Unit 3: Macroeconomic Concepts The Impact of Economics on the American Economy

Micro vs. Macro What’s the difference? Micro – studying economic behavior and decisions in small units  individuals, households, etc. Macro – studying economic behavior and decision making in an entire economy  ex. Nation, state, etc.

Measuring the Economy We look at… ◦ Overall levels of income ◦ Employment ◦ Prices These data sources can provide a picture of the overall economy… Why do you think this is?

What Impacts our Measurements? Spending and production decisions made in the Resource (Factor) and Product Markets ◦ Driven by households, business, and government  Remember Circular Flow????

Gross Domestic Product (GDP) The primary tool of measurement GDP is the total market value of all goods and services produced within a country in a given time period. ◦ Includes items produce within the country

GDP Measures Economic Growth “Real” GDP is used to measure growth from one time period to the next Nominal GDP uses current prices to determine market value Real GDP adjusts prices for inflation to determine market value Why is adjusting for inflation necessary for comparison?

Calculating GDP – Using the Expenditure Approach Expenditure Approach – calculated by totaling transactions in the…Product Market

GDP = C + I + G + (X-M) C = Consumer Spending on Goods (durable and non-durable) & services I = Business Investment in capital goods G = Government Spending (X-M) = Total Exports – Total Imports give you net exports

Economic Growth GDP Growth = Outward shift of Production Possibilities Curve

Economic Growth

Influences on GDP Aggregate Supply- the total amount of goods and services in the entire economy available at all possible price levels… ◦ Average of all prices in the economy

Aggregate Supply Curve AS curve illustrates relationship between prices and output supplied (seen in GDP)

Influences on GDP (cont.) Aggregate Demand- the amount of goods purchased at all possible price levels ◦ This is driven by the collective behavior of consumers in an economy…

Aggregate Demand Curve As Price Levels increase, demand for goods and services decreases (change in quantity impacts GDP)

Equilibrium in the Macro Intersection of AS & AD is an “ideal” economy… What effect would shifting Demand or Supply have on GDP?

Causes of Shifts in AS and AD Business Investment ◦ Increases lead to more jobs – AD & the GDP increases (economy grows)

Causes of Shifts in AS and AD Consumer Expectations ◦ Consumer confidence effects the economy ◦ When good things are expected to happen, consumer confidence grows  spending increases, AD & economy (GDP) grows

Causes of Shifts Interest Rates (the cost of borrowing money) ◦ Low rates = business investment grows and creates jobs & people borrow more $ to buy and do  AD and economy (GDP) grows

Causes of Shifts External Shocks impact AS ◦ Negative – wars, droughts, trade disputes, natural disasters  cause AS & economy (GDP) shrinks ◦ Positive – new discoveries of resources, record crop production due to perfect weather conditions  cause AS & economy (GDP) grows

Factors Impacting GDP & Economic Growth Inflation – Increase in average Price Level of all goods and services ◦ AD is increasing faster than AS ◦ Effects:  Decline in Purchasing Power of the dollar  Real Wages Decline because they grow slower than the Inflation Rate (IR)  Interest Rates Increase  Loss of $ in Savings Investments  Increased Production Costs

Factors Impacting GDP & Economic Growth Types of Inflation ◦ Demand-Pull – occurs when increased AD “pulls” prices higher ◦ Cost-Push – occurs when costs for factors of production increase and “pushes” prices higher

Factors Impacting GDP & Economic Growth tQsT8 Deflation – decrease in overall Price Levels Hyperinflation – Inflation Rate (IR) is several hundred % vs. normal rate that is (1% to 3%) Stagflation – occurs when there is both a RISING Price Level and a DECREASE in Real GDP ◦ Typically comes with rising unemployment

How We Measure These Consumer Price Index (CPI) – measurement of inflation using price levels for a fixed group of products called the “Market Basket”. The “Base Year” (comparison year) is given a standard value or “index” of 100 ◦ is the current Base Year time period ◦ The CPI for every year is based on this scale

CPI Calculation

Calculating Inflation Rate

Factors Impacting GDP & Economic Growth Unemployment – refers to people who do not currently hold a job, but are actively seeking one. ◦ Means we are inefficient using one of our major factors of production ◦ Point of Underutilization in Production Possibilities

Unemployment

Unemployment Three (Four) Types ◦ Structural ◦ Cyclical ◦ Frictional ◦ (Seasonal) See Graphic Organizer & Article

The Business Cycle

A graph that illustrates the relationship between real GDP and time. ◦ Y-axis – Real GDP ◦ X-axis – time

Four Parts of the Cycle Peak – the highest point of real GDP between the end of an economic expansion and beginning of an economic contraction Contraction – phase in cycle when real GDP is declining ◦ > 6 months (two quarters) is recession ◦ If long/sustained, it is depression

Four Parts of the Cycle Trough – the lowest point of real GDP between the end of a contraction and beginning of a recovery Expansion - when real GDP becomes positive after a period of negative real GDP ◦ Recovery lasts until real GDP reaches the previous level at peak ◦ Called expansion/prosperity after the previous level is achieved

Business Cycle Graph Activity On your provided paper 1.Label Y-Axis as “Real GDP” 2.Label X-Axis as “Time” 3.Draw the Business Cycle on your graph as big as possible, but leave room for labels 4.On the back of the paper write the definitions for peak, trough, contraction, expansion, and recovery

Business Cycle Graph 5. Answer these questions: ◦ Why do you think the expansion on your chart is divided between a recovery and prosperity? How do you find the start of prosperity? ◦ How long must a contraction last before it can be considered a recession?

