Transcript Chapter 2 - WordPress.com

PowerPoint Presentation by
Mehdi Arzandeh, University of Manitoba
An Introduction to
Macroeconomics
6
LEARNING OBJECTIVES
LO6.1
LO6.2
LO6.3
LO6.4
LO6.5
LO6.6
Explain why economists focus on GDP, unemployment, and inflation when
assessing the health of an entire economy and what policy to pursue.
Discuss why sustained increases in living standards are historically recent
phenomena.
Identify why saving and investment are key factors in promoting rising living
standards.
Describe why expectations, shocks, and sticky prices are responsible for short-run
fluctuations in output and employment.
Characterize the degree to which various prices in the economy are sticky.
Explain why the greater flexibility of prices as time passes causes economists to
use different macroeconomic models for different time horizons.
© 2016 McGraw‐Hill Education Limited
6-2
6.1
Assessing the Health of the
Economy: Performance and Policy
In assessing the health and development of
an economy, macroeconomists focus on:
• Real GDP
• Unemployment
• Inflation
LO1
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6.1
Assessing the Health of the
Economy: Performance and Policy
Real GDP (real gross domestic product)
• measures the value of final goods and services
produced within the borders of a given country during
a given time period, typically a year.
• To calculate real GDP, nominal GDP must first be
calculated
LO1
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6.1
Assessing the Health of the
Economy: Performance and Policy
Unemployment
• A failure of the economy to fully employ its labour force
• Occurs when a person cannot get a job despite being
willing to work and actively seeking work
LO1
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6.1
Assessing the Health of the
Economy: Performance and Policy
Inflation
• An increase in the overall level of prices.
• Can cause decreases in standard of living
• surprise jump in inflation reduces the
purchasing power of people’s savings
LO1
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6.1
Assessing the Health of the
Economy: Performance and Policy
Macroeconomics Models Help Clarify Government Economic Policies
• Can governments promote long-run economic growth?
• Can governments reduce the severity of recessions?
• Are certain government policy tools, more effective than others, e.g.
monetary policy versus fiscal policy?
• Is there a trade-off between lower rates of unemployment and higher
rates of inflation?
• Does government policy work best when it is announced in advance or
when it is a surprise?
LO1
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6-7
6.2
The Miracle of Modern
Economics Growth
• Modern economic growth refers to an increase in output
per person as compared with earlier times in which output
(but not output per person) increased.
• The vast differences in living standards seen today between
rich and poor countries are almost entirely the result of the
fact that only some countries have experienced modern
economic growth.
LO2
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6-8
6.1 GLOBAL PERSPECTIVE
GDP per Person, Selected Countries
LO2
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6-9
6.3
Savings, Investment, and
Modern Economics Growth
• To raise living standards over time an economy must devote
at least some fraction of its current output to increasing
future output
• Savings The accumulation of funds that results when people
in an economy spend (consume) less than their incomes
during a given time period
• Savings fund Investment
LO3
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6.3
Savings, Investment, and
Modern Economics Growth
• Investment refers to spending for the production and
accumulation of capital and additions to inventories.
• Economists distinguish between financial investment and
economic investment.
• Financial investment refers to the purchasing of financial assets (stocks,
bonds, mutual funds) or real assets (houses, land, factories), or building such
assets, in the expectation of financial gain.
• Economic investment refers to spending for the production and
accumulation of capital and additions to inventories.
LO3
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6.3
Savings, Investment, and
Modern Economics Growth
Banks and Other Financial Institutions
• Households are the principal source of savings, but businesses are the
main economic investors.
• These institutions collect the savings of households, rewarding savers
with interest and dividends and sometimes capital gains (increases in
asset values).
• The banks and other financial institutions then lend the funds to
businesses, which invest in equipment, factories, and other capital
goods.
LO3
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6.4
Uncertainty, Expectations, Shocks,
and Short-Run Fluctuations
The Importance of Expectations and Shocks
• Expectations The anticipations of consumers, firms, and
others about future economic conditions.
• Expectations have a large effect on economic growth
• Expectations can become unmet due to shocks
LO4
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6.4
Uncertainty, Expectations, Shocks,
and Short-Run Fluctuations
The Importance of Expectations and Shocks
• Shocks Situations in which one thing is expected to occur
but in reality something different occurs.
• Demand shocks Sudden, unexpected changes in demand.
