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1 Introduction to Macroeconomics Chapter 20 © 2006 Thomson/South-Western
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2 The National Economy Macroeconomics concerns the overall performance of the economy The term economy describes the structure of economic activity in a community, a region, a country, a group of countries, or the world Gross domestic product: the market value of final goods and services produced in the United States during a given period, typically a year
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3 Flow and Stock Variables Flow Variable An amount per period of time Average spending per week, hours worked per month, etc. Stock Variable An amount measured at a particular point in time Amount of cash on hand you have now Number of housing units in existence today
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4 Economic Fluctuations Economic fluctuations The rise and fall of economic activity relative to the long-term growth trend of the economy Business cycles Vary in length and intensity but have some features in common
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5 Components of Business Cycles Two phases Periods of expansion Periods of contraction Depression Severe contraction Lasting longer than one year and accompanied by high unemployment Recession Milder contraction Decline in total output lasting at least two consecutive quarters
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6 Exhibit 1: Hypothetical Business Fluctuations Contraction begins after a previous expansion has reached its peak and continues until the economy reaches a trough Long-term growth trend is shown by upward sloping straight line. Period between a peak and a trough is a contraction Period between a trough and subsequent peak is an expansion
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7 Exhibit 2: Annual Percentage Change in U.S. Real GDP from 1929 to 2003
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8 Exhibit 3: U.S. – U.K. Annual Growth Rates in Output
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9 Economic Indicators Leading economic indicators Variables that predict, or lead to, a recession or recovery; foreshadow a turning point in economic activity and predict, or lead to, upturns and downturns Coincident economic indicators Those measures that reflect peaks and troughs as they occur Lagging economic indicators Follow or trail changes in overall economic activity
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10 Aggregate Output Aggregate output Total amount of goods and services produced in the economy during a given period Best measure is real gross domestic product, or real GDP Aggregate demand The relationship between the economy’s price level and the quantity of aggregate output demanded
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11 Price Level Average price of aggregate output is called the price level A composite measure reflecting the prices of all goods and services in the economy relative to prices in a base year The price level in the base year has a benchmark value of 100
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12 Price Level Price levels in other years are expressed relative to the base-year price level Price level or price index used to make Comparisons in prices across time Accurate comparisons of real aggregate output over time
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13 GDP Price Index Real GDP: Gross domestic product after adjusting GDP for price changes The GDP price index Shows how the economy’s general price level changes over time Can be used to convert production in different years into dollars of constant purchasing power
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14 Aggregate Demand Curve Aggregate demand curve: shows the relationship between the price level in the economy and the real GDP demanded, other things constant Sums demands of the four economic decision makers: households, firms, governments, and the rest of the world Among the factors held constant along a given aggregate demand curve are The price levels in other countries The exchange rates between the U.S. dollar and foreign currencies
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15 Exhibit 4: Aggregate Demand Curve Sums the demands of four economic decision makers: households, firms, governments, and the rest of the world The inverse relationship reflects the fact that as the price level increases, other things constant, purchases by the four major decision makers decline
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16 Aggregate Supply Curve Shows how much output U.S. producers are willing and able to supply at each price level, other things constant Assumed constant along an aggregate supply curve are Resource prices, including wage rates The state of technology The rules of the game that provide production incentives
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17 Exhibit 5:Aggregate Demand & Supply Wage rates assumed constant along the AS curve; firms find a higher price level more profitable, so they increase real GDP supplied Equilibrium occurs where the AD and AS curves intersect Although employment is not measured directly, firms must usually hire more workers to produce more output
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18 Exhibit 6: Decrease in Aggregate Demand from 1929 to 1933 AS AD 1929 11.9 865 Real GDP (billions of 2000 dollars) AD 1933 8.9 636 0 The Great Depression can be viewed as a shift to the left of the AD curve This resulted in a drop of both the price level and real GDP Price level (2000 = 100)
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19 Short History of U.S. Economy Age of Keynes: After the Great Depression to the Early 1970s Federal budget deficit: amount by which federal outlays exceed federal revenues Demand-side economics: focus was on how changes in aggregate demand could promote full employment
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20 Exhibit 7: Stagflation Between 1973-1975 AD AS 1973 31.9 4.34 0 AS 1975 38.0 4.31 The stagflation of the mid-1970s can be represented as a reduction in aggregate supply Real GDP (trillions of 2000 dollars) Price level (2000 = 100)
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21 Short History of U.S. Economy Experience since 1980 Supply Side economics: federal government would provide incentives to increase the supply of labor and other resources by lowering tax rates Government debt: net accumulation of prior deficits
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22 Exhibit 8: Tracking U.S. Real GDP and Price Level Since 1929
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