Flashcards · IB Diploma Programme Economics · Topic 3

Macroeconomics flashcards

51 cards on Topic 3, subtopics 3.1 to 3.7. Pick a subtopic or study them all.

Study mode needs JavaScript. Every card is listed below, so you can still cover the answers and test yourself.

All 51 cards

For a quick read-through or printing. Cover the right-hand side to test yourself.

3.1 Measuring economic activity and illustrating its variations

GDP versus GNI: GDP: the total value of output (income) produced within a country in a period. GNI = GDP + net income from abroad (income residents earn abroad minus income paid to non-residents). The net term can be negative, so GNI can be below GDP: GDP 100 with net income −15 gives GNI 85.
The phases of the business cycle: Expansion → peak → contraction (recession) → trough, around a long-term upward growth trend in real GDP.
Recession versus slower growth: Recession: a fall in the level of real output. Slower growth: a fall in the rate of growth, with output still rising. Growth falling from 4% to 1% is not a recession.
Nominal versus real GDP, and the GDP deflator: Nominal GDP is valued at current prices; real GDP removes the effect of price changes. Real GDP = nominal GDP ÷ price deflator × 100. Nominal GDP 1,200 with a deflator of 120 gives real GDP 1,000 in base-year prices.
Why use real GDP per capita at PPP to compare living standards between countries?: Per capita divides by population, so countries of different size can be compared. PPP converts at a rate that makes the same basket cost the same in each country, so it reflects what incomes can actually buy.
Limitations of GDP as a measure of well-being: It is an average that hides distribution; it misses unpaid and informal work; it ignores leisure, the quality of goods, and environmental damage and resource depletion. Composite measures such as the HDI try to capture more.
Nominal GDP by the expenditure method: C 620, I 180, G 240, X 210, M 250: GDP = C + I + G + (X − M) = 620 + 180 + 240 + (210 − 250) = 1,000. The output, income and expenditure methods measure the same flow, so in principle they give the same total.

3.2 Variations in economic activity – aggregate demand and aggregate supply

Aggregate demand and its components: Total planned spending on a country's output at each price level. AD = C + I + G + (X − M): consumption, investment, government spending, net exports. A change in any component shifts AD.
What shifts aggregate supply?: Production costs, productivity and productive capacity (the short run and long run differ). A change in costs shifts SRAS; a change in capacity shifts LRAS.
Diagram in words: AD shifts right with SRAS fixed: Axes: price level (vertical) and real GDP (horizontal). The new AD meets SRAS further up and to the right: real GDP and the price level both rise. A leftward AD shift lowers both.
Diagram in words: SRAS shifts left (higher costs) with AD fixed: The new equilibrium has a higher price level and lower real GDP: cost-push inflation with falling output. A rightward SRAS shift lowers the price level and raises output.
Keynesian versus monetarist/new classical aggregate supply: Keynesian AS is flat at low output (spare capacity), then curves up and becomes vertical at full employment; an equilibrium below full employment can persist, so policy action is justified. Monetarist/new classical: LRAS is vertical at potential output and the economy returns there automatically.
Recessionary (deflationary) gap versus inflationary gap: Recessionary gap: actual real GDP is below potential output. Inflationary gap: actual real GDP is above potential output.

