Macroeconomics and the Unit 2 Macroeconomics and the Circular Flow

Macroeconomics The part of economics concerned with the economy as a whole; with such aggregates as the household, business, and government sectors; and measures of the total economy

Why does output fluctuate? As output rises and falls, it can affect; # of goods and services people have Standard of living # of people employed Macroeconomics looks at the determinants of output fluctuation and how these factors can be controlled

What determines economic growth? Growth (long-run) in the economy depends on: Number of workers Education and training of workers Technological advances Amount of machinery and technology labor has to work with Basic material resources Macroeconomics addresses how society can encourage the development of these factors, which determine economic growth

Why do we have unemployment,and why is unemployment a problem? The unemployed are people who are actively seeking jobs or are temporarily laid off Unemployment means that society has fewer products because workers are not working Unemployment also imposes social and psychological costs on society

Why do we have inflation, and why is inflation a problem? An increase in the average price level over time (price level –weighted avg. of the prices of all final goods & services) Unpredictable Macroeconomics studies the causes of inflation, the misallocation of resources that result from inflation, and methods for controlling inflation.

Which government policy affects output, growth, unemployment and inflation? Fiscal policy Summary of the government’s decisions about expenditures and taxation Government decisions on taxes and spending will affect the level of output, growth, unemployment and inflation.

How do changes in the amount of money in the economy affect output, growth, unemployment and inflation? Decisions of the central bank – the Federal Reserve in the United States – determine the amount of money (money supply) in the economy Monetary policy Summary of the Federal Reserve’s decisions about money and interest rates

How do domestic economic activities affect other countries? A nation’s economy does not operate independent of other countries’ economies Trade, Monetary, and Fiscal policies all affect the impact of the domestic economies of other nations

Activities 9 and 10

Economic goals of U.S. society Full Employment Price Stability Economic Growth Goals may conflict Trade-offs

Activity 11

Unemployment Rate Broad measure of economic activity However, if policy makers are going to create and implement programs to help the unemployed, they need to know more about the unemployed: Skill level Ethnic and racial groups Age groups

Measuring Price Changes Critical Issues The CPI (Consumer Price Index)measures the price level; and from this the inflation rate can be calculated The CPI is only one of several price level measures The CPI may overstate the actual change in the cost of living The growth rate in real GDP is a better measure of the change in macroeconomic conditions than the growth rate of nominal GDP because real GDP includes the effects of inflation The growth rate in real GDP per capita captures a measure of changes in the standard of living

Fluctuations in output and long-run economic growth Fluctuations in output (short-run economic growth) Measured by the changes on real GDP from quarter to quarter or year to year In general, caused by greater or lesser utilization of existing capital stock and technology Fluctuations in long-run economic growth Long-run economic growth refers to changes in the productive capability of the economy through changes in the amount of plant, equipment, and technology

GDP and national income accounting Only final goods and services are included in GDP Market activities are included, but financial transactions are not GDP = C+Ig+G+Xn C= consumption spending Ig= investment spending G= government spending Xn= net exports (exports-imports)

GDP Consumption (C) All expenditures by households on final goods and services Investment Spending (Ig) All final purchases of capital by businesses All construction All changes in inventories Government Spending (G) Expenditures for goods and services Expenditures for social capital (schools, highways) Net Exports (Xn) (Exports – Imports)

GDP INCLUDED All final goods & services produced with-in the country for a given year NOT INCLUDED Purely financial transactions Public transfer payments Private transfer payments Stock market transactions Secondhand sales

Two approaches to calculate GDP Expenditures Approach (C+Ig+G+Xn) All the spending on final goods and services throughout the year Income Approach Sums employee compensation, rent, interest, proprietor's income, & corporate profits to obtain national income. Then add indirect business taxes, depreciation, and net foreign factor income to measure GDP

Shortcomings of GDP Nonmarket transactions Leisure Improved Product Quality Underground Economy Environment

Activity 12

Price Indexes and Inflation An index number that shows how the weighted-average of a “market basket”of goods changes over time

Activity 13

Inflation Inflation Increase in the overall level of prices Anticipated inflation The level of inflation people expect to occur and have built into their economic decisions Unanticipated inflation Level of inflation that is not expected or is unforeseen

Who is hurt or helped by unanticipated inflation? Fixed-income receivers, savers, creditors Why? Redistributes real income away from them and toward others Helped Flexible-income receivers, debtors (borrowers) Why? Redistributes real income toward them and away from others

Activity 15

Unemployment Employed Unemployed Labor force Unemployment rate Everyone currently working, including part-time workers Unemployed People looking for work or temporarily laid off from work Labor force Employed + unemployed Unemployment rate Unemployed / labor force Labor force participation rate Labor force / population aged 16 and older

Issues with Unemployment Discouraged workers People who were looking for work but gave up because they didn’t succeed in finding a job Underemployed workers People who are working part time but would like to work full time, or who hold a job that requires a lower skill than they possess Unequal burdens of unemployment Occupation, age, race & ethnicity, gender, education

Types of Unemployment Frictional Cyclical Structural People who are temporarily between jobs Cyclical People who are not working because firms do not need their labor due to lack of demand or a downturn in the business cycle Structural Mismatches between job seekers and job openings

Other terms Natural rate of unemployment “Full employment” There is no cyclical unemployment Frictional and structural unemployment may exist “Full employment” Occurs when the economy is at the natural rate of unemployment

Activity 16

The Business Cycle What causes output to rise and fall? What causes unemployment to rise and fall? The Business Cycle describes economic fluctuations the rising and falling of output in relation to potential output

Phases of the Business Cycle Recession/Contractionary Two consecutive quarters (six months) of negative growth in real GDP Peak The point at which output starts to decline; beginning of recession Trough The point at which output starts to increase; end of recession Recovery or expansion The economy begins to move forward; period between the trough and the next peak

Business Cycle’s affect on Output, Employment & the Price Level Recession Period of decline in output and employment. Price level will fall only if a depression occurs Peak Economy is at full employment, level of real output is at or close to capacity, & the price level is likely to rise Trough Output and employment “bottom out”, they are at there lowest levels. Price level may fall Recovery or Expansion Output and employment rise toward full employment. As recovery intensifies the price level may begin to rise

Key Points There is no consistent length of time for each phase Business cycles are unpredictable After the fact, economists can identify some causes but predicting the actual downturn is hard Countercyclical and Procyclical variables Countercyclical – move in opposite direction from real GDP Procyclical – move in same direction as real GDP

Activity 17 and 18