CH 19: OVERVIEW OF MACROECONOMICS Macroeconomics Macroeconomics is the study of the behavior of the economy as a whole. It examines the forces that aect rms, consumers, and workers in the aggregate. Two Two central themes: themes: . The short!term short!term "uctuations "uctuations in out#ut, em#loyment, em#loyment, nancial nancial conditions, conditions, and #rices #rices that that we call the business cycle $. The longer!term longer!term trends trends in out#ut and living standards standards known as economic economic growth growth
Key Concepts of Macroeconomics The three three central %uestions %uestions of macroeconomics: macroeconomics: . &hy do out#ut out#ut and em#loyment sometimes sometimes fall, and how can unem#loyment unem#loyment be reduced' reduced' ()usiness *ycles+ $. &hat are are the sources sources of #rice in"ation, in"ation, and how how can it be ke#t under under control' control' (In"ation+ a. chicken chicken that cost cost - thousand thousand imbabwean imbabwean dollars dollars at the the beginning beginning of the year would cost - trillion imbabwean dollars at the end/ 0. 1ow can a natio nation n increase increase its its rate of econo economic mic growth' growth' 2ey factors in long!term economic growth according economic historians: . $. 0. 5. 7.
3eliance 3eliance on well!regulated well!regulated #rivate #rivate markets markets for most economic economic activity 4table 4table macr macroec oecono onomic mic #olic #olicy y 1igh rates of saving saving and investmen investmentt 6#enness 6#enness to inter internati national onal trade trade ccount ccountable able and non!corr non!corru#t u#t governing governing Institut Institutions ions..
O!ecti"es an# Meas$rements of Macroeconomics 6b8ectives 6ut#ut: 1igh level and ra#id growth of out#ut 9m#loyment: 1igh level of em#loyment with low involuntary unem#loyment 4table #rices Instruments Monetary #olicy: )uying and selling bonds, regulating nancial institutions iscal #olicy: ;overnment ex#enditures and Taxation • • •
• •
Meas$rin% Economic S$ccess &ross 'omestic (ro#$ct )&'(* is the measure of the market value of all nal goods and services #roduced in a country during a year. • •
is measured in actual market #rices. 3eal ;=> is calculated in constant or invariant #rices
3eal ;=> ? growth rate in year t: ¿
GDP t −GDPt −1 GDPt −1
× 100
Economic &ro+t, is a #rocess wherein an economy exhibits a steady long!term growth in real ;=> and an im#rovement in living standards. (otentia- &'( re#resents re#resents the maximum sustainable level of out#ut that the economy can #roduce.
• •
&hen out#ut rises above #otential out#ut, #rice in"ation tends to rise &hile a below!#otential level of out#ut leads to high unem#loyment.
3ecession is a #eriod of signicant decline in total out#ut, income, and em#loyment, usually lasting more than a few months and marked by wides#read contractions in many sectors of the economy. •
'epression is a severe and #rotracted downturn.
.nemp-oyment rate is the #ercentage of the labor force that is unem#loyed. The -aor force includes all em#loyed #ersons and those unem#loyed individuals who are seeking 8obs. It excludes those without work who are not looking for 8obs.
(rice stai-ity is dened as a low and stable in"ation rate. It is im#ortant because a smoothly functioning market system re%uires that #rices accurately convey information about relative scarcities. Most nations seek the golden mean of slowly rising #rices as the best way of encouraging the #rice system to function e@ciently. (rice in#e/es , or measures of the overall price -e"e- are constructed by government statisticians to track #rices Cons$mer price in#e/ (*>I+, measures the trend in the average #rice of goods and services bought by consumers In0ation rate is the #ercentage change in the overall level of #rices from one year to the next
Inflation Rate ∈ year t =
Pt − Pt −1 Pt −1
× 100
'e0ation occurs when #rices decline (which means that the rate of in"ation is negative+ Hyperin0ation is a rise in the #rice level of a thousand or a million #ercent a year
,e oo-s of Macroeconomic (o-icy po-icy instr$ment is an economic variable under the control of government that can aect one or more of the macroeconomic goals.
