Ann Henson Period: 2 HL Macroeconomics Review

1. Circular flow model-

Shows the interaction between factions of the economy, through the exchange of good and services 2. Leakages- non consumption use of income, i.e. taxes, savings, and imports Injections- A non-consumption expenditure on gross domestic product, including investment expenditures, government purchases, and exports. 3. Gross domestic product (GDP) - A measure of the value of aggregate output of an economy, it is the market value of all final goods and services produced within a country during a given time period (usually a year); it is the most commonly used measure of the value of aggregate output; to be contrasted with gross national product (GNP). 4. Income method: all income earned by the factors of production within a country in a given time period; wages, rent, interest, profit Output method: measures the value of each good and service produced in the economy Expenditure method: consumption spending: C includes all purchases by households, investment spending: I includes spending by firms on capital goods, government spending:G all spending by the government, net exports: X-M exports minus imports

5. The expenditure method is the sum of produced goods and services measured at current market prices. The full equation for GDP using this approach is GDP = C + I + G + (X-M) where; C: Household spending, I: Capital Investment spending, G: Government spending, X: Exports of Goods and Services, M: Imports of Goods and Services 6. Per capita means per person or per head. Therefore, per capita GDP of a country is total GDP of that country divided by its population. 7. Economic growth is caused by increases in total real output produced by an economy (real GDP) over time; may also refer to increases in real output (real GDP) per capita (or per person).

8. 9. The phases of the business cycle are expansion, peak, contraction and trough. An expansion occurs when there is positive growth in real GDP, and is shown by those parts of the curve in that are upward sloping. A peak represents the cycles maximum level of real GDP, and marks the end of the expansion. Following the peak, the economy begins to experience falling real GDP shown by downward-sloping parts of the curve. A trough represents the cycles minimum level of GDP, or the end of the contraction. 10. The cyclical line represents fluctuations in real GDP that is actually achieved by an economy over time and the straight line going through the typical business cycle graph represents the potential GDP which would be the economy at full employment. Essentially the difference between the two is real is what is happening in an economy and potential is what could happen if the economy was perfectly employed.

11. You determine unemployment using the business cycle because when real GDP grows in the expansion phase, unemployment falls; in the contraction phase, when the real GDP falls, the unemployment increases. 12. The components of Aggregate Demand are the demand of consumers (c), the demand of businesses (firms) (I), the demand of government (G), and the demand of foreigners for exports (X) minus the demand for the imports (M) (X-M or net exports). 13. Aggregate Demand is the total amount of real output that consumers, firms, the government and foreigners demand at each possible price level, over a particular time period, ceteris paribus. 14. The short run in macroeconomics is the period of time during which the nominal prices of resources, particularly the price of labor (wages), do not change in response to changes in the price level; we can think of resource prices as being constant. The long run in macroeconomics is the period of time in which the nominal prices of all resources, including the price of labor (wages), change so as to reflect fully any change in the price level. Simply the difference is that in the short run the wages are constant, whereas in the long run wages change in response to changes in the price level and that is why you need to differentiate between the two. 15. The determinants of aggregate supply are domestic resources prices, prices of imported resources, productivity, business taxes and subsidies, and government regulation. 16. The equilibrium level of real GDP occurs where aggregate demand intersects aggregate supply. In the short run, it is given by the point of intersection of the aggregate demand curve and the short-run aggregate supply curve, and determines the price level, the level of real GDP and the level of employment that prevail when the economy is in the short-run equilibrium. There are 3 points the SRAS curve can be and that is a deflationary gap, inflationary gap, and if the economy is at the full employment level of output. 17. Recessionary gap- economy is operating at below its full-employment equilibrium, equilibrium point is left of potential GDP 18. inflationary gap- A macroeconomic condition that describes the distance between the current level of real gross domestic product (GDP) and full employment (long run equilibrium) real GDP. The inflationary gap is so named because the relative increase in real GDP causes an economy to increase its consumption, which causes prices to rise in the long run.

19. working at full employment, therefore at potential GDP 20. A situation is a long run equilibrium if no firm in the industry wants to leave or if no potential firm wants to enter. 21. A shift in aggregate supply can be attributed to a number of variables. These include changes in the size and quality of labor, technological innovations, increase in wages, increase in production costs, changes in producer taxes and subsidies, and changes in inflation

22.

22

25. 26. The objectives of demand-side policies focus on changing aggregate demand in order to achieve the goals of price stability, full employment, and economic growth. 27. Fiscal policy refers to manipulations by the government of its own expenditures and taxes in order to influence the level of aggregate demand.

