Macroeconomics Study Guide

How do we measure the health of our economy?

• First Economic Indicator: GDP• Second Economic Indicator: Inflation• Third Economic Indicator: Unemployment

What is GDP?

• Consumer Spending• Investments by Business• Government Spending• Exports-Imports

• C + I + G + X

What happens when GDP falls?

• It is an indication that our economy is slowing down and our unemployment rate is going up

• We may be in a recession

What is inflation?

• Prices are going up• More money floating around in the economy• Inflation is calculated by using the Consumer Price Index (current market basket/last year’s market basket)

Contractionary Period

• GDP is going down• Our economy is shrinking• Inflation is going up• When we hit rock bottom, we are in a trough

Expansionary Period

• When we come out of a trough and start to recover

Unemployment

• Number of unemployed actively looking for a job/number in the labor force

• Types:– Structural (no skills)– Frictional (changing jobs or entering the work

force after college)– Cyclical (related to business cycle)– Seasonal (weather related)

What’s a recession?

• Six months or more of falling GDP• Inflation is going up• Demand is going down and then prices start to

drop• When prices drop enough to encourage

consumers to start buying again, then our economy picks up

How does the government fight a recession?

• Two Tools– Monetary Policy– Fiscal Policy

Fiscal Policy

• Congress and the President can do two things to combat a recession– Tax– Spend

How does fiscal policy respond to a recession?

• Lower taxes• Increase government spending

How does fiscal policy respond to inflation?

• Raise taxes– With less money to spend, prices will drop

• Decrease government spending– This will decrease demand

Monetary Policy

• The Federal Reserve has three tools– Open Market Operations• Buying and selling treasury bonds and securities

(happens all the time)– Sell bonds: Consumers buy bonds (and have less money to

spend on other things). Selling bonds fights inflation.– Buy bonds: Government buys bonds from consumers and puts

more money in consumer pockets. Buying bonds fights a recession.

Monetary Policy continued

• Discount Rate– Raise or lower the interest that the Fed charges

local banks (happens occasionally)• If Fed raises the rate, less money in our pocket and this

reduces inflation• If Fed lowers the rate, more money in our pocket and

this helps us out of a recession by increasing demand and increasing GDP

Monetary Policy continued

• Change Reserve Requirement Ratio (happens rarely)– If the ratio is raised, banks must keep more money

on hand and loan out less, this fights inflation– If the ratio is lowered, banks loan more money,

GDP goes up and we