20 Ch. Macro Overview
Economic growth is the expansion of the economys production possibilitiesan outward shifting PPF. We measure economic growth by the increase in real GDP. Real GDPreal gross domestic productis the value of the total production of all the nations farms, factories, shops, and offices, measured in the prices of a single year.
Economic Growth and Fluctuations
Economic Growth in the United States Figure 20.1 shows real GDP in the United States from 1962 to 2002. The figure highlights: Fluctuations of real GDP Smoother growth of potential GDP
Economic Growth and Fluctuations
Potential GDP is the value of real GDP when all the economys labor, capital, land, and entrepreneurial ability are fully employed. During the 1970s and early 1980s, real GDP growth sloweda productivity growth slowdown.
Economic Growth and Fluctuations
Real GDP fluctuates around potential GDP in a business cyclea periodic but irregular upand-down movement in production.
Economic Growth and Fluctuations
Every business cycle has two phases: 2. A recession 3. An expansion and two turning points: 5. A peak 6. A trough A recession is a period during which real GDP decreases for at least two successive quarters. An expansion is a period during which real GDP increases.
Economic Growth and Fluctuations
Figure 20.3 shows the long-term growth trend and cycles.
Jobs and Unemployment
Jobs The U.S. economy created around 2 million jobs a year, on the average during the 1990s. But the number fluctuates and since 2001 the pace of job creation has been slow.
Jobs and Unemployment
Unemployment Unemployment is a state in which a person does not have a job but is available for work, willing to work, and has made some effort to find work within the previous four weeks. The labor force is the total number of people who are employed and unemployed. The unemployment rate is the percentage of the people in the labour force who are unemployed. A discouraged worker is a person who available for work, willing to work, but who has given up the effort to find work.
Jobs and Unemployment
Unemployment in the United States Figure 20.6 shows the unemployment rate in the United States since 1926. During the 1930s, the unemployment rate hit 20 percent The lowest rate occurred during World War II at 1.2 percent
Jobs and Unemployment
Unemployment Around the World Figure 20.7 compares the unemployment rate in the United States with those in Western Europe, Japan, and the United States. U.S. unemployment, on the average, lies in the middle of the other countries shown.
Jobs and Unemployment
Why Unemployment Is a Problem Unemployment is a serious economic, social, and personal problem for two main reasons: Lost production and incomes Lost human capital The loss of a job brings an immediate loss of income and productiona temporary problem. A prolonged spell of unemployment can bring permanent damage through the loss of human capital.
Inflation
Inflation is a process of rising prices. We measure the inflation rate as the percentage change in the average level of prices or the price level. The Consumer Price Indexthe CPIis a common measure of the price level.
Inflation
Inflation in the United States Figure 20.8 shows the inflation rate in the United States since 1961. Inflation was low during the 1960s Inflation increased during the 1970s Inflation was lowered in two waves during the 1980s and 1990s
Inflation
Inflation Around the World Figure 20.9 shows the inflation rate in the United States compared with other countries. U.S. inflation has been similar to that in other industrial countries U.S. inflation has been much lower than that in developing countries
Surpluses and Deficits
Figure 20.10(a) shows the changing surplus and deficit of the federal and provincial governments in the United States since 1971. Persistent federal deficit during the 1970s through 1990s. Surplus since 1998
Surpluses and Deficits
International Surplus and Deficit If a nation imports more than it exports, it has an international deficit. If a nation exports more than it imports, it has an international surplus. The current account deficit or surplus is the balance of exports minus imports plus net interest paid to and received from the rest of the world.
