Macroeconomics Review

Macroeconomics Review Notes

Chapter 10: Overview of Macroeconomics

  • Macroeconomics Explained:

    • Study of aggregate economic behavior of the economy as a whole.
    • Main purpose: to explain the business cycle and the forces behind economic expansion and contraction.

  • Basic Measures of Macro Performance:

    1. Output Growth (GDP):
    • Total output (goods + services) in an economy at a given time.
    • Real GDP: Adjusted for inflation, reflects actual output.
    • Nominal GDP: Measured in current prices without adjustment.
    • Recession: Identified by a decline in GDP for two consecutive quarters.
    1. Unemployment:
    • Definition: Individuals are unemployed if they do not have a job and are actively seeking work.
    • Labor Force: Comprises anyone over 16 who is employed or unemployed.
    • Unemployment Rate Formula:
      • Unemployment Rate = (Number of Unemployed) / (Labor Force Size)
    • Categories of Unemployment:
      1. Seasonal: Due to seasonal work fluctuations.
      2. Frictional: Temporary, as individuals transition between jobs.
      3. Structural: Mismatch between skills and employer needs.
      4. Cyclical: Results from economic downturns (recessions).
    • Optimal Rate of Unemployment: Approximately 4-6%.
    • Inflation risk increases as the economy approaches full employment.
    1. Inflation:
    • Nominal Income: Total dollar income measured at current prices.
    • Real Income: Adjusted for inflation; decreases when prices rise.
    • Price Stability: Desired inflation rate < 3%.

Chapter 11: Determinants of Macro Economic Performance

  • Key Determinants of macroeconomic performance include:

    1. Internal Market Forces: Population growth, spending habits, innovation.
    2. External Shocks: Events like wars and natural disasters.
    3. Policy Levers: Government actions through tax policy, interest rates, and immigration.

  • Aggregate Demand (AD):

    • Total quantity of output demanded at various price levels.
    • Formula: AD = C + I + G + N.E.
    • C: Consumption, I: Investment, G: Government Spending, N.E: Net Exports.
    • AD Curve Slopes Downward:
    1. Real Balances Effect: Consumer purchasing power affected by prices.
    2. Foreign Trade Effect: Changes in domestic price lead to variations in exports/imports.
    3. Interest Rate Effect: Lower prices boost borrowing and spending.

  • Aggregate Supply (AS):

    • Total output that producers are willing to supply at various price levels.
    • AS Curve Slopes Upward:
    1. Profit Margins: Higher prices increase profits, motivating more production.
    2. Cost Increases: Rising costs of resources lead to higher prices for output.

  • Macro Failure: Caused by instability or undesirability in achieving full employment and controlling inflation.

Chapter 12: Fiscal Policy

  • Fiscal Policy: Government's use of taxes and spending to influence macroeconomic conditions; it shifts aggregate demand.

    • Consumption accounts for one-third of total spending in the U.S.
    • Increasing Government Spending & Tax Cuts: Stimulates incomes and consumer spending.
    • Multiplier Effect: Total effect on AD from initial government spending.
    • Formula: Change in AD = Change in Spending Multiplier × Initial Change in Spending.
    • Example: If MPC = 0.75, every $1 of government spending may increase AD by $4.

  • Fiscal Restraint: Involves raising taxes to reduce aggregate demand; budget surplus/deficit impact government strategies toward unemployment and inflation.

Chapter 13: Functions and Supply of Money

  • Functions of Money:

    1. Medium of exchange
    2. Store of value
    3. Standard of value

  • Basic Money Supply (M1):

    • Comprises currency in circulation, transaction account balances, and traveler's checks.
    • Credit cards are payment means, not a form of money.

  • Banking Operations:

    • Banks create money through loans, dependent on reserve ratio requirements.
    • Required Reserves: Calculated as required reserve ratio × total deposits.
    • Excess Reserves: The difference between total reserves and required reserves.

  • Money Multiplier: Determines how much money can be created from excess reserves.

    • Higher required reserve ratio decreases potential loan creation.

Chapter 14: Federal Reserve System & Monetary Policy

  • The Federal Reserve System is the central banking authority shaping monetary policy.
  • Monetary Policy: Uses money and credit controls to influence macroeconomic factors, mainly affecting aggregate demand.
    • Tools of the Fed:
    • Altering reserve requirements and the discount rate to manage money supply.
    • Economic Responses:
    • In times of unemployment: Increase AD by lowering interest rates and reserve requirements.
    • In times of inflation: Decrease AD by raising discount rates and increasing reserve requirements.