ECON102 - Principles of Macroeconomics & Monetary Policy Flashcards

Question 1

What is Gross Domestic Product (GDP)?

Accepted Answer

The total market value of all final goods and services produced within a country's borders in a specific time period, typically a year or a quarter.

Question 2

Explain the Expenditure Approach to calculating GDP, including its formula.

Accepted Answer

The expenditure approach sums up all spending on final goods and services in an economy. The formula is $Y = C + I + G + (X - M)$, where:
*   $Y$ = GDP
*   $C$ = Consumption (household spending)
*   $I$ = Investment (business spending on capital, inventories, new housing)
*   $G$ = Government Purchases (spending by all levels of government)
*   $(X - M)$ = Net Exports (Exports minus Imports)

Question 3

Differentiate between Nominal GDP and Real GDP.

Accepted Answer

*   **Nominal GDP:** Measures the value of goods and services at current prices. It can increase due to higher output or higher prices.
*   **Real GDP:** Measures the value of goods and services at constant prices (using a base year). It reflects changes in output only, adjusted for inflation.

Question 4

How is the GDP Deflator calculated, and what does it measure?

Accepted Answer

The GDP Deflator is a measure of the overall price level. It is calculated as: $	ext{GDP Deflator} = \frac{	ext{Nominal GDP}}{	ext{Real GDP}} 	imes 100$.
It measures the average change in prices of all new, domestically produced, final goods and services in an economy.

Question 5

Define the three main types of unemployment.

Accepted Answer

*   **Frictional Unemployment:** Short-term unemployment due to the time workers spend searching for a job that best suits their skills and tastes.
*   **Structural Unemployment:** Unemployment resulting from a mismatch between the skills workers have and the skills employers demand, often due to technological changes or shifts in industry.
*   **Cyclical Unemployment:** Unemployment caused by a downturn in the business cycle (recession), where there is insufficient aggregate demand to employ all those who want to work.

Question 6

What is the Natural Rate of Unemployment (NRU)?

Accepted Answer

The unemployment rate that exists when the economy is producing at its potential output and there is no cyclical unemployment. It includes only frictional and structural unemployment.

Question 7

How is the Unemployment Rate calculated?

Accepted Answer

The unemployment rate is the percentage of the labor force that is unemployed.
$	ext{Unemployment Rate} = \frac{	ext{Number of Unemployed}}{	ext{Labor Force}} 	imes 100$.
The labor force includes all employed and unemployed individuals.

Question 8

What is inflation, and what are its two main types?

Accepted Answer

Inflation is a general increase in the overall price level of goods and services in an economy over a period of time, leading to a decrease in the purchasing power of money.
*   **Demand-Pull Inflation:** Occurs when aggregate demand outpaces the economy's ability to produce goods and services.
*   **Cost-Push Inflation:** Occurs when the costs of production (e.g., wages, raw materials) increase, leading firms to raise prices.

Question 9

How is the Consumer Price Index (CPI) calculated, and what does it measure?

Accepted Answer

The CPI measures the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
$	ext{CPI} = \frac{	ext{Cost of Market Basket in Current Year}}{	ext{Cost of Market Basket in Base Year}} 	imes 100$.
It is a key indicator of inflation experienced by households.

Question 10

Explain the concept of Aggregate Demand (AD) and its components.

Accepted Answer

Aggregate Demand is the total demand for all goods and services produced in an economy at a given price level and time period. Its components are the same as the expenditure approach to GDP: Consumption ($C$), Investment ($I$), Government Spending ($G$), and Net Exports ($X-M$). The AD curve slopes downward due to the wealth effect, interest rate effect, and exchange rate effect.

Question 11

What factors can shift the Aggregate Demand (AD) curve?

Accepted Answer

Shifts in AD are caused by changes in the components of AD, independent of the price level:
*   **Consumption:** Changes in consumer confidence, wealth, taxes.
*   **Investment:** Changes in business confidence, interest rates, technology, taxes.
*   **Government Spending:** Changes in fiscal policy (e.g., infrastructure projects).
*   **Net Exports:** Changes in foreign income, exchange rates, trade policies.

Question 12

Differentiate between the Short-Run Aggregate Supply (SRAS) and Long-Run Aggregate Supply (LRAS) curves.

