Introduction to Macroeconomics

1

• Introduction to Macroeconomics

2
Macroeconomics

• That part of economics that focuses on the
  factors that determine
• the levels of overall output employment
• the average price level

3
Foundations of Macroeconomics

• The (Worldwide) Great Depression of the 1930s

4
Foundations of Macroeconomics

• The (Worldwide) Great Depression of the 1930s
• 1929 late 1930s / early 1940s

5
Foundations of Macroeconomics

• The (Worldwide) Great Depression of the 1930s
• 1929 late 1930s / early 1940s
• By 1933
• The unemployment rate had risen to 25.

6
Foundations of Macroeconomics

• The (Worldwide) Great Depression of the 1930s
• 1929 late 1930s / early 1940s
• By 1933
• The unemployment rate had risen to 25.
• Output had fallen by 50.

7
Foundations of Macroeconomics

• The (Worldwide) Great Depression of the 1930s
• 1929 late 1930s / early 1940s
• By 1933
• The unemployment rate had risen to 25.
• Output had fallen by 50.
• The money supply had fallen by one-third.

8
Foundations of Macroeconomics

• The (Worldwide) Great Depression of the 1930s
• 1929 late 1930s / early 1940s
• By 1933
• The unemployment rate had risen to 25.
• Output had fallen by 50.
• The money supply had fallen by one-third.
• The Great Depression did not really end until the
  buildup for World War II.

9
Classical Model

• Market equilibrium was ensured by flexible prices
  wages.

10
Classical Model

• Market equilibrium was ensured by flexible prices
  wages.
• Surpluses in the labor market, viz., involuntary
  unemployment (UNE), would be eliminated by a fall
  in prices wages.

11
Classical Model

• Market equilibrium was ensured by flexible prices
  wages.
• Surpluses in the labor market, viz., involuntary
  UNE, would be eliminated by a fall in prices
  wages.
• Did not explain the circumstances of the Great
  Depression very well

12
The Keynesian Revolution

• 1936 book
• The General Theory of Employment, Interest and
  Money, by John M. Keynes

13
The Keynesian Revolution

• 1936 book
• The General Theory of Employment, Interest and
  Money, by John M. Keynes
• Great Depression mainly due to deficient
  aggregate spending

14
The Keynesian Revolution

• 1936 book
• The General Theory of Employment, Interest and
  Money, by John M. Keynes
• Great Depression mainly due to deficient
  aggregate spending
• Spending insufficient to buy full-employment
  output

15
The Keynesian Revolution

• 1936 book
• The General Theory of Employment, Interest and
  Money, by John M. Keynes
• Great Depression mainly due to deficient
  aggregate spending
• Spending insufficient to buy full-employment
  output
• Rationale for government intervention

16
Full Employment Act of 1946

• Committed the federal government to intervene in
  the economy to prevent large declines in output
  employment

17
Full Employment Act of 1946

• Committed the federal government to intervene in
  the economy to prevent large declines in output
  employment
• Humphrey-Hawkins Bill of 1978
• Set target unemployment rates

18
Fine-Tuning in the 1960s

• Government policy was used to regulate inflation
  unemployment.

19
The 1970s

• Fine tuning does not always work.

20
The 1970s

• Fine tuning does not always work.
• Especially unsuccessful in dealing with
  stagflation, viz., rising inflation coupled
  with high /or rising unemployment

21
Current Macroeconomic Issues

• Inflation
• Business cycle
• Unemployment
• Global issues

22
Inflation

• Sustained rise in the average price level

23
Inflation

• Sustained rise in the average price level
• Rise in the cost of living

24
Inflation

• Sustained rise in the average price level
• Rise in the cost of living
• Fall in the purchasing power of money

25
Unemployment

• The unemployment rate is the percentage of the
  labor force that is involuntarily unemployed.

26
Unemployment

• The unemployment rate is the percentage of the
  labor force that is involuntarily unemployed.
• The labor force is total employment plus
  unemployment.