28. Monetary policy is carried out by the central bank, which aims at changing interest rates in order to influence aggregate demand. The components of AD that can be affected are investment spending and consumption spending. 29. In an inflationary gap, the central bank can pursue a contractionary policy through higher interest rates aimed at discouraging investment and consumption spending. In a recessionary gap, the central bank may pursue an expansionary policy through lower interest rates, encouraging investment and consumption spending. 30. The objectives of supply-side policies focus on aggregate supply, and specifically on factors aimed at directly shifting the LRAS curve to the right, in order to achieve long-run economic growth. 31. Market-oriented supply-side policies is based on the belief that growth in real GDP does not depend on aggregate demand, but rather on the supply side of the economy. The focus of government policies in this view should be less on stabilization, and more on achieving economic growth, or increases in potential output. 32. Interventionist policies presuppose that the free market economy cannot by itself achieve the desired results in terms of increasing potential output, and argue that what is required for this purpose is government intervention in specific areas. Policies are made to support growth of the industrial sector of an economy. 33. multiplier- the factor by which a change in spending is multiplied to find the change in national income 34. how is the multiplier calculated- by using marginal propensity to consume(mpc) or the value of marginal propensity to withdraw (mpw)or

35. impact of multiplier on AD and real GDP- any increase in aggregate demand will result in a proportionately larger increase in real GDP 36. costs of unemployment- (to unemployed)- less income, lower standard of living, high levels of stress- (to society)- poverty, homelessness, higher rates of crime, increased gang activity(economy as a whole)- foregoing possible output, opportunity costs of government spending, and less direct and indirect taxes 37. structural unemployment- occurs as a result in a fall in demand for a particular type of labor, results in long-term unemployment, lack of occupational mobility and geographic mobility-

policies to help- educational system that trains people to be more occupationally flexible, spending on adult retraining programs, give subsidies to firms that can provide training, subsidies or tax breaks that encourage people to move, support of apprenticeship programs 38. frictional unemployment- short-term unemployment that results from people being between jobs, natural unemployment- solutions to frictional unemployment- governments lower unemployment benefits, improve flow of information from potential employers 39. seasonal unemployment- demand for certain workers fall at certain times of the yearsolutions- encouraging people to have off season jobs, reduce unemployment benefits, and greater flow of information 40. natural rate of unemployment- rate of unemployment when the market is at equilibrium, that is there is no demand for deficient or real-wage unemployment 41. Real wage unemployment is seen as arising from a disequilibrium in the labor market: it occurs when the actual real wage is higher than the equilibrium real wage, giving rise to labor surplus, or unemployed labor.

42. Cyclical unemployment, as the term suggests, occurs during the downturns of the business cycle, when the economy is in a recessionary gap. In this view, the downturn is seen as arising from declining or low aggregate demand, and so is also known as demand-deficient unemployment. 43. Inflation- a continuing (or sustained) increase in the general price level. 44. caused by an increase in aggregate demand

45. Cost-push inflation - caused by a fall in aggregate supply, in turn resulting from increases in wages or prices of other inputs 46. Monetarism is a branch of neoclassical economics, stresses the role of the money supply as the underlying cause of inflation. MxV=PxQ, where, M=the supply of money in the economy, V=the velocity of money, also known as the velocity of circulation, defined as the number times money is spent to buy the goods and services that make up GDP in a particular time period P=the price level Q=the physical volume of output (GDP) produced by an economy 47. Deflation- a sustained decrease in the general price level, is caused by decreases in aggregate demand or increases in aggregate supply. 48. A price index in the most general sense is a measure of average prices in one period relative to average prices in a reference period called a base period. The two most commonly used price indexes are: the consumer price index (CPI) and the GDP deflator. 49. The short-run Phillips curve is represented by SRPC and indicates the inverse relationship between the rate of inflation and the unemployment rate. The long-run Phillips curve is a vertical line at the natural rate of unemployment and it indicates that there is no inverse relationship between inflation and unemployment, suggesting that policy-makers do not have a choice between the two competing alternatives. 50. Today, income redistribution occurs in some form in most democratic countries. Progressive income redistribution diminishes the amount of income one individual or corporation receives, while at the same time benefiting others. In a progressive income tax system, a high

income earner will pay a higher tax rate than a low income earner. A steeper progressive income tax results in more equal distribution of income and wealth across the board. 51. Direct taxes are taxes paid directly to the government tax authorities by the taxpayer. The most important kinds of direct taxes include the following: personal income taxes, corporate income taxes, wealth taxes, and social security tax. 52. Indirect taxes are taxes on spending on goods and services. The most important kinds of indirect taxes are: sales tax, excise taxes, and customs duties (tariffs). 53. The three types of tax rates are proportional, progressive, and regressive. Proportional taxation: as income increases, the fraction of income paid as taxes remains constant; there is a constant tax rate. Progressive taxation: as income increases, the fraction of income paid as taxes increases; there is an increasing tax rate. Regressive taxation: as income increases, the fraction of income paid as taxes decreases; there is a decreasing tax rate. 54. The Lorenz curve illustrates the degree of equality (or inequality) of distribution of income in an economy. It plots the cumulative percentage of income received by cumulative shares of the population. Perfect income equality would be represented by a straight line. The closer the Lorenz curve is to the straight line, the greater the equality in income distribution; the further away it is from the straight line, the more unequal the distribution of income. The Gini coefficient is a summary measure of income inequality, and in a Lorenz diagram is the ratio of the area between the diagonal and the Lorenz curve, to the total area under the diagonal. It has a value between 0 and 1; the closer the value is to 0, the greater the income equality; the closer the value is to 1, the greater the income inequality. 55. The Laffer curve is a curve showing the relationship between income tax rates and government revenues. It indicates that there is a particular tax rate for which revenues are maximum, suggesting that if actual tax rates are above this rate, then cutting taxes will increase government revenues.