Macroeconomics

Question 1

GDP (Gross domestic product)

Answer 1

The total value of all final products and services produced within an economy in a given period of time (output definition),

or equivalently, the aggregate income earned by all households, all companies, and the government within an economy in a given period of time (income definition).

Question 2

GDP equation (expenditure approach)

Answer 2

GDP = C + I + G + (X − M)

The equation shows that GDP is the sum of the following components:

• consumer (or household) spending (C)
• business spending (or gross investment) (I)
• government spending (G)
• exports (or foreign spending on domestic products and services) (X)
• imports (or domestic spending on foreign products and services) (M)

Question 3

Economic growth

Answer 3

The percentage change in real output (real GDP) for an economy.

Question 4

GDP growth is determined by

Answer 4

• growth of the labour force, which represents the increase of labour in the market;
• productivity gains, which represent growth in output per unit of labour; and
• availability of capital, which represents inputs other than labour necessary for production.

Question 5

Business Cycles

Answer 5

Economy-wide fluctuations in economic activity

Question 6

Phases of a Business Cycle

Answer 6

1. Expansion
2. Peak
3. Contraction
4. Trough
5. Recovery

Question 7

GDP components

Answer 7

1. Consumer spending
2. Business spending
3. Government spending
4. Net exports (exports minus imports).

Question 8

Multiplier Effect

Answer 8

The proportional amount of increase (or decrease) in GDP and consumption that results from an injection (or withdrawal) of spending.

Question 9

Categories of Economic Indicators

Answer 9

• Lagging Indicators:
  Turning points that signal a change in economic activity after output has already changed. (employment rate)
• Coincident Indicators:
  Measures of economic activity that are intended to measure the current state of the economy rather than the past or to predict the future. (industrial production and personal income statistics)
• Leading Indicators:
  Turning points that signal changes in the economy in the future, and thus are considered useful for economic prediction and policy formulation. (money supply, broad stock market indices like S&P500)

Question 10

Consumer price index (CPI)

Answer 10

A measure of the change in price of a basket of goods typically purchased by a household over time

Question 11

Implicit GDP deflator

Answer 11

Inflation measure used to measure the changes in prices for all of the goods and services produced in an economy.

Question 12

Stagflation

Answer 12

When a high inflation rate is combined with a high level of unemployment and a slowdown of the economy.

Question 13

Hyperinflation

Answer 13

Price increases so large and rapid that people find it difficult to purchase products and services.

Question 14

Core inflation

Answer 14

Measure of inflation that measures the underlying long-term inflation rate by excluding he effects of temporary volatility in commodity prices (typically food and energy.)

Question 15

Monetary Policy

Answer 15

Actions taken by a nation’s central bank to affect aggregate output and prices through the money supply or credit.

The ultimate goal is to influence key macroeconomic targets:

• Output or GDP
• Price stability
• Employment

Question 16

The tools used for monetary policy

Answer 16

• Open market operations:
  Activities that involve the purchase (to simulate the economy) and sale (to slow the economy) of government bonds by a central bank.
  By conducting open market operations, the central bank creates a shortage or surplus of money.
• Changes in the central bank lending rate:
  When a central bank wants to stimulate the economy, it may reduce its lending rate. When a central bank wants to slow the economy, it may increase its lending rate.
• Changes in reserve requirements for commercial banks:
  By increasing the reserve requirement, central banks reduce access to credit in the economy because bank lending is reduced. When they lower the reserve requirement, central banks increase access to credit because commercial banks are able to make more loans.

Question 17

Fiscal Policy

Answer 17

The use of taxes and government spending to affect the level of aggregate expenditures.
involves the use of government.

Fiscal policy may be aimed at stimulating a weak economy through increased spending or decreased taxes and slowing an overheating economy through decreased spending or increased taxes.

Question 18

Economists are generally divided into two camps regarding the effectiveness of monetary and fiscal policies.

Answer 18

Keynesians:
Economists who believe that fiscal policy can have powerful effects on aggregate demand, output, and employment when there is substantial spare capacity in an economy.

Monetarists:
Economists who believe that the rate of growth of the money supply is the primary determinant of the rate of inflation.

Question 19

Limitations of Monetary Policy

Answer 19

Consumers and companies may not respond to lower interest rates by spending more. Instead, they may prefer to:

• add to their cash balances because they believe either that the economy will slow further and they need protective funds or that prices may drop and offer better purchase opportunities later.
• pay down debt, in a process referred to as deleveraging.

Question 20

Limitations of Fiscal Policy

Answer 20

The effectiveness of fiscal policy is limited by the following:

• Time lags:
  There can be a significant time lag between when a change in economic conditions occurs and when actions based on fiscal policy changes affect the economy.
• Unexpected responses by consumers and companies:
  For example, when a tax reduction is announced, private sector spending is expected to increase. But spending may remain unchanged or even decrease if the private sector chooses to save the funds or pay down debt rather than spend. On the other hand, spending may increase by more than expected.
• Unintended consequences:
  For example, if the government increases spending with the intent of increasing aggregate demand and GDP, the increased aggregate demand may increase employment and lead to a tightening labour market and rising wages and prices. So the economy (GDP) grows as planned, but inflation also increases.