Surpluses and Deficits
Figure 20.10(b) shows The U.S. current account balance since 1962. Persistent current account deficit since 1983 The deficit has swollen during the past few years
Macroeconomic Policy Challenges and Tools
Five widely agreed policy challenges for macroeconomics are to: 2. Boost economic growth 3. Keep inflation low 4. Stabilize the business cycle 5. Reduce unemployment 6. Reduce government and international deficits
Macroeconomic Policy Challenges and Tools
Two broad groups of macroeconomic policy tools are : Fiscal policymaking changes in tax rates and government spending Monetary policychanging interest rates and changing the amount of money in the economy
Ch.21 Gross Domestic Product
GDP Defined GDP or gross domestic product, is the market value of all final goods and services produced in a country in a given time period. This definition has four parts: Market value Final goods and services Produced within a country In a given time period
Gross Domestic Product
Y = C + I + G + (X M) or Income = Output
Gross Domestic Product
We can see these three sources of investment finance by using the fact that aggregate expenditure equals aggregate income. Start with Y = C + S + T = C + I + G + (X M). Then rearrange to obtain I = S + (T G) + (M X) Private saving S plus government saving (T G) is called national saving.
Gross Domestic Product
Gross investment is the total amount spent on purchases of new capital, either for purposes of increasing the capital stock or for replacing depreciated capital. Net investment is the change in the stock of capital and equals gross investment minus depreciation. What is the smallest value that gross investment can be for any given period of time, say, one year? What is the smallest value that net investment can be in any given year?
Gross Domestic Product
Figure 21.2 illustrates the relationships among capital, gross investment, depreciation, and net investment. CS(t+1) = CS(t) + GI(t+1) Depreciation(t+1) CS(t+1) = CS(t) + NI(t+1)
Measuring U.S. GDP
The Bureau of Economic Analysis uses two approaches to measure GDP The expenditure approach measures GDP as the sum of consumption expenditure, investment, government purchases of goods and services, and net exports. The income approach measures GDP by summing the incomes that firms pay households for the factors of production they hire.
Measuring U.S. GDP
The National Income and Product Accounts divide incomes into five categories Compensation of employees Net interest Rental income Corporate profits. Proprietors income. The sum of these five income components is net domestic income at factor cost.
Measuring U.S. GDP
Two adjustments must be made to get GDP Indirect taxes minus subsidies are added to get from factor cost to market prices. Depreciation (or capital consumption) is added to get from net domestic product to gross domestic product. Table 21.2 in the textbook shows the income approach with data for 2003.
Real GDP and the Price Level
Real GDP is the value of final goods and services produced in a given year when valued at constant prices. Calculating Inflation and Real GDP Laspeyres: Base year quantities or prices as weights Paasche: Terminal year quantities or prices as weights Fisher: Geometric mean of Laspeyres*Paasche ln(Expenditure Ratio) = %P + %Q
Real GDP and the Price Level
The new method of calculating real GDP, which is called the chain-weighted output index method, uses the prices of two adjacent years to calculate the real GDP growth rate.
Real GDP and the Price Level
Calculating the Price Level The average level of prices is called the price level. One measure of the price level is the GDP deflator, which is an average of the prices of the goods in GDP in the current year expressed as a percentage of the base year prices. The GDP deflator is calculated in the table on the next slide (and in Table 21.7 in the textbook).
Real GDP and the Price Level
Deflating the GDP Balloon We use the GDP deflator to let the air out of the nominal GDP balloon and reveal real GDP.
Measuring Economic Growth
We use real GDP to calculate the economic growth rate. The economic growth rate is the percentage change in the quantity of goods and services produced from one year to the next. We measure economic growth so we can make: Economic welfare comparisons International welfare comparisons Business cycle forecasts
Measuring Economic Growth
Economic Welfare Comparisons Economic welfare measures the nations overall state of economic well-being. Real GDP is not a perfect measure of economic welfare for seven reasons: 1. Quality improvements tend to be neglected in calculating real GDP so the inflation rate is overstated and real GDP understated. 2. Real GDP does not include household production, that is, productive activities done in and around the house by members of the household.
Measuring Economic Growth
Economic Welfare Comparisons 3. Real GDP, as measured, omits the underground economy, which is illegal economic activity or legal economic activity that goes unreported for tax avoidance reasons. 4. Health and life expectancy are not directly included in real GDP. 5. Leisure time, a valuable component of an individuals welfare, is not included in real GDP. 6. Environmental damage is not deducted from real GDP. 7. Political freedom and social justice are not included in real GDP.
