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IB Economics: Unit 2 – Macroeconomics study guide
Name:_____________
The level of overall economic activity
Circular flow of income
1:
2:
3:
4
3
1
2
4:
Methods of measurement:
 Output

Income (Y)
Components
Rent is paid to suppliers of _____________
Example:
Wages are paid to suppliers of ____________
Example:
Interest is paid to suppliers of ____________
Example:
Profits are paid to suppliers of ____________
Example:
1

Expenditure
Components:
C is for: ______________
Definition:
Example:
I is for ______________
Definition:
Example:
G is for _____________
______________
Definition:
Example:
(X – M) is for _________
minus __________ (a.k.a. NX for ________ _________)
Definition:
Example:
Definition of Gross Domestic Product:
Distinction between:
 Gross Domestic Product (GDP) and Gross National Product (GNP) or Gross National Income
(GNI)

Nominal GDP and real GDP

GDP per capita versus total GDP
2
3
Revised circular flow diagram with leakages and injections:
4
Differences and similarities between Gross Domestic Product (GDP) versus Gross National
Product (GNP) or Gross National Income (GNI) as measures of growth:
GDP
GNP/GNI
Definition of growth:
Meaning and significance of “green GDP”
Value and limitations of using GDP for making comparisons over time
Value and limitations of using GDP as a measure to compare welfare between countries
5
Macroeconomic models

Diagram illustrating business cycle/trade cycle
Output
(in real GDP)
Time
(in years)
“There are no great limits to growth because there are no limits of human intelligence, imagination and
wonder”
-President Ronald Reagan

Keynesian versus New Classical (monetarist) approach:
Aggregate demand—components:
Aggregate supply—components:
 Long-run aggregate supply

Short-run aggregate supply curve (new classical/monetarist approach only)
6

Deflationary gap (a.k.a. Recessionary gap)
Keynesian AD & AS Diagram
Price
Level
PPC Curve
Goods
Output
(Real GDP)

Services
Full employment/equilibrium level of national income
Keynesian AD & AS Diagram
Price
Level
PPC Curve
Guns
Output
(Real GDP)

Butter
Inflationary gap (above full employment)
Keynesian AD & AS Diagram
Price
Level
PPC Curve
Capital
Goods
Output
(Real GDP)
Consumption
goods
7

Deflationary gap (a.k.a. Recessionary gap)
New Classical (Monetarist) AD & AS Diagram
Price
Level
PPC Curve
Goods
Output
(Real GDP)

Services
Full employment/equilibrium level of national income
New Classical (Monetarist) AD & AS Diagram
Price
Level
PPC Curve
Guns
Output
(Real GDP)

Butter
Inflationary gap (above full employment)
New Classical (Monetarist) AD & AS Diagram
Price
Level
PPC Curve
Capital
Goods
Output
(Real GDP)
Consumption
goods
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What are the implications of the Keynesian model for government intervention? Explain.
What are the implications of the new classical model for government intervention? Explain.
Monetary policy
Central banks (Fed in the U.S.) have three tools for changing the money supply and impacting the interest
rates of an economy:
Changing the reserve ratio
Open market operations
Changing the interest rate charged to banks
Illustrations of an increase in the money supply:
Diagram of the loanable funds market:
Impact on AD/AS:
9
Demand-side and supply-side policies
How is
policy
decided?
Fiscal Policy
_____________ branch of
government decides budget. Officials
accountable to the voters in a
democracy
Monetary Policy
_______________ bank makes
decisions independently. Bankers
accountable to elected officials, but
not directly to voters
Demand- Goal 1: Stop a recession
1. ________ government
side
spending and/or
policies
2. ________ taxes in order to
________ consumption
Goal 1: Stop a recession
________ the money supply in
order to ________ interest rates,
thus ________ consumption and
investment
Goal 2: Fight inflation
1. ________ government
spending and/or
2. ________ taxes in order to
________ consumption
Goal 2: Fight inflation
________ the money supply in
order to ________ interest rates,
thus ________ consumption and
investment
Advantage: Money spent on lowincome households has substantial
___________ effect when stopping a
recession
Advantage: Can address problems
__________ because policy decided
by unelected few
Advantage/disadvantage: Can not
only manage the overall economy,
but can also ________ wealth
towards specific groups
Disadvantage: Laws take long time
to enact; economy may have changed
when they come into effect.
Exception: Automatic stabilizers.
Welfare spending instantly
___________ and taxes instantly
___________ in a recession
Disadvantage: Policy decided by
unelected few
Advantage/disadvantage: Can
manage the overall economy, but
more difficult to __________ wealth
towards specific groups
Disadvantage: More popular to
increase AD than decrease it in the
short term. Election cycle makes
fighting _________ unpopular
10
Supplyside
policies
Fiscal Policy
Monetary Policy
Goal: Increase potential output and
decrease prices
Goal: Increase potential output and
decrease prices
1. Offer incentives for firms to
purchase _________
Ex.: Tax breaks for wealthy
2. Offer incentives for
households to supply more
_________
Ex.: Lower taxes or welfare
benefits for workers
3. Relax environmental
legislation that restricts the use
of __________
Advantage: Can _________ output
and _________ prices simultaneously
1. _________ the money supply
in order to _________ interest
rates, thus _________
investment in the short-term
and adding to the capital stock
2. _________ the money supply
in order to _________ interest
rates, thus fighting inflation
and __________ investment in
the long-term
Advantage: #2 successful in
producing long-term price stability
Disadvantage: Long- and short-term
goals can be at odds with each other
Disadvantage: Takes time for capital
to increase _______________ after
initial investment. (AD shifts faster
than LRAS)
Disadvantage: Unproven. Was
introduced under Reagan with
________________ fiscal policy
11
Unemployment and inflation
Unemployment
Full employment and underemployment
Unemployment rate
Difficulties in measuring unemployment
Consequences of unemployment (economic and social)
Types of unemployment
 Frictional

Structural—caused by changes in the demand for particular labor skills, changes in the
geographical location of industries, and labour market rigidities.

Seasonal

Cyclical/demand-deficient
Measures to deal with unemployment
12
Inflation
Definitions of inflation and deflation
Inflation:
Disinflation
Deflation:
Difficulties in measuring inflation
 Different income earners may experience a different rate of inflation when their pattern of
consumption is not accurately reflected by the CPI. Example:

Inflation figures may not accurately reflect changes in consumption patterns and the quality of the
products purchased. Example:

Core inflation (excludes food and fuel). Purpose and limitations:

Producer Price Index (PPI) and future inflation. Steel and plastic examples:
Consequences of inflation
 Greater uncertainty (Investment decisions and shoe leather/menu costs)

Redistributive effects
1. People on fixed v. flexible incomes
2. Borrowers v. lenders

Less saving

Damage to export competitiveness
Consequences of deflation—high unemployment, bankruptcies
Causes of inflation:
 cost push
13

demand pull
14
Distribution of income
• Direct taxation
Example: Income tax
• Indirect taxation
Example: Sales tax
• Progressive taxation
Example: Federal income tax (10% for earnings under about 10K/year, 35% over about 400K/year)
• Regressive taxation
Example: Sales tax, capital gains tax (modest 15%, applies mostly to the wealthy)
• Proportional taxation
Example: Social Security tax (Normally 6.2% for earnings up to about $120k/year)
• Transfer payments
Example: Social Security payments
• Other government policies to affect distribution of income
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