The Power Of Macroeconomics

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The Power Of Macroeconomics
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An Overview Of Modern Macroeconomics
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(No Transcript)
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Lesson 1 Colander McConnell Samuelson
Schiller Brue Nordhaus 3rd Edition 14th
Edition 16th Edition 8th Edition
Complete Textbook (includes both Micro-and
Macroeconomics) Macroeconomics Text Only
7, 8 7, 8 20, 21 5, 6, 7
7, 8 7, 8 4, 5 5, 6, 7
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Macroeconomics in Our Personal Lives
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Macroeconomics in Our Professional Lives
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The Real Power of Macroeconomics

• Macroeconomics can help answer these questions
  because it arms us with a new way of thinking
  about the world we live and work in.
• Indeed, this is the real power of macroeconomics,
  it helps us filter and sort and process all of
  the information we are bombarded with every day
  in the media.

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Seeing Patterns and Trends
A fall in consumer confidence
Value of Yen falls relative to dollar
Federal Reserve Bank raises interest rates
Coffee bean shortage in Brazil
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Jim Wells Decision

• Jim Wells used to own a manufacturing business
  that made high precision components for computer
  games.
• Every July, Jim had to decide how many components
  to produce for the upcoming holiday season, and
  every year, he had simply doubled his production.
  
• Since he never had any trouble moving the
  inventory, Jim decided to do the same thing again
  -- even though it meant taking out a big short
  term loan to finance the expansion.

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What Jim Wells Ignored

• Unfortunately, Jims college studies never
  included a course in macroeconomics so he missed
  some rather significant danger signs.

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Some Danger Signs
Sell Bonds to Public
Individuals have less money to spend
FEDERAL RESERVE
Possible Recession
Individuals
Give Dollars to Fed
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More Warning Signs
Recessionary Implications

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More Warning Signs
Japanese Imports Into US Become Less Expensive
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Disaster Strikes

• So Jim got caught with his proverbial pants down.
  
• By October, the Japanese had taken over half of a
  market that was already shrinking fast from the
  onset of a recession.

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Disaster Strikes

• By Thanksgiving, Jim found himself sitting on a
  huge inventory that he couldnt give away, and by
  December he was unable to pay a huge loan that
  wouldnt go away.
• By June, he was bankrupt.

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Jim Meets Teresa

• Today, Jim works as a consultant for one of his
  old Japanese competitors during the day and
  studies macroeconomics at night in an executive
  MBA program.
• He sits in the front row of class right next to
  Teresa.

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Teresas Dream
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Teresas Gamble
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Some Warning Signs

• Sure, Teresa felt a little nervous about choosing
  the variable rate, but the mortgage banker told
  her not to worry.
• Rates had been stable for over three years now,
  and it shouldnt be any problem.
• What Teresa failed to see, however, were numerous
  warning signs of growing inflationary pressures.

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Inflationary Pressures
Demand-Pull Side
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Inflationary Pressures
Supply of Goods (Cost Push)
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Disaster Strikes

• Within two years, interest rates had climbed into
  the double digits, and Teresa could no longer
  afford her skyrocketing mortgage payments.
• With the climb in interest rates, the economy
  plunged into a recession -- taking the real
  estate market down with it.
• Teresa tried to sell her house at the original
  price, but finally, facing the humiliation of
  foreclosure, she unloaded it for 25,000 less
  than she bought it for losing every cent of
  her equity.

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The Tragedy

• Both Jim and Teresa could have avoided their
  hardships.
• Jim could have halved his production.
• Teresa could have either bought that less
  expensive condo or waited until the real estate
  market went soft.

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The Dismal Science

• Despite the enormous impact macroeconomics has on
  our personal and professional lives, most of us
  view it as a remote, complicated, and indeed
  dismal science.

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Some Personal History

• When I first studied and taught macroeconomics I
  got quickly buried in a jumble of graphs and
  equations.
• I saw that the only way to truly understand the
  importance of macroeconomics is to teach it
  within the context of its historical evolution.
• This is important for at least two reasons.

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A REAL WORLD CONTEXT
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Why History is Important
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Why History is Important -- II

• The second reason to put macroeconomics in an
  historical context is to emphasize that it is
  very much an evolving policy science.
• Put simply, the Keynesian solutions which were
  used to lift us out of the Great Depression in
  the 1930s or to wake us up from the Economic
  doldrums of the 1960s would be inappropriate in
  today's more sophisticated global economy.

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The Remainder of this First Lesson

• Well briefly define macroeconomics and identify
  key policy issues.
• Well move into a short review of macroeconomic
  history.

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What Well Discover

• Well see that the problems facing
  macroeconomists have become progressively more
  complex over time
• unemployment and inflation
• stagflation
• stagnating income
• chronic budget and trade deficits.

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What Well Discover

• Well also see that new macroeconomic theories
  have emerged in response to this increasing
  complexity at key turning points in the worlds
  economic history
• Keynesianism in the 1930s
• Monetarism in the 1970s
• Supply Side economics in the 1980s
• and New Classical economics in the 1990s.

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Macroeconomics Defined

• The word macro means big or large, and
  macroeconomics focuses on the big economic
  picture -- specifically, how the overall national
  economy performs.
• Macroeconomics is distinguished from
  microeconomics which deals with the behavior of
  individual markets and the businesses, consumers,
  investors, and workers that make up the economy.

