Macroeconomics Midterm Review: Chapters 9, 10, 12, and 13 (Unemployment, Inflation, Economic Growth, Aggregate Expenditure, and Aggregate Demand/Supply)

Unemployment

Employment Status and Labor Force

The employment status of the civilian working-age population is a foundational concept in macroeconomics, used to measure labor market health and calculate key statistics.

• Labor Force: Includes all individuals who are either employed or actively seeking work.

• Discouraged Workers: People available for work but not actively seeking a job due to belief that no jobs are available.

• Not in Labor Force: Individuals not seeking work or unable to work.

Key Equations

• Labor Force Participation Rate: $\text{Labor Force Participation Rate} = \frac{\text{Labor Force}}{\text{Working-age population}} \times 100$

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

Types of Unemployment

Unemployment is classified into three main types, each with distinct causes and policy implications.

• Frictional Unemployment: Short-term unemployment from the process of matching workers with jobs.

• Structural Unemployment: Unemployment due to persistent mismatch between worker skills and job requirements.

• Cyclical Unemployment: Unemployment caused by business cycle recessions.

Definition of Unemployed

• To be counted as unemployed, a person must be available for work, have actively looked for work in the previous four weeks, and must not have worked in the week prior to the survey.

Unemployment Insurance

Unemployment insurance provides temporary financial assistance to those who lose their jobs.

• More generous benefits may increase unemployment duration but provide better income support.

• U.S. benefits are less generous and have shorter time limits compared to Western Europe.

Minimum Wage Laws

• Federal minimum wage was introduced in 1938 ($0.25/hour); as of mid-2021, it was $7.25/hour.

• States and cities may set higher minimum wages (e.g., California, San Francisco).

• Studies suggest a 10% increase in minimum wage reduces teenage employment by about 2%.

• Overall effect on unemployment rate is small at current levels.

Inflation and Price Indices

Measuring Inflation

Inflation is the percentage increase in the price level from one year to the next.

• Price Level: Average prices of goods and services in the economy.

• Common Measures:

  • Consumer Price Index (CPI)

  • Producer Price Index (PPI)

Calculating the CPI

• Requires a basket of goods, cost in base year, and cost in current year.

• $\text{CPI}_{\text{current year}} = \frac{\text{Cost of basket in current year}}{\text{Cost of basket in base year}} \times 100$

CPI Biases

• Substitution Bias: Consumers switch to cheaper goods.

• Increase in Quality Bias: Hard to separate price increases from quality improvements.

• New Product Bias: Delay in including new goods.

• Outlet Bias: Changes in where people shop.

Producer Price Index (PPI)

• Measures average prices received by producers at all stages of production.

• Includes raw materials and intermediate goods.

• PPI can signal future changes in consumer prices.

Nominal vs Real Variables

• Nominal Variables: Measured in current-year dollars.

• Real Variables: Adjusted for inflation using price indices.

Interest Rates

• Nominal Interest Rate: Stated rate on a loan.

• Real Interest Rate: $\text{Real Interest Rate} = \text{Nominal Interest Rate} - \text{Inflation Rate}$

GDP Deflator

• $\text{GDP Deflator} = \frac{\text{Nominal GDP}}{\text{Real GDP}} \times 100$

Long-Run Economic Growth

Importance of Economic Growth

Long-run economic growth refers to rising productivity and increases in the average standard of living, measured by real GDP per capita.

• Real GDP per capita: $\frac{\text{Real GDP}}{\text{Population}}$

Calculating Growth Rates

• Growth rate: $\frac{\text{Current year value} - \text{Previous year value}}{\text{Previous year value}} \times 100$

• Rule of 70: $\text{Years to double} = \frac{70}{\text{Growth rate}}$

Factors Affecting Labor Productivity

• Increases in capital per hour worked (physical and human capital)

• Technological change

Potential GDP

• Level of real GDP when all firms are operating at capacity.

• Rises with labor force, capital stock, and technology.

Financial System and Savings-Investment

Key Services of the Financial System

• Risk sharing

• Liquidity

• Information aggregation

Macroeconomics of Savings and Investment

• In a closed economy: $Y = C + I + G$

• Investment: $I = Y - C - G$

• Savings: $S = Y - C - G$

• Thus, $S = I$

Aggregate Expenditure Model

Components of Aggregate Expenditure

• Consumption (C)

• Planned Investment (I)

• Government Purchases (G)

• Net Exports (NX)

• $AE = C + I + G + NX$

Planned vs Actual Investment

• Planned investment excludes unplanned inventory changes.

Macroeconomic Equilibrium

• Occurs when aggregate expenditure equals GDP.

• If AE > GDP, inventories fall and GDP rises; if AE < GDP, inventories rise and GDP falls.

Determinants of Consumption

• Current disposable income

• Household wealth

• Expected future income

• Price level

• Interest rate

Marginal Propensity to Consume (MPC) and Save (MPS)

• $MPC = \frac{\Delta C}{\Delta Y}$

• $MPS = \frac{\Delta S}{\Delta Y}$

• $MPC + MPS = 1$

Determinants of Planned Investment

• Expectations of future profitability

• Interest rates

• Taxes

• Cash flow

Crowding Out

• Occurs when government deficit spending raises interest rates, reducing private investment.

The Multiplier Effect

• Multiplier: $\text{Multiplier} = \frac{1}{1 - MPC}$

• Change in equilibrium GDP: $\Delta Y = \text{Multiplier} \times \Delta \text{Autonomous Expenditure}$

Aggregate Demand and Aggregate Supply

Aggregate Demand (AD)

• AD curve shows the relationship between the price level and the quantity of real GDP demanded.

• Shifts in AD are caused by changes in monetary policy, fiscal policy, expectations, foreign income, and exchange rates.

Variables That Shift AD Curve

Variable	Effect on AD
Interest rates	Higher rates decrease AD
Government purchases	Increase AD
Taxes	Higher taxes decrease AD
Expectations	Optimism increases AD
Foreign income	Higher foreign income increases AD
Exchange rate	Stronger dollar decreases AD

Aggregate Supply (AS)

• AS curve shows the relationship between price level and quantity of goods/services supplied.

• Short-run AS (SRAS) is upward sloping due to sticky wages/prices and menu costs.

• Long-run AS (LRAS) is vertical at potential GDP.

Variables That Shift SRAS Curve

Variable	Effect on SRAS
Labor/capital	More increases SRAS
Technology	Improvements increase SRAS
Expected future prices	Higher expectations decrease SRAS
Supply shocks	Negative shocks decrease SRAS

Supply Shocks

• Unexpected events (e.g., oil price spikes, pandemics) that shift SRAS and affect output and prices.

Macroeconomic Schools of Thought

Keynesian Economics

• Emphasizes wage/price stickiness and government intervention.

New Classical Model

• Focuses on rational expectations and minimizing fluctuations via correct expectations.

Monetarist Model

• Advocates for steady growth in money supply to stabilize the economy.

Summary Tables

Types of Unemployment

Type	Description
Frictional	Short-term, matching jobs
Structural	Skills mismatch
Cyclical	Business cycle recession

Price Indices

Index	Measures
CPI	Consumer goods/services
PPI	Producer goods/services
GDP Deflator	All final goods/services

Aggregate Expenditure Components

Component	Description
C	Consumption
I	Planned Investment
G	Government Purchases
NX	Net Exports

Multiplier Formula

MPC	Multiplier
0.75	4
0.90	10

Additional info: Some context and examples have been expanded for clarity and completeness, including formulas and tables for key macroeconomic concepts.