An overview PPT that covers basic macro concepts.

1. IMPORTANT MACRO
CONCEPTS
Prepared for MGMT 4750
By Nikki M. Finlay

2. Key Terminology
• GDP: The value of all goods and services produced in an
economy during a given year
• NOTE the word produced—if a good is made in December 2013,
but not sold until January 2014, then the value of that good goes
into GDP for 2013.
• Inflation: A general rise in prices
• Unemployment: The percentage of workers in the labor
force who are looking, but not working

3. Key Terminology, continued
• Frictional Unemployment – unemployment due to the time
needed to find work. Those looking for work, and the job
exists
• Structural Unemployment – unemployment due to
changes in demand. Those looking for work, but the job
does not exist.
• Cyclical Unemployment – unemployment due to changes
in the business cycle.

4. Key Terminology, continued
• The natural rate of unemployment =
frictional + structural.
If unemployment is at the natural rate
(about 5-6%), then the economy is producing at full-
employment levels and actual GDP (what GDP actually is)
is equal to potential GDP (what GDP would be if
unemployment was at the natural rate).

5. Key Terminology, continued
• Aggregate Demand: Demand for all goods and services
• (Short-run) Aggregate Supply: Supply of all goods and
services
• Long-Run Aggregate Supply: Where GDP is at full-
employment GDP and unemployment is at the natural
rate.

6. Components of GDP
• Consumption (C): spending on typical household goods
and services
• Investment (I): production of physical capital, including
housing
• Government Spending (G)
• Exports ( X or EX): what we sell to others
• Imports (IM): what we buy from others
GDP = C + I + G + X - IM

7. Real vs. nominal
Nominal (current-dollar) GDP and interest rates can be
deconstructed into two pieces: the “real” part and the part
that is due to inflation.
Suppose:
1996 price deflator is 100 and the 2001 price deflator is
115.
The 2001 GDP in nominal terms is $10 trillion dollars.
Then: Real GDP year 2001 in 1996 dollars =
$10 trillion × (100 / 115) = $8.6 trillion
The rest ($1.4 trillion) is due to inflation.

8. Similarly, for interest rates
• If the nominal interest rate is 8% and the inflation rate is
5%, then the real interest rate is 3% (8% - 5%).

9. Business Cycles
There are two parts to a business cycle:
• Recession: Where real GDP is falling
• Expansion: Where real GDP is rising
• During a recessionary period, we expect to see some prices falling
and unemployment rising
• During an expansion, we would expect to see some prices rising
and unemployment falling
• During periods of recovery, unemployment may rise very
slowly.

10. Policies for recession and expansion
• There are two authorities who make policy decisions at
the macro-level:
• Fiscal: The President and Congress
• Control over Government Spending, Taxes, and Transfer Payments
(Transfer payments are payments made to households to cover
certain situations—unemployment insurance benefits and social
security payments are transfers.)
• Monetary: The Federal Reserve Bank
• Control over the money supply

11. Suppose we’re in a recession at point E1
on the graph below

12. What can be done?
• Fiscal policy options:
• An increase in government purchases of goods and services
• A cut in taxes
• An increase in government transfers
• Each of these would cause AD1 to shift up to AD2 and
GDP would rise to potential GDP.

13. Suppose we’re in an inflationary gap at
point E1 on the graph below

14. What can be done?
• Fiscal policy options:
• A decrease in government purchases of goods and services
• An increase in taxes
• A decrease in government transfers
• Each of these would cause AD1 to shift down to AD2 and
GDP would fall to potential GDP.

15. What about monetary policy?
• For a recessionary gap the Federal Reserve would need
to increase the money supply which would case interest
rates to fall. If interest rates fell, we would buy more (AD
shifts up).
• For an inflationary gap the Federal Reserve would need
to decrease the money supply which would case interest
rates to rise. If interest rates rise, we would buy less (AD
shifts down).

16. Here is what happens:

17. Effect on AD

18. A Little About Exchange Rates
• Exports (X) and Imports (IM) are very important in a global
economy.
• One of the variables that affects X and IM is exchange
rates, the amount of one currency needed to buy another.
• If the rate changes, then the price of goods and services
between two countries changes.

19. An Example
• Suppose $1 costs 12 pesos, then the prices of a $100
item from the US costs 120p in Mexico.
• Suppose that rate changed from 120p to 150p. Then the
$100 item would cost 150p in Mexico and our exports to
them would fall.

20. Example, continued
• Suppose we are dealing with a Mexican item with a price
of 300p. At $1 : 12p, that item would cost us $25. At $1 :
15p, that item would cost us $20. Since their goods are
getting cheaper and we would import more.
($1 : 12p) * 300 / 12 = $25 : 300p
($1 : 15p) * 300 / 15 = $20 : 300p

21. Example, continued
• So as the dollar appreciates (12p to 15p) with respect to
pesos exports fall and imports rise, causing GDP to fall.
• The opposite if true if the dollar is depreciating.