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Macroeconomics Cheat Sheet

Final Exam Review
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GDP & Measurement

GDP = total market value of all final goods & services produced within a country in a given period.

GDP = C + I + G + NX

C consumption Β· I investment (business capital, NOT stocks) Β· G gov't spending (NOT transfers) Β· NX exports βˆ’ imports

Two Approaches (give same answer)

Expenditure: C+I+G+NX. Income: wages + rent + interest + profit.

Nominal vs Real

Nominal = current prices (inflated). Real = base-year prices β†’ use for comparison over time.

GDP Deflator = (Nominal GDP / Real GDP) Γ— 100

Real GDP ↑ = economic growth. Real GDP per capita = better measure of living standards.

What GDP Misses

Underground economy, non-market work (childcare, volunteering), leisure, environmental degradation, inequality, quality improvements.

Intermediate vs Final Goods

Only final goods counted β€” avoids double-counting. Intermediate goods (flour β†’ bread) excluded.

Inflation

A sustained increase in the general price level (not a one-time jump).

Inflation Rate = [(CPIβ‚‚ βˆ’ CPI₁) / CPI₁] Γ— 100

CPI vs GDP Deflator

CPIGDP Deflator
BasketFixed consumer basketAll domestic output
Imports?Yes (consumers buy them)No (domestic only)
BiasSubstitution bias (overstates)None (basket updates)

Types of Inflation

Demand-pull: Too much AD → "too much money chasing too few goods." (AD→R)

Cost-push: Rising input costs → SRAS→L (e.g., oil shocks, wage push).

Costs of Inflation

  • Purchasing power ↓ β€” each dollar buys less
  • Redistribution β€” hurts savers/lenders/fixed income; helps borrowers
  • Uncertainty β€” harder for firms to plan investment
  • Shoe-leather costs β€” time/effort minimizing cash holdings
  • Menu costs β€” cost of repricing goods
  • Tax distortions β€” taxes on nominal gains (not real)

Deflation & Disinflation

Deflation: prices falling (negative inflation) β€” can cause spending delays. Disinflation: inflation rate ↓ but still positive.

Unemployment
Unemployment Rate = (Unemp / Labour Force) Γ— 100 Participation Rate = (LF / Working-Age Pop) Γ— 100

Labour Force = Employed + Unemployed (actively seeking). Not in LF: students, retirees, discouraged workers, homemakers.

Types

TypeCauseExample
FrictionalNormal search/transitionGrads, career change
StructuralSkills mismatch / obsol.Tech displaced workers
CyclicalBusiness cycle downturnRecession layoffs
Natural Rate = Frictional + Structural

"Full employment" = only frictional + structural, no cyclical. Economy at potential GDP.

Key Relationships

Okun's Law: For every 1% unemployment above natural rate, GDP falls ~2% below potential.

Discouraged workers β€” stop looking β†’ leave LF β†’ U-rate may understate true unemployment.

Underemployment β€” part-time workers wanting full-time; overqualified workers.

Foundations & Business Cycle

Scarcity & Opportunity Cost

Scarcity: unlimited wants, limited resources β†’ forces trade-offs.

Opportunity cost: value of next best alternative forgone. Always exists when choosing.

PPF (Production Possibilities Frontier)

  • On curve = efficient Β· Inside = inefficient Β· Outside = unattainable
  • Bowed-out β†’ increasing opportunity costs
  • Shifts outward with: tech, more resources, better institutions

Circular Flow Model

Simple: Households ↔ Firms via product mkt & factor mkt.

Extended: + gov't (taxes/G), financial (S/I), foreign (X/M).

Key: Total spending = Total income = Total output (GDP).

Comparative vs Absolute Advantage

Absolute: more output, same resources. Comparative: lower opp cost β†’ basis for trade.

Business Cycle Phases

Periodic fluctuations in real GDP around long-run growth trend.

PhaseGDPUnempFeatures
Expansion↑↓↑ C, I, confidence
PeakMaxLowBottlenecks, infl risk
Contraction↓↑↓ spending, layoffs
TroughMinHighRecovery begins

Recession: 2+ consecutive quarters of ↓ real GDP.

Output Gap = Actual GDP βˆ’ Potential GDP

Recessionary gap: Actual < Potential β†’ unemp > natural rate.

Inflationary gap: Actual > Potential β†’ unemp < natural rate.

Leading, Lagging, Coincident Indicators

Leading: stock prices, building permits, consumer expectations (predict turns).

Coincident: GDP, employment, industrial production (current phase).

Lagging: unemployment rate, CPI (follow the cycle).

Output Gap Details

Recessionary: cyclical unemployment exists, downward pressure on wages/prices.

Inflationary: upward pressure on wages β†’ cost-push inflation risk.

