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KAPLAN BU204 UNIT 4 Nicholas Bergan Overview Chapter 6 An overview of macroeconomics, the study of the economy as a whole, and how it differs from Microeconomics. ➤ The importance of the business cycle and why policy makers seek to diminish the severity of business cycles ➤ What long-run growth is and how it determines a country’s standard of living ➤ The meaning of inflation and deflation and why price stability is preferred ➤ What is special about the macroeconomics of an open economy, an economy that trades goods, services, and assets with other countries Macroeconomics vs. Microeconomics Microeconomics focuses on how decisions are made by individuals and firms and the consequences of those decisions. Macroeconomics, in contrast, examines the aggregate behavior of the economy—how the actions of all the individuals and firms in the economy interact to produce a particular economy wide level of economic performance. Macroeconomic Policy Economists generally believe there is a much wider role for government to play in macroeconomics—most importantly, to manage short-term fluctuations and adverse events in the economy. Modern macroeconomic toolkit; fiscal policy control of government spending Taxation Monetary policy, control over interest rates and the quantity of money in circulation—now used to manage the performance of the macroeconomy. Long Run Growth Another fundamental area of difference between microeconomics and macroeconomics is the latter’s study of long-run growth. In macroeconomics we consider questions such as: What factors lead to a higher long-run growth rate? Are there government policies capable of increasing the long-run growth rate? Microeconomics, focuses on problems that take the amount of ouput the economy is capable of producing as given. Macroeconomics, though, examines the longer run problem of how a society can increase the total amount of productive resources so that it can achieve higher rates of growth and a higher standard of living. Moreover, what governments should or shouldn’t do to promote long-run growth is also an important area of study. Why long-run growth is considered a part of macroeconomics rather than microeconomics? The subject of long-run growth fundamentally depends on the use of economic aggregates. Economic Aggregates Economic aggregates—economic measures that summarize data across many different markets for goods, services, workers, and assets. (Assets are items that serve as a store of value, like cash or real estate.) For example, macroeconomics analyzes the performance of the economy by studying aggregate output, the total output of the economy over a given time period, and the aggregate price level, a measure of the overall level of prices in the economy. Using these aggregate measures, we will study the business cycle and how fiscal policy and monetary policy can be used to manage the business cycle. These fluctuations affect unemployment, a measure of the total number of unemployed workers in the economy. Business cycle and long-run growth are affected by investment spending, additions to the economy’s supply of productive physical capital, including machines, buildings, and inventories, as well as by savings, the amount that households and the government save in a given year. We’ll see how economic interactions with other countries are analyzed using the current account, the total net amount of goods and services exported abroad, and the financial account, the total net amount of assets sold to foreigners. Great Depression Unemployment Rates GDP This led to a breakthrough in economic measurement, and many of the statistics we now rely on to track the economy’s performance first began to be collected during the 1930s. Economic theory changed dramatically with the 1936 publication of The General Theory of Employment, Interest, and Money by the British economist John Maynard Keynes— a book that ranks in influence with Adam Smith’s The Wealth of Nations. Keynes’s work, and the interpretations and critiques of his work by other economists, gave rise to both the field of macroeconomics and macroeconomic policy-making as we know it. Business Cycle The short-run alternation between economic downturns and upturns is known as the business cycle. A depression is a very deep and prolonged downturn; fortunately, the United States hasn’t had one since the 1930s. Less prolonged economic downturns known as recessions, periods in which output and employment are falling. Economic upturns, periods in which output and employment are rising, are known as expansions (sometimes called recoveries). Unemployment and Employment Employment is the number of people currently employed in the economy. Unemployment is the number of people who are actively looking for work but aren’t currently employed. The labor force is equal to the sum of employment and unemployment. Discouraged workers are nonworking people who are capable of working but have given up looking for a job. Underemployment is the number of people who work during a recession but receive lower wages than they would during an expansion due to fewer number of hours worked, lower-paying jobs, or both. Unemployment Rates The unemployment rate is the percentage of the total number of people in the labor force who are unemployed. The unemployment rate is an indicator of current job market conditions: a high unemployment rate signals a poor job market in which jobs are hard to find; a low unemployment rate indicates a good job market in which jobs are relatively easy to find. Typically during recessions the unemployment rate is rising; during expansions it is falling. Unemployment Rate = Number of unemployed workers x 100 Number of unemployed workers + Number of employed workers Aggregate Output Aggregate output is the economy’s total production of final goods and services for a given time period—usually a year. It excludes goods and services that are produced as inputs for the production of other goods (inputs are often called intermediate goods). Taming the Business Cycle Policy efforts undertaken to reduce the severity of recessions and to rein in excessively strong expansions are called stabilization policy. Monetary policy is a type of stabilization policy that involves changes in the quantity of money in circulation or in interest rates, or both. Fiscal policy is a type of stabilization policy that involves changes in taxation or in government spending, or both. Long Run Growth Secular long-run growth, or long-run growth, is the sustained upward trend in aggregate output over several decades. From 1948 to 2004, on average, the United States experienced secular long-run growth (or simply long-run growth) of real GDP of 3.5% per year, and of real GDP per capita of 2.2% per year, yielding a doubling of the American standard of living approximately every 35 years. ➤ A country can achieve a permanent increase in the standard of living of its citizens only through long-run growth. So a central concern of macroeconomics is what determines long-run growth. Inflation and Deflation A nominal measure is a measure that has not been adjusted for changes in prices over time. A real measure is a measure that has been adjusted for changes in prices over time. The aggregate price level is the overall price level for final goods and services in the economy. A rising aggregate price level is inflation. A falling aggregate price level is deflation. The economy has price stability when the aggregate price level is changing only slowly. The inflation rate is the annual percent change in the aggregate price level (negative in deflation). Open Economy Price controls are legal restrictions on how high or low a market price may go. They can take two forms: a price ceiling is a maximum price sellers are allowed to charge for a good, or a price floor, a minimum price buyers are required to pay for a good. A market or an economy is inefficient if there are missed opportunities: some people could be made better off without making other people worse off. Chapter 7 Economists keep track of the flows of money between sectors with the national income and product accounts, or national accounts. Circular Flow Diagram Revisited; Households earn income via the factor markets from wages, interest on bonds, profit accruing to owners of stocks, and rent on land. In addition, they receive government transfers from the government. Disposable income, total household income minus taxes plus government transfers, is allocated to consumer spending (C) and private savings. Via the financial markets, private savings and foreign lending are channeled to investment spending (I), government borrowing, and foreign borrowing. Government purchases of goods and services (G) are paid for by tax revenues and any government borrowing. Exports (X) generate an inflow of funds into the country from the rest of the world, but imports (IM) lead to an outflow of funds to the rest of the world. Foreigners can also buy stocks and bonds in the U.S. financial markets. Circular Flow Diagram Circular flow of funds connects the four sectors of the economy—households, firms, government, and the rest of the world—via three types of markets: the factor markets, the markets for goods and services, and the financial markets. Funds flow from firms to households in the form of wages, profit, interest, and rent through the factor markets. After paying taxes to the government and receiving government transfers, households allocate the remaining income— disposable income—to private savings and consumer spending. Via the financial markets, private savings and funds from the rest of the world are channeled into investment spending by firms, government borrowing, foreign borrowing and lending, and foreign transactions of stocks. In turn, funds flow from the government and households to firms to pay for purchases of goods and services. Finally, exports to the rest of the world generate a flow of funds into the economy and imports lead to a flow of funds out of the economy. I f we add up consumer spending on goods and services, investment spending by firms, government purchases of goods and services, and exports, then subtract the value of imports, the total flow of funds represented by this calculation is total spending on final goods and services produced in the United States. Equivalently, it’s the value of all the final goods and services produced in the United States—that is, the gross domestic product of the economy. Key terms for Circular Flow Diagram Consumer spending is household spending on goods and services. A stock is a share in the ownership of a company held by a shareholder. A bond is borrowing in the form of an IOU that pays interest. Government transfers are payments by the government to individuals for which no good or service is provided in return. Disposable income, equal to income plus government transfers minus taxes, is the total amount of household income available to spend on consumption and to save. Private savings, equal to disposable income minus consumer spending, is disposable income that is not spent on consumption. The banking, stock, and bond markets, which channel private savings and foreign lending into investment spending, government borrowing, and foreign borrowing are known as the financial markets. Government borrowing is the amount of funds borrowed by the government in the financial markets. Government purchases of goods and services are government expenditures on