1. Macroeconomics

2. Macroeconomics vs. Microeconomics
Major issues:
Determination of aggregate production, income, prices, and employment
Improving the performance of the macroeconomy
Long-run: Economic growth and price stability
Short-run: Reducing fluctuations in output, production and employment/unemployment
Stylized Graph of the Business Cycle
Circular Flow: A model that demonstrates the relationships in the macroeconomy.

3. Figure 1 The Circular Flow
Firms sell
Households buy
MARKETS
FOR
GOODS AND SERVICES
Revenue
Spending
Goods
and services
sold
Goods and
services
bought
FIRMS
Produce and sell
goods and services
Hire and use factors
of production
Buy and consume
goods and services
Own and sell factors
of production
HOUSEHOLDS
Households sell
Firms buy
MARKETS
FOR
FACTORS OF PRODUCTION
Factors of
production
Labor, land,
and capital
Wages, rent,
and profit
Income
= Flow of inputs
and outputs
= Flow of dollars
Copyright © South-Western

4. Macroeconomic Variables
The circular flow diagram demonstrates that the important variables are
Output and income: real and nominal gross domestic product (GDP)
Important implication from the circular flow diagram: Value of output=Aggregate expenditures or demand=Aggregate Income
Aggregate Prices – Inflation
Employment/Unemployment

5. The Measurement of Aggregate Output and Income
By definition, aggregate output is equal to aggregate income. The value of output is equal to the income (wages, interest, rents and profits) received by the factors.
There are Various measures of aggregate output but we will use the concept of:
Gross domestic product (GDP)

6. Gross Domestic Product
GDP is the market value of all final goods and services produced within a country in a given period of time.
Market value – prices, illegal, household
All – imputed values for rent
Final goods and services– intermediate goods are not double counted
Produced (newly) - products resold, inventory
Within the country – Excludes US production abroad includes ROW production with the US
Given period of time (generally yearly or quarterly)

7. Components of GDP
Since aggregate production equals aggregate income, let’s call GDP = Y
Y can be broken up into the following parts
Consumption – HH spending on G&S (except new housing)
Investment – Business spending on K but includes HH of new housing
Government Purchases of G&S
Net Exports (= Exports – Imports) Net addition (subtraction) attributable to purchases by ROW.
Y = C + I + G + NX

8. BEA 2002 GDP 10,480 C 7,385 70% Durable 911 12% Non-Dur 2,086 29%
Services
4,388
58% I
1,589
15%
Non-Res
1,080
68%
Res
504
32%
Chg Inv 5 0% G
1,932
18% F
679
35%
S&L
1,253
65% NX
-426
-4% X
1,006
10%
1,433
14%
BEA
2002

9. GDP Data
The US Department of Commerce’s Bureau of Economic Analysis has data on line:
Economic Report of the President
Graphs and Data

10. Real GDP

11. Table 3 GDP, Life Expectancy, and Literacy
Copyright©2004 South-Western

12. Economic Growth
Economic growth is something that is very important in improving the standard of living of a population.
The Rule of 70 illustrates how small changes in growth rates can affect the standard of living.
Doubling Time = 70/(% growth rate)
Examples: Growth Rate → Doubling time
2% → 35 years
4% → 15 years
6% → years
10% → 7 years
Now, China has been growing pretty close to 10% for the last 20 or so years so the GDP has doubled once, doubled again, and doubled a third time, so it is 2x2x2=8 times larger than it was 20 years ago!

13. Figure 2 The Growth in Real GDP per Person

14. Determinants of Economic Growth
Remember our production possibilities curve and the first week!
Increased number of resources: L, K, NR, E
Investment
Growth in Labor Force
Increased productivity of resources:
Work Ethic
Technology
Education
Risk-taking and innovation
Social system that allows the efficient use of resources and promotes productivity
Market system and self-interest
Laws, property rights, and public order
Political and economic freedom

15. Table 1 The Variety of Growth Experiences
Copyright©2004 South-Western

16. Measuring the Cost of Living
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. 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.
The Bureau of Labor Statistics reports the CPI each month.
It is used to monitor changes in the cost of living over time.
When the CPI rises, the typical family has to spend more dollars to maintain the same standard of living

18. Calculating the Consumer Price Index
Fix the Basket: Determine what prices are most important to the typical consumer.
The Bureau of Labor Statistics (BLS) identifies a market basket of goods and services the typical consumer buys.
The BLS conducts monthly consumer surveys to set the weights for the prices of those goods and services.
Find the Prices: Find the prices of each of the goods and services in the basket for each point in time.
Compute the Basket’s Cost: Use the data on prices to calculate the cost of the basket of goods and services at different times.

19. 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.
Compute the index by dividing the price of the basket in one year by the price in the base year and multiplying by 100.

20. Compute the inflation rate: The inflation rate is the percentage change in the price index from the preceding period
The Inflation Rate
The inflation rate is calculated as follows:

21. Calculating the Consumer Price Index and the Inflation Rate: Another Example
Base Year is 2002.
Basket of goods in 2002 costs $1,200.
The same basket in 2004 costs $1,236.
CPI = ($1,236/$1,200)  100 = 103.
Prices increased 3 percent between 2002 and 2004.