Potential GDP: output when economy at full employment (natural rate). Determined by LRAS.

Okun's Law

For every 1% unemployment above natural rate, GDP falls ~2% below potential.

Aggregate Demand & Aggregate Supply (AD-AS) β€” The Central Model ⭐

Aggregate Demand (AD) β€” slopes DOWN

Why? β‘  Wealth effect: ↑PL β†’ real savings↓ β†’ C↓. β‘‘ Interest-rate effect: ↑PL β†’ Md↑ β†’ r↑ β†’ I↓. β‘’ Exchange-rate effect: ↑PL β†’ goods costlier β†’ X↓, M↑ β†’ NX↓.

AD Shifters (Ξ” C, I, G, NX at every PL)

  • Consumer confidence / wealth
  • Interest rates (monetary policy)
  • Gov't spending ↑ β†’ ADβ†’R Β· Taxes ↓ β†’ ADβ†’R
  • Foreign income ↑ / exchange depreciation β†’ NX↑
  • Business expectations, population growth

SRAS β€” slopes UP

Sticky wages/prices in SR. Shifters: input prices, productivity, supply shocks, taxes, expected inflation.

LRAS β€” VERTICAL at Yf

Output = f(resources, tech). Wages fully adjust. Shifts: ↑ labour, capital, tech, institutions.

Shocks Summary

ShockCurvePLGDPExample
+DemandADβ†’R↑↑↑G, ↓T, ↑confidence
βˆ’DemandADβ†’L↓↓↓C, recession abroad
+SupplySRASβ†’R↓↑↓ oil, tech gain
βˆ’SupplySRASβ†’L↑↓Oil shock β†’ stagflation

Long-Run Self-Correction

Recessionary: High unemp β†’ wages↓ β†’ SRASβ†’R β†’ back to Yf at lower PL.

Inflationary: Low unemp β†’ wages↑ β†’ SRASβ†’L β†’ back to Yf at higher PL.

Self-correction takes years β†’ justification for policy intervention.

Short Run vs Long Run

SR: Wages/prices sticky β†’ output can deviate from Yf. Policy changes real GDP.

LR: Wages/prices flexible β†’ output = Yf. Policy only changes PL (money neutrality).

Demand vs Supply-Side Policies

Demand-side: fiscal & monetary β†’ shift AD β†’ SR GDP effects.

Supply-side: deregulation, education, tax incentives β†’ shift LRAS β†’ LR growth.

Key Exam Distinctions

  • AD shift = both PL and GDP move same direction
  • SRAS shift = PL and GDP move opposite directions
  • LRAS never shifts from AD/SRAS shocks
  • LR self-correction = SRAS adjusts, NOT AD
Fiscal Policy & Phillips Curve

Gov't uses spending (G) & taxes (T) to influence AD.

GapPolicyAction
RecessionaryExpansionary↑G and/or ↓T β†’ ADβ†’R
InflationaryContractionary↓G and/or ↑T β†’ ADβ†’L

The Multiplier Effect

Initial spending β†’ chain reaction of additional spending via MPC.

Spending Mult. = 1 / (1 βˆ’ MPC) Tax Mult. = βˆ’MPC / (1 βˆ’ MPC)

MPC = Marginal Propensity to Consume. MPS = 1 βˆ’ MPC.

Ex: MPC=0.8 β†’ Spend mult=5, Tax mult=βˆ’4.
↑G $10B β†’ Ξ”GDP=+$50B. ↓T $10B β†’ Ξ”GDP=+$40B.
Balanced budget mult = 1 (always).

Automatic Stabilizers

Built-in, no legislation: progressive income tax (revenue ↓ in recession), EI (payments ↑ in recession).

Budget, Debt & Crowding Out

Deficit: G > T β†’ borrow. Surplus: T > G. Debt: accumulated deficits.

Crowding out: Gov't borrowing β†’ ↑ real r β†’ ↓ private I. Partially offsets stimulus.

Fiscal Policy Lags

  • Recognition lag β€” identifying the problem
  • Legislative lag β€” political process
  • Implementation lag β€” rolling out programs
  • Political constraints β€” cutting spending is hard

Phillips Curve β€” SRPC (slopes DOWN)

Inverse relationship: ↑ inflation ↔ ↓ unemployment.

Expansionary policy β†’ move up along SRPC (↓ unemp, ↑ infl).

Shifts when: expected inflation Ξ” or supply shocks.

LRPC β€” VERTICAL

Vertical at natural rate. No long-run trade-off.

Trying to keep unemp below natural rate β†’ inflation accelerates β†’ expectations adjust β†’ SRPC shifts up repeatedly.

Stagflation

High inflation + high unemployment. From βˆ’supply shocks. SRPC shifts up & right.

