11

Introduction to Introduction to MacroeconomicsMacroeconomics

Chapter 20Chapter 20

© 2006 Thomson/South-Western

22

The National EconomyThe National Economy

Macroeconomics concerns the overall Macroeconomics concerns the overall performance of the economyperformance of the economy

The term The term economy economy describes the describes the structure of economic activity in a structure of economic activity in a community, a region, a country, a group community, a region, a country, a group of countries, or the worldof countries, or the world

Gross domestic product: the market Gross domestic product: the market value of final goods and services value of final goods and services produced in the United States during a produced in the United States during a given period, typically a yeargiven period, typically a year

33

Flow and Stock VariablesFlow and Stock Variables

Flow VariableFlow VariableAn amount per period of timeAn amount per period of timeAverage spending per week, hours worked per Average spending per week, hours worked per

month, etc.month, etc.

Stock VariableStock VariableAn amount measured at a particular point in timeAn amount measured at a particular point in timeAmount of cash on hand you have nowAmount of cash on hand you have nowNumber of housing units in existence todayNumber of housing units in existence today

44

Economic FluctuationsEconomic Fluctuations

Economic fluctuations Economic fluctuations The rise and fall of economic activity The rise and fall of economic activity

relative to the long-term growth trend of the relative to the long-term growth trend of the economyeconomy

Business cyclesBusiness cyclesVary in length and intensity but have some Vary in length and intensity but have some

features in commonfeatures in common

55

Components of Business CyclesComponents of Business Cycles

Two phasesTwo phasesPeriods of expansionPeriods of expansionPeriods of contractionPeriods of contraction

DepressionDepressionSevere contractionSevere contractionLasting longer than one year and accompanied by Lasting longer than one year and accompanied by

high unemploymenthigh unemployment RecessionRecession

Milder contractionMilder contractionDecline in total output lasting at least two Decline in total output lasting at least two

consecutive quartersconsecutive quarters

66

Exhibit 1: Hypothetical Business FluctuationsExhibit 1: Hypothetical Business FluctuationsContraction begins after a previous expansion has reached its peak and continues until the economy reaches a troughLong-term growth trend is shown by upward sloping straight line. Period between a peak and a trough is a contraction Period between a trough and subsequent peak is an expansion

77

Exhibit 2: Annual Percentage Change Exhibit 2: Annual Percentage Change in U.S. Real GDP from 1929 to 2003in U.S. Real GDP from 1929 to 2003

88

Exhibit 3: U.S. – U.K. Annual Growth Exhibit 3: U.S. – U.K. Annual Growth Rates in OutputRates in Output

99

Economic IndicatorsEconomic Indicators

Leading economic indicatorsLeading economic indicatorsVariables that predict, or Variables that predict, or lead to, lead to, a recession or a recession or

recovery; foreshadow a turning point in economic recovery; foreshadow a turning point in economic activity and predict, or lead to, upturns and downturnsactivity and predict, or lead to, upturns and downturns

Coincident economic indicatorsCoincident economic indicatorsThose measures that reflect peaks and troughs as they Those measures that reflect peaks and troughs as they

occuroccur Lagging economic indicatorsLagging economic indicators

Follow or trail changes in overall economic activityFollow or trail changes in overall economic activity

1010

Aggregate OutputAggregate Output

Aggregate outputAggregate outputTotal amount of goods and services Total amount of goods and services

produced in the economy during a given produced in the economy during a given periodperiod

Best measure is real gross domestic product, Best measure is real gross domestic product, or real GDPor real GDP

Aggregate demandAggregate demandThe relationship between the economy’s The relationship between the economy’s

price level and the quantity of aggregate price level and the quantity of aggregate output demandedoutput demanded

1111

Price LevelPrice Level

Average price of aggregate output is called the price level

A composite measure reflecting the prices of all goods and services in the economy relative to prices in a base year

The price level in the base year has a benchmark value of 100

1212

Price LevelPrice Level

Price levels in other years are expressed Price levels in other years are expressed relative to the base-year price levelrelative to the base-year price level