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The Big Four Policy Issues

• Inflation
• Unemployment
• The Rate of Economic Growth
• Movements in the Business Cycle

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Macro Problem 1 Inflation

• Defined as an upward movement of prices from one
  year to the next.
• Measured by the percentage change in price
  indices such as the Consumer Price Index, the
  Producer Price Index, or the so-called GDP
  deflator.

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Some Inflation Indices

• The Producer Price Index is based on a number of
  important raw materials.
• The Consumer Price Index or CPI is calculated
  by pricing a basket of goods and services
  purchased by a typical household.

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Consumer Price Index
Inflation Averaged 3.4 percent a year.
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SourceU.S. Department of Labor
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The Cruelest Tax
is greater than
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Not Everyone Loses

• Inflation that is unanticipated can benefit
  borrowers at the expense of lenders.
• How might this happen?

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How This Works

• Suppose you borrow 1,000 from a bank and promise
  to repay it in two years.
• If, during that time, the price level doubles
  because of inflation, the 1,000 which you repay
  will have only half of the purchasing power of
  the 1,000 originally borrowed.

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Macro Problem 2 Unemployment

• The unemployment rate is measured as the number
  of unemployed persons divided by the number of
  people in the labor force.

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Unemployment Rate Since 1900
Percentage of labor force unemployed
Actual unemployment
Average unemployment
1930
1990
1940
1950
1960
1970
1980
1920
1900
1910
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Year
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Kinds of Unemployment

• In talking about unemployment, economists
  distinguish between three kinds frictional,
  cyclical, and structural.

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Frictional Unemployment

• Frictional unemployment is the least of the
  macroeconomists worries.
• It occurs as a natural part of the job-seeking
  process as people quit their jobs just long
  enough to look for and find another one.

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Cyclical Unemployment

• Cyclical unemployment is a much more serious
  problem.
• It occurs when the economy dips into a recession.
• It is this type of unemployment that
  macroeconomists have historically spent most of
  their time trying to solve.

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Structural Unemployment

• Structural unemployment occurs when a change in
  technology makes someones job or job skills
  obsolete.
• E.g., the auto worker replaced by a robot or the
  telephone information operator replaced by a
  computerized voice synthesizer.

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Macro Problem 3The Rate of Economic Growth

• Measured by growth in the Gross Domestic Product
  or GDP.
• GDP is defined as the market value of all the
  final goods and services produced in a country in
  a given year.
• Economists have two ways of measuring GDP, the
  flow-of-cost or income approach and the flow
  of product or expenditures approach.

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Flow of product, or expenditures, approach
Consumption expenditures by households plus Invest
ment expenditures by businesses plus Government
purchases of goods and services plus Net
exportstotal exports-total imports
GDP
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Flow of cost, or income, approach
Flow of product, or expenditures, approach
Wages plus Rents plus Interest plus Profits
Consumption expenditures by households plus Invest
ment expenditures by businesses plus Government
purchases of goods and services plus Net exports
GDP
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Actual vs. Potential GDP

• Actual GDP represents what we are producing.
• Potential GDP represents the maximum amount the
  economy can produce without causing inflation.
• When actual GDP is less than potential GDP, we
  are in the recessionary range of the economy.
• When actual GDP is above potential GDP, we run
  the strong risk of inflation.

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Nominal vs. Real GDP

• Nominal GDP is measured in actual market prices.
• Real GDP is nominal GDP adjusted for inflation.
• Moreover, when we divide nominal GDP by real
  GDP, we obtain the GDP deflator-another valuable
  inflation index.

Click here for a numerical example of the GDP
deflator
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Output Growth

• GDP is the best widely available measure of the
  level and growth of output in the economy.

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U.S. Real GDP, 1929-1994
The Great Depression
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• During those periods, real and nominal GDP were
  moving in opposite directions.
• This point underscores why it is so important to
  focus on real GDP as the best measure of growth.

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Business Cycles

• Closely related to the issue of economic growth
  and real GDP as a measure of such growth is the
  problem of business cycles.
• The term business cycle refers to the recurrent
  ups and downs in real GDP over several years.

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Level of business activity
Time
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Do Business Cycles Exist

• A central concern of macroeconomists is to
  determine whether a business cycle exists and, if
  so, what are the forces behind it.
• More importantly, both macroeconomists and the
  political leaders they may serve want to know
  what macroeconomic policies may be used to
  control or harness the business cycle.

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At The Same Time

• A central concern of business is to determine
  whether the economy is going into a contraction
  or expansion--with a correct guess being the
  difference between a big profit or a big loss.

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End of Part 1
Lecturer Peter Navarro Multimedia Designer Ron
Kahr Female Voice Ashley West Leonard
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The GDP Deflator
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An Example

• Say a country produces 1000 bushels of corn in
  year 1 and 1010 bushels in year 2.
• This means that corn production grew by one
  percent between the two years.
• The price of a bushel is 1 in year 1 and 2 in
  year 2.
• Prices grew by 100 percent.
• What is the rate of growth in nominal GDP?

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An Example

• Nominal GDP is simply P times Q.
• Year 1 GDP110001000
• Year 2 GDP210102020
• Thus, nominal GDP grew by 102.
• Now, what is the rate of growth in real GDP?

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An Example

• The inflation-adjusted real GDP is simply the
  second years output valued in the first or base
  year of 1.
• 1010 bushels11010
• This means that GDP grew by only 1 percent.

• Whats the GDP deflator for year 2?

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An Example

• The inflation-adjusted real GDP is simply the
  second years output valued in the first or base
  year of 1.
• 1010 bushels11010
• This means that GDP grew by only 1 percent.

• Whats the GDP deflator for year 2?

• 2020/1010 2

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