Macroeconomics CLEP prep


Long Run Aggregate Supply, The natural level of GDP, shown vertical on a graph. When LRAS shifts, SRAS (Short Run Aggregate Supply) will follow .

Tangible Assets

Real Estate, Equipment, and Cash (physical assets)

Intangible Assets

Patents, Goodwill, and Trademarks (lack physical substance)

Substitution effect

Economic rule stating that if two items satisfy the same need and the price of one rises, people will buy the other.

Equilibrium price

The price at which the number of products that businesses are willing to supply equals the amount of products that consumers are willing to buy at a specific point in time.

Excess Supply

When quantity supplied is more than quantity demanded. The formula for excess supply is: Supply - Demand = Excess Supply

Reservation price

Maximum price that a customer is willing to pay for a good

Buyer's surplus

The difference between a buyer's reservation price (the price they want to pay) and the actual price paid for a good or service

Seller's surplus

The difference between the price received by the seller and the seller's reservation price

Total surplus

The difference between the buyer's reservation price and the seller's reservation price. Consumer surplus + Producer surplus

Free market

A market with unrestricted trading of goods, where the prices of goods are determined by supply and demand.

Traditional economic system

In a traditional economic system, the availability of resources is based on inheritance. Goods are only produced for consumption and surpluses do not occur. This type of economy is normally found in South American, Asian, and African countries.

Command economic system

An economic system in which all factors of production are owned and controlled by the government. Often referred to as a centrally planned economic system. Example: Former Soviet Union.

Mixed market

Combines pure market and command. Example: Japan

Law of Diminishing Marginal Utility

A law stating that as a person consumes additional units of a good, eventually the utility gained from each additional unit of the good decreases.

Law of Demand

A law stating that as the price of a product increases the demand of that product decreases, while if the price of a product decreases the demand for that product increases.

Law of Supply

The law that states that as the price of any good or service increases, the quantity of that good or service will increase and vice versa.


The ease with which an asset can be converted to currency.


The part of economics study that looks at the operation of a nation's economy as a whole


(n) something of value; a resource; an advantage

Standard of living

The degree to which people have access to goods and services that make their lives better.

Labor productivity

The output per employed worker

Seller's reservation price

The smallest dollar amount for which a seller would be willing to sell an additional unit, generally equal to marginal cost


The adding up of individual economic variables to obtain a large, general picture of the economy.

Aggregate demand

The total demand for a country's output. It includes demands for consumption, investment, government purchases, and net exports.

Aggregate supply

Total supply of goods and services in an economy

Business cycle

A record of economic increases and decreases over time.


A free market system that relies on private property ownership and supply and demand


Sole proprietorships, partnerships, and corporations are private producing units of the economy knows as __________.


Unicorporated entity that has shared ownership.


Legal entity that has received a charter from a state or federal government.

Sole proprietorship

Business entity which legally has no separate existence from its owner.

Adam Smith

A Scottish man (1723-1790) who is known as the father of modern economics.

Invisible hand

A phrase coined by Adam Smith to describe the process that turns self directed gain into social and economic benefits for all.

Economic efficiency

When goods and services are made and consumed at the best levels for the society. Nothing more can be acheived with the resources available.

Socially optimal quantity

The quantity of a good that results in the maximum possible economic surplus from producing and consuming the good.

The principle of efficiency

That efficiency leads to economic prosperity for all.

Menu cost

The real cost of changing a listed price.

Keynesian model

The basic assumption of this model is that in the short run, firms meet demand at present price.

Planned aggregate expenditure (PAE)

The total planned spending on final goods and services.

Consumption function

The relationship between disposable income and spending on consumable goods and services

The Wealth Effect

An increase in spending due to a perceived increase in wealth.

Autonomous Expenditure

The portion of planned aggregate expenditure that is not based on output

Inflation inertia

The slow change in inflation from year to year in industrialized nations

Inflation shock

When inflation suddenly deviates from its normal course.

Marginal tax rate

The rise in taxes that occurs when before-tax income increases by one dollar

Average tax rate

Total tax paid divided by total (taxable) income, as a percentage.


An extreme decline in the rate of inflation. Can lead to high levels of unemployment and recessionary gaps.


The speed that money changes hands in order to buy and sell final goods and services.

Quantity equation

Money multiplied by velocity equals nominal GDP.

Short run equilibrium output

The level of output where output equals planned aggregate expenditure


The economic theory that states the main cause of change in aggregate output and price level is the result of monetary supply and the interest rate that comes from the amount of monetary supply

Aggregate supply shock

A large, unexpected change in the cost of resources.


A result of there only being one buyer of a resource input, good, or service.


On a demand curve, the _____ of the item is placed on the vertical axis of the graph.


Natural Rate of Unemployment - a rate that will always exist

Market equilibrium

When both producers and consumers are satisfied with their quantities at market price.


The opposite of a substitute good, because it usually completes another item and may lead to more consumption of that item.

The real GDP per person

Can be found by multiplying the average labor productivity by the percentage of people that are working in the economy.

Aggregate Supply

Measures the ability of an economy to produce (output) goods and services in the short-term and the long-term.


The continuing increase in the average level of prices of goods and services over time.


A GDP decline that lasts two-quarters (six months). A period of slow economic growth

Gross Domestic Product (GDP)

Is equal to Consumption + Government Expenditures + Investment + Exports - Imports The market value of all goods and services produced within a nation during a specified amount of time.