27
Unemployment

• The unemployment rate is the percentage of the
  labor force that is involuntarily unemployed.
• The labor force is total employment plus
  unemployment.
• Consider the possible effects of unemployment
  compensation (insurance) on unemployment.

28
Business Cycle

• Alternating periods of expansion decline in
  economic activity

29
Business Cycle

• Alternating periods of expansion decline in
  economic activity
• Recession exists when real (inflation-adjusted)
  output falls for two consecutive quarters.

30
Business Cycle

• Alternating periods of expansion decline in
  economic activity
• Recession exists when real (inflation-adjusted)
  output falls for two consecutive quarters.
• Our most recent national recession was over the
  period 1Q01-3Q01.

31
Diagram

• Business Cycle

32
Global Issues

• US economic activity has a major impact on the
  rest of the world.

33
Global Issues

• US economic activity has a major impact on the
  rest of the world.
• Similarly, economic developments in other
  countries have impacts on the US economy.

34
Role of the Federal Government

• Fiscal policy
• Monetary policy
• Incomes policies
• Supply-side policies

35
Fiscal Policy

• Government spending taxation policies

36
Fiscal Policy

• Government spending taxation policies
• Expansionary fiscal policy is designed to
  increase economic activity.

37
Fiscal Policy

• Government spending taxation policies
• Expansionary fiscal policy is designed to
  increase economic activity
• Restrictive fiscal policy is designed to reduce
  economic activity.

38
Fiscal Policy

• Government spending taxation policies
• Expansionary fiscal policy is designed to
  increase economic activity.
• Restrictive fiscal policy is designed to reduce
  economic activity.
• Keynes argued that expansionary fiscal policy
  should be used to fight the Great Depression.

39
Monetary Policy

• The Federal Reserve System (Fed), the nations
  central bank, can change the money supply.

40
Monetary Policy

• The Federal Reserve System (Fed), the nations
  central bank, can change the money supply.
• Monetary policy includes the tools that can be
  used to change the money supply.

41
Monetary Policy

• The Federal Reserve System (Fed), the nations
  central bank, can change the money supply.
• Monetary policy includes the tools that can be
  used to change the money supply.
• Expansionary monetary policy includes tools used
  to increase the money supply and, in turn,
  economic activity.

42
Monetary Policy

• The Federal Reserve System (Fed), the nations
  central bank, can change the money supply.
• Monetary policy includes the tools that can be
  used to change the money supply.
• Restrictive monetary policy includes tools used
  to reduce the money supply and, in turn, economic
  activity.

43
Incomes Policies

• Direct attempts to control prices wages

44
Incomes Policies

• Direct attempts to control prices wages
• Last time that they were used was in the late
  1960s

45
Supply-Side Policies

• Policies designed to stimulate production

46
Supply-Side Policies

• Policies designed to stimulate production
• Main policy used has been reducing tax rates
• A fall in tax rates may lead to an increase in
  the incentive to produce.

47
Macroeconomic Markets

• Q (commodities) market
• Labor market
• Money market

48
Q Market

• Market in which products (goods services) are
  traded

49
Labor Market

• Households supply employers hire labor other
  resources in this market.

50
Money Market

• AKA financial market
• Households supply funds borrowers (households,
  firms, govt) demand funds in this market.

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(No Transcript)
52

• Measuring National Output and National Income

53
Gross Domestic Product (GDP)

• Market value of all final products produced in a
  country during a year

54
Final Vs. Intermediate Products

• Final products are not destined for further
  processing during the current period.
• An example would be the personal computer that
  you may have purchased before classes began.

55
Final Vs. Intermediate Products

• Intermediate products are produced by one firm
  for use by other firms.

56
Final Vs. Intermediate Products

• Intermediate products are produced by one firm
  for use by other firms.
• They undergo further processing basically serve
  as inputs used by other firms.
• An example would be the on-board diagnostic
  computers found in vehicles

57
Final Vs. Intermediate Products

• Intermediate products are produced by one firm
  for use by other firms.
• They undergo further processing basically serve
  as inputs used by other firms.
• If they were counted in GDP, there would be
  multiple counting.

