What Macroeconomics Is All About

What Macroeconomics Is All About
1 Chapter 19 What Macroeconomics Is All About Copyright © 2011 Pearson Canada Inc.

In this chapter you will learn…
2 In this chapter you will learn… …the meaning and importance of the key macroeconomic variables, including national income, unemployment, inflation, interest rates, exchange rates, and trade flows. 2. …that most macroeconomic issues are about either long-run trends or short-run fluctuations, and that government policy is relevant for both. Copyright © 2011 Pearson Canada Inc.

Copyright © 2011 Pearson Canada Inc.
3 19.1 Key Macroeconomic Variables Output and Income The production of output generates income. To measure total output in dollars, we add up the values of the many different goods produced. But how do we add up steel and haircuts? This gives nominal national income. With base-period prices, we get real national income (denoted Y). Fixed set of prices? – (prices from some given year, say 2005) MFC MFC MFC41-111MFC2007 Copyright © 2011 Pearson Canada Inc.

Output and Income National output of goods and services during a given period is measured as gross domestic product - GDP National income is denoted Y – the total of goods and services made available to society during a given period A nation’s income during a given period is exactly equal to the total of all goods and services it creates during a given period Therefore Y = GDP MFC MFC MFC MFC41-111MFC2007

6 Real GDP fluctuates around a rising trend: - the trend shows long-run economic growth - the short-run fluctuations show the business cycle APPLYING ECONOMIC CONCEPTS 19-1 The Terminology of Business Cycles Copyright © 2011 Pearson Canada Inc.

7 Potential output is what the economy could produce if all resources were employed at their normal levels of utilization - often called full-employment output The output gap measures the difference between potential output and actual output. Output Gap = Y-Y* When Y < Y* , there is a recessionary gap. When Y > Y*, there is an inflationary gap. Copyright © 2011 Pearson Canada Inc.

10 Employment, Unemployment, and the Labour Force Employment: the number of workers (15+) who hold jobs. Unemployment: the number who are not employed but are actively looking for one. Labour force: the total number of employed + unemployed. Unemployment rate: the number of unemployed expressed as a percentage of the labour force. Copyright © 2011 Pearson Canada Inc.

Number of people unemployed Unemployment Rate = X 100
11 Number of people unemployed Unemployment Rate = X 100 Number of people in the labour force Even when Y = Y*, some unemployment exists: frictional unemployment structural unemployment Copyright © 2011 Pearson Canada Inc.

Employment, Unemployment, the Labour Force Participation Rate and Unemployment Rate: An example - Windsor CMA 2009 Population (POP): 273,300 (15+) Supplementary slide Employment (E): 150,600 Unemployed (UN): 24,200 Labour force (LF): = E + UN = 150, ,200 = 174,800 Unemployment rate (UR): UN / LF = (24,200 / 174,800) x 100 = 13.84% We can also calculate the following variables of interest (not in text) Participation rate (PR): LF / POP = (174,800 / 273,300) x 100 = 63.95% Employment rate (ER): E / POP = (150,600 / 273,300) x 100 = 55.10% MFC MFC MFC MFC41-111MFC2007

A longer history of labour force and employment growth: What happened after the 1950’s?
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Why Does Unemployment Matter?
15 The unemployment rate when Y=Y* is called: - the natural rate of unemployment ,or NAIRU What is the NAIRU? - some estimates suggest that it is now below 7% Why Does Unemployment Matter? Some unemployment is desirable, as it reflects the time required for workers and firms to “find” each other so that good matches are made. But some unemployment is associated with human hardship, especially for those individuals with skills that are not in high demand by firms. Copyright © 2011 Pearson Canada Inc.

Does the Unemployment Rate Measure Hardship? Not really.
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17 Productivity Productivity: a measure of output per unit of input - often measured as GDP per worker - or GDP per hour of work Increases in productivity are probably the single largest determinant of long-run increases in material living standards. Copyright © 2011 Pearson Canada Inc.

Why Productivity Increases Matter
Supplementary slide Why Productivity Increases Matter Annual growth Change in ouput Number of yrs rate in pph after 40 yrs req'd to double productivity (1 working life) output pph 1.0% % yrs 1.5% % yrs 2.0% % yrs 2.5% % yrs 3.0% % yrs MFC MFC MFC MFC41-111

Long-term growth and increases in productivity
We will see that one of the most important determinants of long-term growth is increased productivity One measure of productivity is output per person hour Output per person hour is determined by many factors (capital, technology, work rules, regulations, etc.) What about how hard people work? MFC MFC MFC MFC41-111

21 Inflation and the Price Level Price level: the average level of all prices in the economy. Inflation: the rate at which the price level is changing. The CPI is based on the price of a typical “consumption basket”, relative to the price in some base year: Copyright © 2011 Pearson Canada Inc.