Measuring Economic Growth between Countries
Using purchasing power parity prices leads to an estimate that per person GDP in the United States is (only) 12 times that in China see Figure 21.4.
Ch. 22 Jobs, Prices, Business Cycles
The business cycle is the periodic but irregular up-anddown movement in production and jobs. The NBER defines the phases and turning points of the business cycle as follows: A recession is a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion.
The Business Cycle
Business Cycle Dates Figure 22.1 shows the percentage change in real GDP over each cycle between 1928 and 2003.
Jobs and Wages
Figure 22.2 shows the population labor force categories for 2003.
Jobs and Wages
To be considered unemployed, a person must be: without work and have made specific efforts to find a job within the past four weeks, or waiting to be called back to a job from which he or she was laid off, or waiting to start a new job within 30 days.
Jobs and Wages
Three Labor Market Indicators The unemployment rate is the percentage of the labor force that is unemployed. The unemployment rate is (Number of people unemployed/Labor force) 100. The unemployment rate reaches its peaks during recessions.
Jobs and Wages
Three Labor Market Indicators Figure 22.3 shows the three labor market indicators for 19632003.
Jobs and Wages
Figure 22.4 shows the changing face of the labor market participation rates and employment-topopulation ratios for males and females separately.
Jobs and Wages
Real Wage Rate The real wage rate is the quantity of goods and services that can be purchased with an hours work. The real wage rate equals the money wage rate divided by the price levelthe GDP deflator. Three measures are Hourly earnings in manufacturing Total wages and salaries per hour Total wages, salaries, and supplements per hour
Jobs and Wages
Figure 22.6 shows the three measures of real wage rates for 19632003.
Unemployment and Full Employment
The Anatomy of Unemployment Three types of people are unemployed Job losersworkers who have been laid off or fired and are searching for new jobs. Job leaversworkers who have voluntarily quit their jobs to look for new ones. Job leavers are the smallest fraction of the unemployed. Entrants and reentrantspeople entering the labor force for the first time or returning to the labor force and searching for work.
Unemployment and Full Employment
Figure 22.7 illustrates the labor market flows between the different states.
Unemployment and Full Employment
The duration of unemployment increases during recessions and Figure 22.9 shows unemployment by duration close to a business cycle peak in 2000 and close to a trough in 2002.
Unemployment and Full Employment
Unemployment Rate Decomposition (weeks) Ur = (Ave. Spells*Ave. Duration per Spell)/52 Ur = (Sbar * Dbar)/52 Types of Unemployment Unemployment can be classified into three types: Frictional Structural Cyclical
Unemployment and Full Employment
Full Employment Full employment occurs when there is no cyclical unemployment or, equivalently, when all unemployment is frictional or structural. The unemployment rate at full employment is called the natural rate of unemployment: NAIRU. The natural rate of unemployment is estimated to have been around 6 percent on the average in the United States, but during the 1990s, the natural unemployment rate fell below 6 percent.
Unemployment and Full Employment
Figure 22.11 shows real GDP, and the unemployment rate... and estimates of potential GDP and the natural unemployment rate, for 1983 2003.
The Consumer Price Index
The price level is the average level of prices and is measured by using a price index. The consumer price index, or CPI, measures the average level of the prices of goods and services consumed by an urban family. 80,000 items in the market basket are priced each month. A Laspeyres computation is used, thus inflation is overstated and real growth is also overstated.
The Consumer Price Index
Figure 22.12 illustrates the CPI basket. Housing is the largest component. Transportation and food and beverages are the next largest components. The remaining components account for only 26 percent of the basket.
The Consumer Price Index
Measuring Inflation The main purpose of the CPI is to measure inflation. The inflation rate is the percentage change in the price level from one year to the next. The inflation formula is: Inflation rate = [(CPI this year CPI last year)/CPI last year] 100.
