Principles of Macroeconomics: Supply & Demand, Market Equilibrium, and GDP

Supply and Demand

Law of Demand

The Law of Demand states that, all else equal, as the price of a good increases, the quantity demanded decreases, and vice versa. This relationship is represented as a downward-sloping demand curve.

• Movement along the demand curve: Caused by a change in the price of the good itself.

Change in Demand vs. Change in Quantity Demanded

• Change in Quantity Demanded: Movement along the demand curve due to a price change.

• Change in Demand: Shift of the entire demand curve, caused by factors such as income, tastes, expectations, or prices of related goods.

Substitution Effect vs. Income Effect

• Substitution Effect: When the price of a good rises, consumers may switch to a cheaper substitute.

• Income Effect: A price change affects consumers' real purchasing power, influencing the quantity demanded.

Normal vs. Inferior Goods

• Normal Goods: Demand increases as income increases.

• Inferior Goods: Demand increases as income decreases.

• Example: Generic brand groceries may be considered inferior goods, while organic produce is a normal good.

Substitutes vs. Complements

• Substitutes: Goods that can replace each other (e.g., oranges and peaches).

• Complements: Goods that are used together (e.g., coffee and creamer).

Market Equilibrium

Equilibrium

Market equilibrium occurs where the quantity demanded equals the quantity supplied. The corresponding price is the equilibrium price.

Shifts in Supply and Demand

• Supply or demand curve shifts cause changes in equilibrium price and quantity.

• Example: A drought reduces lettuce supply, shifting the supply curve left, causing price to rise and quantity to fall.

Shortages vs. Surpluses

• Shortage: Quantity demanded exceeds quantity supplied (price is below equilibrium).

• Surplus: Quantity supplied exceeds quantity demanded (price is above equilibrium).

Business Cycles

Phases of the Business Cycle

• Expansion: Period when total production and employment rise.

• Recession: Period when production and employment fall.

Gross Domestic Product (GDP)

Definition and Components

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

• Included in GDP: Consumption (C), Investment (I), Government Purchases (G), Net Exports (NX = Exports - Imports).

• Excluded from GDP: Intermediate goods, used goods, household production, underground economy.

Methods of Measuring GDP

• Expenditure Approach:

  • Formula: $GDP = C + I + G + (X - M)$

• Value-Added Approach: Sums the value added at each stage of production.

Nominal vs. Real GDP

• Nominal GDP: Measured using current prices; not adjusted for inflation.

• Real GDP: Measured using base-year prices; adjusted for inflation.

• GDP Deflator: Measures the price level of all new, domestically produced, final goods and services in an economy.

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

Growth and Inflation

• Real GDP increases indicate actual output growth.

• Nominal GDP increases may result from higher prices, higher output, or both.

Practice with Tables and Figures

• Be able to calculate GDP from data tables using the expenditure or value-added approach.

• Understand value-added calculations (e.g., steel to car manufacturer to dealer to consumer).

• Practice calculating the GDP deflator and percentage changes to measure inflation.

Key Vocabulary

• Intermediate Goods: Goods used as inputs in the production of other goods; not counted in GDP to avoid double counting.

• Final Goods: Goods purchased by the end user; included in GDP.

• Underground Economy: Economic activity not reported to the government; not included in GDP.

• Household Production: Goods and services produced and consumed within households; not included in GDP.

Study Tips

• Review lecture notes and textbook chapters on supply and demand, GDP measurement, and business cycles.

• Practice drawing and shifting supply and demand curves to understand market changes.

• Work through numerical problems involving GDP calculation, value-added, and GDP deflators.