Chapter 23 An Introduction to Macroeconomics McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

23-2 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

23-3 Performance and Policy Real GDP –Corrects for price changes Nominal GDP –Uses current prices Unemployment –Actively seeking employment Inflation –Increase in overall level of prices

23-4 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?

23-5 Economic Performance Output growth –3.1% per year –2.8% Unemployment rate –4.6% in 2007 Inflation rate –2.7% in 2007

U.S. GDP Growth 23-6

China GDP Growth 23-7

U.S. Unemployment Rate 23-8

U.S. Inflation Rate 23-9

23-10 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

23-11 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

23-12 Savings and Investment Saving –Tradeoff current for future consumption Investment –Financial investment –Economic investment Newly created capital goods Banks and financial institutions

23-13 Expectations The future is uncertain Expectations affect investment Shocks –What happens is not what you expected Demand shocks Supply shocks

23-14 Shocks Optimal Output = min ATC Demand shocks and flexible prices –Price falls if demand low –Sales unchanged Demand shocks and sticky prices –Maintain inventory –Sales change –Business cycles - growth and recession

23-15 Demand Shocks Cars per week Price DMDM DLDL DHDH 900 $40,000 $37,000 $35,000 Flexible Prices

23-16 Demand Shocks Cars per week DMDM DLDL DHDH $37,000 Fixed Prices Price

23-17 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 software 5.5

23-18 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 –“sticky,” not “stuck”

23-19 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

23-20 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

23-21 Next Chapter Preview… Measuring Domestic Output and National Income