2 Learning ObjectivesDescribe the origins of macroeconomics and the problems it deals withDescribe the long-term trends and short- terms fluctuations in economic growth, unemployment, inflation, and government and international deficits
3 Learning Objectives (con't.) Explain why economic growth, unemployment, inflation, and deficits matterIdentify the macroeconomic policy challenges and describe the tools available for meeting them
4 Learning ObjectivesDistinguish between the stocks of capital and wealth and the flows of production, income, investment and savingExplain why aggregate income, expenditure, and product are equalExplain how GDP is measured
5 Learning ObjectivesDescribe the origins of macroeconomics and the problems it deals withDescribe the long-term trends and short- terms fluctuations in economic growth, unemployment, inflation, and government and international deficits
6 MicroeconomicsMicroeconomics is the study of how individual households and firms make decisions and how they interact with one another in markets.
7 Macroeconomics Macroeconomics is the study of the economy as a whole. Its goal is to explain the economic changes that affect many households, firms, and markets at once.
8 Macroeconomics Macroeconomics answers questions like the following: Why is average income high in some countries and low in others?Why do prices rise rapidly in some time periods while they are more stable in others?Why do production and employment expand in some years and contract in others?
9 Origins and Issues of Macroeconomics Modern macroeconomics emerged during the Great Depression.People began to doubt the free market economy.John Maynard Keynes, in 1936, published The General Theory of Employment, Interest, and Money.
10 Origins and Issues of Macroeconomics Macroeconomic Problems1) Economic Growth2) Unemployment3) Inflation4) Deficits
11 Origins and Issues of Macroeconomics Short-Term Versus Long-Term GoalsKeynes focused on the short-term primarilyHe felt the depression was caused by insufficient private spendingGovernment should increase its spending
12 Origins and Issues of Macroeconomics Short-Term Versus Long-Term GoalsLong-term consequences were virtually disregarded“In the long run, we’re all dead”
13 Origins and Issues of Macroeconomics Short-Term Versus Long-Term GoalsToday, macroeconomics is concerned with:Long-term economic growth and inflationShort-term business fluctuations and unemployment
14 Origins and Issues of Macroeconomics The Road AheadThe focus of macroeconomics has shifted:DepressionInflation of the 1970’sInternational economics of today
15 Economic Growth in the United States Fluctuations Around Potential GDPThe business cycle is the periodic but irregular up-and-down movement in production.
16 Economic Growth in the United States Phases of the Business CycleRecessionPeriod during which real GDP decreases for two successive quartersExpansionPeriod during which real GDP increases
17 Economic Growth in the United States Turning PointsPeakExpansion ends, recession beginsTroughRecession ends, expansion begins
18 Long-Term Economic Growth in the United States Instructor Notes:1) The thin black line shows potential GDP.2) Along this line, real GDP grew at an average rate of 3.3 percent a year between 1870 and 1994.3) The blue areas show when real GDP was above potential GDP, and the red areas show when it was below potential GDP.4) During some periods, such as World War II, real GDP expanded quickly.5) During other periods, such as the Great Depression and more recently in 1975 (following the OPEC oil price hike), 1982, and , real GDP declined.
19 Economic Growth Around the World Real GDP per personThe growth rate of real GDP divided by the population is used to compare growth rates over time and across countries.
20 Benefits and Costs of Economic Growth Expanded production possibilitieshealth caremedical researchspace explorationroadsenvironmental improvements (if resources are devoted to solving environmental problems)
21 Benefits and Costs of Economic Growth 1) Foregone consumption2) Depletion of natural resources3) Increased pollution4) More frequent job and location changes
22 Macroeconomic Policy Challenges and Tools 1) Boost economic growth2) Stabilize the business cycle3) Reduce unemployment4) Keep inflation low5) Reduce the government and international deficits
23 Macroeconomic Policy Challenges and Tools Policy Tools1) Fiscal policyMaking changes in taxes and government spendingLong term growthSmooth the business cycle
24 Macroeconomic Policy Challenges and Tools Policy Tools2) Monetary policyChanging interest rates and the amount of money in the economyControl inflationSmooth business cycle
25 The Economy’s Income and Expenditure When judging whether the economy is doing well or poorly, it is natural to look at the total income that everyone in the economy is earning.
26 The Economy’s Income and Expenditure For an economy as a whole, income must equal expenditure because:Every transaction has a buyer and a seller.Every dollar of spending by some buyer is a dollar of income for some seller.
27 Gross Domestic Product Gross domestic product (GDP) is a measure of the income and expenditures of an economy.It is the total market value of all final goods and services produced within a country in a given period of time.
28 The Circular-Flow Diagram The equality of income and expenditure can be illustrated with the circular-flow diagram.
29 The Circular-Flow Diagram SpendingRevenueMarket forGoodsand ServicesGoods & Services soldGoods & Services boughtFirmsHouseholdsWages, rent, and profitIncomeLabor, land, and capitalInputs for productionMarket forFactorsof Production7
30 The Measurement of GDPGDP is the market value of all final goods and services produced within a country in a given period of time.
31 The Measurement of GDP Output is valued at market prices. It records only the value of final goods, not intermediate goods (the value is counted only once).It includes both tangible goods (food, clothing, cars) and intangible services (haircuts, housecleaning, doctor visits).
32 The Measurement of GDPIt includes goods and services currently produced, not transactions involving goods produced in the past.It measures the value of production within the geographic confines of a country.
33 The Measurement of GDPIt measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months).
34 What Is Counted in GDP?GDP includes all items produced in the economy and sold legally in markets.
35 What Is Not Counted in GDP? GDP excludes most items that are produced and consumed at home and that never enter the marketplace.It excludes items produced and sold illicitly, such as illegal drugs.
