The big picture: how entire economies function, grow, and sometimes fail.
What Is Macroeconomics?
Macroeconomics studies the economy as a whole, not individual markets.
| Micro Focus | Macro Focus |
|---|
| One firm's pricing | Overall price level (inflation) |
| One industry's output | Total output (GDP) |
| Individual job search | Economy-wide unemployment |
| One person's income | National income |
| One market's equilibrium | Economy-wide business cycles |
Gross Domestic Product (GDP)
The most important measure of economic activity.
What GDP Measures
GDP = Total market value of all final goods and services produced within a country in a given period.
| Component | What It Includes | % of US GDP |
|---|
| Consumption (C) | Household spending on goods and services | ~68% |
| Investment (I) | Business equipment, structures, inventories | ~18% |
| Government (G) | Government purchases (not transfers) | ~17% |
| Net Exports (NX) | Exports minus imports | ~-3% |
GDP = C + I + G + (X - M)
GDP Calculation Example
| Item | Included? | Reason |
|---|
| New car purchase | Yes | Final good |
| Steel sold to car maker | No | Intermediate good (would double count) |
| Lawyer's fee | Yes | Service |
| Used furniture sale | No | Not produced this period |
| Government salaries | Yes | Government spending |
| Social Security check | No | Transfer payment |
| Homemade meal | No | Not marketed |
| Drug deal | No | Underground economy |
Real vs. Nominal GDP
| Type | Definition | Use |
|---|
| Nominal GDP | Measured in current prices | Raw dollar value |
| Real GDP | Adjusted for inflation | Compare across years |
| GDP Deflator | Nominal/Real x 100 | Measure of price level |
Example:
| Year | Nominal GDP | Price Index | Real GDP |
|---|
| 2020 | $21 trillion | 100 | $21 trillion |
| 2025 | $28 trillion | 120 | $23.3 trillion |
The economy really grew 11%, not 33%. The rest was inflation.
GDP Per Capita
GDP divided by population gives a rough measure of average living standards.
| Country | GDP (2023) | Population | GDP Per Capita |
|---|
| USA | $27 trillion | 335 million | $80,000 |
| China | $18 trillion | 1.4 billion | $13,000 |
| Germany | $4.4 trillion | 84 million | $52,000 |
| India | $3.7 trillion | 1.4 billion | $2,600 |
Limitations of GDP
| What GDP Misses | Example |
|---|
| Distribution | High GDP can coexist with poverty |
| Unpaid work | Childcare, housework, volunteering |
| Quality improvements | Smartphones replaced many devices |
| Leisure | More vacation time is valuable |
| Environmental costs | Pollution cleanup adds to GDP |
| Underground economy | Cash transactions, illegal activity |
| Wellbeing | Mental health, social connections |
GDP measures output, not welfare. It's a useful but incomplete metric.
Inflation
A sustained increase in the general price level.
Measuring Inflation
| Index | What It Measures | Use |
|---|
| CPI (Consumer Price Index) | Basket of consumer goods | Cost of living |
| Core CPI | CPI excluding food and energy | Underlying trend |
| PCE | Personal consumption expenditures | Fed's preferred measure |
| PPI | Producer prices | Early inflation signal |
| GDP Deflator | All goods in GDP | Broadest measure |
CPI Basket Components
| Category | Weight (Approx.) |
|---|
| Housing | 33% |
| Transportation | 17% |
| Food | 14% |
| Medical care | 9% |
| Education/communication | 7% |
| Recreation | 6% |
| Apparel | 3% |
| Other | 11% |
Types of Inflation
| Type | Cause | Example |
|---|
| Demand-pull | Too much spending | Economy overheating |
| Cost-push | Rising production costs | Oil price shock |
| Built-in | Wage-price spiral | Workers expect inflation |
| Monetary | Too much money creation | Money supply grows faster than output |
| Imported | Foreign prices rise | Weak currency makes imports expensive |
Why Inflation Matters
| Effect | Explanation |
|---|
| Erodes purchasing power | $100 buys less over time |
| Redistributes wealth | From savers to borrowers |
| Creates uncertainty | Hard to plan and invest |
| Distorts signals | Price changes from inflation vs. real factors |
| Shoe leather costs | People minimize cash holdings |
| Menu costs | Businesses must update prices |
| Tax distortions | Taxed on nominal gains, not real |
Inflation Rate Interpretation
| Rate | Interpretation | Concerns |
|---|
| 0-1% | Low inflation | Risk of deflation |
| 2% | Target | Optimal for most central banks |
| 3-4% | Elevated | Reduces purchasing power noticeably |
| 5-10% | High | Economic distortions, social unrest |
| >10% | Very high | Serious economic problems |
| >50%/month | Hyperinflation | Economic collapse |
Unemployment
Types of Unemployment
| Type | Definition | Example | Remedy |
|---|
| Frictional | Between jobs, searching | Recent graduate, job switcher | Job search assistance |
| Structural | Skills don't match jobs | Coal miner in service economy | Retraining |
| Cyclical | Due to recession | Layoffs during downturn | Stimulus |
| Seasonal | Regular seasonal pattern | Ski instructor in summer | None needed |
Measuring Unemployment
| Term | Definition |
|---|
| Labor force | Employed + unemployed (actively seeking) |
| Unemployment rate | Unemployed / Labor force x 100 |
| Participation rate | Labor force / Working-age population |
| U-6 | Broader measure including underemployed |
Who Counts as Unemployed?
