IAI Actuarial Core Principles · Business Economics

Impact of the macroeconomic environment on business: formula sheet

Full chapter guide

Key formulas

Real GDP growth rate: Growth rate (%) = (Real GDP this year − Real GDP last year) ÷ Real GDP last year × 100; Use real GDP, which removes the effect of price changes. Nominal GDP can rise from inflation alone.
Inflation rate: Inflation rate (%) = (Price index this year − Price index last year) ÷ Price index last year × 100; Applies to any price index, such as a consumer price index.
Real value: Real value = Nominal value ÷ Price index × 100; Use a base-year index of 100. This converts rupee amounts to constant prices.
Unemployment rate: Unemployment rate (%) = Unemployed ÷ Labour force × 100; Labour force = employed + unemployed. People not looking for work are outside it.
Real interest rate (approximate): Real interest rate ≈ Nominal interest rate − Inflation rate; An approximation that works best when rates are low.
Real GDP growth rate: Growth rate (%) = (Real GDP this period − Real GDP last period) ÷ Real GDP last period × 100; Use real GDP, not nominal, so inflation does not inflate the figure.
Real GDP from nominal GDP: Real GDP = Nominal GDP ÷ GDP deflator × 100; The deflator is an index with the base year at 100.
Output gap: Output gap = Actual real GDP − Potential real GDP; Positive means boom and inflation pressure. Negative means spare capacity and higher unemployment.
Recession rule of thumb: Two consecutive quarters of negative real GDP growth; A common working definition, not a universal one. State it as such.
Growth in output per worker: Labour productivity = Real output ÷ Number of workers (or hours worked); Rising productivity is the key source of long-run growth.
Inflation rate: Inflation rate = (P₁ − P₀) ÷ P₀ × 100%; P₀ is the price index in the base period and P₁ in the later period. A negative result means deflation.
Unemployment rate: Unemployment rate = Unemployed ÷ Labour force × 100%; Labour force = employed + unemployed. People not looking for work are outside the labour force.
Real value: Real value = Nominal value ÷ Price index × 100; Use it to remove the effect of price changes when comparing across years.
Approximate real interest rate: Real interest rate ≈ Nominal interest rate − Inflation rate; An approximation, good for small rates. The exact form is (1 + i) ÷ (1 + π) − 1.
Natural rate of unemployment: Natural rate ≈ Frictional + Structural unemployment; Cyclical unemployment is the gap above the natural rate.
Rupee depreciation (quoted as ₹ per foreign unit): % change in rupee value = (old rate − new rate) ÷ new rate × 100; Rupee value in foreign terms is the inverse of the quote. If ₹ per $ rises, the rupee has depreciated.
Rise in the quote: % rise in ₹ per $ = (new − old) ÷ old × 100; This is not the same as the fall in the rupee's dollar value. Do not mix the two.
Rupee price of an import: Rupee price = foreign price × exchange rate (₹ per unit of foreign currency); Assumes no tax, freight or margin changes.
Foreign price of an export: Foreign price = rupee price ÷ exchange rate (₹ per unit of foreign currency); Assumes the exporter keeps the rupee price fixed.
Interest cost on a loan: Annual interest = principal × rate; Simple annual interest on a loan with no repayments in the year.
Direction rules: Rate ↑ → borrowing cost ↑, investment ↓. Rupee depreciation → exports more competitive, imports dearer.; These are tendencies, not guarantees. They depend on elasticity, hedging and other factors.
Current account balance: CA = (X − M) + net primary income + net secondary income; X = exports of goods and services, M = imports. A positive value is a surplus, a negative value is a deficit.
Trade balance: Trade balance = exports − imports; Can be stated for goods only (visible balance) or goods and services together. Check which one the question wants.
Overall BoP identity: Current account + capital account + financial account + errors and omissions = 0; Sign conventions differ by source. Use the one in the question and state it. Reserve changes sit in the financial account in modern presentation.
Tariff effect on price (small country): Domestic price = world price + tariff; For a specific tariff, add the amount per unit. For an ad valorem tariff, price = world price × (1 + rate).
Tariff revenue: Revenue = tariff per unit × quantity imported after the tariff; Use the post-tariff import quantity, not the original one.
Terms of trade: Terms of trade = (index of export prices ÷ index of import prices) × 100; A rise means each unit of exports buys more imports.

Quick revision

Macro conditions affect firms through demand, costs, funding and competitiveness.
The business cycle has expansion, peak, contraction and trough phases, and firms plan differently in each.
Economic growth is a rise in real output over time, so it is measured after removing price changes.
Inflation is a sustained rise in the general price level, and deflation is a sustained fall.
Unanticipated inflation hurts planning, contracts and fixed-price commitments more than expected inflation.
Higher interest rates raise borrowing costs and tend to reduce investment and consumer spending.
A weaker domestic currency tends to help exporters and raise import costs, all else equal.
A stronger domestic currency makes exports dearer abroad and imports cheaper.
Trade and globalisation widen markets but increase competition and exposure to foreign shocks.
Always add 'all else equal' or a caveat when stating a direction of effect.
The same macro change can help one firm and hurt another, so tie your answer to the business given.

Common mistakes

Using nominal GDP to claim the economy has grown. Fix: Compare real GDP, or deflate the nominal figure by a price index before judging growth.
Saying all firms gain in a boom and lose in a slump. Fix: Separate normal, inferior, luxury and necessity goods. Inferior goods can do better when incomes fall.
Treating economic growth and the business cycle as the same thing. Fix: Say growth is the long-run trend in potential output and the cycle is the short-run fluctuation around that trend.
Calling any one quarter of falling GDP a recession. Fix: State the rule as two consecutive quarters of falling real GDP, and note that definitions can differ.
Treating a one-off price rise as inflation. Fix: Inflation is a sustained rise in the general price level, not one price changing.
Confusing deflation with disinflation. Fix: Disinflation means inflation is lower but still positive. Deflation means the price level itself is falling, so inflation is negative.
Saying a rise in ₹ per $ means the rupee has strengthened. Fix: A higher ₹ per $ means more rupees are needed per dollar. The rupee is weaker.
Using the same percentage for the rise in the quote and the fall in the rupee's value. Fix: Work out each from its own base. Rate from ₹80 to ₹84 is +5%. The rupee's dollar value falls by 4.76%.
Saying the balance of payments can be in deficit overall in the same way as a household budget. Fix: Remember the full BoP balances by construction. A deficit refers to one account, usually the current account, which is financed by the financial account or by reserves.
Putting foreign direct investment in the current account. Fix: Investment in assets goes in the financial account. Only the income earned on it, such as profits, goes in the current account.

Exam tips

Always link an indicator to a firm-level effect. A definition on its own earns few marks.
Show the formula and the working for any growth or inflation figure, even when it is simple.
Use the product type, such as luxury, necessity or inferior, to make your demand argument specific.
In written answers, give both an effect and a response, then add one caveat about size or timing.
For multiple-choice questions, check whether the figures are real or nominal before choosing an option.
Define growth and the cycle separately in the first line. Examiners reward that clear distinction.
Always link the phase to the firm. A description of the cycle alone earns few marks.
Use real GDP in calculations and show the formula before substituting numbers.