Transcript Chapter 11

Introduction to
Macroeconomics
Chapter 11
Macroeconomics
• We will now shift perspectives
• We will look at the economy as a whole
– Micro vs. macro
Comparing Micro and
Macro
Perspectives
Perspectives on War – Micro:
Perspectives on War Micro:
Perspectives on War…Macro: It’s “just”
numbers …
• World War II death toll …
Perspectives on War…Macro:
Perspectives on the Economy
Micro:
Perspectives on the Economy
Micro:
Perspectives on the Economy
Macro:
Perspectives on the Economy
Macro:
Introduction to Macroeconomics
• In Micro we asked questions about
individual …
– People – How do we optimize?
– Firms – How do they compete?
– Markets – How do they work and function, well or
badly, as a system based on price signals?
Introduction to Macroeconomics
• In Macro we will ask questions about
“aggregates” …
– the summation of all the micro effects
Introduction to Macroeconomics
• National Product:
– How big a pie can society sustainably produce?
– Why aren’t we always producing up to that full
sustainable capacity … to our potential?
Introduction to Macroeconomics
• Unemployment:
• Why does it happen?
• What causes it to persist?
Introduction to Macroeconomics
• Inflation/Deflation:
– What causes the purchasing power of our money
to fall/rise?
– Why are such changes a problem?
Introduction to Macroeconomics
• Growth:
– What causes the size of the economy’s potential
production to grow?
Introduction to Macroeconomics
• Method: As with Micro, we…
– Define terms
– Construct model
– Develop the model’s capacity to address our
questions
Macro – Defining Terms
• Gross Domestic Product (GDP) –
– Aggregate final production in a given
economy (domestic…within Nation’s borders) in a
given year.
– We’re going to use a “Y” to represent real GDP
What do you think? (Included in
GDP?)
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•
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•
A new house?
A used house?
The realtor's fee on the used house?
All the products used to produce the new
house? (nails, shingles, siding etc...)
What is included...
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•
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•
A new house?...Yes
A used house?...No
The realtor's fee on the used house?...Yes
All the products used to produce the new
house (nails, shingles, siding etc...)?...No
(secondary goods)
Macro – Defining Terms
• Gross Domestic Product (GDP) -We’ll
distinguish between:
– YF – full sustainable capacity real GDP or potential
GDP – how big a “pie” could sustainably be
produced and…
– Y - actual current real GDP – how big the “pie” is
Business Cycles
• Period of macroeconomic expansion followed
by contraction
Macro – Defining Terms
• Phases of Business Cycles
– Expansion…period of economic growth measured by a rise
in real GDP (Y)
• Growth being a steady, long term rise in GDP (Y)
• Plentiful jobs, falling unemployment
– Recession: two consecutive quarters of declining Y
– Depression: extended, deep decline in Y
– Staglfation: decline in real GDP combined with inflation
• A “caveat” or warning to keep in mind: Y is not a great
measure of well being
– Standard of living vs. quality of life
Phases of Business Cycles (cont.)
• Peak…height of economic expansion
• Contraction…economic decline marked by
falling real GDP
• Trough…bottom of contraction
Keeping the Cycle
• Typically, a sharp rise or fall in a key indicator
sparks a series of events
• 4 main indicators
– Business investment
– Interest rates and credit
– Consumer expectations
– External shocks (positive or negative)
Forecasting Business Cycles
• Not easy to predict…have to predict a change
in real GDP
• Use leading indicators (economic variables)
– Stock market
– Interest rates
– Orders of capital goods
– Housing starts
Limitations of GDP
Nonmarket Activities
GDP does not measure goods and
services that people make or do
themselves, such as caring for
children, mowing lawns, or cooking
dinner.
The Underground Economy
There is much economic activity
which, although income is
generated, never reported to the
government. Examples include
black market transactions and
"under the table" wages.
Negative Externalities
Unintended economic side effects,
such as pollution, have a monetary
value that is often not reflected in
GDP.
Quality of Life
Although GDP is often used as a
quality of life measurement, there
are factors not covered by it. These
include leisure time, pleasant
surroundings, and personal safety.
