving GDP by income approach

GDP = GDI + indirect business taxes and depreciation

these last items are called nonincome expense items

indirect business taxes

all business taxes except the tax on corporate profits

include sales/business property taxes

National Income (NI)

the total all factors payments to resource owners

= NDP + Net U.S. income earned abroad

Personal Income (PI)

total income that individuals receive before personal taxes are paid

Disposable Personal Income (DPI)

the income of households after taxes have been paid

Nominal Values

measurements in terms of the actual market prices at which goods are sold; expressed in current dollars, also called money values

Real values

measurements after adjustments have been made for changes in the average price between years; expressed in constant dollars

constant dollars

- Dollars expressed in terms of real purchasing power

- the price corrected GDP is the real GDP

per capita GDP

real GDP divided by total population

foreign exchange rate

the price of one currency in terms of another

example: British pound or pound

- British income per capita = 39,760 pounds

- British per capita = $39,760pounds

- British per capita income in terms of dollars equals

Purchasing power parity

an adjustment in exchange rate conversions that takes into account differences in the true cost of living across countries

Classical Model

The first attempt to explain determinants of the price level, national levels of real GDP, employment, consumption, saving, and investment.

Say's Law

supply creates its own demand, hence it follows that desired expenditures will equal actual expenditures

classical economists mindset

concluded that the problem in the macroeconomy will be temporary/ market will correct itself if the follow assumptions hold

- pure competition exists

- wages/prices are flexible

- people are motivated by self interest

- people cannot be fooled by money illusion

- the role of the gov't should be minimal

- GDP will only change when LRAS shifts

money illusion

the use of nominal dollars rather than real dollars to gauge changes in one's income or wealth

Aggregate Demand

the amount of goods and services in the economy that will be purchased at all possible price levels

Aggregate Supply (AS)

the total quantity of output (i.e. real GDP) firms will produce and sell

Keynesian Economics

the classical economists world is one of fully utilized resources

- prices including wages (price of labor) are inflexible or sticky downward

- increase in aggregate demand, AD, will not raise the price level

- decrease in AD will not cause firms to lower the price level

- Equilibrium GDP is demand determined

Keynes beliefs

argued that AD determined GDP and insufficient demand led to high unemployment

due to lag time of self correction that classical economists argued for was so great, just too slow bc of that he argued FOR gov't monetary/fiscal intervention

Short-run aggregate supply (SRAS) curve

a curve that shows the relationship in the short run between the price level and the quantity of real GDP supplied by firms

aggregate demand shock

any event that causes the aggregate demand curve to shift inward or outward

aggregate supply shock

any event causes the aggregate supply curve to shift inward or outward

Long-run aggregate supply (LRAS) curve

vertical line at potential GDP showing no relationship between the price level for output and real GDP in the long run

Recessionary Gap

what occurs when the equilibrium quantity of output is below potential output

Inflationary Gap

The amount by which equilibrium GDP exceeds full-employment GDP.

Fiscal Policy

the use of government spending and revenue collection to influence the economy

- high employment (low employment)

- price stability

- economic growth

an increase in gov't spending will stimulate economic activity

expansionary fiscal policy

when the govt spends more

contractionary fiscal policy

when the government spends less

change in taxes

A rise in taxes causes a reduction in aggregate demand because it can reduce consumption spending, investment expenditures, and net exports

- lower taxes in order to increase consumer spending

- raise taxes in order to decrease consumer spending

crowding-out effect

the offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending

Direct expenditure offsets

Actions on the part of the private sector in spending income that offset government fiscal policy actions. Any increase in government spending in an area that competes with the private sector will have some direct expenditure offset.

Supply-side effects of changes in taxes

-Expansionary fiscal policy could involve reducing marginal tax rates

- advocates argue that this increases productivity since individuals will work harder and longer, save more, and invest more.

- The increased productivity will lead to more economic growth (higher GDP)

Supply-side effects of changes in taxes

-Lower tax rates lead to an increase in productivity because individuals will work harder and longer, save more, and invest more

-Increased productivity will in turn lead to more economic growth and thus higher real GDP

-As a result, lower marginal tax rates will not necessarily reduce tax revenues because the tax base will be larger

Recognition time lag

the time required to gather information about the current state of the economy

action time lag

The time required between recognizing an economic problem and putting policy into effect

effect time lag

The time it takes for a fiscal policy to affect the economy

Fiscal policy time lags are

Long - a policy designed to correct a recession may not produce results until the economy is

experiencing inflation.

• Variable in length - they can be from 1-3 years, and the timing of the desired effect cannot be

predicted.

• Because fiscal policy time lags tend to be variable, policymakers have a difficult time fine-tuning the economy.

Automatic or Built-In Stabilizers

Special provisions of certain federal programs that cause changes in desired aggregate expenditures without the action of Congress and the president. Examples are the federal progressive tax system and unemployment compensation.

The Tax System

incomes/profits fall when business activity slows down, and the gov't tax revenues drop as well

Stabilizing Impact

-The key impact of these systems is the ability to mitigate changes in disposable income, consumption, and the equilibrium level of GDP.

-If disposable income is prevented from falling as much as it otherwise would in a recession, the downturn will be moderated.

Government Budget Deficit

the value of government spending exceeds revenue from taxation

Balanced Budget

Budget in which revenues are equal to spending

budget surplus

a situation in which the government takes in more than it spends