Unit 3

Macroeconomics

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Macroeconomics: the branch of economics that deals with the economy as a whole, including employment, gross domestic product, inflation, economic growth and the distribution of income. 2

Gross Domestic Product: The dollar value of all final goods and services produced within a nation’s borders in one year.

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GDP excludes certain items:

1. Intermediate goods: products used to make other products. These require further processing before being sold to the final consumer.

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2. Secondhand Sales: Sales of used goods.

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3. Nonmarket Transactions: work done for which no money is paid such as mowing your own yard, house cleaning or other home improvements.

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4. Underground Economy: unreported legal and illegal activities.

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5. Financial Transactions: money paid for stocks, bonds and other financial assets. This also includes mergers and transfer payments.

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Gross National Product: The dollar value of all final goods and services, and structures produced in one year with labor and property supplied by a nation’s residents.

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To go from GDP to GNP it is necessary to add all payments that Americans receive from outside the U.S., and then subtract all payments made to foreign owned resources in the U.S. 11

Output-Expenditure Model: a macro model used to show aggregate demand by consumers, businesses, government, and foreign sector. Aggregate demand= total spending.

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C = Consumer spending by households.

I = Investment spending by businesses.

G= Government spending, federal, state, and local.

X= Exports or goods sold abroad.M= Imports or goods purchased from abroad.

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(X-M) = Net Exports can also be denoted using an (F).

If (X-M) is positive, we have a trade surplus meaning we export more than we import.

If (X-M) is negative, we have a trade deficit meaning we import more than we export.

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GDP = C + I + G + (X-M)

or

GDP = C + I + G + F

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GDP= C+I+G+NX

Which category from the above equation accounts for the greatest percentage of GDP in our country?A. CB. IC. GD. NX

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Inflation: a rise in the general/average price level.

To remove distortions of inflation on GDP economists must construct a price index.

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Price Index: a statistical series used to measure changes in prices over time, or more simply, it is a ratio of 2 prices.

Base Year: a year that serves as the basis of comparison for all other years.

Market Basket: a representative selection of commonly purchased goods and services by urban consumers. 18

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Major Price Indices

1. Consumer Price Index (CPI): reports on price changes for about 80,000 items in 364 categories used by a typical household.

It is used to calculate the rate of inflation in the economy.

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2. Producer Price Index (PPI): measures price changes paid by domestic firms for their inputs. It can be a good indicator of inflation at the consumer level down the road.

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3. Implicit GDP Price Deflator: an index of the average levels of prices for all goods/services in the economy.

This is the most complete measure of inflation in the economy.

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Current/Nominal GDP: is GDP that has not been adjusted for inflation.

Real/Constant GDP: GDP that has been adjusted for inflation.

Real GDP = Current/nominal GDP ÷ Price Index × 100

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There are 2 ways to measure economic growth. Remember economic growth is the ability to produce more goods and services over time.

1.Changes in real GDP from 1 year to another. (Best short term measure)

2.Changes in real GDP per capita which is real GDP divided by population. (Best long term measure)

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GDP % growth rates per Quarter

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1 Qatar $ 102,800

2 Liechtenstein $ 89,400

3 Bermuda $ 86,000

4 Macau $ 82,400

5 Luxembourg $ 80,700

6 Monaco $ 70,700

7 Singapore $ 60,900

8 Jersey $ 57,000

9 Falkland Islands (Islas Malvinas) $ 55,400

10 Norway $ 55,300

11 Switzerland $ 54,600

12 Isle of Man $ 53,800

13 Hong Kong $ 50,700

14 Brunei $ 50,500

15 United States $ 49,800

GDP per capita for 2012

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Improvements in real GDP per capita indicate an improved standard of living and can be easily compared from 1 nation to another.

Economic growth is the result of more resources and/or better quality resources such as improvements in education and labor productivity.

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Per Capita GDPLuxembourg $80,700United States $49,800Switzerland $54,600Japan $36,200Iceland $39,400

Economists use numbers such as those in the table as a measure of A. Standard of living B. Total dollar value of all final goods and services C. Net Exports D. Net Imports

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Business Cycle: the systematic ups and downs in real GDP.

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Phases1.Recession: a period during

which real GDP declines for a minimum of 6 months.

2. Trough: the turnaround point where real GDP stops going down.

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3. Expansion: a period of recovery from recession where real GDP is rising.

4. Peak: the point where real GDP stops going up.

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Trend Line: shows the long run growth in real GDP. It’s a process of two steps forward and one step back.

Depression: a state of the economy with large numbers of people out of work, acute shortages, and excess capacity in manufacturing plants.

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Index of Leading Indicators: a monthly statistical series that usually turns down before real GDP turns down, and turns up before real GDP turns up.

It’s like trying to forecast where the economy is headed in the future.

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Unemployment Rate: the number of unemployed people looking for work divided by the total number of persons in the civilian labor force.