• Supply shocks Sudden, unexpected changes in aggregate supply
• Economists believe that most short-run fluctuations are the
result of demand shocks
• FULL EMPLYMENT IF THERE ARE NO SHOCKS
LO4
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FIGURE 6-1(a)
The Effect of Unexpected Changes in Demand
under Flexible Prices
Flexible Prices
Price
$40,000
$37,000
$35,000
DH
DL
900
LO4
© 2016 McGraw‐Hill Education Limited
DM
Cars per week
6-15
The Effect of Unexpected Changes in Demand
under Fixed Prices
Price
FIGURE 6-1(b)
Fixed Prices
$37,000
DL
700
LO4
900
1150
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DM
DH
Cars per week
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6.4
Uncertainty, Expectations, Shocks,
and Short-Run Fluctuations
Demand Shocks and Flexible Prices
If the prices of goods and services could always adjust quickly
to unexpected changes in demand,
then the economy could always produce at its optimal
capacity
since prices would adjust to ensure that the quantity
demanded of each good and service would always equal the
quantity supplied.
LO4
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6.4
Uncertainty, Expectations, Shocks,
and Short-Run Fluctuations
Demand Shocks and Sticky Prices
• In reality, many prices in the economy are inflexible and do not change
rapidly when demand changes unexpectedly.
• Manufacturing firms typically attempt to deal with unexpected changes in
demand by maintaining an inventory.
• Inventory Goods that have been produced but remain unsold.
• If demand falls for many goods and services across the entire economy for
an extended period of time, then many firms will find inventories piling up
and will be forced to cut production resulting in recession, with GDP falling
and unemployment rising.
• If demand is unexpectedly high for a prolonged period of time, the economy
will boom and unemployment will fall.
LO4
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6.5
How Sticky Are Prices?
• Inflexible prices (sticky prices) Product prices that remain in
place (at least for a while) even though supply or demand has
changed.
• Flexible prices Product prices that react within seconds to
changes in supply and demand.
LO5
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TABLE 6-1
Average Number of Months Between price
Changes for Selected Goods and Services
Item
Months
Coin-operated laundry machines
46.4
Newspapers
29.9
Haircuts
25.5
Taxi fare
19.7
Veterinary services
14.9
Magazines
11.2
Computer software
5.5
Beer
4.3
Microwaves ovens
3.0
Milk
2.4
Electricity
1.8
Airline tickets
1.0
Gasoline
0.6
Source: Mark Bils and Peter J. Klenow, “Some Evidence on the Importance of Sticky Prices”, Journal of Political Economy,
October 2004, pp 947-985, Used with permission of The University of Chicago Press.
LO5
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6.5
How Sticky Are Prices?
What Causes Sticky Prices?
• Companies selling final goods and services know that
consumers prefer stable, predictable prices that do not
fluctuate rapidly with changes in demand.
• In certain situations a firm may be afraid that cutting its price
may be counterproductive because its rivals might simply
match the price cut - a situation often referred to as a price
war.
LO5
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6.6
Categorizing Macroeconomic
Models Using Price Stickiness
• Price stickiness moderates over time.
• If unexpected changes in demand begin to look permanent,
many firms will allow their prices to change so that price
changes (in addition to quantity changes) can help to equalize
quantities supplied with quantities demanded.
• Prices go from stuck in the extreme short run to fully flexible in
the long run.
LO6
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The LAST
WORD
Debating the Great Recession
Economists Disagreed Vigorously About Both the Causes of
the Great Recession and the Best Ways to Speed a Recovery.
• The Minksy Explanation: Euphoric Bubbles
• The Austrian Explanation: Excessively Low Interest Rates
• The Stimulus Solution
• The Structural Solution
© 2016 McGraw‐Hill Education Limited
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Chapter Summary
LO6.1
Explain why economists focus on GDP, Inflation, and unemployment when
assessing the health of an entire economy and what policy to pursue.
LO6.2
Discuss why sustained increases in living standards are historically recent
phenomena.
LO6.3
Identify why saving and investment are key factors in promoting rising living
standards.
LO6.4
Describe why expectations, shocks, and sticky prices are responsible for short-run
fluctuations in output and employment.
LO6.5
Characterize the degree to which various prices in the economy are sticky.
LO6.6
Explain why the greater flexibility of prices as time passes causes economists to use
different macroeconomic models for different time horizons.
© 2016 McGraw‐Hill Education Limited
6-24