Macroeconomics Vocabulary Flashcards

Chapter 8: Unemployment & Inflation

• Key Formulas:

  • Labour Force = Employed + Unemployed
  • Unemployment Rate = ( \frac{\text{Unemployed}}{\text{Labour Force}} \times 100 )
  • Labour Force Participation Rate = ( \frac{\text{Labour Force}}{\text{Working-Age Population}} \times 100 )

• Types of Unemployment:

  • Frictional: Normal job search/turnover.
  • Structural: Skills no longer match market needs.
  • Seasonal: Affected by weather/seasons.
  • Cyclical: Caused by recession; indicates an unhealthy economy.

• Natural Rate of Unemployment:

  • Combines only frictional, structural, and seasonal unemployment rates.
  • Full employment achieved when cyclical unemployment is at 0%.

• Inflation Basics:

  • Definition: Persistent rise in average prices, which reduces purchasing power.
  • Measured by the Consumer Price Index (CPI).
  • Inflation Rate = % change in CPI.
  • Core Inflation: CPI that excludes food and energy prices.

• Real vs Nominal Interest Rates:

  • Nominal Rate: Quoted interest rate.
  • Real Rate: ( \text{Real Rate} = \text{Nominal Rate} - \text{Inflation} )

• Quantity Theory of Money:

  • Equation: ( MV = PQ ) where:
  • ( M ) = Money supply
  • ( V ) = Velocity of money
  • ( P ) = Average price level
  • ( Q ) = Real output (real GDP)
  • If ( M \uparrow \rightarrow P \uparrow ) (if ( Q ) and ( V ) are fixed).

• Phillips Curve:

  • Short-run: Inverse relationship—decrease in unemployment implies increase in inflation.
  • Long-run: No stable trade-off exists.

Chapter 9: Aggregate Supply & Demand (AS/AD)

• Aggregate Demand (AD):

  • Formula: ( AD = C + I + G + (X − IM) )
  • Law of AD: Price increases lead to a decrease in real GDP demanded.
  • Shifts caused by: Expectations, interest rates, government policy, GDP changes in the rest of the world, and exchange rates.

• Aggregate Supply (AS):

  • Short-Run AS (SAS): Upward sloping.
  • Long-Run AS (LAS): Vertical line at potential GDP (full employment).

• Macroeconomic Performance Target:

  • Potential GDP is indicated by points on the Production Possibilities Frontier (PPF) and is represented by the vertical LAS curve, showing that quantity of real GDP is unaffected by price level.

• Shocks:

  • Demand Shocks: Shift aggregate demand (e.g., fiscal stimulus).
  • Supply Shocks: Shift aggregate supply (e.g., oil price spikes).
  • Negative Supply Shock: Leads to stagflation.
  • Positive Supply Shock: Encourages growth and reduces prices.

• Equilibrium:

  • Short-run: ( AD = SAS )
  • Long-run: ( AD = SAS = LAS ) (full employment condition).

• Output Gaps:

  • Recessionary Gap: Output (Y) is less than potential GDP, leading to increased unemployment.
  • Inflationary Gap: Output (Y) is greater than potential GDP, leading to rising prices.

Chapter 10: Aggregate Expenditure & Multipliers

• Aggregate Expenditure (AE) Formula:

  • ( AE = C + I + G + X - IM )

• Components (Example):

  • Consumption: ( C = 0.8(Y − 100) )
  • Investment: ( I = 250 )
  • Government Spending: ( G = 150 )
  • Exports: ( X = 180 )
  • Imports: ( IM = 0.3Y )
  • Final: ( AE = 500 + 0.5Y )

• Equilibrium Condition:

  • Set ( AE = Y ) and solve for Y: for example, ( AE = 500 + 0.5Y \rightarrow Y = 1000. )

• Injections vs. Leakages:

  • Injections: ( I + G + X )
  • Leakages: ( S + T + IM )
  • Equilibrium: Injections = Leakages.

• Multiplier Effect:

  • Formula: ( \text{Multiplier} = \frac{1}{1 - \text{MPC}} )
  • Example: If MPC = 0.8, then Multiplier = 5.
  • Change in GDP: ( \Delta Y = \text{Multiplier} \times \Delta \text{Spending} ).

• AE & Price Level (link to AD):

  • If price increases, AE decreases resulting in decreased AD and Y.
  • Conversely, if price decreases, AE and AD increase, resulting in higher Y.

Chapter 11: Exchange Rates & International Accounts

• Exchange Rates:

  • Definition: Price of one currency relative to another (C$ in terms of USD).
  • C$ Appreciation: Decrease in exports and increase in imports leading to reduced AD.
  • C$ Depreciation: Increase in exports and decrease in imports leading to increased AD.

