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# AP Macroeconomics Formulas and Definitions: Key Formulas

Expenditure Approach to Real GDP Real GDP = consumption + investment + government spending + net exports GDP r = C + Ig + G + Nx Income Approach to Real GDP Real GDP = Rent + Wages + Interest + Profits GDPr = r + w + I + p Labor Force LF = # Employed + # Unemployed LF = E + U Labor Force Participation Rate Labor Force Labor force participation rate = Unemployment Rate # Unemployed UR = Labor Force U UR = LF Working Age Population LF LFPR = pop

Inflation Rate (CPI is Consumer Price Index) (New CPI Old CPI) Infl. R = Old CPI X 100

Converting Nominal GDP to Real GDP (GDP Deflator) (Nominal GDP) GDP Deflator = Real Interest Rate Real Interest Rate = Nominal Interest Rate Inflation Rate r% = i% - % Nominal Interest Rate Nominal interest rate = Real interest rate + Expected inflation rate i% = r% + % Real GDP X 100

## Marginal Propensity to Consume Change in Spending MPC = Change in Disposable Income

Spending Multiplier 1 Multspend = Tax Multiplier Multtax = Money Multiplier Multm = 1 require reserve ratio -MPC 1 - MPC OR -MPC MPS 1 - MPC OR 1 MPS

Multiple Deposit Expansion Required reserve = amount of deposit X required reserve ratio Maximum amount a single bank can loan = change in excess reserves caused by a deposit Change in loans throughout banking system = initial change in excess reserves X money multiplier Change in money supply = change in loans throughout the banking system + \$ amount of any open market operations (OMOs)

Monetary Equation of Exchange Money Stock X Income Velocity of Money = Nominal GDP Money Stock X Income Velocity of Money = Piece Level X Real GDP MV = PQ MV = PY

Key Definitions:
1. GDP deflator: A measure of the cost of living (substitute for the CPI). GDP deflator = (Nominal GDP/Real GDP)*100. Remember that this is an index. In the base year the GDP Deflator = 100. 2. Constructing the CPI: step 1: compute the cost of a market basket in each year (prices times quantities), step 2: choose a base year. Step 3: Calculate the CPI for the current year by: (Cost current year)/(cost in base year)*100. In the base year the CPI = 100. With inflation, CPI increases. 3. The inflation rate via the CPI: (CPI current year CPI previous year)/CPI previous year times 100. The inflation rate is the percentage change in the CPI from one period to the next. 4. Money Multiplier = 1/R where R = reserve ratio. Application: an initial injection of \$1000 of new money into an economy with a reserve ratio of 10% (.1) will generate \$1000*(10) = \$10,000 in total money. 5. MPC + MPS = 1. 6. Expenditures Multiplier = 1/(1 MPC) OR 1/MPS. It tells you how much total spending an initial injection of spending in the economy will generate. For example, if the MPC = .8 and the government spends \$100 million, then the total increase in spending in the economy = \$100 * 5 = 500 million. 1. Aggregate demand: A schedule or curve which shows the total quantity of goods and services demanded (purchased) at different price levels. 2. Aggregate supply: the total amount spent for final goods and services in the economy. 3. Absolute advantage: the comparison among producers of a good according to their productivity (NOT their opportunity costs). 4. Automatic stabilizers: changes in fiscal policy that stimulate AD when the economy goes into a recession without policymakers having to take any deliberate action Social Security payments, unemployment benefits, etc. 5. Balance of Payments: The accounting of money flowing to and from a country - between the United States and the Rest of the World Divided into two accounts: Current account and Financial Account. 6. Business cycle: recurrent ups and downs over a period of years in the level of economic activity. Includes the Peak, the Trough, recession or contractionary phase & expansionary or recovery phase. 7. Capital: human-made resources (machinery and equipment) used to produce goods and services. 8. Central Bank - an institution that oversees and regulates the banking system and controls the monetary supply (Known in the U.S. as The Federal Reserve. 9. Ceteris paribus: "other things equal" used as a reminder that all variables other than the ones being studied are assumed to be constant. 10. Checkable Bank Deposits - bank accounts on which people can write checks. 11. Circular flow diagram: a visual model of the economy that shows how dollars flow through markets among households and firms. 12. Comparative advantage: a lower relative cost than another producer based on opportunity costs 13. CPI: an index which measures the prices of a fixed market basked of consumer goods bought by a typical consumer. 14. Contractionary Fiscal Policy: a decrease in AD brought about by a decrease in government spending for goods and services, an increase in net taxes, or some combination of the two. 15. Contractionary Monetary Policy: a decrease in AD brought about by a decrease in the money supply, which in turn results from the Fed selling government bonds, increasing the discount rate, or increasing the reserve requirement.