Business Cycle Graph 6. Label the following economic indicators on your graph: CPI Unemployment Real GDP

Business Cycle Graph 7. Closing discussion questions: ◦ Monetary Policy is the Federal Reserve Bank’s power to increase or decrease the supply of money in the economy. They can do this by increasing or decreasing interest rates.  If the FED is worried about inflation, what would they want to do about the supply of money in the economy?  Would they raise or lower interest rates to do this?

Business Cycle Graph ◦ Fiscal Policy is the power of Congress to increase or decrease taxes and increase or decrease government spending.  When the government is worried about inflation should they increase or decrease government spending?  Should they increase or decrease taxation?

The Federal Reserve and Monetary Policy The Federal Reserve Bank ◦ Created in 1913 to instill trust in the nation’s banks ◦ “Banker’s Bank” – the money from our banks flow through the FED ◦ Also the government’s bank

The FED Structure Led by the Chairman the FED – nominated by the President and serves for14 years Has 12 District Banks spread across the country Federal Open Market Committee ◦ Meets to study the health of the economy ◦ Made up of district bank presidents and a Board of Governors appointed by the President

FED District Banks

Goals of the FED Promote Price Stability ◦ Control inflation/deflation Promote Full Employment ◦ No cyclical unemployment Promote Economic Growth ◦ Increase GDP

How does the FED Meet these Goals? MONETARY POLICY ◦ Refers to 3 tools the FED uses to meet these goals

Tool # 1- Open Market Operations FED buys/sells government treasuries (like bonds) from the “public” ◦ FED selling is essentially a loan that will be paid back with interest – decreases the $ supply in the economy ◦ FED buying back – increases the $ supply in the economy

Tool #2 – Change Discount Rate Second most common It’s the interest rate that the FED charges member banks to borrow from them Raising/lowering the rate impacts how much $ banks can borrow Banks can give temporary loans from each other ◦ FED Funds Rate is what they charge each other

Tool #3 – Change Reserve Requirement Least Common Tool % of deposits banks must keep on hand (in reserve) & can’t loan out Raising/lowering the % requirement impacts how much a bank can lend What if the requirement was changed to 20% - how much of the $10,000 could the bank lend?

Summary of Monetary Policy Contractionary (Tight Money) – uses tools to decrease money supply ◦ How will it use each of the 3 tools to do this? Expansionary (Loose Money) – uses tools to increase money supply ◦ How will it use each of the 3 tools to do this?

Government and Fiscal Policy Fiscal Policy - the power of the government to use government spending and taxation policies to influence economic activity.

Fiscal Policy Goals Price Stability Full Employment Economic Growth

Fiscal Policy Tools Taxation & Government Spending ◦ Occurs at federal, state, and local levels ◦ Typically proposed by the executive branch (ex. President) and legislature (ex. Congress) writes a bill to address the action ◦ Bills often have many projects added on to it in order to get it passed & become a law ◦ Many laws have clauses that allow additional taxes/spending without adding new laws

Tool #1: Taxation Many taxes grow with the economy  “automatic stabilizers” ◦ Income Tax is a Progressive Tax because tax dollars paid increase as salary increases  Tax collection increases with inflation in salaries  Tax collection decreases with deflation in salaries ◦ Sales Tax dollars collected also increase when prices of products increase

Use of Taxes Tax increases = less consumer net income & spending declines ◦ Raising taxes is a Contractionary Tool Tax decreases = more consumer net income & spending increases ◦ Lowering taxes is an Expansionary Tool

Tool #2: Government Spending Governments can increase or decrease spending to influence the economy ◦ More spending increases government investment  more workers & businesses ◦ Less spending decreases government investment  less workers & businesses What kind of fiscal tool was the New Deal supposed to be? Why can’t the government keep spending more to keep the economy growing?

Debt vs. Deficit What is the difference between a government budget deficit and government debt?

Debt vs. Deficit Deficits – occur when government spending exceeds its revenue in their annual budget…occurs in one year ◦ Opposite would be a Surplus ◦ Balanced budget occurs when expenses = income Debt – the compilation of all deficits plus interest owed…grows over many years

Government Debt Why doesn’t the government cut back all its spending so we can get out of debt? United States Debt