Fisca- po-icy denotes the use of taxes and government ex#enditures. &o"ernment e/pen#it$res come in two distinct forms. . &o"ernment p$rc,ases com#rise s#ending on goods and servicesA#urchases of tanks, construction of roads, salaries for 8udges, and so forth. $. &o"ernment transfer payments increase the incomes of targeted grou#s such as the elderly or the unem#loyed.
a/ation aects the overall economy in two ways. . Taxes leave households with more or less #isposa-e or spen#a-e income $. Taxes aect the #rices of goods and factors of #roduction and thereby aect incentives and behavior
Monetary po-icy manages the nationBs money, credit, and banking system. The Centra- 2an3 sets short!run interest4rate targets and attains those targets through buying and selling government securities 9xchange!rate system is also a central #art of monetary #olicy in an o#en economy. $
Internationa- 5in3a%es &-oa-i6ation is a #henomenon where nations increasingly #artici#ate in the world economy and are linked together through trade and nance. Internationa- tra#e has re#laced empire4$i-#in% an# mi-itary con7$est as the surest road to national wealth and in"uence. C$rrent acco$nt a-ance re#resents the numerical dierence between the value of ex#orts and the value of im#orts, along with some other ad8ustments. It is closely related to net ex#orts, which is the dierence between the value of ex#orts and the value of im#orts of goods and services. 3emember: international trade and nance are not ends in themselves. 3ather, international exchange serves the $-timate %oa- of impro"in% -i"in% stan#ar#s.
ra#e po-icies consist of taris, %uotas, and other regulations that restrict or encourage im#orts and ex#orts. Forei%n e/c,an%e rate re#resents the #rice of its own currency in terms of the currencies of other nations.
A%%re%ate S$pp-y an# 'eman# A%%re%ate s$pp-y refers to the total %uantity of goods and services that the nationBs businesses willingly #roduce and sell in a given #eriod. It de#ends u#on the (+ #rice level, ($+ the #roductive ca#acity of the economy, and (0+ the level of costs. A%%re%ate #eman#, which refers to the total amount that dierent sectors in the economy willingly s#end in a given #eriod. It e%uals total s#ending on goods and services. It de#ends on the (+ level of #rices, ($+ monetary #olicy, (0+ scal #olicy, and (5+ exogenous forces (e.g. wars, weather, and other government #olicies+ = C * D I D ; D
Microeconomic S$pp-y an# 'eman# C$r"es "ers$s A%%re%ate S$pp-y an# 'eman# C$r"es The microeconomic s$pp-y an# #eman# c$r"es show the %uantities and #rices of individual commodities, with such things as national income and other goodsB #rices held as given. )y contrast, a%%re%ate s$pp-y an# #eman# c$r"es show the determination of total out#ut and the overall #rice level, with such things as the money su##ly, scal #olicy, and the ca#ital stock held constant. macroeconomic e7$i-iri$m is a combination of overall #rice and %uantity at which all buyers and sellers are satised with their overall #urchases, sales, and #rices. t this #osition, there will be neither excess su##ly nor excess demandAand no #ressure to change the overall #rice level.
Macroeconomic History: 1988488 F0-s: Gohn Maynard 2eynes founded macroeconomics as he tried to understand the economic mechanism that #roduced the ;reat =e#ression. F0H: GM2 wrote ;,e &enera- ,eory of Emp-oyment< Interest< an# Money=> It has two main arguments: . It is #ossible for high unem#loyment and underutilied ca#acity to #ersist in market economies
0
$. ;overnment scal and monetary #olicies can aect out#ut and thereby reduce unem#loyment and shorten economic downturns
Emp-oyment Act of 19?@ (GM2 died this year+: 3es#onsibility of ederal ;overnment to #romote maximum em#loyment, #roduction, and #urchasing #ower. FH-s: Wartime 2oom. >resident Gohn 2ennedy brought 2eynesian economics to &ashington. 1is economic advisers recommended ex#ansionary #olicies, and *ongress enacted measures to stimulate the economy FH0 to FH5: *uts in #ersonal and cor#orate taxes. ;=> grew ra#idly during this #eriod, unem#loyment declined, and in"ation was contained. FH7: The J4 economy was at its #otential out#ut. FH7 to FHK: )uildu# for the Lietnam &ar defense s#ending grew by 77 ?. >resident Gohnson #ost#oned N#ainfulO scal ste#s to slow the economy, thus overheating the economy FHK: Tax increases and civilian ex#enditure cuts was im#lemented but too late to #revent in"ationary #ressures FHH to FK: ;,e &reat In0ation=> In"ation began to rise under the #ressure of low unem#loyment and high factory utiliation. NIt was easier to stimulate the economy than to #ersuade #olicymakers to raise taxes to slow the economy when in"ation threatened.O P 9conomists during great in"ation FQ-s: Time of troubles: rising oil #rices, grain shortages, a shar# increase in im#ort #rices, union militancy, and accelerating wages. FQF to FK$: ;i%,t Money (o-icy=> >aul Lolcker, #rescribed the strong medicine of tight money to slow the in"ation interest rates rose shar#ly, stock market fell, and credit was hard to nd. FQF: 1ousing construction, automobile #urchases, business investment, and net ex#orts declined shar#ly. The eects of the tight money were twofold . 6ut#ut moved below its #otential and unem#loyment rose shar#ly $. Tight money and high unem#loyment #roduced a dramatic decline in in"ation, from an average of $? #er year in the FQKPFK- #eriod to an average of around 5? #er year in the subse%uent #eriod. F-- to $--K: ;,e &ro+t, Cent$ry=> verage earnings rose from R-.7 #er hour in F-- to over R0- #er hour in $--K.
