3.1Measuring economic activity and illustrating its variations
Key terms
GDP
Total value of final goods and services produced within a country in a given period.
GNI
GDP + income earned abroad by residents − income paid to foreigners.
Real GDP
GDP adjusted for inflation, so it measures changes in output.
GDP per capita
GDP ÷ population.
PPP
Purchasing power parity: adjusts for different price levels between countries.
Business cycle
Short-term fluctuations of real GDP around its long-term trend (potential output).
National income can be measured by output (value added), income (wages, rent, interest, profit) or expenditure; in the circular flow the three are equal.
The full notes, worked example, interactive diagram and check questions for this subtopic are in the app.
3.2Variations in economic activity: aggregate demand and aggregate supply
Key terms
Aggregate demand (AD)
Total planned spending on domestic output at each price level: C + I + G + (X − M).
SRAS
Output firms supply at each price level when wages and input prices are fixed.
LRAS
The economy's potential output, where all resources are fully employed.
Recessionary (deflationary) gap
Real GDP below potential output.
Inflationary gap
Real GDP above potential output.
AD slopes down because of the wealth effect, the interest rate effect and the international trade effect.
The full notes, worked example, interactive diagram and check questions for this subtopic are in the app.
Exam tip: State which model you're using and draw it accurately. Strong answers compare both views and judge which fits the situation (e.g. a deep recession with low confidence fits the Keynesian view).
3.3Macroeconomic objectives
Key terms
Economic growth
An increase in real GDP. Short-term growth comes from AD; long-term growth from LRAS shifting right.
Unemployment rate
Unemployed ÷ labour force × 100.
Natural rate of unemployment
Unemployment at potential output: frictional + structural + seasonal.
Inflation / deflation / disinflation
Sustained rise in prices / sustained fall / fall in the rate of inflation.
CPI
Weighted price of a basket of goods relative to a base year.
Debt-to-GDP ratio (HL)
Government debt as a percentage of GDP.
Growth raises living standards but can harm the environment and widen inequality.
The full notes, worked example, interactive diagram and check questions for this subtopic are in the app.
3.4Economics of inequality and poverty
Key terms
Lorenz curve
Cumulative share of income received by cumulative shares of the population.
Gini coefficient
Area between the line of equality and the Lorenz curve ÷ total area under the line of equality (0 = equal, 1 = totally unequal).
Absolute poverty
Income too low to meet basic needs; measured by the World Bank's international poverty line (US$3.00 a day at 2021 PPP since June 2025).
Relative poverty
Income well below the national average, often below 50 or 60% of median income.
Progressive / regressive / proportional tax
Average tax rate rises / falls / stays the same as income rises.
Transfer payment
Payment from government without anything produced in return, e.g. pensions, unemployment benefits.
Equality means equal shares; equity means fairness. Economic inequality can be about income (a flow) or wealth (a stock).
The full notes, worked example, interactive diagram and check questions for this subtopic are in the app.
3.5Demand management: monetary policy
Key terms
Monetary policy
Central bank changes to interest rates and the money supply to influence AD.
Inflation targeting
The central bank aims for a set inflation rate, often about 2%.
Real interest rate
Nominal interest rate − inflation rate.
Open market operations (HL)
Buying or selling government bonds to change the money supply.
Quantitative easing (HL)
Large-scale asset purchases to inject money when rates are near zero.
Goals: low and stable inflation, low unemployment, reducing business cycle fluctuations, a stable environment for long-term growth, external balance.
The full notes, worked example, interactive diagram and check questions for this subtopic are in the app.
3.6Demand management: fiscal policy
Key terms
Fiscal policy
Changes to government spending and taxation to influence AD.
Progressive taxes and benefits that change automatically with the cycle.
Keynesian multiplier (HL)
An injection causes a larger final rise in national income.
Crowding out (HL)
Government borrowing raises interest rates and reduces private investment.
Revenue: direct and indirect taxes, sale of goods and services by state-owned enterprises, sale of state-owned assets. Spending: current, capital, transfer payments.
The full notes, worked example, interactive diagram and check questions for this subtopic are in the app.
3.7Supply-side policies
Key terms
Supply-side policies
Policies to raise productive capacity, shifting LRAS right.
Interventionist policies
Government invests directly: education, training, healthcare, research and development, infrastructure, industrial policy.
Market-based policies
Make markets work better: competition, deregulation, privatisation, labour market reform, tax incentives.
Goals: long-term growth, more competition and efficiency, lower labour costs and unemployment, lower inflation and better competitiveness, incentives to invest and innovate.
The full notes, worked example, interactive diagram and check questions for this subtopic are in the app.