Accepted Answer

*   **SRAS:** Upward-sloping, indicating that firms will produce more output at higher price levels in the short run, primarily due to sticky wages and prices.
*   **LRAS:** Vertical at the economy's potential output (full employment output), indicating that in the long run, the economy's output is determined by its resources and technology, not by the price level.

Question 13

What factors can shift the Aggregate Supply (AS) curves?

Accepted Answer

*   **SRAS Shifts:** Changes in input prices (wages, oil), productivity, government regulations, or taxes on businesses.
*   **LRAS Shifts:** Changes in the quantity or quality of labor, capital, natural resources, or technological advancements. These factors determine the economy's potential output.

Question 14

What is Fiscal Policy, and what are its main tools?

Accepted Answer

Fiscal policy refers to the use of government spending and taxation to influence the economy. Its main tools are:
*   **Government Spending:** Direct spending on goods and services (e.g., infrastructure, defense).
*   **Taxation:** Affects disposable income and business investment.

Question 15

Differentiate between Expansionary and Contractionary Fiscal Policy.

Accepted Answer

*   **Expansionary Fiscal Policy:** Aims to increase aggregate demand (and thus output and employment) by increasing government spending or decreasing taxes. Used to combat recessions.
*   **Contractionary Fiscal Policy:** Aims to decrease aggregate demand (to combat inflation) by decreasing government spending or increasing taxes.

Question 16

Explain the concept of the Government Spending Multiplier.

Accepted Answer

The government spending multiplier is the ratio of the change in equilibrium real GDP to the initial change in government spending. It suggests that an initial change in government spending can lead to a larger change in overall economic output due to successive rounds of spending.
$	ext{Multiplier} = \frac{1}{1 - 	ext{MPC}}$, where MPC is the marginal propensity to consume.

Question 17

What is the Money Multiplier, and how is it calculated?

Accepted Answer

The money multiplier indicates the maximum amount of new money that can be created by a commercial bank from an initial deposit, given the reserve requirement.
$	ext{Money Multiplier} = \frac{1}{	ext{Reserve Requirement (RR)}}$.
For example, if RR is 10%, the multiplier is 10, meaning $1 of new reserves can create $10 of new money.

Question 18

What are the three primary functions of money?

Accepted Answer

*   **Medium of Exchange:** Accepted by people for buying and selling goods and services.
*   **Store of Value:** Can be held and exchanged for goods and services in the future.
*   **Unit of Account:** A common measure for valuing goods and services.

Question 19

List and briefly explain the three main tools of monetary policy used by a central bank (e.g., the Federal Reserve).

Accepted Answer

*   **Open Market Operations (OMO):** The buying and selling of government securities (bonds) in the open market. Buying bonds increases the money supply; selling bonds decreases it. This is the most frequently used tool.
*   **Reserve Requirements (RR):** The fraction of deposits that banks must hold in reserve. Lowering RR increases the money multiplier and money supply; raising RR decreases them.
*   **Discount Rate:** The interest rate at which commercial banks can borrow money directly from the central bank. Lowering the discount rate encourages borrowing and increases the money supply; raising it discourages borrowing.

Question 20

Describe the short-run trade-off illustrated by the Phillips Curve.

Accepted Answer

The Short-Run Phillips Curve (SRPC) illustrates an inverse relationship between the rate of inflation and the rate of unemployment. In the short run, policymakers might face a trade-off: reducing unemployment may lead to higher inflation, and reducing inflation may lead to higher unemployment.

Question 21

How does the Long-Run Phillips Curve (LRPC) differ from the SRPC?

Accepted Answer

The Long-Run Phillips Curve (LRPC) is vertical at the Natural Rate of Unemployment (NRU). It suggests that in the long run, there is no trade-off between inflation and unemployment. Any attempt to keep unemployment below the NRU through expansionary policies will only lead to higher inflation, with unemployment eventually returning to its natural rate.

Question 22

What is "Crowding Out" in the context of fiscal policy?

Accepted Answer

Crowding out occurs when increased government borrowing to finance budget deficits leads to higher interest rates, which in turn reduces (crowds out) private investment and consumption. This can partially offset the stimulative effects of expansionary fiscal policy.

ECON102 - Principles of Macroeconomics & Monetary Policy

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