| Status | Counted as Unemployed? |
|---|
| Lost job, actively searching | Yes |
| Quit job, looking for new one | Yes |
| Gave up looking | No (discouraged worker) |
| Working part-time, wants full-time | No (underemployed) |
| Full-time student | No |
| Retired | No |
| Disabled | No |
| Stay-at-home parent | No |
Natural Rate of Unemployment
The unemployment rate when the economy is at full capacity.
| Concept | Description |
|---|
| Natural rate | Typically 4-5% in developed economies |
| Comprises | Frictional + structural unemployment |
| Excludes | Cyclical unemployment |
| Changes over time | Demographics, policies, technology |
Below natural rate: Labor shortage, wage pressure, inflation rises Above natural rate: Economic slack, wage stagnation, inflation falls
Business Cycles
Phases of the Cycle
| Phase | GDP | Unemployment | Inflation | Duration |
|---|
| Expansion | Rising | Falling | Rising | 3-10 years |
| Peak | Highest | Lowest | Highest | Months |
| Recession | Falling | Rising | Falling | 6-18 months |
| Trough | Lowest | Highest | Lowest | Months |
| Recovery | Rising again | Falling | Stable | 1-2 years |
What Causes Recessions?
| Trigger | Examples |
|---|
| Financial crisis | 2008-2009 |
| Oil shock | 1973, 1979 |
| Monetary tightening | 1981-1982 |
| Pandemic | 2020 |
| Asset bubble burst | 2001 (dot-com) |
| War/geopolitical | Various |
Recession Indicators
| Indicator | Warning Sign |
|---|
| Yield curve | Inverted (short rates > long rates) |
| Unemployment claims | Rising weekly claims |
| Consumer confidence | Sharp decline |
| PMI (Purchasing Managers Index) | Below 50 |
| Housing starts | Declining |
| Leading Economic Index | Multiple months of decline |
Aggregate Demand and Supply
Aggregate Demand (AD)
Total spending in the economy at each price level.
| Factor | Effect on AD |
|---|
| Consumer confidence up | AD shifts right |
| Business investment up | AD shifts right |
| Government spending up | AD shifts right |
| Exports up | AD shifts right |
| Tax cuts | AD shifts right |
| Money supply up | AD shifts right |
| Opposite of above | AD shifts left |
Aggregate Supply (AS)
Total output at each price level.
| Short-Run AS | Long-Run AS |
|---|
| Upward sloping | Vertical |
| Wages/prices sticky | Wages/prices flexible |
| Output can vary | Output at potential |
| Influenced by costs | Determined by resources and technology |
Economic Shocks
| Shock Type | Example | AD/AS Effect | Result |
|---|
| Positive demand | Tax cut, stimulus | AD right | Higher output, higher prices |
| Negative demand | Consumer fear | AD left | Lower output, lower prices |
| Positive supply | Technology advance | AS right | Higher output, lower prices |
| Negative supply | Oil price spike | AS left | Lower output, higher prices |
Stagflation: Negative supply shock causes both high unemployment AND high inflation (worst of both worlds).
Economic Growth
Sources of Growth
| Factor | Contribution |
|---|
| Labor force growth | More workers = more output |
| Human capital | Education, skills, health |
| Physical capital | Machines, buildings, infrastructure |
| Technology | More output from same inputs |
| Institutions | Rule of law, property rights |
| Trade | Specialization and efficiency |
Rule of 72
Years to double = 72 / growth rate
| Growth Rate | Years to Double |
|---|
| 1% | 72 years |
| 2% | 36 years |
| 3% | 24 years |
| 5% | 14 years |
| 7% | 10 years |
Small differences matter: 1% vs 3% growth means the difference between 72 years and 24 years to double living standards.
Why Some Countries Are Rich
| Factor | Rich Countries | Poor Countries |
|---|
| Institutions | Strong property rights, rule of law | Corruption, weak enforcement |
| Human capital | High education levels | Low education |
| Infrastructure | Modern roads, internet | Poor infrastructure |
| Geography | Temperate climate, coastal access | Landlocked, tropical disease |
| History | Early industrialization | Colonial extraction |
| Policies | Market-friendly | Protectionist, unstable |
Key Takeaways
GDP measures economic output - Useful but imperfect measure of economic health; doesn't capture wellbeing
Inflation erodes purchasing power - Central banks target 2% as optimal balance between costs and benefits
Unemployment has multiple types - Cyclical responds to policy; structural and frictional are always present
Business cycles are normal - Recessions are painful but regular; average expansion lasts longer than contraction
Aggregate demand and supply - Framework for understanding how shocks affect the entire economy
Growth compounds dramatically - Small differences in growth rates create huge differences over decades
Institutions matter most for development - Property rights, rule of law, and stability enable prosperity