Macro Speed Review

2.1 GDP and its Determinants

Key Concepts

• Micro and Macro Concepts: In Macroeconomics, concepts relate to broader economic activity than those in Microeconomics.

• GDP (Gross Domestic Product): Primary measure of total economic activity in a nation, expressed as the total value of output.

Key Terms in Macroeconomics

• National Economy: Examines all economic activity in a country.

• Demand: Refers to the total quantity of goods and services demanded (Aggregate Demand - AD).

• Supply: Total supply of goods and services produced (Aggregate Supply - AS).

• Price: The average price level reflects the index of average prices over time.

• Quantity: National output denotes the total output of all industries in a country.

Economic Fluctuations

• Recession: A decline in total output caused by a decrease in AD.

• Inflation: An increase in average price levels resulting from an increase in AD.

• Supply Shock: A drop in AS creating a higher price level and lower output.

2.2 Leakages and Injections in Circular Flow

Circular Flow Model

• Leakages:

  • Taxes paid to the government,

  • Money saved in banks,

  • Spending on imports from abroad.

• These leakages do not contribute to national output, acting as a withdrawal from the economy.

Injections:

• Government Spending: Infrastructure, education, and public goods funded by tax revenues.

• Export Revenues: Money from foreigners purchasing domestic goods.

• Investments: Households' savings facilitate capital spending in the economy.

Balancing Act:

• The total output of a nation's economy is determined by the balance between leakages and injections.

2.3 Gross Domestic Product (GDP)

Definition and Calculation

• GDP = Total value of a nation’s output in a specified period.

• Measured via three approaches:

  • Income Approach: Total income earned.

  • Output Approach: Total value of goods/services produced.

  • Expenditure Approach (Used in this course):

    • C: Households' spending,

    • I: Investments by firms and households,

    • G: Government spending on public goods,

    • Xn: Exports - Imports.

2.4 Components of GDP

What GDP Includes

• Measures final output only within a year.

Exclusions from GDP

• Nonproduction transactions like:

  • Financial transactions (e.g., public/private transfer payments, stock sales),

  • Secondhand sales.

2.5 Nominal vs. Real GDP

Definitions

• Nominal GDP: Total value at current prices; can be misleading during inflation.

• Real GDP: Adjusted for price changes; offers a more accurate measure of volume.

2.6 Shortcomings of GDP

Limitations of GDP

• GDP overlooks:

  • Social aspects (e.g., income distribution),

  • Non-market labor (e.g., homemakers),

  • Underground economy,

  • Environmental costs associated with production.

2.7 Alternative Measures

Alternatives to GDP

• Gross National Product (GNP): Measures output from domestic factors abroad, excluding foreign production.

• Green GDP: Adjusts GDP for environmental degradation costs.

2.8 The Business Cycle

Stages

• Recession: Decline in total output lasting >6 months.

• Recovery: Post-recession output begins to increase.

• Expansion: Growth rate exceeds long-term trends.

2.9 Aggregate Demand Curve

Downward Slope Reasons

1. Wealth Effect: Higher prices reduce purchasing power.

2. Interest Rate Effect: Rising prices lead to higher interest rates, reducing borrowing.

3. Net Export Effect: Decreased prices increase attractiveness to foreign buyers.

2.10 Consumption as Aggregate Demand Component

Factors Influencing Consumption

• Disposable Income: After-tax income; rises lead to increased C.

• Wealth: Increase in wealth raises consumption levels.

• Expectations: Future price/income expectations impact current spending.

• Real Interest Rates: Low rates increase consumption.

• Household Debt: Higher debt can lead to short-term increases in consumption, but may later reduce it.

2.11 Marginal Propensities

Definitions

• MPC (Marginal Propensity to Consume): Change in C due to a change in Y.

• MPS (Marginal Propensity to Save): Change in S due to change in Y.

• MPM (Marginal Propensity to Import): Change in M due to change in Y.

• MRT (Marginal Rate of Taxation): Change in T due to change in Y.

2.12 Investment as Aggregate Demand Component

Investment Influencers

• Interest Rate: Lower rates increase investment.

• Business Confidence: Optimism boosts investments.

• Technology: Innovations spur investment.

• Taxation: Lower taxes encourage investments.

2.13 Net Exports as AD Component

Influencers on Net Exports

• Foreign Demand: Higher foreign incomes increase exports.

• Exchange Rates: Rate affects attractiveness of domestic vs foreign goods.

• Protectionism: Restrictions can influence net exports.

2.14 Government Spending as AD Component

Fiscal Policy Effects

• Expansionary: Increased spending can shift AD right.

• Contractionary: Decreased spending shifts AD left due to diminished demand.

2.15 Spending Multiplier

Multiplier Effect

• Increased government spending creates greater overall economic impact due to consumption by recipients.

2.16 Tax Multiplier

Impact of Tax Changes

• Changes in taxation affect disposable income and therefore consumption patterns, influencing AD.

2.17 Aggregate Supply Viewpoints

Classical vs. Keynesian Views

• Classical: Markets self-correct with flexible wages/prices.

• Keynesian: Active government role necessary to manage demand.

2.18 Aggregate Supply Determinants

Key Factors Influencing AS

• Wages: Affects labor costs directly.

• Resource Costs: Higher costs reduce supply.

• Government Regulations: Impose additional costs.

2.19 Short-run Equilibrium Adjustments

Demand Changes and Output Reactions

• Demand Drop: Leads to layoffs and reduced output.

• Demand Increase: Results in demand-pull inflation and increased output but can exceed full-employment levels.

2.20 Supply Shocks: Stagflation and Growth

Negative Shocks

• Stagflation: High prices with reduced output.

Positive Shocks

• Economic Growth: Lower costs increase output and reduce prices.

