Transcript Macroeconomics

Macroeconomics
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Macroeconomic
objectives
• Distinction between microeconomics and
macroeconomics
• The major macroeconomic issues
– Economic growth
– Unemployment
– Inflation
– Balance of payments and exchange rates
• balance of payments deficits and surpluses
• exchange rate movements
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Economic Fluctuations
• Economic fluctuations are irregular and
unpredictable
• Most macroeconomic quantities fluctuate
together
– Most macroeconomic variables that measure
some type of income or production fluctuate
closely together.
– Although many macroeconomic variables
fluctuate together, they fluctuate by different
amounts.
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Economic Fluctuations
• As output falls, unemployment rises.
– Changes in real GDP are inversely related to
changes in the unemployment rate.
– During times of recession, unemployment
rises substantially.
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Measuring Nation’s Income
• Gross Domestic Product (GDP)
– A measure of the total income and
expenditures of an economy
• For an economy as a whole, income must
equal expenditure because:
– Every transaction has a buyer and a seller.
– Every dollar of spending by some buyer is a
dollar of income for some seller.
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GDP
• Output is valued at market
The market value…
prices
…of all final …
• Not intermediate
…goods and services…
• Tangibles and intangibles
…produced…
• Currently, not past
…within a country…
• Geographic boundaries
…in a given period of time. • Usually a year or a quarter
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GDP
Y
C
I
G
NX
Y = C + I + G + NX
= GDP
= Consumption – household
spending
= Investment – spending on capital
equipment
= Government purchases – No
transfer payments
= net exports – exports-imports
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GDP
• Nominal GDP
– Values the production of goods and services
at current prices.
• Real GDP
– Values the production of goods and services
at constant prices.
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Measuring Cost of Living
• Consumer Price Index (CPI)
– A measure of the overall cost of the goods
and services bought by a typical consumer.
• When the CPI rises, the typical family has
to spend more dollars to maintain the
same standard of living.
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Calculating CPI
1. Fix the basket
– Determine which prices are most important to the
typical consumer.
2. Find the prices
– Find the prices of each of the goods and services in
the basket for each point in time.
3. Calculate the basket’s cost
– Calculate the cost of the basket of goods and
services at different times.
4. Choose a base year and compute the index
– Divide the price of the basket in one year by the
price in the base year and multiplying by 100.
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Calculating CPI
An Example
• Step 1: Survey consumers to determine a
fixed basket of goods
4 hotdogs and 2 hamburgers
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Calculating CPI
An Example
• Step 2: Find the price of each good in
each year
Year
Hotdogs
Burgers
2008
$1
$2
2009
$2
$3
2010
$3
$4
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Calculating CPI
An Example
• Step 3: Compute the cost of the basket of
goods and services in each year.
2008
($1x4) + ($2x2) = $8 per basket
2009
($2x4) + ($3x2) = $14 per basket
2010
($3x4) + ($4x2) = $20 per basket
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Calculating CPI
An Example
• Step 4: Choose one year as a base year
(2008) and compute the CPI in each year
2008
($8 / $8) x 100 = 100
2009
($14 / $8) x 100 = 175
2010
($20 / $8) x 100 = 250
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Problem in measuring
the cost of living
•
•
•
•
Substitution bias
Introduction of new goods
Unmeasured quality changes
The CPI overstates inflation by about 1
percentage point per year
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Inflation
• A situation in which the economy’s overall
price level is rising.
• The inflation rate is the percentage
change in the price level from the previous
period.
CPIyear2 - CPIyear1
Inflation rateyear2 
x 100
CPIyear1
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Inflation Rate
• Use the CPI to compute the inflation rate
from previous year (using previous
example)
2009
(175 – 100) / 100 x 100 = 75%
2010
(250 – 175) / 175 x 100 = 43%
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Monetary System
• Money?
– the set of assets in an economy that people
regularly use to buy goods and services from
other people.
• Three function of money:
– Medium of exchange
– Unit of account
– Store of value
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The types of money
• Commodity money
– Takes the form of a commodity with intrinsic
value e.g. gold, silver, cigarettes.
• Fiat money
– used as money because of government
decree and it does not have intrinsic value e.g.
coins, bank notes, cheque deposits.
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The Quantity Theory of
Money
• The quantity of money available
determines the price level and that the
growth rate in the quantity of money
available determines the inflation rate
• If we would all like more money, why
doesn’t the government simply print a lot
more?
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Unemployment
• The meaning of 'unemployment'
– Those of working age who are without work,
but who are available for work at current wage
rates
Number of unemployed
Unemployment rate 
x 100
Labor force
• Labor Force?
– Those in employment plus those unemployed
• Costs of unemployment?
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The Banking System
• Retail banking
– Retail deposits and loans at published interest
rates and charges mainly with individual
• Wholesale banking
– Wholesale deposits and loans at negotiable
interest rates and charges mainly with firms
and other financial institutions
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The Central Bank
• Note issue
• Banking functions
• Management of government’s borrowing
program
• Oversees the activities of banks and other
financial institutions
• Operates monetary and exchange rate
policy
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Exchange Rate
• The rate at which one currency trades for
another on the foreign exchange market
• Determination of exchange rates
▪ The equilibrium exchange rate (Floating
exchange market)
▪ Shifts in currency demand and supply
▪ Appreciation – a rise in the exchange rate
▪ Depreciation – a fall in the exchange rate
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Determination of the rate of exchange
S by UK
2.20
2.00
$ price of £
b
a
1.80
Excess supply of pounds
leads to a depreciation.
1.60
1.40
1.20
D by USA
1.00
0
QD
QS
Q of £
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Determination of the rate of exchange
S by UK
2.20
$ price of £
2.00
1.80
Shortage of pounds
leads to an appreciation.
1.60
d
c
1.40
1.20
D by USA
1.00
0
QS
QD
Q of £
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Floating exchange rates: movement to a new equilibrium
•
•
•
•
•
1.50
1.40
S1
S2
1.30
€/£
fall in interest rate
rise in inflation rate
rise in aggregate demand
inward investment less attractive
speculation against depreciation
1.20
1.10
1.00
D1
0.90
D2
0.80
0
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of £
Fixed vs. Floating
• Advantages of fixed exchange rates
– certainty
– no speculation (if rate is absolutely fixed)
– prevents 'irresponsible' government
macroeconomic policies
• Disadvantages of fixed exchange rates
– conflicts with other macro objectives
– problems of international liquidity
– difficulties in adjusting to shocks
– speculation
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Fixed vs. Floating
• Advantages of free-floating rates
– automatic correction
– no problem of international liquidity
– insulation from external events
– less constraints on domestic macro policy
• Disadvantages of free-floating rates
– possibly unstable exchange rates
– speculation
– uncertainty for business
• but use of forward markets
– lack of discipline on economy
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