Unit 4 The Big Picture And Tracking the Macroeconomy Macroeconomics, Paul Krugman and Robin Wells.

Tonight, we will learn about: -Differences between Microeconomics and Macroeconomics -Business Cycle -Long-run growth in the economy -inflation, deflation and price stability -Open economy vs. closed economy -GDP, Gross Domestic Product -Unemployment -Price Indexes used to calculate Inflation An overview of macroeconomics, the study of the economy as a whole, and how it differs from microeconomics The importance of the business cycle and why policy-makers seek to diminish the severity of business cycles What long-run growth is and how it determines a country’s standard of living The meaning of inflation and deflation and why price stability is preferred What is special about the macroeconomics of an open economy, an economy that trades goods, services and assets with other countries What is special about the macroeconomics of an open economy, an economy that trades goods, services and assets with other countriesAn overview of macroeconomics, the study of the economy as a whole, and how it differs from microeconomics -How economists use aggregate measures to track the performance of the economy. -What gross domestic product , or GDP, is and the three ways of calculating it -The difference between real GDP and nominal GDP and why real GDP is the appropriate measure of real economic activity -The significance of the unemployment rate and how it moves over the business cycle -What a price index is and how it is used to calculate the inflation rate

Macroeconomics vs. Microeconomics Microeconomics focuses on how decisions are made by individuals and firms and the consequences of those decisions Example: How much would it cost to add a new course? Macroeconomics examines the aggregate behavior of the economy ─ how the actions of all the individuals and firms in the economy interact to produce a particular level of economic performance as a whole. Paradox of Thrift

The Great Depression precipitated a thorough rethinking of macroeconomics, which gave rise to modern macroeconomics.

The Business Cycle What happens during a business cycle? And what can be done about it? -effects of recessions, and expansions on unemployment -the effects of aggregate output -the possible role of government policy

Employment and Unemployment Employment is the number of people working in the economy. Unemployment is the number of people who are actively looking for work but aren’t currently employed. The labor force is equal to the sum of employment and unemployment.

Employment/Unemployment -Discouraged workers are non-working people who are capable of working but are not actively looking for a job. -Underemployment is the number of people who work during a recession but receive lower wages than they would during an expansion due to smaller number of hours worked, lower-paying jobs, or both. -The unemployment rate is the ratio of the number of people unemployed to the total number of people in the labor force, either currently working or looking for jobs.

Taming the Business Cycle Policy efforts undertaken to reduce the severity of recessions are called stabilization policy. One type of stabilization policy is monetary policy, changes in the quantity of money or the interest rate. The second type of stabilization policy is fiscal policy, changes in tax policy or government spending, or both.

Long-Run Economic Growth Secular long-run growth, or long-run growth, is the sustained upward trend in aggregate output per person over several decades. A country can achieve a permanent increase in the standard of living of its citizens only through long-run growth. So a central concern of macroeconomics is what determines long-run growth

Aggregate Price Level A nominal measure is a measure that has not been adjusted for changes in prices over time. A real measure is a measure that has been adjusted for changes in prices over time. The change in real wages is a better measure of changes in workers’ purchasing power than the change in nominal wages. The aggregate price level is the overall level of prices in the economy.

Real vs. Nominal GDP To illustrate the difference between nominal GDP and real GDP, this figure shows the percent change in both measures over successive decades within the United States. (Real GDP was calculated using chained 2000 dollars.) The years 1929–1939 show the effect of deflation on the difference between nominal and real GDP: U.S. nominal GDP in 1939 was 11% lower than in 1929, but U.S. aggregate output as measured by real GDP was nearly 10% higher. The remaining years show the effect of inflation on the difference between the two measures: relatively high growth of U.S. nominal GDP in the years 1969–1979 and 1979–1989 contrast with relatively low growth of U.S. real GDP during those same periods. Those years experienced high levels of inflation and a simultaneous slowdown in real GDP growth. Source: Bureau of Economic Analysis.

Inflation and Deflation A rising aggregate price level is inflation. A falling aggregate price level is deflation. The inflation rate is the annual percent change in the aggregate price level. The economy has price stability when the aggregate price level is changing only slowly.

Price Indexes and the Aggregate Price Level A price index is the ratio of the current cost of that market basket to the cost in a base year, multiplied by 100.

Indexes CPI: Consumer Price Index Bureau of Labor Statistic consumer basket PPI: Producer Price Index (producer basket) GNP Deflater (ratio of nominal to real GDP)

The CPI, the PPI, and the GDP Deflator As the figure shows, these three different measures of inflation usually move closely together. Each reveals a drastic acceleration in the inflation rate during the 1940s and the 1970s and a return to relative price stability in the 1990s.

The Open Economy A closed economy is an economy that does not trade goods, services, and assets. The United States has become increasingly open, so that open-economy macroeconomics has become increasingly important. Open-economy macroeconomics is the study of those aspects of macroeconomics that are affected by movements of goods, services, and assets across national boundaries.

The Open Economy One of the main concerns introduced by open-economy macroeconomics is the exchange rate, the price of one currency in terms of another. Exchange rates can affect the aggregate price level. They can also affect aggregate output through their effect on the trade balance, the difference between the value of the goods and services a country sells to other countries and the value of the goods and services it buys in return. Economists are also concerned about capital flows, movements of financial assets across borders.

Value of GDP= Consumer spending, investment spending Figure 7.1 An Expanded Circular-Flow Diagram: The Flows of Money Through the Economy Krugman and Wells: Macroeconomics, First Edition Copyright © 2006 by Worth Publishers

Gross Domestic Product Gross domestic product , or GDP, measures the value of all final goods and services produced in the economy. It does not include the value of intermediate goods.

Calculations for an Economy GDP Consumer Spending + Investment Spending + Government Spending + exports – imports = GDP Net Exports Exports – Imports = net Exports Disposable Income: Total wages + Government transfers – taxes = DI

Homework 7-2 What is value of GDP? What is the value of net exports? What is the value of disposable income? What is total flow of money out of households?

In this hypothetical economy consisting of three firms, GDP can be calculated in three different ways: Measuring GDP as the value of production of final goods and services, by summing each firm’s value added; measuring GDP as spending on domestically produced final goods and services, and measuring GDP as factor income earned from firms in the economy.

Real vs. Nominal GDP Real GDP: the value of the final goods and services produced calculated using the prices of some base year. Nominal GDP: output valued at current prices. Real GDP per capita is a measure of average output per person, but is not by itself an appropriate policy goal.

Review: Which is correct? Microeconomics/Macroeconomics focuses on economy as a whole. Inflation is one of the topics studied in Macroeconomics/Microeconomics. The unemployment rate is the % of the labor force that is unemployed/employed. Expansion/Recession is when output it increasing and unemployment is decreasing. A business cycle is a short-term/long-term fluctuation between upturns & downturns. Nominal GDP is adjusted/not adjusted for changes over time.

Homework/Next Week Chapter 6: The Big Picture: 2 & 4 Chapter 7: Tracking the Macroeconomy: 2 & 4 Next Week: Chapter 8: Long Run Growth Chapter 9: Saving, Investing, Spending and the Financial System

Problem #11 Calculate market basket for books in each year. Cost of TB 2002 = Cost of TB 2003 = Cost of TB 2004 = 2. Establish a base year of 2002 3. Apply each year to formula: Cost of TB 2002/ base year x 100 = ??? TB=