The Big Ideas in Macroeconomics

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CHAPTER 5

• The Big Ideas in Macroeconomics

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MACROECONOMICS

• The branch of economics that deals with the
  nations economy as a whole
• It focuses on economic issues most often
  discussed in newspapers, on the radio or on
  television
• -- unemployment
• -- inflation
• -- growth
• -- trade
• -- gross domestic product

3
WHAT IS MACROECONOMICS ?

• Microeconomics studies the behavior of individual
  consumers, firms and markets
• Macroeconomics steps back from the details of the
  individual markets and looks at the economy as a
  whole

4
MICROECONOMICS VS MACROECONOMICS

• Microeconomics Macroeconomics might study
  might study
• What is number of computers What determines
  total produced in U.S. ? output of U.S. economy
  ?
• Why unemployed workers in What determines total
  aerospace industry ? unemployment in entire
  U.S. economy ?
• Why does price of corn rise Why are prices rising
  at 5 if farmers have bad per year ? weather
  and smaller crop than usual ?

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MICROECONOMICS VS MACROECONOMICS

• There is not a hard-and-fast line between
  macroeconomics and microeconomics
• Sometimes macroeconomists study the effects of
  price changes in individual markets
• 1973 and 1979 oil price increases as they
  affected macroeconomic concerns

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JOHN MAYNARD KEYNES

• Known as the father of Keynesian economics
• Renowned British economist and writer who taught
  at Cambridge University in England
• In 1930s, Keynes wrote The General Theory of
  Employment, Interest, and Money
• The influence of this book continues to felt
  throughout the world

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MACROECONOMICS DURING THE 1930S

• Keynes developed theories to explain why economic
  times were so bad and how we could cure the
  worldwide crisis following the Great Depression
• Keynes emphasized the short-run benefits of
  increased government spending to reduce
  unemployment in the country
• Examples of such government spending might be new
  highway construction or the employment of
  additional teachers

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MACROECONOMICS TODAY

• Does not just focus on short-term crises, but on
  longer view
• It attempts to understand how government spending
  affects the economy when there is not massive
  unemployment and we are not in a deep crisis

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SOME POLICY QUESTIONS ADDRESSED BY MACROECONOMICS

• If economy experiences increased unemployment,
  should government increase spending ? If so,
  should the government increase taxes or borrow
  funds from the public ?
• Are there government policies which can help
  raise the rate at which the economy grows ?
• How should the government react if prices of all
  goods start to rise at a rapid rate ?
• What actions should the government take if the
  rate at which you can trade U.S. dollars for
  Japanese yen starts to fall suddenly ?

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GROSS DOMESTIC PRODUCT

• The total market value of all final goods and
  services produced within a given year.

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TOTAL MARKET VALUE

• Take the quantity of goods produced and multiply
  them by their respective prices and add up the
  totals.
• -- Example If an economy produced two cars at
  15,000 a car and three computers at 3,000 a
  computer, the total value of these goods and
  services would be
• ( 2 15,000 ) ( 3 3,000 ) 39,000

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FINAL GOODS AND SERVICES

• Those goods and services that are sold to
  ultimate or final purchasers.

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INTERMEDIATE GOOD

• A good that is used in the production process
  and is not the final good or service.

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IN A GIVEN YEAR

• Goods produced in prior years would not be
  included in GDP this year.

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REALITY PRINCIPLE

• What matters to people is the real value or
  purchasing power of money or income, not its face
  value.

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REAL GDP

• A measure of GDP that controls for price
  changes.

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NOMINAL GDP

• GDP that is measured using current prices
• It can increase for one of two reasons
• Production of goods and services has increased
• The prices of the goods and services has increased

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GDP EXAMPLE

• YEAR 1 YEAR 2
• Production 10 computers 12 computers
• Price 1,000 1,100
• Nominal GDP in year 1 is 10,000
• (10 1,000) 10,000
• Nominal GDP in year 2 is 13,200
• (12 1,100) 13,200
• Real GDP in year 1 is 10,000
• (10 1,000) 10,000
• Real GDP in year 2 is 12,000
• (12 1,000) 12,000

