Unit 3 - Macroeconomics

Standard -

What is Macroeconomics?

Macroeconomics is the study of large scale economies.

Macro – examines entire economies Ex. Unemployment in the US

Productivity in China Micro – examines a single household

or business

How do economists measure an economy?

There are several macroeconomic indicators.

Most Common: GDP

Gross Domestic Product (GDP):

The total dollar value of all final goods and service produced within a country in one calendar year

Must consider:1. Final Output (not the intermediate

phases…think tree – lumber – house)2. Current Year (not used cars or second

hand clothes)3. Output Produced Within National Borders

(not international factories)

How is GDP Calculated?

Output-Expenditure Model

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

C = Personal Consumption Expenditures

Consumer purchases…anything new that you buy

2 Types:1. Durable Goods – last longer than 1

yearExamples: cars, houses, computers

C = Personal Consumption Expenditures

2. Nondurable Goods – last less than 1 yearExamples: food, make-up, etc.

I = Gross Investment

o Total investment in capital goods

o Factories, office space, raw materials

G = Government Purchases

o Includes federal, state, and local spending…highways, education, national defense, transfer payments

o Transfer Payments: govt taxes “transferred” to others

(X – M) = Net Exports (Exports – Imports)

May have a trade surplus or trade deficit

Surplus (Exports > Imports) Deficit (Exports < Imports)

Limitations of GDP:

1. Accuracy and Timeliness of Data Gathering data is slow process

2. Nonmarket Activities Performing activities at no charge…

mowing the lawn

Limitations Cont.

3. Underground Economy Illegal or unreported legal activity

4. “Goods” and “Bads” Things that are beneficial are

sometimes not reported and things that are detrimental are reported

GDP

Nominal GDP – current dollar amount of GDP

Real GDP – dollar amount adjusted for inflation

The Business Cycle: the regular ups and downs in an economy

Expansion:•Period of economic growth•GDP

Peak:•Highest Point in an economy•Strong Economy

Contraction:•Period of economic slowdown•GDP (or increasing at a slower rate)

Trough:•Lowest Point in an economy

Business Cycle Continued…

Recession: a decline in the rate of national economic activity Usually measured by a decline in real

GDP for at least 2 consecutive quarters (6 months)

Depression: a severe, prolonged economic contraction

Types of Unemployment (p.331)

Seasonal Frictional Cyclical Structural

Seasonal:

Frictional:

Cyclical:

Structural:

Is there anything we can do to maintain a stable economy?

How do we do it?

1. Monetary Policy (The Fed)2. Fiscal Policy (Congress)

Money and the Money Supply

Money: anything that is generally accepted as final payment for g/s

Money Supply: Currency (coins and paper $) in the hands of the public plus checking-type accounts

The supply of money in the economy is important for price stability and economic growth.

Key Points about the Money Supply

1. Too much money in the economy can cause inflation.

Inflation: rise in the average price level of g/s Money doesn’t “go as far”…it isn’t

worth as much

2. Too little money in the economy can lead to falling prices and falling production.

Deflation: a decrease in the avg. price level of g/s

Money Supply Continued…

The Federal Reserve controls the money supply through monetary policy.

Monetary Policy works by increasing or decreasing the money supply.

The Federal Reserve System

“The Fed” The bankers’ bank and the govt’s

bank Created in 1914 after a series of

bank failures. The Fed Board of Governors:

7 members appointed by the President, confirmed by the Senate

President appoints chairperson to a 4 year term

The Fed

Current Chair: Ben Bernanke

The Fed – 12 Regional Banks

Located in major cities around the country

Each bank has president chosen by board of directors (local business/banking community)

Tools of Monetary Policy

Stimulate Economy – Increase Money Supply

Control Inflation – Decrease Money Supply

Tools of Monetary Policy (3)

1. Open Market Operations: when the Fed buys or sells U.S. govt.

securities (bonds) Buy securities…more money in

circulation (stimulate economy) Sell securities…less money in

circulation (slow down economy)

Govt. Bonds/Securities

Essentially…a loan to the US Govt.

