Macroeconomics
Core Concepts
Macroeconomics studies economy-wide phenomena: national income accounting (GDP, GNP, NNP), aggregate demand and supply, consumption and investment functions, the multiplier, fiscal and monetary policy, inflation, unemployment, and economic growth. You must know the Keynesian cross, IS-LM (or AD-AS) framework, Phillips curve, and the distinction between short-run and long-run equilibrium. Open-economy macro (exchange rates, balance of payments) is also included.
Common Traps
- Confusing GDP with GNP: GDP measures production within borders; GNP measures income of residents.
- Forgetting that GDP excludes transfer payments, intermediate goods, and second-hand sales.
- Misapplying the multiplier: it is 1/(1-MPC) in a closed economy, but with income taxes and imports the multiplier is smaller.
- Assuming the Phillips curve is stable; expectations matter (Lucas critique).
- Mixing up nominal and real variables; always adjust for inflation when comparing over time.
Worked Example / Rule of Thumb
Rule of thumb: In the Keynesian cross, equilibrium income Y = C + I + G + (X - M). If consumption C = a + b(Y - T), then the government expenditure multiplier is 1/(1 - b(1 - t) - m) where t is the tax rate and m is the marginal propensity to import. For a simple closed economy with b = 0.8, the multiplier is 5.
Example: Suppose an economy has autonomous consumption 100, MPC = 0.8, taxes = 0, investment = 50, government spending = 80. Equilibrium Y = 100 + 0.8Y + 50 + 80 → 0.2Y = 230 → Y = 1150. If government spending rises by 20, new Y = 100 + 0.8Y + 50 + 100 → 0.2Y = 250 → Y = 1250. The multiplier is 5 (ΔY/ΔG = 100/20). This demonstrates the multiplier effect.