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UR = # unemployed but looking ÷ civilian labor force × 100 = %

Civilian Labor Force: those 16 years and older who are currently working or looking for work.

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Employment-population ratio measures the percent of the U.S. adult population that has a job. CNNMoney 10/18/12.

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When the president entered office on Jan. 20, 2009, the economy was issue No. 1. It still is today. Monthly Payrolls:

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The Unemployment Rate under President Obama,cnnmoney 10/18/12.

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Criticisms of UR:1.Discouraged workers:

People who have become frustrated with looking for a job and quit looking. This tends to understate the actual rate of unemployment.

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2. Part time workers: These workers are counted the same as full time workers. Again, this tends to understate the true rate of unemployment.

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Kinds of Unemployment

Frictional Unemployment: workers who are between jobs for one reason or another. Also called search and wait unemployment.

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Structural Unemployment: this is unemployment caused when a fundamental change in the economy reduces the demand for workers and their skills. This if often caused by changes in technology, called automation.

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Cyclical Unemployment: this is unemployment related to swings in the business cycle, caused by a recession.

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Seasonal Unemployment: unemployment resulting from changes in the weather or changes in the demand for certain products at regular intervals each year.

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Full Employment: the lowest possible unemployment rate with the economy growing and all factors of production being used as efficiently as possible.

Our estimate is 4.5% in the United States.

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The first 4.5% represents frictional and structural unemployment. Anything over and above that is cyclical.

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Price Level: measures the relative magnitude of prices at a point in time using the Consumer Price Index (CPI).

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The inflation rate can be measured using the following formula.

Inflation Rate = ∆ in price index ÷ beginning price index × 100 = %

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Deflation: a decrease in the general/average price level as measured by an index number.

The effects of deflation are the opposite of inflation.

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Inflation under President Obama,cnnmoney 10/18/12.

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When the economy is working normally in the United States, what is the inflation rate? A. 1 to 3 percent B. 4 to 7 percent C. 8 to 11 percent D. 12 to 15 percent

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The immediate result of inflation is a decrease in the purchasing power of the dollar.

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3 types of inflation include:

1.Demand-pull inflation: when different groups such as consumers, businesses or the government attempt to spend beyond what the economy can produce. “Too many dollars chasing too few goods.”

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2. Cost-push inflation: when costs for producers rise they will raise prices to compensate for higher costs. This could come primarily from wages or energy/oil prices.

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3. The government prints too much money.

This normally results in hyperinflation.

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Inflation also causes a redistribution of income from some people to others.

Some will benefit from inflation while others will be hurt.

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Winners LosersFlexible incomes Fixed incomesBorrowers Savers Lenders

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In 1913 Congress created the Federal Reserve System or the “Fed” as our nation’s central bank. Because everyone uses money, and because interest rates affect the overall level of economic activity, the Fed’s activities affect us all.

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Figure 15.1Figure 15.1

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Board of Governors7 membersAppointed by the president

and confirmed by the SenateServe 14 year termsSets the general policies for

Fed and banks to follow 69

Federal Open Market Committee12 membersMeets 8 times a yearMakes decisions about the growth of money supply and interest ratesIs the Fed’s primary policymaking

body70

District Banks 12 districts and 25 branchesDistrict banks accept deposits from and make

loans to banks and Thrift institutions

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Member BanksCommercial banks that are members of and hold stock in the Fed bank in their district.

These are the banks we use.

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This man is considered the 2nd most powerful person in the U.S.

Who is he?

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Monetary Policy: the expansion or contraction of the money supply in order to influence the cost and availability of credit which is the interest rate. (Federal Reserve controls this)

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The Fed controls the money supply to create greater stability within the economy.

It’s goal is to promote economic growth, full employment and price level stability. 75

Our definition of money will include 3 things, all of which are immediately usable to buy goods and services.

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M1 includes:

1.Paper money2.Coins3.Checking accounts

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Fractional Reserve System: a system that requires banks and other depository institutions to keep a fraction of their deposits in the form of legal reserves.

Let’s look at a bank’s balance sheet.

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Reserve Requirement: a rule stating that a percentage of every deposit be set aside as legal reserves.

Ex. Deposit $100 with a reserve requirement of 10%. The bank must set side $10 as a required reserve and may loan the rest, $90.The $90 is called excess reserves. It is logical to assume the bank will want to loan that money because banks will earn interest on those loans.

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The fractional reserve system will allow the money supply to grow to several times the size of the excess reserves the banking system keeps.

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Ex. Fred deposits $1,000 in a bank with a reserve requirement of 20%.

By how much will the money supply expand?

$1,000 ÷.20 = $5,000 (money supply) or1 ÷ RR × ∆ in reserves.

1 ÷ .20 = 5 × $1,000 = $5,00082

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The Fed has 3 main tools it uses to conduct monetary policy. Each tool affects the amount of excess reserves in the banking system.