,e Ro-e of Macroeconomic (o-icy ;,e &reat Mo#eration>: a #eriod of reduced business!cycle volatility caused by the discovery and a##lication of macroeconomics, along with a good a##reciation of the role and limitations of monetary and scal #olicy.
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CH 8: MACROECONOMIC 'AA &ross 'omestic (ro#$ct: ,e ar#stic3 of an EconomyBs (erformance ;ross domestic #roduct (;=>+ measures the total value of goods and services #roduced in a country during a year. long with consum#tion goods and services, we must also include gross investment. The gross domestic #roduct (;=>+ is the sum of the dollar values of consum#tion (* +, gross investment (I +, government #urchases of goods and services (; +, and net ex#orts (E + #roduced within a nation during a given year.
+o Meas$res of Nationa- (ro#$ct )+,ic, are e/act-y t,e same* . low!of!>roduct ##roach or E/pen#it$re Approac, includes only na- %oo#s A goods ultimately bought and used by consumers.
Nationa- Acco$nts 'eri"e# from 2$siness Acco$nts )usiness account for a rm or nation is a numerical record of all "ows (out#uts, costs, etc.+ during a given #eriod. The national accounts sim#ly add together or aggregate the out#uts and costs of all the rms in the country.
,e (ro-em of ;'o$-e Co$ntin%> na- pro#$ct is one that is #roduced and sold for consum#tion or investment. ;=> excludes interme#iate %oo#sAgoods that are used u# to #roduce other goods. ;=> only includes the rmBs value added. Va-$e a##e# is the dierence between a rmBs sales and its #urchases of materials and services from other rms.
'etai-s of t,e Nationa- Acco$nts Rea- "s= Nomina- &'(: ;'e0atin%> &'( y a (rice In#e/ Nomina- &'( (or ;=> at current #rices+ for a #articular year is measured using the actual market #rices of that year. #er ca#ita C S >o#ulation 7
Rea- &'( is calculated by tracking the volume or %uantity of #roduction after removing the in"uence of changing #rices or in"ation. #ea$ GDP per !apita = #ea$ GDP % Popu$ation
&'( #e0ator (or >rice of ;=>+ is the dierence between nominal ;=> and real ;=> GDP De&ator = '(( x Nomina$ GDP % #ea$ GDP 6ne common a##roach is to use the rst year as the base year. The ase year is the year in which we measure #rices. *onsumer >rice Index (*>I+ can be substituted to ;=> de"ator.
Cons$mption *onsum#tion ex#enditures are divided into three categories: . =urable goods such as automobiles $.
In"estment an# Capita- Formation Increasing ca#ital re%uires the sacrice of current consum#tion to increase future consum#tion.
In"estment consists of the additions to the nationBs ca#ital stock of buildings, e%ui#ment, software, and inventories during a year. The national accounts inc-$#e mainly tangible ca#ital (such as buildings and com#uters+ and omit most intangible ca#ital (such as research!and! develo#ment or educational ex#enses+. , but <6T nancial investment. Net Investment = Gross Investment ) Depre!iation
&o"ernment ($rc,ases 4ome government #urchases are cons$mption4type %oo#s (like food for the military+, while some are in"estment4type items (such as schools or roads+. ayments are not included in ;=> O*!ia$ Government udget = Government Spending + "rans,er Paments Taxes are included in the Income ##roach but not in the 9x#enditure ##roach to ;=>
Net E/ports
&ross 'omestic (ro#$ct< Net 'omestic (ro#$ct< an# &ross Nationa(ro#$ct )y subtracting de#reciation from ;=> we obtain net #omestic pro#$ct )N'(*
NDP = GDP – depreciation ;<> is the total out#ut #roduced with labor or ca#ital owned by J.4. residents, while ;=> is the out#ut #roduced with labor and ca#ital located inside the Jnited 4tates.
From &'( to 'isposa-e Income .
NI = GDP – Depreciation H
=is#osable income (=I+ is what actually gets into the hands of consumers to dis#ose of as they #lease
DI = NI + Transfer Payments – Taxes – Net Business Saving
Sa"in% an# In"estment Measured saving is exactly e%ual to measured investment. This e%uality is an identity, which means that it must hold by denition. I = produ!t-approa!h GDP minus C S = earnings-approa!h GDP minus C Nationa$ Investment = Private Investment + Net Exports Nationa$ Saving = Private Saving + Government Saving Nationa$ Investment = Nationa$ Saving NIt should be no sur#rise that national #ros#erity does not guarantee a ha##y society, any more than #ersonal #ros#erity ensures a ha##y familyO P rthur 6kun
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