eco2013 (6) - principles of economics: macro unit 1 study guides

Key Concepts and Definitions

• Macroeconomics studies the behavior and performance of an economy as a whole, focusing on aggregate economic variables such as GDP, inflation, and unemployment
• Gross Domestic Product (GDP) measures the total value of all final goods and services produced within a country's borders in a given period (usually a year)
  • Nominal GDP is measured in current prices, while real GDP adjusts for inflation to provide a more accurate picture of economic growth
• Inflation refers to a sustained increase in the general price level of goods and services over time, typically measured by the Consumer Price Index (CPI) or the GDP deflator
• Unemployment rate represents the percentage of the labor force that is actively seeking work but unable to find employment
  • Types of unemployment include frictional (temporary), structural (skills mismatch), and cyclical (due to economic downturns)
• Aggregate demand (AD) is the total demand for goods and services in an economy at a given price level, consisting of consumption, investment, government spending, and net exports
• Aggregate supply (AS) represents the total supply of goods and services in an economy at a given price level, determined by factors such as technology, labor, and capital

Economic Indicators and Measurements

• Leading economic indicators provide early signals of future economic trends (consumer confidence index, stock market performance)
• Coincident indicators move in tandem with the current state of the economy (personal income, industrial production)
• Lagging indicators confirm long-term trends and changes in the economy (unemployment rate, average duration of unemployment)
• Consumer Price Index (CPI) measures the average change in prices paid by urban consumers for a basket of goods and services
  • Core CPI excludes volatile food and energy prices to provide a more stable measure of underlying inflation
• Producer Price Index (PPI) measures the average change in prices received by domestic producers for their output
• Gross National Product (GNP) measures the total value of all final goods and services produced by a country's citizens, regardless of their location
• Misery Index combines the unemployment rate and the inflation rate to gauge the overall economic well-being of a country

Aggregate Supply and Demand

• Short-run aggregate supply (SRAS) curve is upward sloping, reflecting the positive relationship between price level and output in the short run
  • Factors that shift SRAS include changes in input prices, productivity, and government regulations
• Long-run aggregate supply (LRAS) curve is vertical, indicating that output is determined by factors such as technology, labor, and capital in the long run
• Aggregate demand (AD) curve is downward sloping, showing the inverse relationship between price level and aggregate quantity demanded
  • Factors that shift AD include changes in consumption, investment, government spending, and net exports
• Equilibrium occurs when AD intersects with SRAS, determining the equilibrium price level and output in the short run
• Changes in AD or AS lead to adjustments in price level and output until a new equilibrium is reached
• Inflationary gap occurs when AD exceeds AS at full employment, leading to demand-pull inflation
• Recessionary gap occurs when AD falls short of AS at full employment, resulting in unemployment and unused capacity

Fiscal Policy and Government Intervention

• Fiscal policy involves the use of government spending and taxation to influence macroeconomic conditions
• Expansionary fiscal policy aims to stimulate economic growth during recessions by increasing government spending or reducing taxes
  • Increases in government spending directly contribute to AD, while tax cuts boost disposable income and consumption
• Contractionary fiscal policy seeks to control inflation during economic booms by decreasing government spending or raising taxes
• Automatic stabilizers are built-in fiscal mechanisms that automatically adjust to changes in economic conditions (progressive income tax, unemployment benefits)
• Crowding-out effect occurs when increased government borrowing leads to higher interest rates, reducing private investment and partially offsetting the impact of expansionary fiscal policy
• Fiscal multiplier measures the change in GDP resulting from a change in government spending or taxes
  • Size of the multiplier depends on factors such as the marginal propensity to consume (MPC) and the economy's proximity to full employment
• Budget deficit occurs when government spending exceeds tax revenue, while budget surplus arises when tax revenue exceeds government spending

Monetary Policy and Banking System

• Monetary policy refers to the actions taken by a central bank to control the money supply and interest rates to achieve macroeconomic goals
• Federal Reserve System (Fed) is the central bank of the United States, responsible for conducting monetary policy and regulating the banking system
  • Federal Open Market Committee (FOMC) is the primary decision-making body within the Fed, setting the target for the federal funds rate
• Open market operations involve the Fed buying or selling government securities to influence the money supply and interest rates
  • Buying securities increases the money supply and lowers interest rates, while selling securities has the opposite effect
• Reserve requirements determine the minimum amount of reserves banks must hold against their deposits, influencing their ability to lend
• Discount rate is the interest rate charged by the Fed on loans to commercial banks, affecting the cost of borrowing and the money supply
• Expansionary monetary policy aims to stimulate economic growth by increasing the money supply and lowering interest rates
• Contractionary monetary policy seeks to control inflation by decreasing the money supply and raising interest rates

International Trade and Exchange Rates

• International trade involves the exchange of goods and services across national borders
• Comparative advantage is the ability of a country to produce a good or service at a lower opportunity cost than another country
  • Countries specialize in producing goods for which they have a comparative advantage and trade for goods they can obtain at a lower cost from other countries
• Exchange rate is the price of one currency in terms of another, determined by the supply and demand for currencies in foreign exchange markets
  • Appreciation occurs when a currency increases in value relative to another, while depreciation refers to a decrease in value
• Flexible exchange rate system allows exchange rates to be determined by market forces without government intervention
• Fixed exchange rate system involves the government setting and maintaining a specific exchange rate, often by buying or selling foreign currencies
• Balance of payments records all international transactions of a country, including the current account (trade in goods and services) and the capital account (financial flows)
• Trade deficit occurs when a country's imports exceed its exports, while trade surplus arises when exports exceed imports

Economic Growth and Development

• Economic growth refers to the increase in a country's real GDP over time, reflecting an expansion in the production of goods and services
• Productivity growth, driven by technological progress and human capital improvements, is a key determinant of long-term economic growth
• Solow growth model emphasizes the role of capital accumulation, labor force growth, and technological progress in determining long-run economic growth
  • Diminishing marginal returns to capital imply that sustained growth requires continuous technological advancement
• Human capital, the knowledge and skills possessed by workers, contributes to productivity and economic growth
  • Investment in education and training can enhance human capital and promote long-term growth
• Infrastructure investment, such as transportation networks and communication systems, can facilitate economic activity and support growth
• Institutions, including property rights, contract enforcement, and the rule of law, create an enabling environment for economic growth and development
• Income inequality and poverty can hinder economic growth by limiting access to opportunities and reducing aggregate demand

Current Macroeconomic Issues

• Globalization has increased economic integration and interdependence among countries, presenting both opportunities and challenges
  • Benefits include increased trade, investment, and knowledge spillovers, while challenges involve job displacement and income inequality
• Climate change poses significant risks to long-term economic growth and stability, necessitating a transition to sustainable practices and technologies
  • Carbon pricing, renewable energy investment, and green infrastructure can help mitigate the economic impacts of climate change
• Demographic shifts, such as population aging in developed countries, can affect labor force participation, productivity, and fiscal sustainability
  • Policies to support longer working lives, encourage immigration, and adapt social security systems can help address demographic challenges
• Income and wealth inequality have risen in many countries, with potential implications for social cohesion and economic growth
  • Progressive taxation, investment in education and skills development, and policies to promote inclusive growth can help reduce inequality
• Technological disruption, including automation and digitalization, is transforming labor markets and the nature of work
  • Policies to support lifelong learning, skills upgrading, and social protection can help workers adapt to technological change
• Global imbalances, such as large and persistent current account deficits or surpluses, can create economic vulnerabilities and contribute to financial instability
  • International policy coordination and structural reforms can help address underlying causes of global imbalances