Links to AD-AS

AD→R → move up SRPC. SRAS→L → SRPC shifts up (stagflation).

Macroeconomics Cheat Sheet

Money, Monetary Policy, Growth, International & Reference
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Money & Banking

Functions of Money

β‘  Medium of exchange (accepted for transactions) β‘‘ Unit of account (common measure of value) β‘’ Store of value (holds purchasing power)

Commodity money: intrinsic value (gold). Fiat money: gov't decree (CAD, no intrinsic value).

Money Supply Measures

M1: currency in circulation + chequable deposits (most liquid).

M2: M1 + savings deposits, term deposits, etc. (broader, less liquid).

Fractional Reserve Banking

Banks hold fraction (required reserve ratio, rr) as reserves, lend rest β†’ money creation through lending chain.

Money Multiplier = 1 / rr

rr = 10% β†’ mult = 10. $1,000 deposit β†’ up to $10,000 new money.

Actual < theoretical because: banks hold excess reserves, public holds cash (currency drain), banks may not lend fully.

Deposit Expansion Process

Bank A receives $1000 β†’ keeps $100 (rr=10%), lends $900 β†’ deposited in Bank B β†’ keeps $90, lends $810 β†’ ... β†’ total = $1000 Γ— (1/rr) = $10,000.

Bank of Canada (BoC)

Canada's central bank. Primary goal: low, stable, predictable inflation. Target: 2% (1–3% band). Key tool: overnight rate (rate banks charge each other for overnight loans).

Monetary Policy

The Money Market

Md: slopes down β€” lower interest rates β†’ people hold more money (opportunity cost of holding cash ↓).

Ms: vertical β€” set by Bank of Canada (independent of interest rate).

Equilibrium β†’ nominal interest rate.

↑ Ms β†’ surplus of money β†’ interest rate ↓. ↓ Ms β†’ shortage β†’ interest rate ↑.

Transmission Mechanism

BoC Δ overnight rate→ Market interest rates Δ→ I & C change→ AD shifts→ GDP & PL change

Open Economy Channel

↑ πŸ‡¨πŸ‡¦ rates β†’ foreign capital inflows β†’ CAD appreciates β†’ exports ↓, imports ↑ β†’ NX ↓ β†’ additional contractionary effect on AD.

↓ rates β†’ opposite: CAD depreciates β†’ NX ↑ β†’ extra expansionary effect.

Policy Actions

GapActionMechanism
Recess.↓ overnight rate↓ r β†’ ↑ I, C, NX β†’ ADβ†’R β†’ ↑ GDP
Inflat.↑ overnight rate↑ r β†’ ↓ I, C, NX β†’ ADβ†’L β†’ ↓ inflation

Limitations of Monetary Policy

  • Time lags β€” recognition, decision, transmission (6-18 months full effect)
  • Liquidity trap β€” near-zero rates β†’ can't lower further β†’ pushing on a string
  • Inflation expectations β€” if people expect high inflation, harder to control
  • Global capital flows β€” open economy complicates domestic control

Monetary vs Fiscal Policy

MonetaryFiscal
Who?Bank of CanadaGovernment (Parliament)
ToolsOvernight rateG and T
SpeedFaster to implementSlower (legislation)
Political?IndependentSubject to politics
Loanable Funds Market

Market for savings & investment β†’ determines real interest rate.

ComponentSource
SupplyNational saving (private + public). Slopes UP.
DemandBorrowing for investment (firms, gov't). Slopes DOWN.
PriceReal interest rate (Fisher eq.)

Fisher Equation

Real Interest Rate = Nominal Rate βˆ’ Inflation Rate

Real rate is what matters for saving/investment decisions.

Key Shifts & Crowding Out

Gov't deficit β†’ borrows more β†’ Demand↑ β†’ real rate ↑ β†’ private I ↓ = crowding out.

↑ Private saving β†’ Supply↑ β†’ real rate ↓ β†’ more I.

↑ Business optimism β†’ Demand↑ β†’ real rate ↑ β†’ more saving incentive.

vs Money Market

Money MktLoanable Funds
PriceNominal rReal r
FocusSR liquidity, monetary pol.LR saving & investment
SupplyBoC (Ms)National saving
Economic Growth

Sustained ↑ in real GDP per capita = ↑ living standards. Shown by rightward shift of LRAS / outward shift of PPF.