22. FYI: What’s in the CPI’s Basket?
16%
Food and
beverages
41%
Housing
17%
Transportation 6%
Education and
communication
Medical care 6%
Recreation 6%
Apparel 4%
Other goods
and services 4%
Copyright©2004 South-Western

23. Problems in Measuring the Cost of Living
The CPI is an accurate measure of the selected goods that make up the typical bundle, but it is not a perfect measure of the cost of living.

24. Problems in Measuring the Cost of Living
Substitution bias
Introduction of new goods
Unmeasured quality changes

25. The GDP Deflator versus the Consumer Price Index
The GDP deflator reflects the prices of all goods and services produced domestically, whereas...
…the consumer price index reflects the prices of all goods and services bought by consumers.

26. Figure 2 Two Measures of Inflation
Percent
per Year 15
CPI 10
GDP deflator 5
1965
1970
1975
1980
1985
1990
1995
2000
Copyright©2004 South-Western

27. CORRECTING ECONOMIC VARIABLES FOR THE EFFECTS OF INFLATION
Price indexes are used to correct for the effects of inflation when comparing dollar figures from different times.

28. Dollar Figures from Different Times
Do the following to convert (inflate) Babe Ruth’s wages in 1931 to dollars in 2001:

29. Table 2 The Most Popular Movies of All Times, Inflation Adjusted
Copyright©2004 South-Western

30. Real and Nominal Interest Rates
Interest represents a payment in the future for a transfer of money in the past.
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.

31. Then, Real interest rate = Nominal interest rate – Inflation
If you borrow $1,000 for one year, and
Nominal interest rate was 15%.
During the year inflation was 10%.
Then, Real interest rate = Nominal interest rate – Inflation
= 15% - 10% = 5%

32. Figure 3 Real and Nominal Interest Rates
(percent
per year) 15 10
Nominal interest rate 5
Real interest rate –5
1965
1970
1975
1980
1985
1990
1995
2000
Copyright©2004 South-Western

33. Inflation Summary
The consumer price index shows the cost of a basket of goods and services relative to the cost of the same basket in the base year.
The index is used to measure the overall level of prices in the economy.
The percentage change in the CPI measures the inflation rate.

34. Inflation Summary
The consumer price index is an imperfect measure of the cost of living for the following three reasons: substitution bias, the introduction of new goods, and unmeasured changes in quality.
Because of measurement problems, the CPI overstates annual inflation by about 1 percentage point.

35. Inflation Summary
The GDP deflator differs from the CPI because it includes goods and services produced rather than goods and services consumed.
In addition, the CPI uses a fixed basket of goods, while the GDP deflator automatically changes the group of goods and services over time as the composition of GDP changes.

36. Inflation Summary
Dollar figures from different points in time do not represent a valid comparison of purchasing power.
Various laws and private contracts use price indexes to correct for the effects of inflation.
The real interest rate equals the nominal interest rate minus the rate of inflation.

37. Economic fluctuations are irregular and unpredictable.
Business Cycle
Economic fluctuations are irregular and unpredictable.
Fluctuations in the economy are often called the business cycle.
Most macroeconomic variables fluctuate together.
As output falls, unemployment rises.

38. Figure 1 A Look At Short-Run Economic Fluctuations
(a) Real GDP
Billions of
1996 Dollars
$10,000
9,000
Real GDP
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1965
1970
1975
1980
1985
1990
1995
2000
Copyright © South-Western

39. THREE KEY FACTS ABOUT ECONOMIC FLUCTUATIONS
Most macroeconomic variables fluctuate together.
Most macroeconomic variables that measure some type of income or production fluctuate closely together.
Although many macroeconomic variables fluctuate together, they fluctuate by different amounts.

40. Figure 1 A Look At Short-Run Economic Fluctuations
(b) Investment Spending
Billions of
1996 Dollars
$1,800
1,600
1,400
Investment spending
1,200
1,000
800
600
400
200
1965
1970
1975
1980
1985
1990
1995
2000
Copyright © South-Western

41. THREE KEY FACTS ABOUT ECONOMIC FLUCTUATIONS
As output falls, unemployment rises.
Changes in real GDP are inversely related to changes in the unemployment rate.
During times of recession, unemployment rises substantially.

42. EXPLAINING SHORT-RUN ECONOMIC FLUCTUATIONS
Short Run Differs from the Long Run
Long-run Growth
Short-run fluctuations
Stylized Business Cycle
Recessions
Depressions
Expansions

43. Unemployment and Its Natural Rate
Long-run versus Short-run Unemployment:
Long-run: The natural rate of unemployment
Short-run: The cyclical rate of unemployment
Natural Rate of Unemployment
The amount of unemployment that the economy normally experiences and does not go away on its own even in the long run. (sum of frictional, structural and seasonal unemployment)
Cyclical Unemployment
Associated with with short-term ups and downs of the business cycle and refers to the year-to-year fluctuations in unemployment around its natural rate.

