AP Macroeconomics: GDP, Inflation, Monetary & Fiscal Policy

Gross domestic product: the market value of all final goods and services produced within a country in a given period.

GDP = C + I + G + (X - M) Consumption + investment + government purchases + net exports

Intermediate goods (to avoid double counting) Used goods Transfer payments (Social Security, welfare) Purely financial transactions (buying stocks) Nonmarket and underground activity

Nominal GDP uses current prices; real GDP adjusts for inflation using base-year prices, so it shows changes in actual output.

\text{GDP deflator} = \frac{\text{nominal GDP}}{\text{real GDP}} \times 100

Expansion, peak, contraction (recession), trough

\frac{\text{unemployed}}{\text{labor force}} \times 100 The labor force is employed plus unemployed people actively looking for work.

Frictional: between jobs or just entering the workforce Structural: skills don't match available jobs (often from technology) Cyclical: caused by recessions

At full employment, cyclical unemployment is zero.

The change in the price of a fixed market basket of goods and services bought by a typical consumer. It is the most common measure of inflation.

Demand-pull: too much spending chasing too few goods (AD shifts right). Cost-push: rising production costs, like oil prices, push prices up (SRAS shifts left).

Hurt: lenders, savers and people on fixed incomes. Helped: borrowers with fixed-rate loans, who repay with cheaper dollars.

A 5% loan with 3% inflation has a real rate of 2%.

Stagflation

In the short run, a tradeoff between inflation and unemployment. In the long run it is vertical at the natural rate of unemployment: no lasting tradeoff.

Wealth effect: lower prices make money worth more Interest rate effect: lower prices lower interest rates, raising investment Exchange rate (foreign purchases) effect: exports become cheaper

In the long run, output depends on resources and technology, not the price level, so LRAS sits at full-employment (potential) output.

Changing government spending and taxes to influence the economy. Controlled by Congress and the President.

Expansionary (for recessions): increase government spending and/or cut taxes. Contractionary (for inflation): cut spending and/or raise taxes.

Spending multiplier = \frac{1}{MPS} = \frac{1}{1 - MPC} . Tax multiplier = -\frac{MPC}{MPS} .

Automatic stabilizers

Government borrowing to finance deficits raises interest rates, which reduces private investment and weakens the effect of expansionary fiscal policy.

A deficit is the shortfall in one year (spending greater than revenue). The national debt is the total of all past deficits minus surpluses.

Maximum employment and stable prices (low, stable inflation).

Open market operations (buying or selling government bonds) The discount rate The reserve requirement Interest on reserve balances (the main tool in today's ample-reserves system)

Buys bonds, lowers the discount rate or interest on reserves, or lowers the reserve requirement. The money supply rises, interest rates fall, and investment and AD increase.

The federal funds rate

\frac{1}{\text{reserve requirement}} . With a 10% requirement, $1 of new reserves can create up to $10 in money.

Medium of exchange, unit of account, store of value

M1: currency, checkable deposits and other highly liquid deposits. M2: M1 plus small time deposits (CDs), money market funds and similar near-money.

MV = PQ : money supply × velocity = price level × real output. If V and Q are stable, increasing M raises prices.