1. Chapter 6 Introduction to Macroeconomics McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter Objectives Long-run economic growth and short-run fluctuations GDP, inflation, and unemployment Sustained increase in living standards Savings and investment Shocks and sticky prices 6-2

3. Performance and Policy Real GDP –Corrects for price changes Nominal GDP –Uses current prices Unemployment Inflation –Increase in overall level of prices 6-3

4. Performance and Policy Can governments: –Promote economic growth? –Reduce severity of recession? Is monetary or fiscal policy more effective at mitigating recession? Is there a tradeoff between inflation and unemployment? 6-4

5. Economic Performance Output growth –3.1% per year 1995-2005 Unemployment rate –4.6% in 2007 Inflation rate –2.7% in 2007 6-5

6. Economic Growth Standard of living measured by output per person No growth in living standards prior to Industrial Revolution Modern economic growth –Output per person rises –Not experienced by all countries 6-6

7. GDP Per Person 2007 Zimbabwe$188 United States$45,845 Canada$38,345 Japan$33,576 United Kingdom$35,134 South Korea$24,782 France$33,187 Russia$14,692 Saudi Arabia$23,243 Burundi$371 Tanzania$1,256 North Korea$1,900 India$2,659 China$5,292 Mexico$12,774 U.S. dollars based on purchasing power parity 6-7

8. Savings and Investment Saving –Tradeoff current for future consumption Investment –Financial investment –Economic investment Banks and financial institutions 6-8

9. Expectations The future is uncertain Expectations affect investment Shocks –What happens is not what you expected Demand shocks Supply shocks 6-9

10. Shocks Demand shocks and flexible prices –Price falls if demand low –Sales unchanged Demand shocks and sticky prices –Maintain inventory –Sales change –Business cycles 6-10

11. Demand Shocks Cars per week Price DMDM DLDL DHDH 900 $40,000 $37,000 $35,000 Flexible Prices 6-11

12. Demand Shocks Cars per week DMDM DLDL DHDH 700 900 1150 $37,000 Fixed Prices Price 6-12

13. Sticky Prices Explain fluctuations is GDP Average months between price changes Coin-operated Beer4.3 Laundry Machine46.4 Microwave Ovens3.0 Newspaper29.9 Milk2.4 Haircut25.5 Electricity1.8 Taxi fare19.7 Airline ticket1.0 Veterinary service14.9 Gasoline0.6 Magazine11.2 Computer software5.5 6-13

14. Sticky Prices Many prices sticky in short run –Consumers prefer stable prices –Firms want to avoid price wars All prices flexible in long run –Firms adjust to unexpected, but permanent changes in demand 6-14

15. Inventory Management Computerized inventory tracking Unexpected changes in demand easier to observe Firms make better output and employment decisions Less severe business cycles Only two mild recessions since adoption –Possible explanation 6-15

16. Key Terms business cycle recession real GDP nominal GDP unemployment inflation modern economic growth savings investment financial investment economic investment expectations shocks demand shocks supply shocks inventory inflexible prices (“sticky prices”) flexible prices 6-16

17. Next Chapter Preview… Measuring Domestic Output and National Income 6-17