Core Macroeconomic Definitions & Formulas

Posted on Sep 7, 2025 in Economy

This document provides a comprehensive reference for key macroeconomic terms, concepts, and essential formulas. Understanding these definitions is crucial for analyzing economic performance and policy.

Key Economic Indicators & Concepts

Gross Domestic Product (GDP) & Output

  • GDP Omissions: GDP calculations do not include:
    • Nonmarket Goods and Services
    • Used Goods
    • Financial Transactions
    • Government Transfers
  • Real GDP: The value of the entire output produced annually within a country’s borders, adjusted for price changes (by using base year prices).
  • Economic Growth: Sustained increases in Real GDP over time.

Business Cycles

The economy experiences recurrent swings (up and down) in Real GDP, known as the Business Cycle. These cycles typically include five phases:

  1. Peak: A temporary high point in Real GDP.
  2. Contraction: A period of decline in Real GDP.
  3. Trough: The low point in Real GDP, just before it begins to turn upward.
  4. Recovery: The period when Real GDP is rising from a trough.
  5. Expansion: Refers to increases in Real GDP beyond the recovery phase, often reaching new peaks.

Unemployment Metrics

  • Unemployment Rate: The percentage of adults who are in the labor force and actively seeking jobs but do not have employment.
  • Labor Force: The total number of employed individuals plus the unemployed individuals.
  • Hidden Unemployment: People who are mislabeled in the categorization of employed, unemployed, or out of the labor force, often understating the true unemployment level.
  • Marginally Attached Workers: Persons who are not in the labor force, want and are available for work, and had looked for a job sometime in the prior 12 months (excluded from the official labor force).
  • Discouraged Workers: Those who have stopped looking for employment due to the perceived lack of suitable positions available (also excluded from the official labor force).
  • Frictional Unemployment: Unemployment due to the natural frictions in the economy, caused by changing market conditions, and represented by qualified individuals with transferable skills who are transitioning between jobs.
  • Structural Unemployment: Unemployment due to structural changes in the economy that eliminate some jobs and create others for which the unemployed are unqualified.
  • Natural Unemployment: Unemployment caused by frictional and structural factors in the economy; it is the lowest sustainable unemployment rate.
  • Cyclical Unemployment: Unemployment closely tied to the business cycle, such as higher unemployment during a recession or lower unemployment during an expansion.

Price Levels & Inflation

  • Aggregate Price Level: A measure of the overall level of prices in the economy.
  • Market Basket: A hypothetical set of consumer purchases of goods and services used to track price changes.
  • Consumer Price Index (CPI): A measure of inflation that U.S. government statisticians calculate based on the price level from a fixed basket of goods and services that represents the average consumer’s purchases; it includes only out-of-pocket spending made directly by consumers.
  • Personal Consumption Expenditures (PCE) Price Index: Accounts for expenditures made on consumers’ behalf, often considered a broader measure of inflation than CPI.
  • Producer Price Index (PPI): Measures the average change over time in the selling prices received by domestic producers for their output, reflecting the costs of producing consumer goods and commodities.
  • Inflation Rate: The positive percentage change in the price level on an annual basis.
  • Core Inflation Index: Takes the CPI and excludes volatile economic variables, such as energy and food prices, to provide a clearer picture of underlying inflation trends.
  • Disinflation: The process of bringing the inflation rate down from a higher level.

Interest Rates & Inflation Costs

  • Interest Rate: The return a lender receives for allowing borrowers the use of their savings for one year, calculated as a percentage of the amount borrowed.
  • Nominal Interest Rate: The interest rate expressed in dollar terms, without adjustment for inflation.
  • Real Interest Rate: The nominal interest rate minus the rate of inflation, reflecting the true cost of borrowing or return on lending.
  • Real Wage: The wage rate divided by the price level, indicating purchasing power.
  • Real Income: Income divided by the price level, indicating purchasing power.
  • Shoe-Leather Costs: The increased costs of transactions when people are running around, trying to avoid holding money during periods of high inflation.
  • Menu Costs: The real cost to firms of changing a listed price, especially frequent during inflation.
  • Unit-of-Account Costs: Costs arising from the way inflation makes money a less reliable unit of measurement, making economic calculations difficult when inflation is high.

Consumption & Investment Dynamics

  • Marginal Propensity to Consume (MPC): The increase in consumer spending when disposable income rises by $1.
  • Marginal Propensity to Save (MPS): The fraction of an additional dollar of disposable income that is saved.
  • Multiplier: The ratio of the total change in real GDP caused by an autonomous change in aggregate spending to the size of that autonomous change.
  • Aggregate Consumption Function: The relationship for the economy between aggregate current disposable income and aggregate consumer spending.
  • Inventories: Stocks of goods held by firms to satisfy future sales.
  • Inventory Investment: The value of the change in total inventories held in the economy during a given period.
  • Unplanned Inventory Investment: Unplanned changes in inventories that occur when actual sales are more or less than businesses expected.
  • Actual Investment Spending: The sum of planned investment spending and unplanned inventory investment.
  • Employment Rate: Employed persons divided by the civilian non-institutional population.

Economic Time Horizons

  • Short-Run (S-R): Focuses on movements in aggregate output, with the aggregate price level often assumed to be fixed.
  • Medium-Run (M-R): Considers movements in both aggregate output and the aggregate price level.
  • Long-Run (L-R): Primarily concerned with long-run economic growth and potential output, rather than business cycle fluctuations.

