Macroeconomics Final Exam Study Guide: GDP, Unemployment, Inflation, Aggregate Demand & Supply

Macroeconomics Overview

Key Areas of Macroeconomic Analysis

Macroeconomics studies the behavior of the economy as a whole, focusing on broad aggregates and their interactions. The main topics include:

• Economic Growth Over Time: Examines how the economy expands and develops.

• Inflation and Price Levels: Studies changes in the general price level and purchasing power.

• Unemployment and the Labor Market: Analyzes labor force participation and joblessness.

• Business Cycles: Investigates fluctuations in economic activity over time.

• Aggregate Demand and Aggregate Supply: Explores total spending and production in the economy.

GDP Basics

Definition and Measurement

Gross Domestic Product (GDP) is the total market value of all final goods and services produced within a country in a given period.

• Formula: $GDP = C + I + G + NX$

• C: Consumer spending

• I: Business investment

• G: Government purchases

• NX: Net exports ($NX = ext{exports} - ext{imports}$)

GDP counts only final goods and services, excluding:

• Intermediate goods

• Underground/illegal economy

• Non-market activities (e.g., household production)

• Measures of happiness or well-being

Nominal GDP uses current prices. Real GDP uses base year prices to remove inflation effects.

GDP vs. GNP

GDP measures production within a country's borders. Gross National Product (GNP) measures production by a country's citizens, regardless of location.

• Example: A US company in Japan counts toward Japan's GDP, but US GNP.

What Increases Measured GDP?

• More paid market transactions

• Legalization of previously illegal activity (e.g., marijuana becoming legal)

What GDP Does Not Measure

• Leisure time

• Environmental quality

• Household production (e.g., cooking, cleaning)

Unemployment

Labor Force and Unemployment Rate

The labor force consists of all employed and unemployed individuals actively seeking work.

• Unemployment Rate Formula: $\text{Unemployment Rate} = \frac{\text{Unemployed}}{\text{Labor Force}} \times 100$

Types of Unemployment

• Frictional: Between jobs or new graduates entering the workforce

• Structural: Skills no longer needed due to technological change

• Cyclical: Caused by economic downturns (recessions)

• Seasonal: Predictable timing (holidays, weather)

Full employment does not mean 0% unemployment; frictional and structural unemployment always exist.

Price Level and CPI

Consumer Price Index (CPI)

The CPI measures the average change in prices paid by consumers for a basket of goods and services.

• CPI Formula: $\text{CPI} = \frac{\text{Cost of basket this year}}{\text{Cost of basket base year}} \times 100$

Inflation Rate

• Formula: $\text{Inflation Rate} = \frac{\text{CPI}_{\text{new}} - \text{CPI}_{\text{old}}}{\text{CPI}_{\text{old}}} \times 100$

If wages increase faster than CPI, purchasing power rises. If CPI increases faster than wages, purchasing power falls.

Deflation is a decrease in the general price level.

Aggregate Expenditure (AE) Model

AE Model and Equilibrium

The Aggregate Expenditure (AE) Model shows the relationship between total spending and output in the short run.

• Formula: $AE = C + I + G + NX$

• Equilibrium: $AE = GDP$

If $AE > GDP$:

• Unplanned inventories fall

• Production rises

• GDP and jobs increase

If $AE < GDP$:

• Unplanned inventories rise

• Production falls

• GDP and jobs decrease

Aggregate Demand (AD) and Aggregate Supply (AS)

Aggregate Demand (AD)

Aggregate Demand shows total spending at each price level.

• Price up: move up along AD, real GDP down

• Price down: move down along AD, real GDP up

AD shifts due to:

• Consumer confidence changes

• Investment changes (interest rates)

• Government spending changes

• Net exports changes (world economy)

Aggregate Supply (AS)

• SRAS (Short-Run Aggregate Supply): Upward sloping

• LRAS (Long-Run Aggregate Supply): Vertical at potential GDP (full employment)

SRAS shifts right when:

• Wages fall

• Input costs fall

• Technology improves

SRAS shifts left when:

• Wages rise

• Oil prices rise

• Negative supply shock (disasters)

Equilibrium on AD-AS Graph

Short run: AD and SRAS meet anywhere. Long run: AD, SRAS, and LRAS meet at the same point.

• If equilibrium is left of LRAS: recession gap, output below potential, unemployment high

• If equilibrium is right of LRAS: inflation gap, economy overheated

SRAS shifts left over time in response to persistent shocks.

Minimum Wage and Unemployment

If minimum wage exceeds market wage:

• Labor supply exceeds labor demand

• Unemployment rises

Net Exports

If US inflation is lower than other countries:

• US goods become cheaper

• Exports increase

• AD shifts right

Summary Table: Key Macroeconomic Formulas

Concept	Formula (LaTeX)	Description
GDP	$GDP = C + I + G + NX$	Total value of final goods/services produced domestically
CPI	$CPI = \frac{\text{Cost now}}{\text{Cost base}} \times 100$	Measures price level changes
Unemployment Rate	$\text{Unemployment Rate} = \frac{\text{Unemployed}}{\text{Labor Force}} \times 100$	Percentage of labor force unemployed
Inflation Rate	$\text{Inflation Rate} = \frac{\text{CPI}_{\text{new}} - \text{CPI}_{\text{old}}}{\text{CPI}_{\text{old}}} \times 100$	Annual percentage change in price level

Additional Info

• Potential GDP is represented by the vertical LRAS line; the economy tends to return to this in the long run.

• Movement along AD is caused by price changes; shifts in AD are caused by spending changes.

• Shifts in SRAS are caused by input cost changes.

• Long run: AD + SRAS always move the economy back to LRAS.