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Real GDP 1992
U.S. REAL GDP, 1930 - 1995
8,000
Source U.S. Department of Commerce
6,000
4,000
2,000
0
1930
1935
194 0
1945
1950
1955
1960
1965
1970
1975
1975
1980
1985
1990
YEAR
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U.S. REAL GDP

• The data for real GDP control for changes in
  prices and thus capture movements in real output
  only
• Real GDP has grown substantially over the period
  graphed
• This is what economists term economic growth
• sustained increases in real production of an
  economy over a period of time
• Differences in economic growth between countries
  and changes in economic growth over time are
  among the most important issues of macroeconomics

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GROWTH RATES

• The growth rate of a variable is the percentage
  change in the variable from one period to another
• If GDP was 100 in year 1, and 104 in year 2
• growth rate percentage change
• change in GDP / initial GDP
• ( GDP year 2 -GDP year 1) / GDP year 1
• ( 104 -100 ) / 100
• 4 / 100 .04 4

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GROWTH RATES

• May be negative as well as positive
• If GDP was 104 in year 1, and 100 in year 2
• growth rate change in GDP / initial GDP
• ( GDP year 2 -GDP year 1) / GDP year 1
• ( 100 -104 ) / 104
• - 4 / 104 -0.38 -3.8

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GROWTH RATES

• If we know the growth rate and the initial GDP
  value, we can also calculate the GDP for the next
  period
• g is the growth rate,
• GDP year 2 ( 1 g ) GDP year 1
• GDP in the second year is 1 plus the growth rate
  times GDP in the first year
• If g 4 and GDP in year 1 were 100,
• GDP year 2 ( 1 0.04) 100 104

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GROWTH RATES

• If the economy grew at a rate g for n years, and
  the economy started at 100, the formula for real
  GDP after n years would be
• GDP n years later ( 1 g ) n (100)
• If the economy starts at 100 and grows at a rate
  of 4 for 10 years
• GDP 10 years later ( 1 0.04 ) 10 (100)
• 148
• This is nearly 50 higher than in the first year.

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RULE OF 70

• If you knew the constant growth rate of real GDP
  but wanted to know how many years it would take
  until the level of real GDP doubled
• years to double 70 / percentage growth rate
• If growth rate were 5
• Years to double 70 / 5 14 years

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STARTING IN 1960, HOW MANY YEARS IT TOOK FOR GDP
TO DOUBLE
YEARS
25
24.0
20
19.0
17.0
15
10
14.0
8.0
5
Belgium
Germany
Japan
United States
Canada
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GROWTH AND PRODUCTIVITY

• Economic growth in the United States has slowed
  down
• -- from 1950 to 1973, real GDP grew at an
  annual rate of 3.58
• -- from 1974 to 1995, real GDP grew at an
  annual rate of 2.66
• The decline in growth rate of real GDP in the
  United States was also associated with a decline
  in the growth of labor productivity.

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LABOR PRODUCTIVITY

• The amount of output produced per worker
• It gives us an idea of how much is produced by
  the average worker
• Living standards can rise over time only if more
  output is produced by the average worker

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Slowdown in productivity after 1973
Source Economic Report of the President
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PRODUCTIVITY SLOWDOWN

• Although productivity may continue to grow during
  a period, it grows at a slower rate
• This also means that wages and salaries have not
  grown as fast as they had in the past

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P
P
T
T
P peak of recessions T trough of recessions
Source U.S. Department of Commerce
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RECESSION

• A period when economic growth is negative (real
  GDP falls) for two consecutive quarters
• A quarter is three consecutive months during the
  year
• A recession is a period when real GDP falls for
  at least six months

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RECESSION

• Peak
• The date at which a recession starts
• Trough
• The date at which output starts to increase again
• Since World War II, the United States has
  experienced nine recessions.