Drivers of Growth

  1. Physical capital β€” machines, factories, infrastructure
  2. Human capital β€” education, skills, training, health
  3. Technological progress β€” innovation, R&D (most important for sustained growth)
  4. Institutional quality β€” rule of law, property rights, stable gov't
  5. Natural resources β€” helpful but not necessary (e.g., Japan)
Rule of 70: Years to Double β‰ˆ 70 / g%

1% β†’ 70 yrs Β· 2% β†’ 35 yrs Β· 3.5% β†’ 20 yrs Β· 7% β†’ 10 yrs

Key Concepts

  • Diminishing returns to K β€” more capital β†’ smaller output gains (holding labour constant)
  • Catch-up (convergence) β€” poorer countries grow faster β†’ converge toward rich countries
  • Productivity = output/worker β€” the key determinant of living standards
  • Savings ↑ β†’ Investment ↑ β†’ Capital ↑ β†’ Growth (but with diminishing returns)

Only technology avoids diminishing returns β†’ sustains LR growth.

International Economics

Balance of Payments

AccountRecords
Current AcctTrade (goods/services), investment income, transfers
Capital AcctAsset purch/sales (FDI, portfolio investment)

Current + Capital β‰ˆ 0. Trade surplus: X > M. Trade deficit: M > X.

Exchange Rates

Nominal: price of one currency in another. Real: adjusts for price levels β†’ purchasing power comparison.

ChangeXMNX
Appreciation (CAD↑)↓↑↓
Depreciation (CAD↓)↑↓↑

Exchange Rate Determinants

  • Interest rate differentials (↑ r β†’ capital inflows β†’ appreciation)
  • Inflation differentials (↑ inflation β†’ depreciation)
  • Income growth, speculation, BoC intervention

Flexible (floating): market-determined (πŸ‡¨πŸ‡¦). Fixed (pegged): gov't maintains set rate.

↑ CAD rates β†’ capital inflows β†’ CAD↑ β†’ NX↓ β†’ extra monetary policy channel
All Key Formulas β€” Quick Reference
GDP (Expenditure)C + I + G + NX
GDP Deflator(Nom GDP / Real GDP) Γ— 100
Inflation Rate[(CPIβ‚‚βˆ’CPI₁) / CPI₁] Γ— 100
Real Interest RateNominal βˆ’ Inflation (Fisher)
Unemployment RateUnemp / LF Γ— 100
Participation RateLF / Working-Age Pop Γ— 100
Spending Multiplier1 / (1 βˆ’ MPC)
Tax Multiplierβˆ’MPC / (1 βˆ’ MPC)
Money Multiplier1 / Reserve Ratio
Rule of 7070 / Growth Rate (%)
MPC + MPS= 1 (always)
Balanced Budget Mult.= 1 (always)
6 Diagrams to Draw From Memory β€” Know Axes, Labels, Curves & Shifts
β‘  AD-AS Model Y-axis: PL Β· X-axis: Real GDP
ADβ†˜ SRASβ†— LRAS| at Yf
Show demand/supply shifts
β‘‘ Money Market Y: Nominal int. rate Β· X: Qty $
Mdβ†˜ Ms| (vertical)
BoC shifts Ms β†’ Ξ” rate
β‘’ Loanable Funds Y: Real int. rate Β· X: Qty LF
Supplyβ†— Demandβ†˜
Show crowding out
β‘£ Phillips Curve Y: Inflation rate Β· X: Unemp rate
SRPCβ†˜ LRPC| at un
Shifts with Ο€e changes
β‘€ PPF Bowed-out curve
Mark Efficient/Inefficient/Unattainable
Outward shift = growth
β‘₯ Business Cycle Y: Real GDP Β· X: Time
Peak→Contraction→Trough→Expansion
Wavy line around trend↗
Exam Strategy & Common Mistakes ⚑

🧠 Explain the chain: "If X β†’ then Y β†’ causes Z." Don't just state outcomes β€” show the mechanism step by step.

πŸ“Š AD-AS is everything: For every scenario: β‘  which curve shifts? β‘‘ direction? β‘’ PL & GDP effect? β‘£ LR self-correction?

⚠️ Common mistake: LRAS does NOT shift with AD/AS shocks. It only shifts with real changes to productive capacity.

πŸ”’ Multiplier math: Ξ”GDP = mult Γ— Ξ”G. Tax mult is smaller (some saved). Balanced budget mult = 1 always.

πŸ”— Connect all models: BoC ↓ rate β†’ money mkt (↓ r) β†’ AD-AS (ADβ†’R, ↑GDP, ↑PL) β†’ Phillips (move up along SRPC: ↑π, ↓u).

⚠️ Common mistake: Confusing money market (nominal r, SR) with loanable funds (real r, LR).

πŸ‡¨πŸ‡¦ Canadian context: Bank of Canada, overnight rate, 2% inflation target. NOT the Federal Reserve / federal funds rate.

πŸ“ MyLS = gold: Practice exams & in-class problems = closest format to the actual final.

⚠️ Common mistake: Investment (I) in GDP = business spending on capital. NOT financial investment (stocks/bonds).