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Exclusions from GDP

• Transactions in used goods

59
Exclusions from GDP

• Transactions in used goods
• Paper transactions

60
Exclusions from GDP

• Transactions in used goods
• Paper transactions
• Q produced in other countries by
  domestically-owned resources

61
Value Added

• Selling P of a product produced at a stage of
  production minus () cost of intermediate
  products purchased by firms at that stage

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Value-Added Example1 lb. bag of organic coffee
63
GDP Gross National Product (GNP)

• GDP
• Value of all final products produced within a
  nations borders
• Measure of the value of output

64
GDP Gross National Product (GNP)

• GDP
• Value of all final products produced within a
  nations borders
• GNP
• Value of all final products produced by a
  nations resources regardless of the location of
  production
• Measure of income

65
Calculating GDP

• Value-added approach
• Estimate value-added by sector and sum

66
Calculating GDP

• Value-added approach
• Estimate value-added by sector and sum
• Expenditure approach
• Sum all annual expenditures on final products

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Calculating GDP

• Value-added approach
• Estimate value-added by sector and sum
• Expenditure approach
• Sum all annual expenditures on final products
• Resource cost / income approach
• Sum all costs incurred in producing final products

68
Expenditure Approach

• Consumption (C)
• (Actual) Investment (I)
• Government spending (G)
• Net Exports (Xs) Exports (Xs) Imports (Ms)

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Consumption (C)

• HH spending
• Durable goods (3-year life)

70
Consumption (C)

• HH spending
• Durable goods
• Nondurable goods

71
Consumption (C)

• HH spending
• Durable goods
• Nondurable goods
• Services

72
Consumption (C)

• HH spending
• Durable goods
• Nondurable goods
• Services
• Assume that planned C actual C

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(Actual) Investment (I)

• Spending by firms HHs on new capital (K)

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(Actual) Investment (I)

• Spending by firms HHs on new capital (K)
• Plant, equipment, inventories

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(Actual) Investment (I)

• Spending by firms HHs on new capital (K)
• Plant, equipment, inventories
• New residential structures

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Gross Net I

• Net I Gross I - depreciation

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Relate to GDP

• GDP
• Market value of final products

78
Relate to GDP

• GDP
• Market value of final products
• Change in business inventories

79
Actual I

• Actual I need not equal planned I (IP)

80
Actual I

• Actual I need not equal IP
• There may be unplanned changes in inventories.

81
Actual I

• Actual I need not equal IP
• There may be unplanned changes in inventories.
• Counting actual investment ensures that an item
  goes into GDP in the year in which it is produced.

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Govt Spending (G)

• Spending by federal, state, local govts on
  final products labor

83
Govt Spending (G)

• Spending by federal, state, local govts on
  final products labor
• Transfer payments excluded

84
Govt Spending (G)

• Spending by federal, state, local govts on
  final products labor
• Transfer payments excluded
• Assume that planned G actual G

85
Net Exports (Net Xs)

• Net Xs Exports (Xs) Imports (Ms)

86
Net Exports (Net Xs)

• Net Xs Exports (Xs) Imports (Ms)
• Can be positive or negative
• Assume that planned net Xs actual net Xs

87
Resource Cost / Income Approach

• Sum wages, rents, profits, interest earned by
  all resources producing final products

88
Income Payments

• National income
• Depreciation
• Indirect business taxes (IBT) subsidies
• Net factor payments to the rest of the world

89
National Income (Y)

• Total Y earned by resources

90
National Income (Y)

• Total Y earned by resources
• Employee compensation

91
National Income (Y)

• Total Y earned by resources
• Employee compensation
• Proprietors Y
• Self-employed Y

92
National Income (Y)

• Total Y earned by resources
• Employee compensation
• Proprietors Y
• Self-employed Y
• Corporate profits

93
National Income (Y)

• Total Y earned by resources
• Employee compensation
• Proprietors Y
• Self-employed Y
• Corporate profits
• Net interest

