MACROECONOMICS!

Measure health of the economy Guide government policy Macroeconomics: the study of the economy as a whole. Goals: Measure health of the economy Guide government policy

For all countries there are three major policy goals: Promote Economic Growth Limit Unemployment Limit Inflation

Promote Economic Growth How does a country measure Goal #1 Promote Economic Growth How does a country measure economic growth?

How do we know how well the economy is doing? Economists collect statistics on production, income, investment, and savings. The most famous statistic is GDP. Gross Domestic Product (GDP): the dollar value of all final goods and services produced within a country’s borders in one year. *Final Goods - GDP does not include the value of intermediate goods (goods used in the production of final goods and services)

What does GDP tell us? Uses of GDP Basically, how much wealth a country produces Uses of GDP Compare to previous years (Is there growth?) Compare policy changes (Did a new policy work?) Compare to other countries (Are we better off?) Countries by GDP (2014) We’re number 1!

World map – land area

World map – population

World GDP Distribution

World GDP Distribution Nominal GDP – 2014 rankings 10

U.S. State Rankings – Gross State Product

The GDP of US states is comparable to entire countries 12

How can we measure economic growth? % Change in GDP = Year 2 - Year 1 Year 1 X 100 Mordor’s GDP in 2007 was $4000 Mordor’s GDP in 2008 was $5000 What is the % Change in GDP? Transylvania’s GDP in 2007 was $2,000 Transylvania’s GDP in 2008 was $2,100 13

What is NOT included in GDP? Intermediate Goods No Multiple Counting, Only Final Goods EX: Price of finished car, not the radio, tire, etc. 2. Nonproduction Transactions Financial Transactions (nothing produced) Ex: Stocks, bonds, Real estate Used Goods Ex: Old cars, used clothes 3. Non-Market (Illegal) Activities Ex: Illegal drugs, unpaid work

Calculating GDP Two Ways to calculate GDP: 1. Expenditures Approach - Add up all the spending on final goods and services produced in a given year. 2. Income Approach - Add up all the income from sales of final goods and services *Same result; all money spent is income to someone else

Expenditures Approach Four components of GDP: Consumer Spending Ex: $5 Little Caesar's Pizza Investment Spending - When businesses put money back into their own business. Ex: Machinery or tools Government Spending Ex: Bombs or tanks, NOT social security Net Exports - Exports (X) – Imports (M) Ex: Value of 3 Ford Fiestas minus 2 Honda Civics GDP = C + I + G + Xn

Calculating GDP

Included or not Included in GDP? For each situation, identify if it is included in GDP the identify the category C, I, G, or Xn $10.00 for movie tickets $5M increase in defense spending $45 for a used economics textbook Ford makes new $2M factory $20K Toyota made in Mexico $10K profit from selling stocks $15K car made in US, sold in Canada $10K Tuition to attend college $120 Social Security payment to Bob Farmer purchases new $100K tractor

Nominal GDP vs. Real GDP

What is the problem with this method? How can you figure out which is the most popular movie of all time? What is the problem with this method? Nominal Box Office Receipts

How can you figure out which is the most popular movie of all time? Real Box Office Receipts (adjusted for inflation)

The Problem with GDP If a country’s GDP increased from $4 Billion to $5 Billion in one year, is the country experiencing economic growth? Did the country definitely produce 25% more products? What is Inflation? A rising general level of prices

Warm Up What is Macroeconomics? What is GDP? Answer the following with your neighbor: What is Macroeconomics? What is GDP? What are the four main components of GDP (using the expenditures approach)? What’s NOT included in GDP? What’s the difference between nominal and real GDP growth? What’s the best movie of all time?

What’s Macroeconomics? What is GDP? What are the four main components of GDP? What’s NOT included in GDP? What’s the difference between Nominal and Real GDP? What’s inflation? What’s the best movie of all time?

Real vs. Nominal GDP Nominal GDP is measured in current prices. Doesn’t account for inflation Real GDP is expressed in constant, or unchanging, dollars Real GDP adjusts for inflation. REAL GDP IS THE BEST MEASURE OF ECONOMIC GROWTH

Real vs. Nominal GDP 2013 10 cars at $15,000 each = $150,000 10 trucks at $20,000 each = $200,000 Nominal GDP = $350,000 The GDP in year 2013 shows the dollar value of all final goods produced. The nominal GDP in year 2014 is higher, which suggests that the economy is improving. But did the economy really grow? How can we find out? 2014 10 cars at $16,000 each = $160,000 10 trucks at $21,000 each= $210,000 Nominal GDP = $370,000 Use 2013 Prices 2014 GDP is the same as 2013 GDP after the inflation adjustment 2014 10 cars at $15,000 each = $150,000 10 trucks at $20,000 each= $200,000 REAL GDP = $350,000

Real GDP “deflates” nominal GDP by adjusting for inflation in terms of a base year prices.

Does GDP accurately measure standard of living? Example: Norway and Nigeria have roughly the same GDP ($500 Billion). Is Nigeria as wealthy as Norway? Two adjustments: 1) divide GDP by population (GDP per capita) 2) adjust for cost of living – PPP (Purchasing Power Parity)

Country rankings – GDP per capita (PPP adjusted)

Why are some countries wealthier than others? 1. Economic System and Institutions Capitalism vs. fascism, socialism, totalitarianism Good governance vs. corruption 2. Physical Capital Ex: Machinery, tools, and man-made resources. Example#1: Bangladesh has over 100 million people but relatively few capital resources => poverty 3. Human Capital An educated, knowledgeable workforce is more productive – E.g. Japan is wealthy despite limited natural resources 4. Natural Resources Ex: Mauritania is mostly barren desert

Where-To-Be-Born Index (WTBBI) Even better than GDP (PPP) per capita! WTBBI Includes: Average Income Life expectancy Divorce rates Political freedoms Corruption Climate

Bottom 10

Warm Up According to results from a Gallup poll of over 140,000 people in 143 different countries, the happiest* country in the world is Paraguay. Paraguay ranks 110th in the world in GDP per capita and 111th on the Human Development Index. How do you explain this apparent discrepancy? *The survey defines happiness as “experiencing positive emotions on a daily basis”

THE BUSINESS CYCLE

The Business Cycle The Business Cycle describes the fluctuations in economic activity (as measured by real GDP) that a national economy experiences over time

The Business Cycle Peak Peak Expansion Contraction Contraction Trough

Expansion During a period of expansion: Wages increase Unemployment is low Consumers spend more money High demand for goods/services More businesses are launched Getting a loan is easier Businesses make more profits and stock prices rise

Peak When the business cycle peaks: The economy stops growing Real GDP reaches a maximum Businesses stop expanding and hiring workers Economy begins to contract

Contraction

Contraction During a period of contraction: Businesses cut back production and lay off workers Unemployment increases Wages fall Consumers become pessimistic about the economy and decrease spending Banks cut back on lending

Trough When the business cycle reaches a trough: Real GDP “bottoms-out” (reaches a low point) High unemployment and low spending Stock prices drop On the bright side, when an economy bottoms out, there’s nowhere to go but up!

Recession and Depression A prolonged contraction is called a recession (contraction for over 6 months) A really prolonged recession (generally a year or more) is called a depression

Causes of the Business Cycle External “shocks” to the economy e.g. sharp changes in oil prices, wars, droughts Financial crises e.g. the Great Depression and Recession