The tools are used within 2 broad policies.

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Easy Money Policy: the Fed allows the money supply to expand and interest rates to fall which normally stimulates the economy.

This policy is used when the economy is in a recession.

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Tight Money Policy: the Fed restricts the money supply which increases interest rates and slows the economy down.

This is used when the economy is experiencing inflation. 86

Tools

1.Reserve Requirement: the amount that banks must set aside for every dollar deposited.

The following chart shows how a change in the reserve requirement will change the money supply. 87

Figure 15.5Figure 15.5

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2. Open Market Operations: this is the most popular tool of monetary policy. It involves the buying and selling of government securities/bonds.

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3. Discount Rate: this is the interest rate the Fed charges on loans to other banks.

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Misery Index: sometimes called the discomfort index, is the sum of the monthly inflation and unemployment rates.

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When we studied markets in unit 2 we used the tools of supply and demand to show how the equilibrium price and quantity of output were determined. When we study the economy as a whole, we can use the concepts of supply and demand in much the same way. 93

Aggregate Supply: the total value of goods and services that all firms would produce in a specific period of time at various price levels.

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The AS curve is up-sloping and can also increase or decrease. When costs go down producers are willing to increase output so AS shifts right. When costs rise the AS curve shifts left. 95

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The factors that shift the AS curve include the following:

Ex. Costs of inputs Productivity Technology Taxes Subsidies Government regulations Number of sellers

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Which one of the following is

a determinant of aggregate

supply? A. input costs B. substitute goods C. consumer

expectations D. tastes or

preferences98

How do subsidies given to a business

affect aggregate supply?A They can make it cheaper for firms

to produce their products, thereby allowing them to increase

supply.B They can make it more expensive

for firms to produce their products, thereby forcing them to

decrease supply. C No impact on Aggregate Supply D All of the above

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Stagflation: a period of stagnant growth combined with inflation. This is caused by a leftward shift in the AS curve due to say rising oil prices or wages.

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Aggregate Demand: the total quantity of goods and services demanded at different price levels. Figure 16.4aFigure 16.4a

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The AD curve is downsloping and can also increase or decrease. It consists of the following components; consumption, investment, government, and foreign spending.

AD = C + I + G + (X-M)102

Factors that shift the AD curve include the following.

Ex. Consumer wealth Taxes Expectations Interest Rates Exchange Rates Incomes

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Figure 16.4bFigure 16.4b

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Which one of the following

would cause aggregate demand

to shift?A. substitutionB. complementary good

pricesC. an increase in

resourcesD. a change in consumer spending

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Which of the following factors would cause a shift in the aggregate demand curve? A. changes in input prices B. changes in productivity C. changes in the supply of labor D. changes in government spending

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Macroeconomic Equilibrium: this represents the level of real GDP consistent with a given price level, as determined by the intersection of the AS and AD curves.

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Fiscal Policy: the federal government attempts to stabilize the economy by taxing and spending decisions. (Congress)

The stimulus package passed in February of 2009 by Congress is a good example.

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Here are the governments options.

Recession ( increase AD) Lower taxes Increase spending

Inflation ( decrease AD)Raise taxesLower spending

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When (AD) shifts to the right real GDP increases, employment increases, but we may see some inflation too.

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A second part of fiscal policy uses automatic stabilizers which are programs that trigger benefits if changes in the economy threaten income.

Ex. Unemployment Compensation Entitlement Programs Progressive Income Taxes

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Supply-Side Economics/Reaganomics

Supply-Side Economics attempts to create greater stability in the economy by shifting the (AS) curve rather than the (AD) curve.

It does this by: 112

1.Reducing marginal tax brackets to give people the incentive to work longer and harder which in turn increases our productive capacity.

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2. Reducing government regulations on businesses so they can produce output more efficiently.

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The goal of Supply-Side policies is to shift the (AS) curve to the right. This increases real GDP and employment and also creates stable prices.

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The Federal government’s budget has 3 possible outcomes.

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•Balanced budget: Tax revenues exactly equal spending for a given year.

•Budget surplus: Tax revenues are greater than spending for a given year.

•Budget deficit: Tax revenues are less than spending for a given year.

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The main problem with fiscal policy when fighting a recession is that the increase in government spending and reduction in taxes will push the government’s budget toward deficit.In essence we are spending money we don’t have and we must borrow.

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Deficit Spending: when government spending is in excess of revenues collected for a given year.

Federal Debt: the total amount borrowed from investors to finance the government’s deficit spending.

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Let’s put the federal debt into perspective.

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Add up all past Federal government ___________’s and you get the Federal ___________. A. debt, deficit B. deficit, debt

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Federal Debt as of May 23, 2011 is

$14,392,239,651,000

http://www.usdebtclock.org/

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