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Understanding Macroeconomics: A Study Guide

written by: Kathy Foust • edited by: SForsyth • updated: 1/20/2012

How does the economy work? What is supply and demand, and what do we mean by macroeconomics? Learn it all here in this complete study guide!

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    What is Macroeconomics?

    Two of the major pieces of the economic puzzle are macroeconomics and microeconomics. While microeconomics focuses on individuals or specific companies and how they interact as buyers and sellers, macroeconomics focuses on the overall impact of economics on society and society on economics. You can easily remember the difference if you think of “micro” in terms of the “smaller” picture and “macro” in terms of the “larger” picture.

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    Components of Macroeconomics

    The study of macroeconomics is used to help find solutions to big problems such as setting budgets. The larger the branch that the budget is set for, the more components that go in to answering the questions and developing the budget.

    For instance, if the state of Indiana is changing their minimum wage, they will have to consider how this will affect the state economy as whole using information on the cost of living, jobs available and median incomes and prices. They would NOT have to consider the national income of Africa because they are only working within their own state, not considering the global economy.

    However, if the federal government is considering changing its free trade agreement, it may consider the national income of Africa as part of the economic plan. Below is a list of variables that are considered when working with macroeconomics.

    • Unemployment
    • Inflation
    • Growth of the Economy
    • Money Supply
    • National Incomes

    Some of the people who use macroeconomics work within the following areas.

    • Internal Revenue Service
    • Economists
    • Global Economics
    • Policy Setters

    One way to think of macroeconomics is to compare it to your own household. When you or your parents consider only their own income and expenditures, they are dealing in microeconomics in their own household. When you or they are considering the income and bills of the entire household, they are considering the macroeconomics of the household.

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    Exploring Supply & Demand

    What is Supply?

    When you hear the term "supply", you probably think of products made. While this is true to some extent, it is not the whole definition of supply as it applies to economics. When looking at supply in economics, it means the amount that producers of the product are willing to produce and offer for sale at a specific price during a specific period of time. Certain variables will change this amount. For instance, if people drop from buying 10 of the products a week to buying 10 of the products a month. In this situation, suppliers are forced to adjust their supply or take a loss.

    What is Demand?

    Demand in economics is based on the quantity that consumers are willing to purchase of a certain product during a specific time for a specific period of time. For instance, if all other variables remain the same and the only change is a drastic price increase on a certain item, chances are that the demand for the item will decrease unless it is an item of need. Even then, if consumers can do without it or replace it they will.

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    Nonprice Determinant

    Changes in price will have an impact on both supply and demand, but what about nonprice determinants or things that have nothing to do with the price of the product? These nonprice determinants are listed below. To increase your understanding of how these apply to the relationship of supply and demand, decide whether the relationship is direct or inverse and provide and example for each nonprice determinant.

    Demand

    • Number of buyers
    • Taste and preference
    • Income; normal goods and inferior goods (for instance steak and hot dogs)
    • Expectations of buyers
    • Prices of related goods; substitute and complimentary

    Supply

    • Number of sellers
    • Technology
    • Resource prices
    • Taxes and subsidies
    • Expectations of producers
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    Components of Economic Measurement

    There are several components that go into measuring the macro economy. The list of terms below are all a part of these measurements. Look up and define these terms in order to help you understand the next section of this Macroeconomics Study Guide.

    • Gross Domestic Product (GDP)
    • Gross National Product (GNP)
    • Expenditure Approach
    • National Income (NI)
    • Personal Income (PI)
    • Disposable Personal Income (DI)
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    Expenditure

    The expenditure approach is an algebraic formula that allows us to figure out the total gross domestic product. The equation is written below.

    GDP= C + I + G + (X-M) where C=consumption or spending by households, I=spending by firms, G=government consumption expenditures and gross investment or spending by the government and (X-M)= net exports or spending by foreigners.

    The four measures of the Macroeconomy cannot be expressed without this equation because the result of this equation is the Gross Domestic Product, which is one of the four measures of the economy.

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    Measure the Macroeconomy

    Remember, the very definition of the macroeconomy is the economy on a large scale or in consideration of the grand scheme of things. Therefore, measures of the macroeconomy are going to be in large numbers, especially when dealing with national measurements.

    To measure the disposable personal income of a nation, one has to start with the GDP, which is basically consumption plus investment plus government consumption and investments plus net exports. Once you have the GDP, it must be adjusted for depreciation.

    The National Income (NI) measures the income earned by households, Therefore depreciation must be subtracted from the GDP. That is because used capital must be replaced as it is consumed. With that being said, the next formula for measuring the macroeconomy is GDP-Depreciation=National Income.