2.21 Long-run Growth Dynamics

Long-run Economic Conditions

• Economic growth requires increases in AD and AS, influenced by technological improvements and resource availability.

2.22 Macroeconomic Objectives

Essential Goals

• Price Stability, Full Employment, Economic Growth, Income Equity.

2.23 Understanding Unemployment

Definitions and Measures

• Unemployment: Actively seeking work without success.

• Unemployment Rate Calculation: (Number Unemployed / Total Labor Force) x 100.

2.24 Types of Unemployment

Classifications

• Frictional, Structural, Cyclical: Each with distinct causes/characteristics.

2.25 Causes of Unemployment

General Causes

• Demand Decrease: Reduction in AD or negative supply shocks lead to layoffs.

• Structural Changes: Technological advancements making jobs obsolete.

2.26 Unemployment Consequences

Negative Outcomes

• Individual: Decreased income, health issues.

• Societal: Increased crime and poverty.

• Economic: Underutilization of resources and lower AD.

2.27 Inflation Degrees

Types and Definitions

• Deflation: Price level decreases.

• Low vs. High Inflation: 0-5% is stable; >5% is high and risky.

2.28 Inflation Causes

Types of Inflation

• Demand-pull: Increases in total demand elevate prices.

• Cost-push: Production costs increase, leading to elevated prices.

2.29 Inflation Consequences

Impact on Economy

• Reduced Real Income and Competitiveness: Falling purchasing power and attractiveness to foreign buyers.

2.30 Deflation Consequences

Negative Effects on the Economy

• Increased Unemployment: Recession potential, delayed spending, and declining investment.

2.31 Short-run Phillips Curve

Inflation-Unemployment Relationship

• Changes in AD affect movement along the Phillips Curve.

2.32 Economic Growth Overview

Economic Growth Defined

• Increased Output: Both total and per capita measurements.

2.33 Economic Growth Models

Illustrating Economic Growth

• AD/AS Model: Growth indicated by shifts in AD and AS.

2.34 Sources of Economic Growth

Fundamental Sources

• Physical and Human Capital: Investments in resources/materials needed for production.

2.35 Economic Growth Consequences

Potential Impacts

• Higher Incomes vs. Environmental Costs: Balancing growth with sustainability.

2.36 Income Distribution Equitability

Equity Definition

• Equity vs. Equality: Fair distribution based on contribution vs. uniform distribution.

2.37 Measuring Income Distribution

Lorenz Curve Utilization

• Provides a visual representation of income distribution and equity levels.

2.38 Poverty Types

Definitions

• Relative vs. Absolute Poverty: Classifies poverty based on living standards relative to the wealth of others vs. the inability to meet basic needs.

2.39 Equity Promotion by Government

Methods

• Taxes: Progressive tax systems help narrow income gaps.

• Transfer Payments: Social safety nets aimed at assisting economically disadvantaged individuals.

2.40 Fiscal Policy Overview

Objectives and Tools

• Fiscal Policy: Government's use of spending and taxation to influence economic performance.

2.41 Government Budget

Revenues and Expenditures

• Types of Taxes: Direct and indirect taxes; importance for funding public services.

2.42 Government Budget Dynamics

Surpluses and Deficits

• Balanced Budgets: Net zero effect on AD;

  • Surplus and Deficit Effects: Impact on national debt and consumption flows.

2.43 Expansionary Fiscal Policy - Effects

Stimulating the Economy

• Impact on AD: Government spending increases AD; tax cuts stimulate consumption.

2.44 Automatic Stabilizers

Fiscal Policy Dynamics

• Automatic responses to economic conditions that minimize fluctuations.

2.45 Long-run Economic Growth

Fiscal Policy Impacts

• Effective fiscal measures can encourage long-term growth through sustained improvements.

2.46 Crowding-out Effect

Policy Discourse

• Increased government borrowing may limit private investment; potential for stunted growth.

2.47 Crowding-out - AD/AS Implications

Economic Outcomes

• Identification of decreased AD increase due to elevated borrowing costs affecting private sector.

2.48 Money Supply Mechanics

Understanding Money

• M1, M2, M3: Classification of liquidity levels within the money supply.

2.49 Money Market Model

Dynamics of Supply and Demand

• Interest rates determined by the interaction of money demand and supply.

2.50 Money Market Demand Shifts

Economic Fluctuations

• Changes in GDP influence the demand curve for money; implications for interest rates.

2.51 Money Market Supply Adjustments

Policy Effects

• Central bank interventions directly impact interest rates.

2.52 Interest Rates and Aggregate Demand

Interest Relations

• Interest rates influence investment and consumption, key components of AD.

2.53 Expansion Monetary Policy Overview

Response to Economic Slowdowns

• Expansionary measures reduce interest rates, and stimulate AD.

2.54 Monetary Policy Tools

Central Bank Power

• Changing RRR, Discount Rate, Open Market Operations: These tools modulate money supply, guiding overall economic activity.

2.55 Fractional Reserve Banking System

Money Creation Process

• Depositors' funds are leveraged through lending practices, effectively expanding the money supply.

2.56 Money Creation Example

Process Overview

• Illustrates how initial deposits in a fractional reserve banking system can significantly amplify the money supply.

2.57 Open Market Operations

Practical Mechanism

• Explains buying and selling of government bonds as a direct method to influence money supply.

2.58 Discount Rate Functionality

Banking Dynamics

• Provides insight into how the discount rate impacts commercial lending and reserve behaviors.

2.59 Monetary Policy Tool Importance

Tool Effectiveness

• Open market operations are the most common and flexible methods for managing money supply changes.

2.60 Evaluating Monetary Policy

Policy Effectiveness Challenges

• Inflation levels and depth of economic downturns influence the monetary policy's capacity to achieve intended effects.