Macroeconomics Unit 2 Summary

Introduction

• Overview of key concepts for Unit 2: Economic Indicators and the Business Cycle.
• Reminder to download the accompanying study guide.

Five Big Picture Concepts

1. Economic Indicators: Gross Domestic Product (GDP), unemployment rate, Consumer Price Index (CPI) for measuring inflation.
2. Circular Flow Model: Interaction between households, businesses, and government.
3. Gross Domestic Product (GDP): Dollar value of final goods and services produced in a country in one year.
4. Types of Unemployment: Frictional, structural, and cyclical unemployment.
5. Real vs. Nominal GDP: Real GDP is inflation-adjusted; nominal GDP is not.

Topic 2.1: Circular Flow Model

• The model illustrates interactions in a market economy:
  • Households sell factors of production to businesses in the factor market.
  • Businesses produce and sell goods/services to households in the product market.
  • Households pay for goods/services; businesses pay for factors (Factor Payments).
  • Government involvement: taxes, public goods, transfer payments.
• Importance of recognizing financial sector and international trade in later units.

Economic Goals

• Growth, limit unemployment, and keep prices stable.

Topic 2.2: Measuring GDP

• Three Approaches to Measuring GDP:
  1. Expenditures Approach: C + I + G + X (Consumer + Investment + Government + Net Exports).
  2. Income Approach: Wages + Rent + Interest + Profit = Total Income.
  3. Value Added Approach: Adds value at each production stage.
• Most important is the expenditures approach.

GDP Components Explained

• C: Consumer spending.
• I: Business investment (not stocks/bonds).
• G: Government spending (excludes transfer payments).
• X: Net exports (exports - imports).

Limitations of GDP

• GDP does not include:
  • Used goods.
  • Intermediate goods.
  • Non-production transactions (like stocks/bonds).
  • Illegal/non-market transactions.

Topic 2.3: Unemployment

• Definitions:
  • Labor Force: Individuals 16+ who are employed or actively seeking work.
  • Labor Force Participation Rate: Labor force divided by working-age population x 100.
  • Unemployment Rate: Unemployed individuals divided by labor force x 100.
• Types of Unemployment:
  1. Frictional: Between jobs.
  2. Structural: Skills mismatch.
  3. Cyclical: Due to recession.

Natural Rate of Unemployment

• Combination of frictional and structural unemployment; no cyclical unemployment (around 4-5%).

Topic 2.4: Measuring Inflation

• Consumer Price Index (CPI): Measures price level changes over time.
  • CPI formula: (Current year market basket value / Base year market basket value) x 100.
• Terms:
  • Inflation: Prices increase.
  • Deflation: Prices decrease.
  • Disinflation: Prices increase at a slower rate.

Limitations of CPI

• Substitution bias can lead to CPI inaccuracies.

Topic 2.5: Impacts of Inflation

• Who is Hurt:
  • Lenders at fixed interest rates.
  • People on fixed incomes.
• Who Benefits:
  • Borrowers at fixed interest rates.

Topic 2.6: GDP Deflator

• Compares nominal GDP to real GDP.
• Formula: (Nominal GDP / Real GDP) x 100.
• Used to assess price level changes across the entire economy.

Topic 2.7: Business Cycles

• Four Phases:
  1. Trough: Lowest point.
  2. Expansion: Recovery phase.
  3. Peak: Highest point.
  4. Recession: Economic contraction.
• Economic output can be above or below potential GDP (full employment level).

Conclusion

• Review the key equations and concepts in preparation for the quiz/exam.
• Encourage further study through practice questions.