94
National Income (Y)

• Total Y earned by resources
• Employee compensation
• Proprietors Y
• Self-employed Y
• Corporate profits
• Net interest
• Rental Y

95
Depreciation

• A measure of the fall in the value of a K asset
  due to wear obsolescence

96
Indirect Business Taxes (IBT)

• Include sales taxes, customs duties, license
  fees

97
Indirect Business Taxes (IBT)

• Include sales taxes, customs duties, license
  fees
• Represent expenditures, but not Y, of firms

98
Subsidies

• Payments made by govt for which no products are
  received

99
Net Factor Payments to Rest of World

• Factor payments to the rest of the world Factor
  payments from the rest of the world

100
National Income Accounts

• GNP
• GDP Factor payments from rest of world Factor
  payments to rest of world

101
National Income Accounts

• GNP
• GDP Factor payments from rest of world Factor
  payments to rest of world
• Net National Product (NNP)
• GNP Depreciation

102
National Income Accounts

• GNP
• GDP Factor payments from rest of world Factor
  payments to rest of world
• Net National Product (NNP)
• GNP Depreciation
• National Income (NI)
• NNP (IBT subsidies)

103
Personal Income (PI)

• Total income of HHs

104
PI

• Total income of HHs
• PI NI Retained earnings Social insurance
  payments Personal interest payments received
  Transfer payments

105
Disposable Personal Income (DPI)

• DPI PI Personal taxes

106
Disposable Personal Income (DPI)

• DPI PI Personal taxes
• DPI C Personal saving

107
Nominal Real Quantities

• Nominal GDP
• Value of final products in current dollars (at
  current prices)

108
Nominal Real Quantities

• Nominal GDP
• Value of final products in current dollars (at
  current prices)
• Real GDP
• Value of final products adjusted for changes in
  the price level
• I.e., the value of final products in constant
  dollars

109
Nominal Real Quantities

• Nominal GDP
• Value of final products in current dollars (at
  current prices)
• Real GDP
• Value of final products adjusted for changes in
  the price level
• Permits a more valid assessment of how output
  has changed over time

110
Price Indexes

• A price index is used to change a nominal
  quantity into a real quantity.

111
Price Indexes

• A price index is used to change a nominal
  quantity into a real quantity.
• A price index can be defined as a measure of how
  a set of prices has changed over time.

112
Price Indexes

• A price index is used to change a nominal
  quantity into a real quantity.
• A price index can be defined as a measure of how
  a set of prices has changed over time.
• A base period is selected values of the price
  index indicate how the current average price
  differs from the base-period average price.

113
Use of Price Indexes

• To convert a nominal quantity into a real
  quantity, divide the nominal quantity by the
  price index in decimal form.

114
Price Indexes

• Most price indexes are fixed-weight price indexes.

115
Price Index Example
116
Price Index Example (cont.)
117
Price Index ExampleYear 1 Weights (cont.)
118
Price Index ExampleYear 2 Weights (cont.)
119
Price Index Interpretation

• Year 1 weights
• Price index for year 2 115
• Prices rose 15 between year 1 year 2

• Year 2 weights
• Price index for year 2 113.7
• Prices rose 13.7 between year 1 year 2

120
Consistency

• Compute geometric average of the price indexes

121
Consistency

• Compute geometric average of the price indexes
• Year 2
• (115113.7)(1/2) 114.3

122
Consistency

• Compute geometric average of the price indexes
• Year 2
• (115113.7)(1/2) 114.3
• The price index for year 2 is 114.3. Thus,
  prices rose 14.3 percent between year 1 year 2.

123
Chained Price Index

• Years 1 2 are the base years for computing the
  change in prices between years 1 2.

124
Chained Price Index

• Years 1 2 are the base years for computing the
  change in prices between years 1 2.
• Years 2 3 are the base years for computing the
  change in prices between years 2 3.
• Etc.