3.3 Macroeconomic objectives (includes HL-only calculation)

Main macroeconomic objectives: Economic growth, low unemployment, and low and stable inflation. They can conflict: policy that boosts growth can worsen inflation.
Unemployment rate: formula and example with 140,000 unemployed and a labour force of 3,500,000: Unemployment rate = number unemployed ÷ labour force × 100. 140,000 ÷ 3,500,000 × 100 = 4.0%. The labour force is the employed plus the unemployed.
Types of unemployment and the natural rate: Structural (mismatch of skills or location), frictional (between jobs), seasonal, and cyclical or demand-deficient (weak AD). The natural rate of unemployment is the rate when the economy is at potential output: structural + frictional + seasonal, with no cyclical unemployment.
Demand-pull versus cost-push inflation: Demand-pull: AD shifts right faster than capacity grows, so the price level rises with output. Cost-push: higher costs (wages, imported raw materials) shift SRAS left, so the price level rises while output falls.
Inflation, disinflation and deflation: Inflation: a sustained rise in the general price level. Disinflation: the inflation rate falls but prices still rise. Steady 2% inflation still means a rising price level. Deflation: a sustained fall in the general price level.
Inflation from a price index that rises from 125.0 to 128.5: Inflation rate = (new index − old index) ÷ old index × 100 = 3.5 ÷ 125.0 × 100 = 2.8%.
Weighted price index: weights 60 and 40 with category indices 110 and 95: Multiply each index by its weight, add, and divide by the total weight: (60 × 110 + 40 × 95) ÷ 100 = 104.0. Categories with a bigger share of spending move the index more. (HL only)
Why might the official unemployment rate understate unemployment?: Hidden unemployment: discouraged workers who have stopped looking are not counted. Underemployment: part-time workers who want full-time work count as employed. The national average also hides differences by region, age, gender and education.
Deflation from falling AD versus deflation from rising AS: Falling AD: the price level and real GDP both fall, unemployment rises, and consumers may delay spending, so it is harmful. Rising AS (for example new technology): prices fall while real GDP rises, so it is far less harmful.

3.4 Economics of inequality and poverty (includes HL-only calculation)

Equality versus equity in the distribution of income: Equality: similar economic outcomes for different people or groups. Equity: fairness, a normative idea, so views differ.
Absolute versus relative poverty: Absolute: income or consumption below a fixed standard for basic needs. Relative: far less than others in the same society, often below a share of median income. Poverty can fall while inequality rises.
Lorenz curve and Gini coefficient: Lorenz curve: cumulative % of income (vertical) against cumulative % of households, poorest first (horizontal). The 45° line is perfect equality. Gini = area between the line and the curve ÷ area under the line, from 0 (equality) to 1. A curve moving towards the line means falling inequality.
Measures of poverty, and the difficulties in measuring it: Single indicators: international poverty lines, minimum income standards. Composite: the Multidimensional Poverty Index (health, education, living standards). Difficulties: arbitrary thresholds, regional price and household-size differences, informal work, sharing within households, infrequent surveys.
Causes of inequality and poverty listed in the IB guide: Inequality of opportunity; different levels of resource ownership; different levels of human capital; discrimination; unequal status and power; government tax and benefit policies; globalisation and technological change; market-based supply-side policies.
Average versus marginal tax rate, and progressive taxation: Average rate = total tax ÷ income × 100. Marginal rate = change in tax ÷ change in income × 100. A progressive tax has an average rate that rises with income; under it the marginal rate is above the average rate. Regressive: the average rate falls as income rises.
Tax calculation: first 8,000 tax-free, 8,000 to 24,000 at 25%, above 24,000 at 35%. Income 40,000.: 16,000 × 0.25 = 4,000 plus 16,000 × 0.35 = 5,600. Total tax 9,600, an average rate of 24.0%. (HL only)
Policies to reduce inequality and poverty: Progressive taxation, transfer payments, targeted spending, investment in human capital, minimum wages, anti-discrimination policies and universal basic income. Trade-offs: cost, possible work disincentives, slow effects of human capital spending.

3.5 Demand management (demand-side policies) – monetary policy (includes HL-only sub-topics)

Monetary policy and inflation targeting: Monetary policy: the central bank's control of the money supply and interest rates to influence aggregate demand. Inflation targeting: a published numerical inflation goal, with interest rates adjusted to meet it.
Real interest rate: a saver earns 2.0% when inflation is 3.5%: Real rate = nominal rate − inflation rate = 2.0 − 3.5 = −1.5%. The saver's purchasing power falls.
What happens to the economy when the central bank cuts interest rates?: Borrowing becomes cheaper and saving less rewarding, so consumption and investment rise. The exchange rate may fall, raising net exports. AD shifts right: real GDP rises, unemployment falls, the price level rises.
Strengths and limits of monetary policy: Strengths: incremental, flexible and easily reversed; shorter time lags; a credible target anchors expectations. Limits: little room when rates are near zero; low confidence blunts it; weak against cost-push inflation and structural unemployment; it does not raise productive capacity.
Tools of monetary policy: open market operations, minimum reserve requirement, minimum lending rate, QE: Expansionary: buy bonds; lower the reserve requirement; cut the lending rate; quantitative easing (create reserves to buy assets in bulk). Contractionary: sell bonds; raise the reserve requirement; raise the lending rate. (HL only)
Money creation: a deposit of 800 with a reserve ratio of 12.5%: Money multiplier = 1 ÷ reserve ratio = 1 ÷ 0.125 = 8. Maximum deposits = 800 × 8 = 6,400; new money created = 6,400 − 800 = 5,600. (HL only)
Diagram in words: the money market: Axes: nominal interest rate (vertical) and quantity of money (horizontal). Demand for money slopes down; money supply is vertical (set by the central bank). An increase in money supply moves the vertical line right and lowers the interest rate. (HL only)

