Macroeconomics Key Concepts & Formulas

Posted on Sep 5, 2024 in Economy

Macroeconomics Key Concepts

Categories of Unemployment

  • Frictional Unemployment: Temporary unemployment as workers search for suitable jobs.
  • Seasonal Unemployment: Short-term unemployment due to seasonal variations in industries (e.g., Santa Claus impersonators).
  • Structural Unemployment: Unemployment caused by a mismatch between worker skills and job requirements.
  • Cyclical Unemployment: Unemployment caused by economic downturns, primarily due to a lack of aggregate demand for labor. This is considered the most concerning type of unemployment.

Other Labor Market Concepts

  • Discouraged Workers: Individuals who want to work but have given up searching due to a lack of job prospects.
  • Marginally Attached: Individuals who want a job and have searched within the past year but not in the past four weeks.

Determinants of Economic Growth

  1. Natural Resource Endowments
  2. Ease of Trade
  3. Geographic Advantages (Defense)
  4. Institutions/Property Rights

Factors 1-3 are often considered a matter of luck.

Convergence and Divergence

  • Convergence: The tendency for poorer countries to grow faster than richer countries, leading to a narrowing gap in per capita GDP over time.
  • Divergence: The opposite of convergence, where the gap in per capita GDP between countries widens over time.

Aggregate Demand (AD) and Aggregate Supply (AS)

Why is the AD curve downward sloping?

The AD curve is downward sloping due to:

  1. Interest Rate Effect (I): Higher prices lead to higher interest rates, which reduce investment spending.
  2. Money Wealth Effect (C): Higher prices reduce the real value of money holdings, leading to decreased consumption.
  3. International Effect (EX): Higher prices make domestic goods more expensive relative to foreign goods, reducing exports.
  4. Multiplier Effect: An initial change in spending can have a larger impact on aggregate demand through a multiplier effect.

Shifters of the AD Curve

The AD curve can be shifted by changes in:

  1. Expectations (C + I): Changes in consumer or business confidence can affect consumption and investment spending.
  2. Distribution of Income (C): Changes in income distribution can affect consumption patterns.
  3. Government Policies (Fiscal/Monetary) (G + I): Changes in government spending, taxes, or interest rates can affect aggregate demand.
  4. Foreign Income (EX): Changes in foreign income can affect demand for domestic exports.
  5. Exchange Rates (EX & IM): Changes in exchange rates can affect the relative prices of domestic and foreign goods, impacting exports and imports.

Marginal Propensity to Consume (MPC)

MPC = 0.75

MPC + MPS = 1

Why is the Short-Run Aggregate Supply (SRAS) Curve Upward Sloping?

The SRAS curve is upward sloping because:

  • Higher Resource Costs: As production increases, resource costs tend to rise.
  • Fixed Wage Contracts: In the short run, wages may not adjust immediately to changes in the price level.

When the price level rises faster than costs, firms experience higher profits, leading to increased production and employment beyond full employment. This results in an expansionary gap.

Why is the Long-Run Aggregate Supply (LRAS) Curve Vertical?

The LRAS curve is vertical because in the long run, resource prices and wages are flexible and adjust to changes in the price level. Therefore, changes in the price level do not affect the potential output of the economy.

When the price level falls faster than costs, firms experience lower profits, leading to decreased production and cyclical unemployment. This results in a recessionary gap.

Expansionary and Recessionary Gaps

  • Expansionary Gap: The amount by which actual output exceeds potential output in the short run. Nominal wage changes are relatively easy to implement in this situation.
  • Recessionary Gap: The amount by which actual output falls short of potential output in the short run. Nominal wages are often sticky and resistant to downward adjustments in this situation.

Fiscal Policy and Crowding Out

Crowding Out

Crowding out occurs when increased government borrowing leads to higher interest rates, which reduce private investment spending.

↑G -> ↓S -> ↑r -> ↓I -> ↓Y

National Saving

SN = Y – C – G

Crowding In

Crowding in occurs when government spending stimulates private investment in a weak economy.

Twin Deficits

Twin deficits refer to the simultaneous occurrence of a budget deficit and a trade deficit. Increased government borrowing can lead to higher interest rates, which increase the value of the dollar, making imports cheaper and exports more expensive, leading to a larger trade deficit.

↑G -> ↑Borrowing -> ↑r -> ↑Dollar Value -> ↑Imports -> ↑Trade Deficit

Automatic Stabilizers

Automatic stabilizers are government policies that automatically adjust to changes in the economy, helping to stabilize aggregate demand. For example, unemployment insurance provides income support during economic downturns, helping to maintain consumer spending.

  • Hot Economy: More employment -> Less unemployment insurance payouts.
  • Cold Economy: Less employment -> More unemployment insurance payouts.

Supply of Loanable Funds

The supply of loanable funds comes from households.

Supply-Side Fiscal Policy

Supply-side fiscal policies aim to stimulate the economy by increasing aggregate supply. These policies are generally slower to take effect and can lead to deflation.

  • ↓Business Taxes
  • ↓Regulations
  • ↑Infrastructure

These policies lead to an increase in aggregate supply (↑AS).

Deficit and Debt

  • Deficit: A shortfall of government revenue relative to spending in a given period.
  • Debt: The accumulation of past deficits.

Approximately 30% of U.S. debt is held in government accounts, and another 30% is foreign-owned (China owns about 5% of the total debt).

Money and Banking

M1 Money Supply

M1 includes currency and coins held by the non-banking public, checkable deposits, and traveler’s checks.

Federal Reserve Goals

The Federal Reserve has several key goals, including maintaining price stability, promoting full employment, and ensuring the stability of the financial system.

Key Formulas

Unemployment Rate

Unemployment Rate = (Unemployed / Labor Force) * 100

Labor Force Participation Rate

Labor Force Participation Rate = (Labor Force / Adult Population) * 100

Rule of 70

Rule of 70 = 70 / Growth Rate = Years to Double in Size

Multiplier

Multiplier = 1 / (1 – MPC)

Change in rGDP = Initial Change * Multiplier

Simple Spending Multiplier

Simple Spending Multiplier = 1 / (1 – MPC) = 1 / MPS = 4

Example: If the MPC is 0.75, then the simple spending multiplier is 1 / (1 – 0.75) = 1 / 0.25 = 4.

Change in rGDP

Change in rGDP = Initial Change * Multiplier

Change in rGDP / Multiplier = Change in Government Spending

Disposable Income (YD)

YD = C + S & Y – NT = YD

Simple Money Multiplier

Simple Money Multiplier = 1 / Reserve Requirement (RR)

Final Change in Money Supply

Final Change in Money Supply = Initial Change * Multiplier