The Consumer Price Index
Figure 22.13 shows the CPI and the inflation rate, 1973 2003.
The Consumer Price Index
The Biased CPI: Boskin Commission The CPI may overstate the true inflation for four reasons Laspeyres calculation New goods bias Quality change bias Commodity substitution bias Outlet substitution bias.
Ch 23. Aggregate Supply/Demand & Inflation Dynamics
Aggregate Supply Fundamentals The aggregate quantity of goods and services supplied depends on three factors: The quantity of labor (L ) The quantity of capital (K ) The state of technology (T ) The aggregate production function shows how quantity of real GDP supplied, Y, depends on labor, capital, and technology: Y = f(L, K, T).
Aggregate Supply
Long-Run Aggregate Supply The macroeconomic long run is a time frame that is sufficiently long for all adjustments to be made so that real GDP equals potential GDP and there is full employment. The long-run aggregate supply curve (LAS) is the relationship between the quantity of real GDP supplied and the price level when real GDP equals potential GDP.
Aggregate Supply
Figure 23.1 shows an LAS curve with potential GDP of $10 trillion. The LAS curve is vertical because potential GDP is independent of the price level. Along the LAS curve all prices and wage rates vary by the same percentage so that relative prices and the real wage rate remain constant.
Aggregate Supply
Short-Run Aggregate Supply The macroeconomic short run is a period during which real GDP has fallen below or risen above potential GDP. At the same time, the unemployment rate has risen above or fallen below the natural unemployment rate. The short-run aggregate supply curve (SAS) is the relationship between the quantity of real GDP supplied and the price level in the short-run when the money wage rate, the prices of other resources, and potential GDP remain constant.
Aggregate Supply
The SAS curve is upward sloping because: A rise in the price level with no change in costs induces firms to bear a higher marginal cost and increase production. A fall in the price level with no change in costs induces firms to decrease production to lower marginal cost. Along the SAS curve, real GDP might be above potential GDP or below potential GDP.
Aggregate Supply
Movement along the LAS and SAS Curves A change in the price level with an equal percentage change in the money wage causes a movement along the LAS curve. A change in the price level with no change in the money wage causes a movement along the SAS curve.
Aggregate Supply
Figure 23.4 shows how these factors shift the LAS curve and have the same effect on the SAS curve.
Aggregate Supply
Figure 23.5 shows the effect of a change in the money wage rate on aggregate supply. A rise in the money wage rate decreases short-run aggregate supply and shifts the SAS curve leftward. But it has no effect on long-run aggregate supply.
Aggregate Demand
The Aggregate Demand Aggregate Curve demand is the relationship between the quantity of real GDP demanded and the price level. The aggregate demand (AD) curve plots the quantity of real GDP demanded against the price level. Buying plans depend on many factors and some of the main ones are: The price level Expectations Fiscal and monetary policy The world economy
Aggregate Demand
Figure 23.6 shows an AD curve. The AD curve slopes downward for two reasons A wealth effect Substitution effects
Intertemporal International
Aggregate Demand
Changes in Aggregate Demand A change in any influence on buying plans other than the price level changes aggregate demand. The main influences on aggregate demand are Expectations Fiscal and monetary policy The world economy.
Aggregate Demand
Figure 23.7 illustrates changes in aggregate demand. When aggregate demand increases, the AD curve shifts rightward and when aggregate demand decreases, the AD curve shifts leftward.
Short Run Macroeconomic Equilibrium
Figure 23.8 illustrates a short-run equilibrium. If real GDP is below equilibrium GDP, firms increase production and raise prices and if real GDP is above equilibrium GDP, firms decrease production and lower prices.
Macroeconomic Equilibrium
Long-run macroeconomic equilibrium occurs when real GDP equals potential GDPwhen the economy is on its LAS curve. Long-run equilibrium occurs where the AD and LAS curves intersect and results when the money wage has adjusted to put the SAS curve through the long-run equilibrium point.