Price level or price index used to makePrice level or price index used to makeComparisons in prices across timeComparisons in prices across timeAccurate comparisons of real aggregate Accurate comparisons of real aggregate

output over timeoutput over time

1313

GDP Price IndexGDP Price Index

Real GDP: Gross domestic product after Real GDP: Gross domestic product after adjusting GDP for price changesadjusting GDP for price changes

The GDP price indexThe GDP price indexShows how the economy’s general price level Shows how the economy’s general price level

changes over timechanges over timeCan be used to convert production in different Can be used to convert production in different

years into dollars of constant purchasing poweryears into dollars of constant purchasing power

1414

Aggregate Demand CurveAggregate Demand CurveAggregate demand curve:Aggregate demand curve: shows the shows the

relationship between the price level in the relationship between the price level in the economy and the real GDP demanded, other economy and the real GDP demanded, other things constantthings constant

Sums demands of the four economic Sums demands of the four economic decision makers: households, firms, decision makers: households, firms, governments, and the rest of the worldgovernments, and the rest of the world

Among the factors held constant along a Among the factors held constant along a given aggregate demand curve aregiven aggregate demand curve areThe price levels in other countriesThe price levels in other countriesThe exchange rates between the U.S. dollar The exchange rates between the U.S. dollar

and foreign currenciesand foreign currencies

1515

Exhibit 4: Aggregate Demand CurveExhibit 4: Aggregate Demand Curve

Sums the demands of four economic decision makers: households, firms, governments, and the rest of the worldThe inverse relationship reflects the fact that as the price level increases, other things constant, purchases by the four major decision makers decline

1616

Aggregate Supply CurveAggregate Supply Curve

Shows how much output U.S. producers Shows how much output U.S. producers are willing and able to supply at each are willing and able to supply at each price level, other things constantprice level, other things constant

Assumed constant along an aggregate Assumed constant along an aggregate supply curve aresupply curve areResource prices, including wage ratesResource prices, including wage ratesThe state of technologyThe state of technologyThe rules of the game that provide The rules of the game that provide

production incentivesproduction incentives

1717

Exhibit 5:Aggregate Demand & SupplyExhibit 5:Aggregate Demand & Supply

Wage rates assumed constant along the AS curve; firms find a higher price level more profitable, so they increase real GDP suppliedEquilibrium occurs where the AD and AS curves intersectAlthough employment is not measured directly, firms must usually hire more workers to produce more output

1818

Exhibit 6: Decrease in Aggregate Exhibit 6: Decrease in Aggregate Demand from 1929 to 1933Demand from 1929 to 1933

AS

AD1929

11.9

865 Real GDP(billions of 2000 dollars)

AD1933

8.9

6360

The Great Depression can be viewed as a shift to the left of the AD curveThis resulted in a drop of both the price level and real GDP

Pri

ce le

vel (

2000

= 1

00)

1919

Short History of U.S. EconomyShort History of U.S. Economy

Age of Keynes: After the Great Age of Keynes: After the Great Depression to the Early 1970sDepression to the Early 1970sFederal budget deficit: amount by which Federal budget deficit: amount by which

federal outlays exceed federal revenuesfederal outlays exceed federal revenuesDemand-side economics: focus was on how Demand-side economics: focus was on how

changes in aggregate demand could promote changes in aggregate demand could promote full employmentfull employment

2020

Exhibit 7: Stagflation Between 1973-1975Exhibit 7: Stagflation Between 1973-1975

AD

AS1973

31.9

4.34

0

AS1975

38.0

4.31

The stagflation of the mid-1970s can be represented as a reduction in aggregate supply

Real GDP(trillions of 2000 dollars)

Pri

ce le

vel (

2000

= 1

00)

2121

Short History of U.S. EconomyShort History of U.S. Economy

Experience since 1980Experience since 1980Supply Side economics: federal government Supply Side economics: federal government

would provide incentives to increase the would provide incentives to increase the supply of labor and other resources by supply of labor and other resources by lowering tax rateslowering tax rates

Government debt: net accumulation of prior Government debt: net accumulation of prior deficitsdeficits

2222

Exhibit 8: Tracking U.S. Real GDP and Exhibit 8: Tracking U.S. Real GDP and Price Level Since 1929Price Level Since 1929