Macro Economics Review: Key Concepts & Formulas for Exams

This guide walks through the core concepts needed for introductory and AP macroeconomics exams, organized by the five units typically covered in a semester‑long course.

Unit 1 – Basic Economic Concepts

Scarcity is the condition of unlimited wants facing limited resources. Opportunity cost measures the value of the next best alternative forgone. The Production Possibilities Curve (PPC) illustrates trade‑offs: a straight‑line PPC reflects constant opportunity cost, while a concave PPC shows increasing opportunity cost as production shifts. Trade allows a country to consume beyond its own PPC, though it does not alter the underlying production capacity. Comparative advantage arises when a country’s opportunity cost for a good is lower than another’s, prompting specialization. Absolute advantage simply identifies who can produce more of a good and is described as “a joke” because it requires no deeper analysis. The circular flow model depicts businesses buying resources and selling products, while households sell resources and buy products.

Unit 2 – Macroeconomic Measures

Gross Domestic Product (GDP) is the dollar value of all final goods produced within a nation’s borders in a year. The expenditure approach sums consumption (C), investment (I), government spending (G), and net exports (X − n): GDP = C + I + G + Xn. GDP excludes non‑market transactions and intermediate goods. Unemployment is categorized as frictional (between jobs), structural (skills become obsolete), and cyclical (linked to recessions). The natural rate of unemployment includes only frictional and structural components, roughly 5 % in the United States. Inflation is measured by the Consumer Price Index (CPI) and the GDP deflator. Nominal wages and interest rates do not adjust for price changes, whereas real rates do. Unexpected inflation erodes lenders’ returns and benefits borrowers.

Unit 3 – National Income and Price Determination

Aggregate Demand (AD) slopes downward because higher price levels reduce wealth, raise interest rates, and make foreign goods cheaper, each lowering domestic spending. Aggregate Supply (AS) can shift left, producing stagflation—higher prices with lower output. In the short run, wages and resource costs adjust slowly; in the long run, a recessionary gap prompts falling wages, shifting short‑run AS rightward back to full employment. The Phillips Curve captures the short‑run trade‑off between inflation and unemployment. Fiscal policy influences AD: expansionary policy raises G or cuts taxes, while contractionary policy does the opposite. Government borrowing can “crowd out” private investment by raising interest rates.

Unit 4 – Financial Sector

Money serves as a medium of exchange, a unit of account, and a store of value. The narrow money supply (M1) includes cash and checking deposits. Fractional‑reserve banking means banks keep only a fraction of deposits as reserves; the money multiplier = 1 / Reserve Requirement. The money market’s supply curve is vertical, set by the Federal Reserve, while demand slopes downward. Monetary policy operates through open‑market operations: the Fed buys bonds to increase the money supply and lower interest rates, or sells bonds to do the opposite. The federal funds rate is the interbank lending rate; the discount rate is what the Fed charges banks directly.

Unit 5 – International Trade and Foreign Exchange

The balance of payments records a nation’s transactions with the rest of the world, separating the current account (trade in goods and services) from the financial account (capital flows). In foreign‑exchange markets, a rise in demand for a currency causes it to appreciate, making net exports fall; a decline causes depreciation, boosting net exports. Currency values also shift due to changes in tastes, income, inflation, and interest rates. Two currencies cannot appreciate relative to each other simultaneously; one must weaken as the other strengthens.

Mechanisms and Key Formulas

• PPC Shifts occur when land, labor, capital, or technology change.
• GDP Calculation can use the expenditure approach (C + I + G + Xn) or the income approach (rent, wages, interest, profit).
• Quantity Theory of Money: M × V = P × Y. With constant velocity (V) and output (Y), changes in the money supply (M) lead to proportional price changes (P).
• Long‑Run Adjustment: In a recessionary gap, falling wages and resource costs shift short‑run AS right until full employment is restored.
• Foreign‑Exchange Appreciation: Increased demand for a currency raises its value, forcing the counterpart currency to depreciate.

Hard Numbers to Remember

• GDP Equation: GDP = C + I + G + Xn
• Money Multiplier: 1 / Reserve Requirement
• Spending Multiplier: 1 / MPS (Marginal Propensity to Save)
• Tax Multiplier: One less than the spending multiplier
• Natural Rate of Unemployment (US): Approximately 5 %

Notable Voices

Jacob Clifford, the instructor behind ACDC Econ, delivers these concepts in a rapid‑review format. The Fed, the United States’ central bank, implements monetary policy through the tools described above.