3.6 Demand management – fiscal policy (includes HL-only sub-topics)

Fiscal policy, and the sources of government revenue: Fiscal policy: changing government spending and taxation to influence aggregate demand and the economy. Revenue: direct taxes, indirect taxes, sales of goods and services by state-owned enterprises, and (usually one-off) sales of government assets.
Current expenditure, capital expenditure and transfer payments: Current: day-to-day running costs of government. Capital: spending on lasting assets such as roads and schools. Transfer payments: money passed to recipients with no output produced in return (pensions, benefits).
Budget balance: revenue 320 and expenditure 345, of which 20 of revenue came from selling a state asset: Balance = revenue − expenditure = 320 − 345 = −25, a deficit. Without the one-off asset sale: 300 − 345 = −45. One-off receipts flatter the balance.
Expansionary fiscal policy in a recessionary gap, in Keynesian and monetarist views: Higher spending and/or lower taxes shift AD right. Keynesian: with spare capacity, real GDP rises towards potential with little rise in prices. Monetarist/new classical: the economy returns to potential anyway, so in the long run fiscal policy mainly changes the price level.
Constraints on fiscal policy: Political pressure (tax rises and cuts are unpopular), time lags (recognition, decision, implementation), and the need for a sustainable level of debt: deficits raise debt and interest costs. Strengths: it can be targeted at sectors or regions, and works in a deep recession.
Multiplier: MPS 0.10, MPT 0.10, MPM 0.30; government spending rises by 30: Multiplier = 1 ÷ (MPS + MPT + MPM) = 1 ÷ 0.50 = 2. Change in GDP = 2 × 30 = 60. Simple form if saving is the only leakage: 1 ÷ (1 − MPC). (HL only)
Crowding out: Government borrowing raises interest rates and cuts private investment, so the net injection is smaller. Spending of 16 that crowds out 6 of investment adds a net 10; with a multiplier of 2, GDP rises by 20, not 32. (HL only)
Automatic stabilisers: Progressive taxes and unemployment benefits soften swings in the cycle with no new decision: in a downturn tax revenue falls and benefit spending rises. They avoid policy lags but only soften a deep slump. (HL only)

3.7 Supply-side policies

Supply-side policies: aim and diagram: Policies that raise productive capacity and market efficiency. Axes: price level and real GDP. A successful policy shifts LRAS to the right, raising potential output with downward pressure on the price level.
Market-based supply-side policies: Competition: deregulation, privatisation, trade liberalisation, anti-monopoly regulation. Labour market: reducing union power, reducing unemployment benefits, abolishing minimum wages. Incentives: cuts in personal income tax, business tax and capital gains tax.
Interventionist supply-side policies: Government provides or funds: education and training, health care, research and development, infrastructure, and industrial policies supporting chosen sectors.
Evaluate market-based versus interventionist supply-side policies: Market-based: better resource allocation and no burden on the budget, but equity issues, time lags, vested interests and environmental impact. Interventionist: direct support for sectors important to growth, but costly and slow.
Demand-side effects of supply-side policies: An income tax cut raises consumption; a business tax cut raises investment; spending on infrastructure, education and health raises G at once and capacity later. AD may shift right too, so the fall in the price level is smaller.
Which unemployment can supply-side policy reduce?: Structural (and frictional) unemployment, through training, flexible labour markets and better job matching. It has little effect on cyclical (demand-deficient) unemployment.