44. Describing Unemployment
Three Basic Questions:
How does government measure the economy’s rate of unemployment?
What problems arise in interpreting the unemployment data?
How long are the unemployed typically without work?

45. How Is Unemployment Measured?
Unemployment is measured by the Bureau of Labor Statistics (BLS).
It surveys 60,000 randomly selected households every month.
Based on the answers to the survey questions, the BLS places each adult (over 16) years old into one of three categories:
Employed
Unemployed
Not in the labor force

46. Employed, Unemployed, Not in the Labor Force, Labor Force
Employed: A person is considered employed if he or she has spent most of the previous week working at a paid job.
Unemployed: A person is unemployed if he or she is on temporary layoff, is looking for a job, or is waiting for the start date of a new job.
Not in the Labor Force: A person who fits neither of these categories, such as a full-time student, homemaker, or retiree, is not in the labor force.
Labor Force
The labor force is the total number of workers and the BLS defines the it as the sum of the employed and the unemployed.

47. Figure 1 The Breakdown of the Population in 2001
Adult
Population
(211.9 million)
Employed
(135.1 million)
Labor Force
(141.8 million)
Unemployed (6.7 million)
Not in labor force
(70.1 million)
Copyright©2003 Southwestern/Thomson Learning

48. How Is Unemployment Measured?
The unemployment rate is calculated as the percentage of the labor force that is unemployed.
Unemployment Rate= (Unemployed/Labor Force)*100
The labor-force participation rate is the percentage of the adult population that is in the labor force.
Labor-force Participation Rate=
(Labor Force/Adult Population)*100

49. Table 1 The Labor-Market Experiences of Various Demographic Groups
Copyright©2004 South-Western

50. Figure 2 Unemployment Rate Since 1960
Percent of
Labor Force 10
Unemployment rate 8 6
Natural rate of
unemployment 4 2
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
Copyright©2003 Southwestern/Thomson Learning

51. Figure 3 Labor Force Participation Rates for Men and Women Since 1950
Rate (in percent)
100
Men 80 60 40
Women 20
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
Copyright©2003 Southwestern/Thomson Learning

52. Issues in Measuring Unemployment
It is difficult to distinguish between a person who is unemployed and a person who is not in the labor force.
Discouraged workers, people who would like to work but have given up looking for jobs after an unsuccessful search, don’t show up in unemployment statistics.
Other people may claim to be unemployed in order to receive financial assistance, even though they aren’t looking for workLength of Unemployment
Duration of Unemployment
Most spells of unemployment are short.
Most of the economy’s unemployment problem is attributable to relatively few workers who are jobless for long periods of time.

53. Why does unemployment occur?
In an ideal labor market, wages would adjust to balance the supply and demand for labor, ensuring that all workers would be fully employed.
Frictional unemployment refers to the unemployment that results from the time that it takes to match workers with jobs. In other words, it takes time for workers to search for the jobs that are best suit their tastes and skills.
Structural unemployment is the unemployment that results because the number of jobs available in some labor markets is insufficient to provide a job for everyone who wants one.

54. Frictional Unemployment and Job Search
the process by which workers find appropriate jobs given their tastes and skills.
results from the fact that it takes time for qualified individuals to be matched with appropriate jobs.

55. Public Policy and Job Search
Government programs can affect the time it takes unemployed workers to find new jobs.
Government-run employment agencies
Public training programs
Unemployment insurance

56. Effects of Unemployment Insurance
Unemployment insurance increases the amount of search unemployment.
It reduces the search efforts of the unemployed.
It may improve the chances of workers being matched with the right jobs.

57. Structural Unemployment
Structural unemployment occurs when the quantity of labor supplied exceeds the quantity demanded.
Structural unemployment is often thought to explain longer spells of unemployment.

58. Public Policy and Job Search
Why is there Structural Unemployment?
Minimum-wage laws
Unions
Efficiency wages

59. Figure 4 Unemployment from a Wage Above the Equilibrium Level
Labor
supply
Surplus of labor =
Unemployment
Labor
demand
Minimum
wage LD LS WE LE
Quantity of
Labor
Copyright©2003 Southwestern/Thomson Learning

60. Unemployment Summary
The unemployment rate is the percentage of those who would like to work but don’t have jobs.
The Bureau of Labor Statistics calculates this statistic monthly.
The unemployment rate is an imperfect measure of joblessness.
In the U.S. economy, most people who become unemployed find work within a short period of time.
Most unemployment observed at any given time is attributable to a few people who are unemployed for long periods of time.

61. Unemployment Summary
One reason for unemployment is the time it takes for workers to search for jobs that best suit their tastes and skills.
A second reason why our economy always has some unemployment is minimum-wage laws.
Minimum-wage laws raise the quantity of labor supplied and reduce the quantity demanded.
A third reason for unemployment is the market power of unions.
A fourth reason for unemployment is suggested by the theory of efficiency wages.
High wages can improve worker health, lower worker turnover, increase worker effort, and raise worker quality.