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Credit Sprint's Guide to Macroeconomics Unit 2: Economic Indicators & the Business Cycle

AP® weight 12–17%CLEP® weight 12–16%

GDP measures the market value of final goods and services produced within a country in a year. Real GDP strips out price changes; the CPI and GDP deflator measure them. Unemployment is split into frictional, structural and cyclical.

What you need to know

  • GDP = C + I + G + Xn. Used goods, financial transactions, transfer payments and intermediate goods are excluded.
  • Real GDP = nominal GDP ÷ price index × 100.
  • Unemployment rate = unemployed ÷ labor force. Discouraged workers are not in the labor force.
  • Natural rate of unemployment = frictional + structural. Cyclical unemployment is zero at full employment.
  • The CPI overstates cost-of-living changes because of substitution bias and quality changes.
  • Unanticipated inflation hurts lenders and people on fixed incomes; it helps borrowers.
  • Business cycle phases: expansion, peak, contraction (recession), trough.

Formulas

Real GDP = (Nominal GDP ÷ GDP deflator) × 100
CPI = (Cost of basket this year ÷ Cost in base year) × 100
Inflation rate = (Index₂ − Index₁) ÷ Index₁ × 100
Unemployment rate = Unemployed ÷ Labor force × 100
Real wage change ≈ Nominal wage change − Inflation

Exam traps

Watch forA used car or a stock purchase is not counted in GDP.
Watch for"Investment" in GDP means new capital goods, never stocks or bonds.
Watch forDiscouraged workers make the measured unemployment rate understate true joblessness.

Key terms

  • GDP: Market value of all final goods and services produced within a country in a year. C + I + G + Xn.
  • Investment (in GDP): Spending on new capital goods, new housing and inventory changes. Not stocks or bonds.
  • Transfer payments: Payments like Social Security with no good or service in return. Excluded from G and GDP.
  • Real GDP: GDP measured in base-year prices, so it changes only when output changes.
  • GDP deflator: A price index covering all goods in GDP. Real GDP = nominal GDP ÷ deflator × 100.
  • CPI: Consumer Price Index: the cost of a fixed basket of consumer goods relative to a base year, × 100.
  • Labor force: People who are employed plus people who are unemployed and actively looking for work.
  • Frictional unemployment: Short-term unemployment while people search for or switch jobs.
  • Structural unemployment: Unemployment from a mismatch between workers' skills or location and available jobs.
  • Cyclical unemployment: Unemployment caused by a recession. Zero at full employment.
  • Natural rate of unemployment: Frictional + structural unemployment. The rate when the economy is at full employment.
  • Discouraged worker: Someone who wants a job but has stopped looking. Not counted in the labor force.

Practice questions

Five of the 44 Unit 2 questions in Credit Sprint. Every choice is explained in the app.

1. Which of the following is counted in this year's U.S. GDP?
  1. A newly built house
  2. Flour a bakery buys to make bread
  3. A share of stock in a tech company
  4. A Social Security check
  5. A used car bought from a dealer
Show answer

A newly built house. New residential construction counts as investment.

2. The CPI rises from 200 to 210. The inflation rate is:
  1. 5%
  2. 2.1%
  3. 210%
  4. 10%
  5. 0.5%
Show answer

5%. (210 − 200) ÷ 200 = 5%.

3. How does the GDP deflator differ from the CPI?
  1. The CPI covers only government purchases
  2. The deflator measures unemployment
  3. The deflator covers all domestically produced final goods; the CPI tracks a consumer basket
  4. The CPI includes only capital goods
  5. They measure exactly the same goods
Show answer

The deflator covers all domestically produced final goods; the CPI tracks a consumer basket. That's why imports can move the CPI but not the deflator.

4. In the base year, real GDP and nominal GDP are:
  1. Real GDP is always larger
  2. Equal
  3. Unrelated
  4. Real GDP is zero
  5. Nominal GDP is always larger
Show answer

Equal. Base-year prices are the current prices in that year.

5. Cost-push inflation is caused by:
  1. An increase in LRAS
  2. Rising consumer confidence
  3. A decrease in AD
  4. A decrease in SRAS
  5. An increase in AD
Show answer

A decrease in SRAS. Rising costs push prices up as output falls.