Short-Run Economic Interactions

In the short-run, the economy often exhibits a cyclical interaction:

  1. Changes in demand lead to changes in production.
  2. Changes in production lead to changes in income.
  3. Changes in income lead to changes in demand.

Important Economic Notes & Principles

  • Hyperinflation: Occurs when a country’s inflation rate is more than 50% per month.
  • Full Employment: Economists consider the economy to be at full employment when the actual unemployment rate is equal to the natural unemployment rate.
  • Income-Expenditure Equilibrium: The economy is in income-expenditure equilibrium when aggregate output (real GDP) is equal to planned aggregate spending.
  • Income-Expenditure Equilibrium GDP (Y*): The level of real GDP at which real GDP equals planned aggregate spending.
  • Shifts of the Aggregate Consumption Function: The aggregate consumption function can shift due to:
    • Changes in future disposable income.
    • Changes in aggregate wealth.
  • Factors Affecting Planned Investment (Iplanned):
    • Interest Rate: If interest rates rise, planned investment spending tends to be lower (inverse relationship).
    • Expected Future Real GDP: Higher expected future real GDP typically leads to a higher level of planned investment.
    • Level of Production Capacity: Higher existing production capacity may lead to lower planned investment spending.
  • Inventory Signals:
    • Rising inventories typically indicate positive unplanned inventory investment and a slowing economy.
    • Falling inventories typically indicate negative unplanned inventory investment and a growing economy.
  • Equilibrium & Inventories: When the economy is in income-expenditure equilibrium, unplanned inventories are zero. At any level of real GDP that is less than the income-expenditure equilibrium level of GDP, unplanned inventory investment is negative, and firms respond by increasing production (and vice versa).
  • Aggregate Demand Curve: According to the aggregate demand curve, when the aggregate price level rises, the quantity of aggregate output demanded falls.

Essential Macroeconomic Formulas

GDP & Output Formulas

  • Nominal GDP: Sum of (Price × Quantity) for all final goods and services.
  • GDP Per Capita: GDP / Population.
  • GDP (Expenditure Approach): C (Consumption) + I (Investment) + G (Government Spending) + X (Exports) – IM (Imports).
  • Real GDP: Production × Base Year Price.

Unemployment & Labor Force Formulas

  • Unemployment Rate: (Number of Unemployed Persons × 100) / Total Labor Force.
  • Labor Force Participation Rate (LFP): (Labor Force / Working-age Population) × 100.

Price Level & Inflation Formulas

  • Real Wage/Income: (Nominal Wage/Income / Price Index) × 100.
  • Consumer Price Index (CPI): (Market Basket Cost in Current Year / Market Basket Cost in Base Year) × 100.
  • Inflation Rate: [(CPI of New Year – CPI of Old Year) / CPI of Old Year] × 100. (Note: If using 100 for base year, adjust accordingly).

Growth Rate Formulas

  • Real GDP Growth Rate: [(Real GDP of New Year – Real GDP of Old Year) / Real GDP of Old Year] × 100.

Consumption & Multiplier Formulas

  • Marginal Propensity to Consume (MPC): Change in Consumer Spending / Change in Disposable Income.
  • Marginal Propensity to Save (MPS): 1 – MPC.
  • Multiplier: 1 / (1 – MPC).
  • Consumption Function: C = a (Autonomous Consumption) + MPC × YD (Household Current Disposable Income).
  • Slope of individual consumption function: w9DQ3ayc2dWAAAAAABJRU5ErkJggg==

Investment & Aggregate Spending Formulas

  • Total Investment: IActual = IUnplanned + IPlanned.
  • Aggregate Planned Expenditure (AEPlanned): C + IPlanned.
  • Unplanned Inventory Investment (IUnplanned): GDP – AEPlanned.

Economic Equilibrium Calculation Example

Problem: In a simple, closed economy (no government and no foreign sector), autonomous consumer spending is $100, and planned investment spending is $300. The marginal propensity to consume is 0.75.

  1. Solve for the equilibrium level of real GDP.
  2. If real GDP is $2,000, what is unplanned inventory investment?

Answer:

  1. Equilibrium Real GDP:
    Given this information, Aggregate Planned Expenditure (AEPlanned) = Autonomous Consumption + Planned Investment + MPC × Disposable Income.
    AEPlanned = $100 + $300 + 0.75 × YD
    AEPlanned = $400 + 0.75YD
    In equilibrium, AEPlanned = GDP = YD. So, we can write:
    YD = $400 + 0.75YD
    Subtract 0.75YD from both sides:
    0.25YD = $400
    Divide by 0.25:
    YD = $400 / 0.25
    The equilibrium level of real GDP is thus YD = GDP = $1,600.
  2. Unplanned Inventory Investment at GDP = $2,000:
    If GDP = $2,000, then YD = $2,000.
    AEPlanned = $400 + (0.75 × $2,000)
    AEPlanned = $400 + $1,500
    AEPlanned = $1,900
    Unplanned Inventory Investment (IUnplanned) = GDP – AEPlanned
    IUnplanned = $2,000 – $1,900
    Unplanned inventory investment in this case is $100. This indicates that output exceeds spending, leading to an accumulation of inventories.