• Foreign Exchange Market (FX Market):

  • Demand for C$ arises from foreigners buying Canadian goods/assets.
  • Supply of C$ arises from Canadians purchasing foreign goods/assets.

• Purchasing Power Parity (PPP):

  • Concept that the same goods should cost the same in different countries; if not, currency values will adjust.

• Rate of Return Parity (RRP):

  • States that interest rates between countries will equalize after adjusting for expected changes in exchange rates.

• Balance of Payments:

  • Current Account: Represents exports minus imports plus net income/transfers.
  • Financial Account: Records investment in assets such as bonds or real estate.
  • Balance must exist: Any surplus in one account must be offset by a deficit in another.

Chapter 12: Money & Monetary Policy

• Who Supplies Money?

  • Commercial banks in Canada hold minimal cash reserves, usually less than 1% of demand deposits, leading to a risk-reward balance in loan issuance.

• Money Supply Mechanics:

  • The current money supply relates directly to the actions of the Bank of Canada and the loans/deposits created by banks.

• Functions of Money:

  1. Medium of exchange
  2. Unit of account
  3. Store of value

• Types of Money:

  • Commodity Money: Has inherent value (e.g., gold).
  • Fiat Money: Government-issued money that holds no intrinsic value.
  • Deposit Money: Bank deposits that are used to facilitate payments.

• Money Supply Measures:

  • M1+: Currency + demand deposits.
  • M2+: M1+ plus other types of savings accounts.

• Money Creation by Banks:

  • Banks use fractional reserve banking whereby only a fraction of deposits are held in reserve, allowing for loan creation that increases the money supply.

• Monetary Policy Tools (Bank of Canada):

  • Overnight Rate (Policy Rate):
  • Increasing the rate leads to decreased borrowing and money supply, resulting in contraction.
  • Decreasing the rate leads to increased borrowing and money supply, fostering expansion.

• Operating Band:

  • Consists of the Bank Rate (for lending) at the top and the Deposit Rate at the bottom, with the policy rate positioned centrally.

• Transmission Mechanism:

  • Domestic: A decrease in the rate leads to increased consumption and investment.
  • International: A decrease in the rate causes a depreciation of the C$, boosting exports and AD.

• Bank of Canada Goals:

  • Maintain inflation around 2% (target range of 1-3%).
  • Promote objectives of price stability, full employment, and sustainable economic growth.

Graph Descriptions, Labels, and Shifts

• Quantity Theory of Money (MV = PQ):

  • Shape: Upward-sloping.
  • X-axis: Money Supply (M).
  • Y-axis: Price Level (P).
  • As the money supply increases, the price level rises if quantity and velocity are held constant.

• Phillips Curve (Short Run):

  • Shape: Downward-sloping.
  • X-axis: Unemployment Rate (%).
  • Y-axis: Inflation Rate (%).
  • Shows the inverse short-run trade-off between employment and inflation.

• Long-Run Aggregate Supply (LAS):

  • Shape: Vertical line.
  • X-axis: Real GDP (Y).
  • Y-axis: Price Level (P).
  • Indicates that LAS is fixed at potential GDP, where price changes do not affect output level.

• Short-Run Aggregate Supply (SAS) & Aggregate Demand (AD):

  • SAS is upward sloping; AD is downward sloping.
  • X-axis: Real GDP (Y).
  • Y-axis: Price Level (P).
  • Equilibrium occurs at the intersection of SAS and AD curves.

• AE = Y Equilibrium (45° Line):

  • Shape: AE curve intersecting with a 45° line.
  • X-axis: Real GDP (Y).
  • Y-axis: Aggregate Expenditure (AE).
  • Equilibrium occurs where AE equals Y, evidenced by intersection with the 45° line.

• Multiplier Effect:

  • Shape: Linear (varied slopes).
  • X-axis: Change in Spending ($).
  • Y-axis: Change in GDP ($).
  • Depicts the impact on GDP across different multipliers based on changes in spending.

• Foreign Exchange Market for C$:

  • Demand curve is downward sloping, while the supply curve is upward sloping.
  • X-axis: Quantity of Canadian Dollars.
  • Y-axis: Exchange Rate (C$ per USD).

• Balance of Payments Identity (CA + FA = 0):

  • Shape: Downward-sloping line.
  • X-axis: Current Account.
  • Y-axis: Financial Account.

• Money Market (MD & MS):

  • Demand curve is downward sloping; money supply curve is vertical.
  • X-axis: Quantity of Money.
  • Y-axis: Interest Rate.