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Overview of Macroeconomics


Economic Growth

  1. Potential output is the output an economy produces when operating at its full productive capacity, at the target rate of unemployment. Potential outputs are points on the production possibility curve.

  2. Long-run economic policy focuses on increasing the economy’s potential output.

  3. Productivity is the output produced per unit of input.

  4. Per capita output is total output divided by total population. If there is per capita growth, then more output is being produced per person.

  5. Sources of growth include the accumulation of capital through investment, increases in available resources, and technological improvements.


Business Cycles

The Business Cycle

FIGURE 4 Business cycles are short-run fluctuations of the economy (real GDP and employment) around the growth trend.

  1. Peak: The highest point before a recession

  2. Recession: A decline that lasts at least six months (two quarters)

  3. Trough: The lowest point at the end of a recession and before an expansion

  4. Expansion: The period between the end of a recession and the next peak

  5. Recovery: The very beginning of an economic expansion

  6. Boom: An extremely fast increase in output, usually near the end of an expansion

  7. Depression: A very long and low recession



The unemployment rate is the ratio of individuals without jobs to the number of people in the labor force.

  1. The labor force consists of those people in the economy who are over 16, not in the armed forces, and willing and able to work.

  2. The target rate of unemployment is the lowest sustainable rate of unemployment believed to be achievable under existing circumstances. Some unemployment (called frictional unemployment) will always exist as new people enter the labor force, retire, or quit one job to find another. The natural unemployment rate is the rate when the economy is in neither a recession nor an expansion. It changes over time and is generally thought to be around 5% in the U.S. today.

  3. Unemployment is related to economic output. Okun’s rule of thumb states that a 1% decrease in the unemployment rate is generally associated with a 2% increase in output growth.



Inflation is a rise in the overall price level over time. It is measured through the use of price indexes.

  1. Price indexes summarize what happens to the prices in a constant “market basket” of goods and services. Different price indexes may produce different results because they contain a different composition in their market baskets.

  2. Price indexes choose a base year in which the price level for the market basket of goods is set to 1 or 100. The price level in other years is then shows changes of the price level since the base year.

  3. The Producer Price Index (PPI) uses a basket of goods common to industrial production. It measures the change in the prices received by the producers for their goods as well as the prices of their raw materials and intermediate goods.

  4. The GDP deflator uses the aggregate output of the economy as the market basket.

  5. The Consumer Price Index (CPI) measures the prices of a fixed basket of consumer goods, which is designed to represent the average consumer’s expenditures.

  6. Another way to find inflation is the spread between real and nominal interest rates: nominal interest rate = real interest rate + inflation rate.