Gross National Product (GNP)

The value of all goods and services produced anywhere in the world by a nation's citizens during a specified amount of time.

Intermediate goods

Goods that are used in the production of final goods.

Capital goods

Used in the production of final goods, but instead of being consumed, are available for reuse.


The amount spent by a household on goods and services such as: entertainment, food, and other perishables.

Consumer Nondurables

Goods like food and clothing that have a short lifespan.

Intermediate Goods

Goods not counted in the nation's GDP.

Capital income

Includes payment to the owners of tangible and intangible capital items such as: factories, machines, and copyrights.

Nominal GDP

The total value of goods and services produced in a country valued at current prices.

Real GDP

Gross domestic product adjusted for inflation; gross domestic product in a year divided by the GDP price index for that year, the index expressed as a decimal

Participation rate

The percentage of working-age people within the labor force

The rate of inflation

The annual percentage rate of change in price level reflected by price indexes


When prices fall consistently over time, leading to negative inflation.

Real quantity

A quantity that is measured in real terms - the actual quantity of a good or service

Real employment

When there is no cyclical unemployment and every person who wishes to work is able to find a job at the prevailing rate for wages and in the prevailing working conditions.


Involves increasing a nominal quantity so that it remains unaffected by increases in inflation

Substitution bias

A flaw in the CPI that exaggerates real increases in the cost of living by failing to take into account customers ability to choose equally desirable goods or services when the price of their preferred good or service increases

The quality adjustment bias

When economists fail to account for improvements in goods or services and incorrectly report inflation as higher.

Price level

A measure of overall price levels at a specific point in the price index.

Relative price

The price of a good or service in relation to the price of other goods and services.


When the rate of inflation is extremely high.

Worker mobility

The movement of workers between jobs, companies, and industries

Cyclical unemployment

Caused by changes in the overall economy.

Structural unemployment

Caused by changes in demand or technology. Long-term and continual unemployment that continues even though the economy is producing normally

Frictional unemployment

Refers to individuals between jobs seeking new employment, people re-entering the workforce (ie mom whose kids are grown), and new entrants (ie college graduates).

Inflationary gap

There is an ___________ ___ when aggregate output is above potential output

AD curve intersects the SAS curve

Short-run macroeconomic equilibrium occurs at the level of GDP where the:

Labor productivity

An increase in which of the following would cause an increase in the aggregate supply?Labor productivityThe wage rateThe price of importsConsumer spendingInterest rates

Labor unions

Organizations that act as moderators between employers and employees

Unemployment insurance

Payments that the government makes to unemployed workers.


When an economic unit makes more than it spends

Labor supply

The amount of workers that are willing to work for a real wage.


The beginning of a recession

decreases increases

If the Federal Reserve lowers the reserve ratio, it ______ the bank's required reserves and ______ the quantity of money.


The lowest point of the recession


Extreme economic growth

Potential output

The maximum amount that an economy can output over a period of time

Output gap

A difference between the potential output (potential GDP) of an economy and its actual output (actual GDP)

Okun's Law

1 percent more unemployment results in 2 percent less output.


Distributing a good or resource among consumers that would like to have more of that good or resource than is made available

Sunk cost

A cost that is beyond recovery the moment a consumer decides to purchase a certain good or service is made

Marginal cost

The increase in total cost that comes from producing one additional unit of a specific good or service.

Marginal benefit

The increase in total benefit that comes from producing one additional unit.

Structural policy

A macroeconomic policy that directly affects the structure and various institutions of an economy

Normative analysis

Concerned with analyzing whether or not a policy should be used.

Stabilization policies

Government policies aimed at stabilizing the economy by eliminating output gaps

Expansionary policies

Government policies intended to increase spending and output.

Contractionary policies

Government policies intended to avoid inflation and other effects due to increased expansion. Includes: Action such as decreasing government spending, increasing taxes, and decreasing the supply of money, and raising interest rates.

Automatic stabilizers

Programs and economic policies such as income taxes, unemployment insurance and TANF (Temporary Aid to Needy Families) that are automatically in place, help to decrease fluctuations in the GDP.

Policy reaction function

Describes how the economy directly effects the actions policymakers take.

Supply-side policy

A policy that affects potential output

Anchored inflation expectations

When people's expectations of future inflation do not change even though inflation rates change.

Core rate of inflation

The rate of price increase on all things except food and energy

Credibility of monetary policy

When the people believe that the nation's central bank will keep inflation rates low.

Inside lag

The time between the need for a macroeconomic policy and its implementation

Outside lag

The time period between a policy's implementation and its desired effects on an economy.

Fisher effect

The tendency for nominal interest rates to be high when inflation rates are high and low when inflation rates are low.

Four sectors of the economy

Goods and services sector, Labor sector, monetary sector, international sector.


The goods and services sector focuses largely on the level of ______ .


The labor sector highlights the rate of ____ .


The monetary sector focuses on the ________ rate.


The international sector emphasizes the ________ rate.

Keynesian economic theory

Economies based on capitalism have microeconomic instability and that government is required to properly stabilize the economy.

Laffer curve

Represents the governmental tax rate that will best maximize tax revenues.

Lorenz curve

Used to demonstrate shifts in income distribution among a population over time.

Congressional budget office

The government office that is responsible for projecting federal surpluses and deficits


Most free-market banking systems are based on __________ reserves.

Phillips curve

Demonstrates that there is an inverse relationship between inflation and unemployment; as inflation increases, unemployment decreases (and vice versa).