Macroeconomic Equilibrium
Economic Growth Economic growth occurs because the quantity of labor grows, capital is accumulated, and technology advances, all of which increase potential GDP and bring a rightward shift of the LAS curve.
Macroeconomic Equilibrium
Inflation Inflation occurs the forces of AD grow faster than potential GDP, which increases aggregate demand by more than long-run aggregate supply. The AD curve shifts rightward faster than the rightward shift of the LAS curve.
Macroeconomic Equilibrium
Fluctuations in Aggregate Demand Firms increase production and rise pricesa movement along the SAS curve.
Macroeconomic Equilibrium
Fluctuations in Aggregate Demand The money wage rate begins to rise and short-run aggregate supply begins to decrease. The SAS curve shifts leftward. The price level rises and real GDP decreases until it has returned to potential GDP.
Macroeconomic Equilibrium
Fluctuations in Aggregate Supply Figure 23.13 shows the effects of a decrease in aggregate supply. Starting at long-run equilibrium, a rise in the price of oil decreases short-run aggregate supply and the SAS curve shifts leftward.
Macroeconomic Equilibrium
Fluctuations in Aggregate Supply Real GDP decreases and the price level rises. The combination of recession combined with inflation is called stagflation.
U.S. Economic Growth, Inflation, and Cycles
From1963 to 2003: Real GDP and potential GDP grew from $2.8 trillion to $10.3 trillion. The price level rose from 22 to 105. Business cycle expansions alternated with recessions.
Ch 24 (part) Investment, Saving, and the Interest Rate
Investment Decisions Business investment decisions are influenced by The expected profit rate The real interest rate
Investment, Saving, and the Interest Rate
Investment Demand Investment demand is the relationship between the level of planned investment and the real interest rate. Figure 24.7 illustrates an investment demand curve.
Investment, Saving, and the Interest Rate
Personal saving is personal disposable income minus consumption expenditure. Business saving is retained profits and additions to pension funds by businesses. Government saving is the governments budget surplus. Any of these components can be negative. National saving is the sum of private saving and government saving. Households divide their disposable income between consumption expenditure and saving.
Investment, Saving, and the Interest Rate
Saving is influenced by The real interest rate Disposable income Wealth Expected future income
Investment, Saving, and the Interest Rate
Saving Supply Saving supply is the relationship between saving and the real interest rate, other things remaining the same. Figure 24.8 shows a saving supply curve, which slopes upward.
Investment, Saving, and the Interest Rate
Determining the Real Interest Rate The real interest rate is determined by investment demand and supply of savings. In Figure 24.9, ID is the investment demand curve. SS is the supply of saving curve.
Ch. 29 Keynesian Model of Income Determination
Consumption Function and Saving Function Consumption and saving are influenced by Disposable income The real interest rate Real Wealth Expected future income. Price Level Disposable income is aggregate income (GDP) minus taxes plus transfer payments.
Consumption and Savings Functions
To explore the two-way link between real GDP and planned consumption expenditure, we focus on the relationship between consumption expenditure and disposable income when the other factors are constant. The relationship between consumption expenditure and disposable income, other things remaining the same, is the consumption function. And the relationship between saving and disposable income, other things remaining the same, is the saving function.
Fixed Prices and Expenditure Plans
Figure 29.1 illustrates the consumption function and the saving function.
Fixed Prices and Expenditure Plans
Marginal Propensities to Consume and Save The marginal propensity to consume (MPC) is the fraction of a change in disposable income spent on consumption. It is also the slope of the consumption function. It is calculated as the change in consumption expenditure, C, divided by the change in disposable income, YD, that brought it about. That is:
MPC = C/ YD
Fixed Prices and Expenditure Plans
The marginal propensity to save (MPS) is the fraction of a change in disposable income that is saved. It is calculated as the change in saving, S, divided by the change in disposable income, YD, that brought it about. That is:
MPS = S/ YD MPC + MPS = 1
Fixed Prices and Expenditure Plans
Slopes and Marginal Propensities Figure 29.2 shows that the MPC is the slope of the consumption function and the MPS is the slope of the saving function.
