1. Macro Economic Environment - Unemployment, Inflation
4th of March

2. Macroeconomic Objectives
The major macroeconomic issues
economic growth
unemployment
inflation
balance of payments and exchange rates 2

3. Economic Growth
Actual growth: Percentage annual increase of national output or ‘GDP’ (Gross Domestic Product.
Potential growth: The speed at which the economy could grow. It is the percentage annual increase of economic capacity to produce
Potential output: The output that could be produced in the economy if all firms were operating at their normal level of capacity utilisation. 4

4. The business cycle
The periodic fluctuations of national output round its long-term trend
the phases of the business cycle
the upturn – growth of actual output resumes
the expansion – periods of economic growth
the peaking out – growth slows down or even ceases
the slowdown or recession – periods of negative or no growth

5. The business cycle National output Time Full-capacity output Trend
Actual
output O
Time

6. Growth rates in selected industrial countries
Notes: 2013 and 2014 based on forecasts; EU-15 = the member countries of the European Union prior to 1 May 2004
Source: based on data in AMECO Database, European Commission, DGECFIN 6

7. Measuring a nation’s income
Macroeconomics answers questions like the following:
Why is average income high in some countries and low in others?
Why do prices rise rapidly in some periods of time while they are more stable in other periods?
Why do production and employment expand in some years and contract in others? 7

8. The economy’s income and expenditure
For an economy as a whole, income must equal expenditure because:
Every transaction has a buyer and a seller.
Every dollar of spending by some buyer is a dollar of income for some seller. 8

9. The measurement of GDP Y = C + I + G + NX
“GDP is the market value of all final goods and services produces within a country in a given period of time”
Y = C + I + G + NX
Y = GDP
C – Consumption
I – Investment
G – Government Purchases
NX – Net Exports 9

10. The measurement of GDP Final A greeting card is a final product
GDP is the Market Value
Since market prices measure the amount people are willing to pay for different goods they accurately reflect their value
If a price of an apple is twice that of an orange, the apple contributes twice as much to GDP as the orange
Of All
GDP tries to be comprehensive.
Includes all items produced in the economy and sold legally in the market
GDP also includes the market value of housing services. If people own their houses the govt estimates rent.
GDP excludes illegal items (drugs)
GDP excludes items that are produced and consumed at home (Vegetable Gardens)
Final
A greeting card is a final product
Paper used to make the greeting card is an intermediate product. (This is not calculated in the GDP)
The exception is when the “paper” is kept in inventory after being processed.
Only FINAL goods are calculated in GDP
Goods and Services
GDP includes both tangible and intangible goods.
Produced
GDP includes goods and services currently produced. (Used cards don’t count)
Within a country GDP measures the value of production within the geographic confines of a country. In a given period of time GDP measures the value of production that takes place within a specific interval of time 10

11. The components of GDP Consumption (C): Investment (I):
The spending by households on goods and services, with the exception of purchases of new housing.
Investment (I):
The spending on capital equipment, inventories and structures, including household purchases of new housing. 11

12. The components of GDP Government purchases (G): Net exports (NX):
The spending on goods and services by local, state and federal governments.
Does not include transfer payments because they are not made in exchange for currently produced goods or services.
Net exports (NX):
Exports minus imports. 12

13. Real versus nominal GDP
Nominal GDP values the production of goods and services at current prices.
Real GDP values the production of goods and services at constant prices. 13

14. GDP and economic wellbeing
GDP is the best single measure of the economic well being of a society.
GDP per person tells us the income and expenditure of the average person in the economy. 14

15. GDP and economic wellbeing
Higher GDP per person indicates a higher standard of living.
However, GDP is not a perfect measure of the happiness or quality of life. 15

16. GDP and economic wellbeing
Some things that contribute to wellbeing are not included in GDP.
The value of leisure.
The value of a clean environment.
The value of almost all activity that takes place outside of markets, such as the value of the time parents spend with their children and the value of volunteer work. 16

17. Inflation
Inflation refers to a situation in which the economy’s overall price level is rising.
The inflation rate is the percentage change in the price level from the previous period. 17

18. The consumer price index
The consumer price index (CPI) is a measure of the overall cost of the goods and services bought by a typical consumer. 18

19. How the CPI is calculated
Fix the basket: Determine which prices are most important to the typical consumer.
2. Find the prices: Find the prices of each of the goods and services in the basket for each point in time.
3. Calculate the basket’s cost: Use the data on prices to calculate the cost of the basket of goods and services at different times.
4. Choose a base year and compute the index: Designate one year as the base year, making it the benchmark against which other years are compared.
5. Compute the inflation rate: The inflation rate is the percentage change in the price index from the preceding period 19

20. What’s in the CPI’s basket?
Copyright©2004 South-Western 20

21. Real and nominal interest rates
The nominal interest rate is the interest rate usually reported and not corrected for inflation.
It is the interest rate that a bank pays.
The real interest rate is the nominal interest rate that is corrected for the effects of inflation. 21

22. Real and nominal interest rates
You borrowed $1,000 for one year.
Nominal interest rate was 15%.
During the year inflation was 10%.
Real interest rate = Nominal interest rate – Inflation
= 15 percent − 10 percent = 5 percent 22

23. Unemployment
Labor Force – the total numbers of worker including both the unemployed and the employed.
Unemployment rate – the % of the labor force that is unemployed
Unemployment rate = Number of unemployed *100
Labor Force
Employed
Paid/unpaid
Part time/full time
Unpaid workers in a family business
Unemployed
People who are available to work
People who are trying to find work
Not in the labor force
Full time students
Home makers
People who have given up looking for jobs.

24. Frictional unemployment
Unemployment that results because it takes time for workers to search for the jobs that best suit their tastes and skills

25. Natural rate of unemployment
The normal rate of unemployment which unemployment rate fluctuates.
Why is there always unemployment
Frictional unemployment
Minimum wage laws
Unions
Unemployment insurance
Wages
Efficiency wage theory suggest that firms maybe better off paying more that the equilibrium wage.
Healthier workforce.
Lower turnover
Worker Quallity