goods and services. Goods and services sold to residents of other countries are exports; goods and services purchased from residents of other countries are imports. Investment spending is spending on productive physical capital, such as machinery and construction of structures, and on changes to inventories. GDP Gross domestic product, or GDP, measures the value of all final goods and services produced in the economy. It does not include the value of intermediate goods and services. It can be calculated in three ways: add up the value added by all producers; add up all spending on domestically produced final goods and services, l leading to the equation GDP = C + I + G + X − IM; or add up all the income paid by domestic firms to factors of production. These three methods are equivalent because in the economy as a whole, total income paid by domestic firms to factors of production must equal total spending on domestically produced final goods and services. (X − IM), exports minus imports, is often called net exports. GDP, Further Examination The most important use of GDP is as a measure of the size of the economy, providing us a scale against which to measure the economic performance of other years, or compare the economic performance of other countries. Included Domestically produced final goods and services, including capital goods, new construction of structures, and changes to inventories Not Included Intermediate goods and services Inputs Used goods Financial assets like stocks and bonds Foreign-produced goods and services Key Terms for Gross Domestic Product Final goods and services are goods and services sold to the final, or end, user. Intermediate goods and services are goods and services—bought from one firm by another firm—that are inputs for production of final goods and services. Gross domestic product, or GDP, is the total value of all final goods and services produced in the economy during a given year. Aggregate spending, the sum of consumer spending, investment spending, government purchases, and exports minus imports, is the total spending on domestically produced final goods and services in the economy. Real GDP Real GDP is the value of the final goods and services produced calculated using the prices of a selected base year. Except in the base year, real GDP is not the same as nominal GDP, aggregate output calculated using current prices. Analysis of the growth rate of aggregate output must use real GDP because doing so eliminates any change in the value of aggregate output due solely to price changes. Real GDP per capita is a measure of average aggregate output per person, but is not in itself an appropriate policy goal. Unemployment Rates The unemployment rate is an indicator of the state of the labor market, but it should not be taken literally as a measure of the percentage of people who want to work but can’t find jobs. It may overstate the true level of unemployment because a person typically spends time unemployed while searching for a job. It may also understate the true level of unemployment because it does not include discouraged workers. Relationship between Real GDP and Unemployment Rate There is a strong negative relationship between growth in real GDP and changes in the unemployment rate: when growth is above average, the unemployment rate falls; when it is below average, the unemployment rate rises. Measuring Aggregate Price Level To measure the aggregate price level, economists calculate the cost of purchasing a market basket. A price index is the ratio of the current cost of that market basket to the cost in a selected base year, multiplied by 100. Inflation Rate, PPI and GDP Deflator The inflation rate is the yearly percent change in a price index, typically based on the consumer price index, or CPI, the most common measure of the aggregate price level. A similar index for goods and services purchased by firms is the producer price index. Finally, economists also use the GDP deflator, which measures the price level by calculating the ratio of nominal to real GDP times 100. Mid Term – See File in Unit 4 1) Your assignment should have a cover sheet with the following information: a) your name; b) the course number; c) the section number; and, d) the date, 2) Copy and paste the questions into your paper. 3) Copy and paste the appropriate graphs into your work, then add whatever arrows, or other indicators that you feel are necessary to illustrate your analysis. 4) Your answers should follow the APA format by being in double spaced paragraph format, with citations to your sources and, at the bottom of your last page, a list of references). You answers should also be in Standard English with correct spelling and punctuation, grammar and style. 5) Unless specified differently by your instructor, your completed assignment should be saved with the following file name format: course number, an underscore, Section number, an underscore, your LAST name, underscore, your FIRST name, an underscore, and the word “mid”. It will look like this: BU204_xx _LAST_FIRST_mid (where the “xx” is the section number). 6) Respond to the questions in a thorough manner, providing specific examples of concepts, topics, definitions and other elements asked for in the questions. Your paper should be highly organized, logical and focused. 7) Maximum grade on format (total 15 points): 3 points = correct filename 3 points = correct APA format for answers (coversheet with name, course number, section number, Unit number, date, answers double spaced, in Times Roman black 12 point font) 3 points = correct citations within answers 3 points = Standard English with no spelling or punctuation errors 3 points = correct references at the bottom of the last page. Questions for Unit 4 Questions?