Fixed Prices and Expenditure Plans
Other Influences on Consumption Expenditure and Saving When an influence other than disposable income changesthe real interest rate, wealth, or expected future income the consumption function and saving function shift. Figure 29.3 illustrates these effects.
Fixed Prices and Expenditure Plans
The consumption function has shifted upward over time because economic growth has created greater wealth and higher expected future income. The assumed MPC in the figure is 0.9.
Fixed Prices and Expenditure Plans
Import Function In the short run, imports are influenced primarily by U.S. real GDP. The marginal propensity to import is the fraction of an increase in real GDP spent on imports. In recent years, NAFTA and increased integration in the global economy have increased U.S. imports. Removing the effects of these influences, the U.S. marginal propensity to import is probably about 0.2.
Real GDP with a Fixed Price Level
Aggregate Planned Expenditure and Real GDP Figure 29.5 shows how the aggregate expenditure curve is built from its components.
Real GDP with a Fixed Price Level
Figure 29.6 illustrates equilibrium expenditure, which occurs at the point at which the aggregate expenditure curve crosses the 45 line and there are no unplanned changes in business inventories. Figure 29.6 also illustrates the process of convergence toward equilibrium expenditure.
The Multiplier
The multiplier is the amount by which a change in autonomous expenditure is magnified or multiplied to determine the change in equilibrium expenditure and real GDP.
The Multiplier
Figure 29.7 illustrates the multiplier. The Multiplier Effect The amplified change in real GDP that follows an increase in autonomous expenditure is the multiplier effect.
The Multiplier
The Multiplier and the Marginal Propensities to Consume and Save Ignoring imports and taxes, the marginal propensity to consume determines the magnitude of the multiplier. The multiplier (k) equals 1/(1 MPC) or, alternatively, 1/MPS. This is a two-sector : C = Ca + cY I = Ia Equilibrium Condition: Y = C + I = Ca + cY + Ia Y cY = Ca + Ia Y(1 c) = Ca + Ia Y=(1/(1-c))(Ca+Ia) = k (Ca+Ia)
The Multiplier
Figure 29.8 illustrates the multiplier process and shows how the MPC determines the magnitude of the amount of induced expenditure at each round as aggregate expenditure moves toward equilibrium expenditure.
The Multiplier
Imports and Income Taxes Income taxes and imports both reduce the size of the multiplier. Including income taxes and imports, the multiplier equals 1/(1 slope of the AE curve).
The Multiplier
Business Cycle Turning Points Turning points in the business cyclepeaks and troughs occur when autonomous expenditure changes. An increase in autonomous expenditure brings an unplanned decrease in inventories, which triggers an expansion. A decrease in autonomous expenditure brings an unplanned increase in inventories, which triggers a recession.
The Multiplier and the Price Level
Aggregate Expenditure and Aggregate Demand The aggregate expenditure curve is the relationship between aggregate planned expenditure and real GDP, with all other influences on aggregate planned expenditure remaining the same. The aggregate demand curve is the relationship between the quantity of real GDP demanded and the price level, with all other influences on aggregate demand remaining the same.
The Multiplier and the Price Level
Figure 29.11 illustrates the effects of an increase in autonomous expenditure. An increase in autonomous expenditure shifts the aggregate expenditure curve upward and shifts the aggregate demand curve rightward by the multiplied increase in equilibrium expenditure.
The Multiplier and the Price Level
The increase in investment shifts the AE curve upward and shifts the AD curve rightward. With no change in the price level real GDP would increase to $12 trillion at point B.
The Multiplier and the Price Level
Real GDP increases from $10 trillion from $11.3 trillion, instead of to $12 trillion as it does with a fixed price level.
The Multiplier and the Price Level
If the increase in autonomous expenditure ...