16. Cost push inflation: inflation resulting from a decrease in AS (from higher wage rates and raw material prices) and accompanied by a decrease in real output and employment. 17. Current Account: In the Balance of Payments, the current account includes Net Exports, Net Income & Net Transfers. 18. Credit in the Balance of Payments: When there is an inflow of money into a country 19. Crowding out effect: the rise in interest rates and the resulting decrease in investment spending in the economy caused by increased borrowing in the money market by the government. 20. Cyclical unemployment: Unemployment caused by insufficient Aggregate Demand. 21. Debit in the Balance of Payments: When there is an outflow of money from a country. 22. Deflation - a fall in the overall level of prices. 23. Demand deposit: a deposit in a commercial bank against which checks may be written. 24. Demand pull inflation: inflation resulting from an increase in AD 25. Demand Shock - an event that shifts the aggregate demand curve. A positive demand shock is associated with higher demand for aggregate output at any price level and shifts the curve to the right. A negative demand shock is associated with lower demand for aggregate output at any price level and shifts the curve to the left. 26. Depreciation of the dollar: a decrease in the value of the dollar relative to another currency; a dollar now buys a smaller amount of the foreign currency. 27. Discount rate: the interest rate which the FED charges on the loans they make to commercial banks. 28. Discouraged Workers - individuals who want to work but who aren't currently searching for a job because they see little prospect of finding one given the state of the job market. 29. Disposable Income - the total amount of household income after taxes, available to spend on consumption and saving. 30. Economic Efficiency: getting the most from our scarce resources: for a given amount of input producing the greatest amount of goods and services. Or, producing a certain amount of goods and services with the least amount of inputs. 31. Economic Resources: land, labor, capital, and entrepreneurial ability which are used in the production of goods and services. 32. Equity: the property of distributing economic prosperity fairly among the members of society. 33. Excess Reserves: the amount by which a banks actual reserves exceeds its required reserves. 34. Exchange Rates: The prices of foreign currency Rates are determined by supply and demand of currency. 35. Expansionary Fiscal Policy - fiscal policy that increases aggregate demand by increasing government purchases, or decreasing taxes. 36. Expansionary Monetary Policy - monetary policy through lowering of the interest rate, increases aggregate demand and therefore output. 37. Exports: goods and services produced in a nation and sold to customers in other nations. 38. Federal funds rate: the interest rate banks charge one another on overnight loans made out of their excess reserves. 39. Fiat money: anything that is money because government has declaired it to be money (it has no intrinsic value) 40. Financial Account: In the Balance of Payments, the Financial (Capital) Account includes Direct Investments and investments in bonds, stocks, securities, etc. 41. Fiscal policy: changes in government spending and tax collections designed to achieve a full employment and noninflationary domestic output.

42. Fractional reserve banking: a banking system in which banks hold only a fraction of deposits as reserves. 43. Frictional unemployment: unemployment caused by workers voluntarily changing jobs and by temporary layoffs; unemployed workers "between jobs" 44. Full employment: when the unemployment rate is equal to the full employment unemployment rate there is only frictional and structural unemployment; cyclical unemployment equals zero. At this point we are also at potential output. 45. GDP: the total market value of all final goods and services produced during a given time period within the boundaries of the U.S., whether by American or foreign-supplied resources. 46. GDP deflator: the price index for all final goods and services used to adjust the nominal GDP into real GDP. (a substitute for the CPI). 47. GNP: the total market value of all final goods and services produced within a given time period by American residents, whether these people are located in the U.S. or abroad. 48. Imports: spending on goods and services produced in a foreign nation. 49. Inferior Good - a good for which a rise in income decreases the demand for the good-Steak vs. spam 50. Inflation: a rise in the general level of prices in the economy (percentage change in either the CPI or the GDP deflator) 51. Intermediate Goods - goods that are inputs for production of final goods and services 52. Investment Spending: Business spending on capital equipment, inventories, and structures. NOT the purchase of financial assets (stocks and bonds). 53. Invisible hand: the tendency of firms and households seeking to further their self interests in competitive markets to further the best interest of society as a whole. 54. Keynesian Economics - According to Keynesian economics, government intervention can help a depressed economy through monetary policy and fiscal policy. 55. Law of Demand - the principle that a higher price for a good or service, other things equal, leads people to demand a smaller quantity of that good or service. 56. Law of increasing opportunity cost: as the amount of a product produced is increased, the opportunity cost of producing an additional unit of the product increases. 57. Loanable Funds Market: The supply of loans come from households with savings, businesses, government surplus and from foreign investors - The demand for loans come from businesses and households that wish to spend for investment, and from the government for deficit spending. 58. Liquidity: money or things which can be quickly and easily converted into money with little or no loss of purchasing power. 59. LRAS: the AS curve associated with a time period in which input prices and output prices move freely. 60. M1: the narrowly defined money supply; currency, coins, checkable deposits and travelers checks. 61. M2: a more broadly defined money supply; equal to M1 plus non-checkable savings deposits, money market deposits, mutual funds, and small time deposits. 62. M3: very broadly defined money supply: includes M2 plus large time deposits. 63. Macroeconomics: the study of economy-wide phenomena, including inflation, unemployment, and economic growth. 64. Marginal analysis: decision making which involves a comparison of marginal (extra) benefits and marginal costs. 65. Marginal propensity to consume (MPC): fraction of any change in income spent for goods and services; equal to the change in consumption divided by the change in disposable income.