Economic Growth
• A change in GDP over time illustrates growth
• For growth to occur, it should change with
population
• Real GDP per capita measures such growth
and the standard of living
Capital Deepening
• The process of increasing capital per worker
• Goal is to increase productivity
• Savings and investing lead to capital
deepening
Population
• Increased population without capital
deepening will lower the standard of living
• Increased population without increase in
production will lower the standard of living
Government
• Taxes can increase or decrease capital
deepening
• It is dependant upon what the taxes are spent on
Foreign Trade
• Foreign trade and running a trade deficit can
actually be good in some ways
– If the goods being trading enhance capital
deepening
– In the long run…this capital deepening can
increase productivity and help to pay back debt
that results from a trade deficit
Labor Force and Unemployment
Macro – Defining Terms
• Labor force (LF) vs. (voluntary unemployed)
– LF includes all those adults who want to be
participating in the market system as a worker
– By that standard: Who would be voluntarily
unemployed?
Macro – Defining Terms
• Within the Labor force (LF) some are
employed (EMP) and some are unemployed
(UEMP), so…
LF
EMP
UNEMP
Unemployment Rate is the % of the LF that is UNEMP
Unemployment
• Within the unemployed (UEMP), there are
several sources/types of unemployment:
– Structural Unemployment
– Frictional Unemployment
– Demand Deficient (Cyclical) Unemployment
Structural Unemployment
• Structural Unemployment
– There is a job available
– There is a worker looking for a job, but …
the worker’s skills don’t match the
job’s requirements
How could this happen in significant numbers?
Structural Unemployment
• Due to technological change the workers’ skills
become outdated …
– We expect this to happen in a growing, dynamic
economy
– There will always be some structural
unemployment in a healthy, growing economy
– It would only disappear in a stagnant economy,
and we don’t want that
Frictional Unemployment
• Frictional Unemployment
– There is a job available
– There is a worker with the right skills looking for a
job, but …
the worker is still searching for the job.
How could this happen in significant numbers?
Frictional Unemployment
• Frictional Unemployment
– Job search takes time …
– This time spent searching is beneficial to the
individual and to a growing, dynamic economy
– We want individuals to find the right job for their
skills, not just take the first job they find
– This is more productive for the individual and
society.
Frictional Unemployment
• Frictional Unemployment
– We can help facilitate workers’ search process
– But there will always be some frictional
unemployment in a healthy, growing economy…
– It would only disappear in a stagnant economy,
and we don’t want that.
Demand Deficient Unemployment
• Demand Deficient (Cyclical) Unemployment
– This represents the unemployment caused by a
lack of job opportunities …
– Not enough jobs for the workers who want to be
employed
– No amount of training or search will solve this
problem.
Demand Deficient Unemployment
• Demand Deficient Unemployment is NOT a
part of a healthy, growing economy
– It represents wasted resources and lower standard
of living
– This is a Macro problem that urgently needs
attention
Unemployment Types and Rate
• Recall the UR is the % of the LF that is UNEMP
– Of the three kinds of UNEMP two, structural and
frictional, are a natural part of a healthy and
growing economy.
• Since structural and frictional unemployment
are a natural part of a healthy and growing
economy…
– We call that part of the overall UR that consists of
structural and frictional unemployment the:
Natural Rate of Unemployment
Natural Rate of Unemployment
• So suppose the government’s reported
unemployment rate is 7%...
– If the natural rate is 5%, that means that there’s
2% that is not part of a healthy growing
economy… so that 2% must be demand deficient
unemployment.
Natural Rate
• The Natural Rate (NR) plays a central role
policy discourse for it represents the
unemployment condition we’d find in a
healthy, growing economy
• As such, by comparing the actual UR to
the NR, we can see how close/far the
economy is from a healthy, growing
condition
Natural Rate
• The problem with this standard of macro
economic health is that there is disagreement
about the standard.
– Some economists argue that the NR is 4.5-5.0%...
– Others put it at 6.0-6.5%
– It’s very difficult to directly measure the NR, thus
the potential for differences
Natural Rate
• Given these different views of the NR it’s possible
for two economists to look at the same reported
UR, say 5.5%, and for one to say the UR is above
the NR so we have demand deficient
unemployment and therefore slack in the
economy …
• And the other to say that the UR is below the NR
(which we’ll see is possible) and thus, as we will
see, we are putting too much pressure on the
economy
Unemployment Terms
LF
EMP
UNEMP
Demand Structural Frictional
Deficient
YF
Natural Rate
The NR is achieved
when the economy
is effectively
using all its resources
The economy is at YF
when all resources are
being used effectively
So …
Natural Rate
Natural Rate
YF
When the economy is at the Natural Rate then we
know that it’s also at YF - Full sustainable capacity real
GDP …
and vice versa
Thus they are proxies for one another
Macro –Arranging Terms
• When the economy is at the Natural Rate…at YF…it’s
using its resources most efficiently and effectively
– There’s no “slack”
• There is a micro condition that must be true
for this macro case to be true…
• What is it??