An Example – How to calculate the rate of inflation
* An Example – How to calculate the rate of inflation The value of the CPI in January 2009 was In January 2008, it was (2002 base year) The year-over-year inflation rate can be found by dividing the CPI for 2009 by that for 2008, subtracting 1 and multiplying by 100 — it is 1.07 percent. [(113.0 / 111.8) - 1] x 100 = 1.07% That is, the price level increased by 1.07 percent between January 2008 and January 2009 — an inflation rate of 1.07% MFC MFC MFC MFC41-111MFC2007

The formula for inflation calculations
Supplementary slide The formula for inflation calculations Inflation is the rate of change in the price level. The rate of inflation is the percentage change in the price level over any two periods. Consider the price level in 2006 and 2007 as measured by the CPI: CPI06 and CPI07 The rate of inflation is given by: The change in the price level divided by the price level in the initial period multiplied by 100. [(CPI07 – CPI06) / CPI06] x 100 which is equal to: [(CPI07 / CPI06) – (CPI06 / CPI06)] x 100 or, [CPI07 / CPI06 – 1] x 100 Example from the previous slide: [(130.3 / 128.8) - 1] x 100 = 1.2% MFC MFC MFC MFC41-111MFC2007

Why Inflation Matters Because it is hard to forecast accurately, inflation adds to the uncertainties of economic life. Highly variable inflation rates cause great uncertainty. If all financial contracts are written to incorporate a fully-anticipated inflation, then inflation will have no real effects. An unanticipated inflation benefits anyone who has an obligation to pay money in the future (debtors) and harms anyone who is entitled to receive money in the future (creditors). MFC MFC MFC MFC41-111MFC2007

26 In 1970 could you have predicted what inflation would be during the 1980’s? In 1980 could you have predicted what inflation would be during the 1990’s? MFC MFC MFC41-111MFC2007 Copyright © 2011 Pearson Canada Inc.

Inflation over the longer term
CPI Rate of inflation MFC MFC MFC MFC41-111

28 Interest Rates The interest rate is the price of “credit”, and the flow of credit is crucial to firms and households in a modern economy. Nominal interest rate: the rate expressed in money terms. Real interest rate: the rate expressed in terms of purchasing power. The burden of borrowing depends on the real interest rate. Copyright © 2011 Pearson Canada Inc.

Interest rates vs. the interest rate
There are many different interest rates. Each reflects the cost of borrowing in a particular financial market There are numerous financial markets (specific set of borrowers and lenders) Each market is characterize by ‘risk’, ‘liquidity’, ‘term’ of loans, etc. Each gives rise to a unique rate of interest MFC MFC MFC MFC41-111

Examples of interest rates
TD - Canada Trust, September 7, 2010 TD charges Prime % 1 year 'open' mortgage 1 year 'fixed' mortgage 10 year 'fixed' mortgage Car loan – 5 year term VISA unpaid balance VISA cash advance TD pays 1 yr GIC 5 yr GIC Long term G of C bond MFC MFC MFC MFC41-111

32 The International Economy Foreign exchange: foreign currencies or claims on foreign currencies. Exchange rate: the number of Canadian dollars required to purchase one unit of foreign currency. A depreciation of the Canadian dollar means that it is worth less on the foreign-exchange market  a rise in the exchange rate Copyright © 2011 Pearson Canada Inc.

Impact of Changes in the exchange rate : an example
Exchange rate Cdn $ = 1 US $ June 1990 P of a Meal in Windsor $10.00 Cdn P of same meal in Detroit $ US P of Detroit meal for Windsorite $9.36 in Cdn $’s (1.17 x $8.00 US = $9.36 Cdn) Now what if the exchange increases (Canadian dollar depreciates) to 1.65 Cdn $ = 1 US $ as it did by Jan. 2003 P of Detroit meal for Windsorite $13.20 in Cdn $’s (1.65 x $8.00 US = $13.20 Cdn) What is your prediction about Windsorites dining out in Detroit? MFC MFC MFC MFC41-111

From the Detroiter’s perspective if 1.17 Cdn $ = 1 US $ then
the US exchange rate is 0.85 US $ = 1 Cdn $'s /1.17 = 0.85 P of a Meal in Windsor $10.00 Cdn P of same meal in Detroit $ US P of Windsor meal for a Detroiter $8.50 US (0.85 x $10.00 Cdn = $8.50 US) Now what if the exchange rate increases (Canadian dollar depreciates) to 1.65 Cdn $ = 1 US $ as it did by Jan. 2003 the US exchange rate is 0.61US $ = 1 Cdn $'s P of Windsor meal for a Detroiter $6.10 US (0.61 x $10.00 Cdn = $6.10 US) What is your prediction about Detroiters eating in Windsor? MFC MFC MFC MFC41-111

Exchange rate 1.04 Cdn $ = 1 US $ or 0.96 US $ = 1Cdn $
NOTE: as of January 2010 the situation had reversed (the Canadian dollar has appreciated) Exchange rate 1.04 Cdn $ = 1 US $ or 0.96 US $ = 1Cdn $ Why are the Erie Street restaurants, Casino Windsor and the local manufacturing industry doing so poorly? Why are you shopping in Detroit again? Work out the numbers. MFC MFC MFC MFC41-111

37 The balance of payments accounts record all payments made in international transactions — goods, services, and assets. - trade balance - current account balance - capital account balance For Canada, exports and imports are both very large — roughly 35% of GDP — but the trade balance is usually small. Copyright © 2011 Pearson Canada Inc.

39 Growth Versus Fluctuations Long-Term Economic Growth Long-term growth is considerably more important for a society’s living standards from decade to decade than short-term fluctuations. There is considerable debate regarding the ability of government to influence the economy’s long-run growth rate. Copyright © 2011 Pearson Canada Inc.

40 Short-Term Fluctuations Short-term fluctuations are often called business cycles. Economists debate the effectiveness of monetary and fiscal policy in influencing these fluctuations. Some economists argue that despite the “power” of policy to affect the economy, governments should not attempt “fine-tuning”. Copyright © 2011 Pearson Canada Inc.

41 What Lies Ahead? To organize our thinking about macroeconomics, we must develop some tools. These will include: discussing measurement of national income building a simple model of the economy modifying the model to make it more realistic using our model to analyze some pertinent economic issues Copyright © 2011 Pearson Canada Inc.

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