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NINE POSTWAR RECESSIONS

• Peak Trough Percent Decline in real GDP
• November 1948 October 1949 1.5
• July 1953 May 1954 3.2
• August 1957 April 1958 3.3
• April 1960 February 1961 1.2
• December 1969 November 1970 1.0
• November 1973 March 1975 4.9
• January 1980 July 1980 2.5
• July 1981 November 1982 3.0
• July 1990 March 1991 1.4

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DEPRESSION

• A common term for a severe recession
• In the United States, the Great Depression refers
  to the 1929 - 1933 period, in which real GDP fell
  by over 33
• It created the most severe economic dislocations
  that the United States has experienced in the
  twentieth century
• Banks closed, businesses failed, and many people
  lost their life savings
• Unemployment rose sharply
• In 1933, over 25 of the people looking for work
  failed to find jobs

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CAUSES OF RECESSION

• Changes in technology
• Disruptions to the financial system
• Increases in prices of key commodities
• (Deliberate or inadvertent) government policies

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UNEMPLOYED

• Those people who do not currently have a job
  but who are actively looking for work.

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LABOR FORCE

• All the people in an economy who either have
  jobs or are currently looking for jobs.

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UNEMPLOYMENT RATE

• The number unemployed divided by the total
  labor force
• Unemployment rate Number unemployed / labor
  force

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UNEMPLOYMENT RATES AROUND THE WORLD

• Country Unemployment Rate
• Canada 9.4
• United States 5.6
• Belgium 14.5
• Sweden 7.8
• France 11.9
• Italy 12.0
• Spain 22.7
• United Kingdom 8.0
• Netherlands 7.0
• Japan 3.4
• Australia 8.1

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Source Bureau of Labor Statistics
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CYCLICAL UNEMPLOYMENT

• Unemployment that accompanies fluctuations in
  real GDP
• Cyclical unemployment rises during recessions
  and falls when the economy improves

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FRICTIONAL UNEMPLOYMENT

• Unemployment that occurs naturally during the
  normal workings of an economy
• It can occur for a number of reasons
• -- people change jobs
• -- people move across country
• -- people get laid off from their current jobs
  and search for new opportunities
• -- people take their time after they enter the
  labor force to find an appropriate job
• The economy needs some frictional unemployment
  to operate efficiently so that workers and firms
  find the right matches

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STRUCTURAL UNEMPLOYMENT

• Unemployment which occurs because of a
  mismatch between jobs that are available and the
  skills of workers seeking jobs.

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NATURAL RATE OF UNEMPLOYMENT

• The level of unemployment at which there is no
  cyclical unemployment
• It consists only of frictional and structural
  unemployment
• It is the economists notion of full employment
• In the United States, estimated to be between 5
  and 6.5
• In Europe, estimated to be between 7 and 10

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PRICE LEVEL

• Average of all prices in the economy.

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CHAIN-TYPE PRICE INDEX FOR GDP

• An index that measures the average of the prices
  of the goods and services that are contained in
  the GDP
• Starting in 1996, a chain-type price index for
  GDP replaced the GDP deflator as the principle
  index reported by the U.S. Department of Commerce

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CHAIN-TYPE PRICE INDEX

• It has a value of 100 in a given year, called the
  base year
• The important information in the value of the
  index for any other year is contained in its
  relation to the base year
• If a chin-type price index for GDP in one year is
  105, it means that prices have increased by 5
  since the base year
• ( 105 - 100 ) / 100
• By using a chain price index, we see how the
  overall level of prices changes from one year to
  the next over a long period of time

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CHAIN PRICE INDEX EXAMPLE

• YEAR OUTPUT PRICE
• 1 10 1,000
• 2 12 1,100
• If year 1 is chosen as the base year, the price
  index for GDP will be 100
• The price of the single good in the economy,
  computers, rose by a factor of 1.1
• ( 1,100 / 1,000 1.1 )
• The price index for year 2 is equal to the value
  of the index in year 1 (100) times the factor by
  which prices increased (1.1)
• 100 1.1 110

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Sources R.J. Gordon, Macroeconomics, New York,
(Harper Collins, 1993) U.S. Department of
Commerce
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INFLATION

• The percentage rate of change in price level
  increase
• If GDP in year 1 is 100 and GDP in year 2 is 110,
  inflation rate is 10

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Source U.S. Department of Commerce Based on
Chain-type Price Index
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CLASSICAL ECONOMICS

• The study of the economy when it operates at or
  near full employment.

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KEYNESIAN ECONOMICS

• The study of business cycles and economic
  fluctuations that we develop.