36 Other Measures of Income Gross National Product (GNP)Net National Product (NNP)National IncomePersonal IncomeDisposable Personal Income
37 Gross National Product Gross national product (GNP) is the total income earned by a nation’s permanent residents (called nationals).It differs from GDP by including income that our citizens earn abroad and excluding income that foreigners earn here.
38 Net National Product (NNP) Net National Product (NNP) is the total income of the nation’s residents (GNP) minus losses from depreciation.Depreciation is the wear and tear on the economy’s stock of equipment and structures.
39 National IncomeNational Income is the total income earned by a nation’s residents in the production of goods and services.It differs from NNP by excluding indirect business taxes (such as sales taxes) and including business subsidies.
40 Personal IncomePersonal income is the income that households and noncorporate businesses receive.Unlike national income, it excludes retained earnings, which is income that corporations have earned but have not paid out to their owners.In addition, it includes household’s interest income and government transfers.
41 Disposable Personal Income Disposable personal income is the income that household and noncorporate businesses have left after satisfying all their obligations to the government.It equals personal income minus personal taxes and certain nontax payments.
42 Y = C + I + G + NX The Components of GDP GDP (Y ) is the sum of the following:Consumption (C)Investment (I)Government Purchases (G)Net Exports (NX)Y = C + I + G + NX
43 The Components of GDP Consumption (C): Investment (I): The spending by households on goods and services, with the exception of purchases of new housing.Investment (I):The spending on capital equipment, inventories, and structures, including new housing.
44 Gross Domestic Product Gross InvestmentThe total amount spent on adding to the stock of capital and on replacing depreciated capitalNet InvestmentThe amount spent on adding to the stock of capitalGross Investment minus Depreciation
45 Capital and Investment InitialcapitalInstructor Notes:Tom’s gross investment is the 2 new machines bought during the year, and its depreciation is the 1 machine that Tom’s scrapped during the year.
46 The Components of GDP Government Purchases (G): Net Exports (NX): The spending on goods and services by local, state, and federal governments.Does not include transfer payments because they are not made in exchange for currently produced goods or services.Net Exports (NX):Exports minus imports.
48 GDP: The Income Approach Amount in PercentageItem (billions of dollars of GDPCompensation of employees 4,Net InterestRental IncomeCorporate ProfitsProprietors’ incomeIndirect taxes less subsidiesCapital consumption (depreciation)Gross domestic 7, productInstructor Notes:1) The sum of all incomes equals net domestic income2) GDP equals net domestic income plus capital consumption (depreciation).3) In 1996, GDP measured by the income approach was $7,576.
51 GDP and Its Components (1998) Investment16%Consumption68 %
52 GDP and Its Components (1998) GovernmentPurchases18%Investment16%Consumption68 %
53 GDP and Its Components (1998) Government Purchases18%Investment16%Net Exports-2 %Consumption68 %
54 Aggregate Expenditure, Output, and Income 100NXGGDPDepreciationIndirect taxesless subsidies80IProprietor’sincomesInterestCProfits60RentWages and otherlabor income40Instructor Notes:1) The red bar illustrates the components of aggregate expenditure as well as their relative magnitudes.2) Net exports, the smallest component, is shown here as a positive quantity, but in some years it is negative.3) The figure illustrates the equality between aggregate expenditure, aggregate income, and GDP (the yellow bar).4) The green bar illustrates the components of aggregate income and their relative magnitudes.Percentage of GDP20AggregateexpenditureGDPAggregateincome
55 Real versus Nominal GDP Nominal GDP values the production of goods and services at current prices.Real GDP values the production of goods and services at constant prices.
56 Real versus Nominal GDP An accurate view of the economy requires adjusting nominal to real GDP by using the GDP deflator.
57 GDP DeflatorThe GDP deflator measures the current level of prices relative to the level of prices in the base year.It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced.
58 GDP DeflatorThe GDP deflator is calculated as follows:
59 Converting Nominal GDP to Real GDP Nominal GDP is converted to real GDP as follows:
64 Real GDP in the United States Billions of 1992 Dollars(Periods of falling real GDP)8,0007,0006,0005,0004,0003,0001970197519801985199019952000
65 GDP and Economic Well-Being GDP is the best single measure of the economic well-being of a society.GDP per person tells us the income and expenditure of the average person in the economy.
66 GDP and Economic Well-Being Higher GDP per person indicates a higher standard of living.GDP is not a perfect measure of the happiness or quality of life, however.
67 GDP and Economic Well-Being Some things that contribute to well-being are not included in GDP.The value of leisure.The value of a clean environment.The value of almost all activity that takes place outside of markets, such as the value of the time parents spend with their children and the value of volunteer work.
69 SummaryBecause every transaction has a buyer and a seller, the total expenditure in the economy must equal the total income in the economy.Gross Domestic Product (GDP) measures an economy’s total expenditure on newly produced goods and services and the total income earned from the production of these goods and services.
70 SummaryGDP is the market value of all final goods and services produced within a country in a given period of time.GDP is divided among four components of expenditure: consumption, investment, government purchases, and net exports.
71 SummaryNominal GDP uses current prices to value the economy’s production. Real GDP uses constant base-year prices to value the economy’s production of goods and services.The GDP deflator--calculated from the ratio of nominal to real GDP--measures the level of prices in the economy.
72 SummaryGDP is a good measure of economic well-being because people prefer higher to lower incomes.It is not a perfect measure of well-being because some things, such as leisure time and a clean environment, aren’t measured by GDP.