125

• Unemployment and Inflation

126
Recession

• Real GDP falls for at least 2 consecutive
  quarters.
• In turn, the fall in real Q leads to a
• Fall in EMP
• Rise in UNE
• Fall in real income (Y)

127
Depression

• Prolonged deep recession
• Great Depression 1929 Late 1930s
• Recessions
• Most recent 1Q01-3Q01 (? as to dates)
• Most severe since Great Depression 1980-82

128
UNE

• Involuntary UNE
• Out-of-work, available for work, looking for work
• UNE rate
• (UNE/Labor Force)100
• Where labor force is EMP UNE
• Labor force gt 16 years old

129
UNE

• Involuntary UNE
• Out-of-work, available for work, looking for work
• UNE rate
• (UNE/Labor Force)100
• Where labor force is EMP UNE
• Labor force gt 16 years old
• Current UNE rate
• US 5.0 (7/05)

130
Labor Force Participation Rate

• (Labor Force/Population)100

131
Factors Affecting UNE

• UNE rates differ across demographic groups.

132
Factors Affecting UNE

• UNE rates differ across demographic groups.
• UNE rates differ by state region.

133
Factors Affecting UNE

• UNE rates differ across demographic groups.
• UNE rates differ by state region.
• UNE rates differ across industries.

134
Factors Affecting UNE

• UNE rates differ across demographic groups.
• UNE rates differ by state region.
• UNE rates differ across industries.
• Discouraged workers are not counted.

135
Factors Affecting UNE

• UNE rates differ across demographic groups.
• UNE rates differ by state region.
• UNE rates differ across industries.
• Discouraged workers are not counted.
• Length or duration

136
Types of UNE

• Frictional UNE
• Structural UNE
• Cyclical UNE

137
Frictional UNE

• Individuals entering the labor force or switching
  jobs
• Due in large part to imperfect information

138
Structural UNE

• Mismatch between available labor skills
  abilities skills abilities in demand
• Includes individuals w/ obsolete labor skills

139
Natural UNE (Rate)

• UNE due to frictional structural factors

140
Natural UNE (Rate)

• UNE due to frictional structural factors
• Level of UNE at full EMP
• Full EMP UNE Rate

141
Cyclical UNE

• Due to deficient (insufficient) total spending
• Occurs during downswings

142
Relationship Between EMP UNE

• Question
• Are EMP UNE necessarily inversely (negatively)
  related?

143
Possible Reasons for Being Unemployed

• New entrants to the labor force
• Re-entrants to the labor force
• Laid-off workers

144
Possible Reasons for Being Unemployed

• New entrants to the labor force
• Re-entrants to the labor force
• Laid-off workers
• If an increase in UNE is due to new entrants /or
  re-entrants, EMP need not fall (rise) as UNE
  rises (falls), i.e., EMP UNE need not be
  inversely or negatively related.

145
Inflation

• Sustained (continued) rise in the average price
  level
• Deflation
• Sustained fall in the average price level

146
Price Indexes Revisited

• Used to measure the average price level
• The GDP deflator, price index for GDP, is a
  variable weight chain-weighted price index for
  GDP.

147
Fixed-Weight Price Indexes

• Consumer Price Index (CPI)
• Producer Price Index (PPI)

148
Consumer Price Index (CPI)

• Price index for the market basket purchased by
  the typical urban household

149
Consumer Price Index (CPI)

• Price index for the market basket purchased by
  the typical urban household
• The base period is 1982-84.

150
Consumer Price Index (CPI)

• Price index for the market basket purchased by
  the typical urban household
• The base period is 1982-84.
• A fixed-weight price index implies a perfectly
  inelastic demand for items in market basket.
• There is an experimental version of a
  variable-weight chained CPI.

151
Consumer Price Index (CPI)

• Most frequent measure of inflation
• (CPIt CPIt-11)/CPIt-12100
• 7/04-7/05
• (195.10-189.20)/189.20100 3.12

152
Rule of 72

• Used to estimate doubling time
• The amount of time required for a quantity to
  double in size given a rate of growth
• Divide 72 by the growth rate in percentage form
• 72/3.12 23.1 years

153
Quarterly Change at an Annual Rate

• Frequently, the Federal government will report
  information on the growth in real GDP as a
  quarterly change at an annual rate.
• The reported growth rate is the annual compound
  growth rate based on a one-quarter change.
• It is assumed that the quarterly change will be
  the same in each of the four quarters.