General Competitive Equilibrium (GCE)
Micro/Macro Connection
• Macro is just the aggregate condition that is
created by all the micro conditions so it
follows that for the macro economy to be
healthy (NR/YF), the micro economy must be
healthy (at GCE)
Macro Conditions:
Y = YF
UNEMP = NR
Y < YF
UNEMP > NR
Slack
Y > YF
UNEMP < NR
Pressure
The Goal (GCE)
Inflation and Prices
Price Levels
• Price Level – the cost of living
• Measured by the market basket…
– The aggregate cost of the “things” we buy.
– When the cost of that market basket goes up,
that’s inflation
– When the cost of that market basket goes down,
that’s deflation
Inflation/Deflation - Problems
• Inflation – very corrosive to national “psyche”
if it is too fast…
– many are making desperate efforts to keep up
with “cost of living”
– discourages investment
– it raises interest rates because …
• lenders charge higher interest to cover the anticipated
loss of buying power in the dollars they’ll receive in the
future
Inflation/Deflation - Problems
• Inflation – Distributive effects
• There are winners and losers –
– those who can keep up do fine, but those who
can’t see their standard of living fall
Inflation/Deflation - Problems
• Deflation –
– Discourages consumption
• Individuals hold back on buying in anticipation of lower
prices in the future
– Discourages investment
• Borrowers will have to pay back in more valuable
dollars (dollars with more buying power) than the ones
they borrowed
– Distributive effects
• Those who need to borrow are in a very difficult
position
Measuring Price Level to Determine
Inflation/Deflation
• Consumer Price Index (CPI) – one measure of
the price level
• “A dollar doesn’t buy what it used to!
• http://www.bls.gov/data/inflation_calculator.
htm
Measuring Price Level to Determine
Inflation/Deflation
• Calculating the CPI:
• Government determines what’s in a “standard
market basket” (food, entertainment, housing,
recreation) of a “normal” family of four and it
identifies a “base year”
– a year that will be the reference or orientation
year in which a dollar is worth its full value, in real
purchasing power
Measuring Price Level in a Target Year
Cost basket in base year: CB
Cost of basket in target year
CT
Measuring Consumer Price Index in
Target Year
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CPIT = (CT/CB) × 100
CT = 250
CB = 125
Then…CPIT = 200
Consumer Price Index
• Consumer Price Index (CPI) – What it
represents in our example:
– If in the base year a dollar is worth 100 cents in
purchasing power, in the target year it takes 200
cents to buy the same market basket
CPI and Inflation/Deflation
• Consumer Price Index (CPI) and measuring
Inflation/Deflation
– Measuring % Change in price level from year X to
year Y
– % Change in price level = [(CPIY – CPIX) ⁄ CPIX] ×
100
– If CPIX = 100 and CPIY = 125, then % Change in
Price Level = [(125 – 100) ⁄ 100] × 100 = 25%
Real vs. Nominal
• Real values reflect what is actually so while
nominal values only reflect what is apparently
so…
– A non-economic example???
Real vs. Nominal
• Comparing economic data over time
measured in current (nominal) dollars, these
nominal values may not reflect the underlying
real changes, because the dollar itself is
constantly changing in value
• Using nominal values as a measure is like
using ruler that is constantly changing length
Real vs. Nominal
• Comparing economic data, measured in
dollars (or any currency), across time:
– Supposed the measured GDP changed from
$5,000 to $10,000
• You have to ask yourself:
• Does this increase really reflect a bigger pie … more
actual, real GDP or does this increase simply reflect a
rise in the price level that doubled the apparent,
nominal GDP?
Real vs. Nominal
• Nominal values include both real and price
effects, because …
– Nominal value = Real value × Price level
• How much of the nominal change is real
depends on how much of the nominal change
is caused by a change in the price level
• To determine that …
Real vs. Nominal
• We divide out the price effect:
– Nominal value ⁄ Price level = Real value
• When looking at economic data measured in
dollars, you should always ask yourself:
– Is this real or nominal data?
Real vs. Nominal
• If it’s real data, intertemporal comparisons are
valid because the price effects have been
divided out
• If it’s nominal data intertemporal comparisons
are meaningless because you can’t determine
how much of the change is real and how much
is the effect of a changing price level