    However, the national income is not an accurate assessment of how much a household actually receives. If you've ever seen a paycheck of yours or your parents, you know that what they earn and what they receive are two completely different amounts. To figure out the Personal Income of the nation, one must use the formula NI-(corporate profits + FICA or contributions to Social Security + Transfer Payments and other income)=Personal Income (PI).

    However, even after taxes are taken out of paychecks, there are still personal taxes to pay and those are not considered to be figured into a nations Disposable Personal Income (DPI). To figure out the nation's DPI, the formula is PI- personal taxes= disposable income.

    Use this formula to figure out a nations disposable personal income using the following variables.

    • GDP=$12,973 billion
    • Depreciation= $2,003 billion
    • Corporate profits= $1,281 billion
    • FICA= $951 billion
    • Transfer payments and other income= $2,943 billion
    • Personal taxes= $4, 779 billion
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  • slide 9 of 10

    What is Aggregate Demand?

    Remember, in macroeconomics we are focusing on the bigger picture. Instead of looking at one tree, look at the entire forest or groups of trees within the forest. Keeping that in mind makes it easier to understand aggregate demand.

    The market demand curve looks at products within a specific period of time in a specific area or market. However, since aggregate demand is part of macroeconomics, it looks at the level of real Gross Domestic Product (GDP) purchased not by individuals, but households, businesses and branches of government.

    Review Questions

    1. The aggregate demand curve is downward sloping, but why is it downward sloping?
    2. How does the aggregate demand curve differ from the market demand curve?
    3. Look at the scenarios below and determine which direction the aggregate demand curve will shift for each scenario.
    • There is an increase in the United States of corn exports to Russia, Germany and Australia.
    • Due to natural disasters in other parts of the world, American businesses are expected to see an enormous increase in profits.
    • The federal government raises spending on roadwork and bridges.

    4. List the four non-price determinants of aggregate demand.

    As you study aggregate demand, simply keep in mind that there are a lot of factors to consider when dealing with this type of spending. The prices on various items always have an impact on others. For instance, if the average household spends $400 a month on groceries, but the prices in groceries drop so that they only need to spend $200 a month in groceries, where will the other $200 go? Will the household likely spend it on more groceries or will they spend it on a new dvd player? The very key to aggregate demand lies in being able to look at the whole picture rather than just a portion of it.

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    The Global Economy

    History

    Since the time that man was able to travel and trade, there has been an impact on every part of the world. Consider one of the most important pieces of American history, the Boston Tea Party. Would America be any different today if they had never relied in any way on imports or exports to fuel the economy in some way?

    Consider the current economic crisis in relation to global economics. The goals of some are to make every country as economically sound as the other. But, what price will that cost individuals in countries that are reliant on exports or imports? How does it impact America as a whole? These are just some of the questions that should be considered when global trade agreements are made. Read the section below and pick an area of interest to you in order to gain insight into global economics.

    From Global to Individual

    If I were to ask you to measure out 50 feet without a tape measure, you would likely do so by using some standard of measurement that you are familiar with, like a 10 foot ladder laid down five times. That's because as we look at the world and try to gain perspective in things we are not normally familiar with, we use terms that we are familiar with to compare it to.

    The same is true of global economics. For instance, if I told you that a country made a profit of $120 billion, you would likely have a limited concept of what that number actually means. But if I told you that every person in that country made a profit of $100, you could easily understand those terms. That has been the philosophy behind this study guide. To review what you've learned, pick one of the following projects or topics and write a two page paper that explains your research and results that you obtained using your research.

    • With your parents' permission, go online and pick a country. Pretend you have $500 to spend. Purchase $500 worth of that country's currency, then at the end of the week, trade it in and see how much money you have in the form of the American dollar. Explain how you came up with this amount and what may have happened in this country to account for any drastic changes in the value of their currency.
    • Keep track of your spending for a week, using an itemized sheet. Do not use the total on the receipts, but the actual individual amounts. Now, consider that there are those who move to get rid of the penny. Use rounding off to see what you would have spent if there were no pennies. For simplicity, do no use nickles. In other words, if and item was $1.03, round it off to $1. If the item was $1.06, round it off to $1.10. If this is done on a global level and the results are similar to yours, what is going to happen to the global economy? Why?
    • Pick a country that is involved in the Free Trade Agreement with the United States. Do some research and look within your own home to find out what impact their importing to the United States has on them as well as residents of the United States.
    • Pick five items in your home that were made outside of the United States. Do some research to see if those same items are made within the United States. What is the cost difference. Do some research and find out why there is a cost difference. What impact do these items have on the economy of either country?

    Did this study guide help you understand economics a little better? Let us know what you've learned in the comments!