CLEP Principles of Macroeconomics cheat sheet

Scarcity: unlimited wants exceed limited resources, so every choice has an opportunity cost - the value of the next-best alternative forgone.

Production possibilities frontier (PPF): bowed-out shape reflects increasing opportunity cost; points inside are inefficient, points outside are unattainable with current resources and technology.

Comparative advantage: the lower opportunity-cost producer of a good should specialize in it; absolute advantage (using fewer inputs) does not by itself determine gains from trade.

Law of demand: price and quantity demanded move inversely, ceteris paribus; a change in price is a movement along the curve, while income, tastes, or prices of related goods shift the curve.

Market equilibrium: quantity demanded equals quantity supplied; a price above equilibrium creates a surplus (downward pressure), a price below creates a shortage (upward pressure).

Price ceilings below equilibrium cause shortages and non-price rationing; price floors above equilibrium cause surpluses, e.g. minimum wage creating unemployment.

Positive vs. normative economics: positive statements are testable claims about what is; normative statements are value judgments about what ought to be.

Marginal analysis: optimal decisions occur where marginal benefit equals marginal cost; sunk costs are irrelevant to forward-looking choices.

GDP = C + I + G + (X − M): consumption, gross private investment, government purchases, and net exports; transfer payments are excluded from G.

Expenditure approach counts final goods only; intermediate goods and secondhand sales are excluded, while inventory accumulation counts as investment.

Nominal vs. real GDP: real GDP values output at base-year prices, removing price-level changes; the GDP deflator = (nominal GDP ÷ real GDP) × 100.

Real GDP per capita is the standard proxy for living standards, but GDP omits nonmarket production, leisure, and income distribution.

Inflation measured by CPI: CPI = (cost of basket in current year ÷ cost of basket in base year) × 100; inflation rate = percentage change in CPI.

CPI overstates inflation when it ignores substitution toward cheaper goods and quality improvements; the GDP deflator covers all domestic output, CPI a fixed consumer basket.

Unemployment rate = (unemployed ÷ labor force) × 100; labor force = employed + unemployed; discouraged workers are not counted as unemployed.

Business cycle: expansion, peak, contraction (recession, conventionally two or more quarters of falling real GDP), trough.

Aggregate demand slopes downward from the wealth effect, interest-rate effect, and net-export effect; it shifts with changes in C, I, G, net exports, or money supply.

Short-run aggregate supply slopes upward because sticky wages and prices; it shifts with input prices, productivity, and expected inflation.

Long-run aggregate supply is vertical at potential output, determined by resources and technology, not by the price level.

Short-run equilibrium: AD = SRAS; a negative demand shock creates a recessionary gap, a positive demand shock an inflationary gap.

Spending multiplier = 1 ÷ (1 − MPC) = 1 ÷ MPS; tax multiplier = −MPC ÷ MPS; the balanced-budget multiplier equals 1.

MPC + MPS = 1; the multiplier applies only to autonomous spending changes and is smaller when the economy is near full employment.

Cost-push inflation (SRAS shifts left) raises prices and lowers output; demand-pull inflation (AD shifts right) raises both prices and output.

Crowding out: government borrowing raises interest rates and reduces private investment, weakening fiscal policy's effect on aggregate demand.

Money functions: medium of exchange, unit of account, store of value; M1 = currency + checkable deposits + traveler's checks; M2 = M1 + savings deposits, small time deposits, money market funds.

Money is created when banks make loans; each bank holds reserves equal to a fraction of deposits, and the money multiplier = 1 ÷ required reserve ratio.

Excess reserves = total reserves − required reserves; maximum new deposit creation = excess reserves × money multiplier.

Demand for money depends on income (positively) and interest rate (negatively); money supply is set by the central bank and is vertical.

Money market equilibrium sets the nominal interest rate; an increase in money supply lowers the interest rate, which raises investment and aggregate demand.

Bond prices and interest rates move inversely: when the interest rate rises, existing bond prices fall.

Central bank tools: open-market operations (buying bonds increases reserves), discount rate, and reserve requirements; open-market operations are the most-used tool.

Loanable funds market: supply from saving, demand from investment and government borrowing; government deficits shift demand right and raise the interest rate.

Phillips curve: short-run trade-off between inflation and unemployment; a shift in expected inflation or supply shocks shifts the short-run curve.

Long-run Phillips curve is vertical at the natural rate of unemployment; there is no permanent inflation–unemployment trade-off.

Types of unemployment: frictional (search), structural (skills/geography mismatch), cyclical (insufficient demand); only cyclical is reduced by demand stimulus.

Natural rate of unemployment = frictional + structural; actual unemployment below it signals an inflationary gap.

Expansionary policy (raise G, cut taxes, buy bonds, lower rates) closes a recessionary gap but risks inflation; contractionary policy does the reverse.

Rational expectations: anticipated policy has little real effect because expected inflation adjusts immediately; unanticipated policy has short-run real effects.

Inflation costs: shoe-leather costs, menu costs, tax distortions, and arbitrary redistribution from lenders to borrowers when inflation is unanticipated.

Real interest rate ≈ nominal interest rate − inflation rate (Fisher equation); expected real rate guides saving and investment decisions.

Growth rate: percentage change in real GDP or real GDP per capita between periods; sustained per-capita growth requires productivity gains.

Sources of growth: increases in capital stock, labor quantity and quality, technology, and efficiency of resource allocation.

Production function view: output depends on capital per worker, human capital, and technology; diminishing returns to capital alone limit growth without innovation.

Investment in physical capital raises the capital-to-labor ratio but faces diminishing marginal returns.

Human capital (education, skills, health) and research and development are key drivers of long-run productivity growth.

Saving and investment fund capital accumulation; policies that encourage saving, property rights, and open trade tend to support growth.

Rule of 70: doubling time in years ≈ 70 ÷ annual growth rate (percent).

Growth accounting intuition: technological progress shifts the production function upward, unlike capital deepening, which moves along it.

Balance of payments: current account (goods, services, income, transfers) plus financial/capital account plus official reserves sums to zero.

Trade deficit means imports exceed exports; it is matched by a financial-account surplus (net capital inflow) or reserve changes.

Exchange rate: price of one currency in another; appreciation makes exports dearer and imports cheaper, reducing net exports.

Currency demand comes from exports, investment inflows, and speculation; supply from imports and capital outflows; equilibrium sets the exchange rate in floating regimes.

Depreciation of a currency raises net exports, shifting aggregate demand right; appreciation lowers net exports.

Tariffs and quotas reduce imports, raise domestic prices, and invite retaliation; they help domestic producers but harm consumers.

Comparative advantage, not absolute advantage, explains why trade raises total output; restrictions reduce the gains from specialization.

Net capital outflow equals the trade balance in an open economy: capital flowing abroad corresponds to a trade surplus, and inflows to a deficit.