Macro Economics Overview

Macro Study Notes

Business cycles are short-run fluctuations in economic activity that occur year to year.
Recession is a period of falling incomes and rising unemployment. Expansion is the opposite.
Depression is a severe recession.
Explaining the causes of economic fluctuations is challenging and the theory remains controversial.
Classical economics theory views money as a veil, emphasizing real variables (like real GDP) and economic forces over nominal variables in the long-run.
Economists use the aggregate demand and aggregate supply (AD-AS) model to analyze short-run fluctuations.
The AD model considers how real and nominal economic variables interact.
The model incorporates GDP, unemployment, and prices, which are examined in previous chapters.
Aggregate demand (AD) is the total demand for all goods and services in the economy.
The AD curve shows the relationship between the overall price level and the level of demand.
AD is comprised of four categories (C, I, G, NX) describing the ways people spend in the economy.
There's a negative relationship between price level and national expenditure for C, I, and NX, but no relationship for G.
The wealth effect, interest rate effect, and exchange rate effect influence consumer, investment, and net export decisions, respectively, when the price level changes.
AD can shift due to factors other than price changes, influencing market confidence and government policy. These shifts have a multiplier effect, leading to more than a dollar of output for each dollar of expenditure.
Aggregate supply (AS) shows the relationship between the overall price level and total output in the economy.
The AS curve mirrors the market supply curve in microeconomics but accounts for the overall economy and time horizons, distinguishing between short-run and long-run behavior.
Two AS curves exist: short-run aggregate supply (SRAS) and long-run aggregate supply (LRAS).
The SRAS curve is upward sloping because not all input prices adjust immediately to changes in the price level; wages are often sticky creating an incentive for increased output when the price of output rises.
The LRAS curve is vertical at the economy's potential, or full-employment output, as a change in the price level does not affect output in the long run.
Macroeconomic equilibrium is when AD equals AS.
Long-run equilibrium is where AD intersects LRAS.
Short-run equilibrium is where AD intersects SRAS.
Short-run equilibrium doesn't always fall along the LRAS.
Business cycles are fluctuations in GDP relative to potential GDP. Expansion (boom) occurs when output is above potential output and raises prices and potential demand for labor/capital. Recession is when output is below potential, putting downward pressure on wages and costs of inputs.
Business cycles have two main sources: instability of aggregate demand (AD) and supply shocks.
Instability in AD leads to expansions or contractions.
Supply shocks directly impact short-run production, with examples including temporary or permanent supply-side shocks.
Stagflation is a period of decreasing output and increasing prices resulting from supply shocks.
The output gap is the horizontal difference between actual and potential output.
An inflationary gap is a positive output gap; a recessionary gap is a negative output gap.
Government policy can attempt to return the economy to its long-run equilibrium. Fiscal policies to accomplish this include increasing government spending or raising taxes in the case of a recession.
Fiscal policy involves government decisions about taxation and public spending.
Expansionary fiscal policy aims to increase AD during recessions. Contractionary fiscal policy aims to decrease AD during inflationary periods.
This policy can shift AD by either increasing or decreasing government spending.
Fiscal policy may have issues due to time lags in policy decisions and implementation; this means that the policy intended to resolve an economic issue may become irrelevant as the economic condition changes.
Automatic stabilizers are changes in fiscal policy that increase AD as the economy enters a recession without explicit action by the government.
Tools like the tax system and government spending programs for welfare and unemployment benefits operate as automatic stabilizers.
Ricardian equivalence is a theory suggesting that changes in taxation policies will not affect national savings.
Government budgets can have deficits if government spending is more than government revenue.
Government budgets can have surpluses if government revenue is more than government spending.
Government debt is the total amount of money a government owes.
Government finance its debt by issuing treasury securities like T-bills and bonds.
Benefits of government debt include financial flexibility and investment in long-term economic growth. Costs are the direct and indirect costs of repayment of debt.
Financial markets facilitate the trade of future claims on funds.
Information asymmetry, adverse selection, and moral hazard are key characteristics of financial markets.
The market for loanable funds shows the interaction between savers and borrowers at a given equilibrium interest rate.
Factors influencing savings are wealth, economic conditions, expectations about the future, uncertainty, borrowing constraints, and social welfare policies. Factors influencing investment include expected future profits, uncertainty, changes in government policies for budgets, and external factors influencing supply of loanable funds and interest rates and.
Risk and return in financial markets are important considerations. The risk-free rate is the interest rate without any chance of default. Credit risk is the risk that a borrower will not repay a loan.
Financials assets like equity (stock ownership) and debt (loans and bonds) exist in complex markets. Major players in these markets include banks, savers/borrowers, entrepreneurs, and speculators.
Risk and return are key considerations for investment decisions.
Valuing assets uses tools like fundamental analysis, technical analysis, and the efficient-market hypothesis.