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.