…with a promise of earning interest!

Tools of Monetary Policy:

2. Changes in Discount Rate: The interest rate the Fed charges on

loans to banks Lower rate…banks are encouraged to

make more loans (money supply increases)

Raise rate…banks are discouraged from making loans (money supply decreases)

Tools of Monetary Policy:

3. Changes in Reserve Requirement: The minimum percentage of deposits

that banks must keep on reserve to back up checking-type accounts

Lower reserve requirement…banks have more money to lend (increases money supply)

Raise reserve requirement…banks have less to lend (decreases money supply)

Fiscal Policy

Is what the government (Congress) can do to influence the economy

2 Types:1. Contractionary (slow down)2. Expansionary (stimulate)

Limitations: Slow Political

Tools of Fiscal Policy

1. Tax: either increase (contractionary) or decrease (expansionary)

Proportional: flat tax…burden on poor Progressive: income tax…burden on

rich Regressive: sales tax…burden on

poor

2. Spend: either increase (expansionary) or decrease (contractionary)

Purchases –g/s purchased by the govt. Transfer Payments – money payment

sent to individuals (welfare, Social Security)

3. Borrow

Multiplier Effect

The idea that increased spending by consumers, businesses, or govt. becomes income for someone else. (then their spending becomes someone else’s income, etc.)

“A chain reaction”

Supply Side Economics

“Voodoo Economics” Tax cuts for big business

http://www.killerclips.com/clip.php?id=110&qid=1287

National Debt – all the $ the federal government owes to bondholders

Government Deficits – spending more than you take in during a fiscal year Also referred to as deficit spending

Other Economic Challenges

1. Unemployment (4 types) Seasonal, Frictional, Cyclical, Structural

Unemployed: those who wish to work but cannot find jobs

Issues:

- Doesn’t include those who have given up looking for work (discouraged workers)

- Part-time workers are counted as fully employed

- Unemployed seeking PT counted same as those seeking FT

Unemployment Rate

# of Unemployed# in Workforce

X 100 =___%

Practice

If there are 500 students at SCHS who are counted in the workforce and 100 are unemployed…what is the unemployment rate of the students at SCHS?

100500

X 100 = 20%

2. Inflation: an increase in the average price level of all products in an economy

Occurs because aggregate demand increases faster than aggregate supply

Also…too much money chasing too few goods Aggregate Demand: total demand for all

final g/s at a range of price levels of an entire economy

Aggregate Supply: total production of all final g/s at a range of price levels of an entire economy

S1

S2

D1

D2

P1

P2

How is Inflation Measured?

Changes in the Consumer Price Index reflects inflation of prices.

Consumer Price Index (CPI): a measure of the average change over time in the price of a fixed group of products

Market Basket: a representative sample of commonly purchased items

Prices of g/s in a market basket are compared to the same g/s in a market basket from another year.

If prices go up = inflation.

Inflation Rate Formula

B-A A

X 100 = ___%

CPI 1979 – 163 (A) CPI 2007 – 187 (B)

187-163 163

X100 = 14.72% inflation

Example - Have prices increased since 1987?

1987 – Base Year (100)$30002007 – Current Year$5000

5000/3000 x 100 = 166

1987 – (100) 2007 – (166)(Prices are 66% higher)

Now calculate inflation rate…

1987 – CPI 1502007 – CPI 166

166-150 150

10.7% inflation rate

X 100

CPI: The “Easy” Way

http://www.bls.gov/data/home.htm

Why should I care about Inflation?

Think about this… You get a 5% pay raise (yippee!) But inflation is 7% (oh no!)

Did you really get a pay raise or a pay cut?

What about people living on fixed incomes?

Zimbabwe Currency

Zimbabwe Currency- A 10 million dollar bill!