154
Example

• Real US GDP rose 0.76 percent between 4Q04
  1Q05.
• The associated annual growth rate is 3.1
• (10.0076)4 1

155
Producer Price Index (PPI)

• Index of prices for intermediate products
• Changes in PPI are often used to forecast changes
  in the CPI.

156
Costs of Inflation

• Inflation may change the distribution of income.
• Whether a person wins or loses during inflation
  depends on whether their income rises more or
  less than the prices they pay.

157
Costs of Inflation

• Inflation may change the distribution of income.
• Whether a person wins or loses during inflation
  depends on whether their income rises more or
  less than the prices they pay.
• Losers
• Individuals on fixed incomes
• Low income

158
Costs of Inflation (Cont.)

• Net debtors net creditors
• Under-anticipated inflation
• (Actual gt Expected)
• If inflation is under-anticipated, net debtors
  gain at the expense of net creditors.

159
Example(s) of Wealth Transfer Effects of Inflation

• Real interest rate
• Nominal interest rate adjusted for inflation
• Real interest rate Nominal interest rate
  Inflation rate

160
Example(s) of Wealth Transfer Effects of Inflation

• Loan of 1,000 for one year at 5 simple interest
• Borrower repays 1,050 at the end of the year.
• 1,000 principal (amount borrowed)
• 50 interest

161
Example(s) of Wealth Transfer Effects of Inflation

• Suppose that inflation over the period of the
  loan were 10.
• Net creditor loses.
• Net creditor receives a negative real rate of
  return of 5.

162
Example(s) of Wealth Transfer Effects of Inflation

• Suppose that inflation over the period of the
  loan were 10.
• Net creditor loses.
• Net creditor receives a negative real rate of
  return of 5.
• The purchasing power of the principal has fallen
  10 to 900.

163
Example(s) of Wealth Transfer Effects of Inflation

• Suppose that inflation over the period of the
  loan were 10.
• Net creditor loses.
• Net creditor receives a negative real rate of
  return of 5.
• The purchasing power of the principal has fallen
  10 to 900.
• The purchasing power of the interest payment has
  fallen 10 to 45.

164
Example(s) of Wealth Transfer Effects of Inflation

• Suppose that inflation over the period of the
  loan were 10.
• Net creditor loses.
• Net creditor receives a negative real rate of
  return of 5.
• The purchasing power of the principal has fallen
  10 to 900.
• The purchasing power of the interest payment has
  fallen 10 to 45.
• Principal interest 945 lt 1,000

165
Variable-Rate Loans

• First implemented by Wachovia Bank
• The interest rate on loans is tied to the
  inflation rate.

166
Other Costs of Unanticipated Inflation

• Welfare costs
• Individuals use resources to compensate for
  (offset) the effects of inflation.

167
Other Costs of Unanticipated Inflation

• Welfare costs
• Individuals use resources to compensate for
  (offset) the effects of inflation
• Higher risk slower economic growth
• Investors are likely to be more reluctant to make
  investments due to higher risks.
• Thus, economic growth will slow.

168
Using Price Indexes

• Deflating nominal quantities
• AKA converting a nominal figure into a real
  figure
• Example Purchasing Power of the
• Nov. 2004 CPI 191.0
• Purchasing Power of the Dollar
• 1/(191.0/100) 0.52

169
Using Price Indexes

• Deflating nominal quantities
• AKA converting a nominal figure into a real
  figure
• Example Purchasing Power of the
• July 2005 CPI 195.1
• Purchasing Power of the Dollar
• 1/(195.1/100) 0.51
• Interpretation
• A market basket that cost 0.51 in 1982-84 cost
  1 in July 2005.
• A market basket that cost 1 in 1982-84 cost
  1.95 in July 2005.