66. Marginal propensity to save (MPS): fraction of any change in income that is saved; equal to the change in savings divided by the change in disposable income. 67. Microeconomics: the part of economics concerned with such individual units within the economy as Industries, firms, and households; and with individual markets, particular prices, and specific goods and services. 68. Monetary policy: changing the money supply to assist the economy to achieve a full employment, noninflationary level of total output. 69. Money: any item which is generally acceptable to sellers in exchange for goods and services. 70. Money Market: The Money Supply (MS) is determined only by the Federal Reserve because the Fed has monopoly control over the supply of money MS determines nominal interest rate. 71. Natural rate hypothesis: the idea that the economy is stable in the long run at the natural rate of unemployment; views the long run Philips curve as vertical at the natural rate of unemployment. 72. Nominal GDP - the value of all final goods and services produced in the economy during a given year, calculated using the prices current in the year in which the output is produced. 73. Nominal Interest Rate - the stated interest rate. 74. Normative economics: that part of economics pertaining to value judgments about what the economy should be like; concerned with economic goals and policies. 75. Productivity: total output divided by the quantity of labor employed to product the output. 76. Okuns law: as the unemployment rate increases by 1% we see GDP growth decrease by 2 percent. 77. Open Economy - an economy that trades goods and services with other countries. 78. Open Market Operations: The Fed sells bonds in the open market to control the money supply; therefore, controlling the nominal interest rate. 79. Opportunity cost: the amount of other products which must be forgone or sacrificed to produce a unit of a product. 80. Philips curve: a curve showing the relationship between the unemployment rate and the inflation rate. In the short run it shows a negative (inverse) relationship. In the long run there is no relationship. 81. Positive economics: the analysis of facts or data to establish scientific generalizations about economic behavior (as opposed to normative economics). 82. Potential GDP: the real output an economy is able to produce when it fully employs its available resources. 83. Price Ceiling - the maximum price sellers are allowed to charge for a good or service; a form of price control. 84. Price Controls - legal restrictions on how high or low a market price may go. 85. Price Floor - the minimum price buyers are required to pay for a good or service; a form of price control. 86. Production possibilities frontier: a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and the available production technology. 87. Productivity - output per worker; a shortened form of the term labor productivity. 88. Rational expectations theory: the hypothesis that firms and households expect monetary and fiscal policies to have certain effects on the economy and take, in pursuit of their own self interests, actions which make these policies ineffective. 89. Reserve Requirements: The amount of money banks must keep on reserve at the Fed.

90. Real GDP: proceeds just as calculating nominal GDP, but instead of current prices you use base prices: Price of hotdog (base year)*Quantity of hotdog (current year) + Price of hamburger (base year)*Quantity of hamburger (current year). In the base year Nominal GDP = Real GDP. 91. Rule of 70: Used to determine how many years it takes for a value to double, given a particular annual growth rate. 92. Seasonal unemployment: Examples = Mall Santas, Schlitterbahn Life-guards, Ride operators at Fiesta Texas, Golf-pros in Alaska during January. 93. Stagflation: inflation accompanied by stagnation in the rate of growth of output and a high unemployment rate in the economy. Caused by a decrease in AS. 94. Structural unemployment: workers who are unemployed because their skills are not demanded by employers, they lack sufficient skills to obtain employment, or they cannot easily move to locations where jobs are available. 95. Terms of trade: the rate at which units of one product can be exchanged for units of another product; the amount of one good or service given up to obtain one unit of another good or service.