From Markets to Macro Lecture 7 Dr. Jennifer P. Wissink ©2016 John M. Abowd and Jennifer P. Wissink, all rights reserved. September 13, 2016

Announcements: 1120 Fall 2016 u Places To Go For Econ 1120 Help –Wissink’s Office hours –Any TA’s Section –Any TA’s Office Hours –Albert Alexander’s LSC “00” course or their tutoring/office hours –The Economics Tutoring Center! –Sample materials on –Hire an Econ Field Graduate Student by the hour. u If you have a Cornell created evening prelim conflict with Prelim 1, make sure you have... –read the syllabus concerning your options –and then use the link you can find on our Blackboard site (see left hand menu choices) and register for Option 1 or Option 2. »Note: You WILL NOT get any reply from me or the head TA – all you need to do is sign up. If you want “proof” you signed up, print the screen you see once you submit the form. u If you have any other type of prelim conflict issue you must see me during office hours.

u Final Exam Schedule for Fall 2016 Has Been Posted –We have been given a very early slot! –Our final is slotted for Wednesday December 7 from 2:00pm- 4:30pm! –Everyone should be prepared to take the final on that day and time. –The makeup final the next week - Wednesday December 14 at 2pm - will only be for people who qualify under Cornell’s guideline OR for people who come and see me in person with extremely compelling reasons. Note that I am very very tough on this. Papers that are due at the end of the term do not count as extremely compelling since you know they are due and have plenty of time to get them done. So don’t procrastinate! Also make sure you carefully read Cornell’s guidelines – many people seem to misinterpret them. –See: Final Exam Announcement for 1120 Fall 2016

i>clicker question Suppose the following two events simultaneously occur in the “tennis ball” market: 1) there is a fall in the wages of workers who make the balls 2) the fabulousness of Stan Wawrinka at the US Open increases interest in youth tennis. At the new market equilibrium we expect A. both P* and Q* must fall. B. both P* and Q* must rise. C. P* must fall and Q* must rise. D. Q* must fall and P* must rise. E. Q* must rise and P* can either rise, fall or stay the same. Price Supply 0 Quantity P*o Q*o Demand 0

Comparative Statics Summary: Can You Fill This In? u The demand curve –Q D = f(P) given P s, P c, I, T&P, Pop u The supply curve –Q S = g(P) given P fop, P oc, S&T, N u Comparative Statics Summary: EVENTP*Q* ↑D ↓D ↑S ↓S ↑D ↑S etc...

3 Classic Government Interventions u Price Floors u Price Ceilings u Quantity Quotas Ambrogio Lorenzetti, The Effects of Good Government in the city, Siena Italy, circa 1338

Price Floors u Government established minimum selling price. –Floor must be above P* to be binding. –Why? Government usually thinks the market price is too low for some reason. u Usually end up with…. –Surpluses! –And all the problems they create. u Examples: –supported milk prices –minimum wage laws

Price Supply Quantity Demand Price Floors & Market Surplus u Equilibrium is at P*=17 and Q*= Surplus = 16 u P floor = $25. u At the artificially high price of $25, sellers want to sell 31. u There is a surplus of 16. u But buyers only want to buy 15.

Price Ceilings u Government established maximum selling price. –Must be below P* to be binding. –Why? Government usually thinks the market price is too high for some reason. u Usually end up with…. –Shortages! –And all the problems they generate. u Examples: –Gas price ceilings –Apartment rent control

Price Supply Quantity Demand Shortage = 14 Price Ceilings & Market Shortage u Equilibrium is at P*=17 and Q*= u P ceiling =$10. u At the artificially low price of $10, buyers want to buy 30. u There is a shortage of 14. u But sellers only want to sell 16.

Quantity Quota u Government established maximum number of units sold. –Q max must be below Q* to be binding. –Why? Government thinks too many units are being traded. –Example: import restrictions u Usually end up with... –Higher prices and more.

Quantity Quotas P S D P S D Q Q

Final Comments

The Roots of Macroeconomics u The Great Depression –a period of severe economic contraction and high unemployment that began in 1929 and continued throughout the 1930s. u Classical economists applied microeconomic models, or “market clearing” models, to economy- wide problems. u However, simple classical models failed to explain the prolonged existence of high unemployment during the Great Depression. u This provided the impetus for the development of macroeconomics.

The Roots of Macroeconomics u In 1936, John Maynard Keynes published The General Theory of Employment, Interest, and Money. u Keynes believed governments could intervene in the economy and affect the level of output and employment. u During periods of low private demand, the government can stimulate aggregate demand to lift the economy out of recession. –Fiscal policy –Monetary policy u For nice short bio, see keynes.htm keynes.htm John Maynard Keynes

A Very Brief Macroeconomic History u F.D.R. and The New Deal u WWII and its aftermath u Keynesian “success” into the 60’s –Fine-tuning was the phrase used by Walter Heller in the 60’s to refer to the government’s role in regulating inflation and unemployment. u Keynesian “disillusionment” –The use of Keynesian policy to fine-tune the economy in the 1960s, led to disillusionment in the 1970s and early 1980s. –Inflation and Stagflation »Inflation occurs when there an increase in the overall price level. »Stagflation occurs when the overall price level rises rapidly (inflation) during periods of recession or high and persistent unemployment (stagnation). –Supply Side and “Reaganomics” in the 80’s –Micro-foundations of macroeconomics u Keynesian “renaissance?”

Macroeconomic Concerns u Output/Production u Income/Employment u Price Levels/Interest Rates u Global Trade u Growth

Output & Growth: Short & Long Run u The business cycle is the cycle of short-term ups and downs in the economy. u Growth looks at what happens to output (inter alia) over long periods of time. u The main measure of how an economy is doing is aggregate output. –Aggregate output is the total quantity of goods and services produced in an economy in a given period. »Note: In order to add up all the different things an economy produces, one uses a currency value. »For example, in the U.S., we use the dollar value of the total quantity of goods and services produced in the U.S. in a given period. »This is basically what we call “Gross Domestic Product” or GDP.

Output & Growth: Short & Long Run u A recession is a period during which aggregate output declines. Two consecutive quarters of decrease in output (as measured by real GDP) signal a recession. u A prolonged and deep recession becomes a depression. u Policy makers attempt not only to smooth fluctuations in output during a business cycle but also to increase the growth rate of output in the long-run. u “It's official: U.S. is in recession Economy began shrinking in December 2007, panel declares” (on 12/1/2008) u “Diagnosing depression: What is the difference between a recession and a depression?” cfm?story_id=

Unemployment u The unemployment rate is the percentage of the labor force that is unemployed. u The unemployment rate is a key indicator of the economy’s health. u The existence of unemployment seems to imply that the aggregate labor market is not in equilibrium. –Why do labor markets not clear when other markets do?

Inflation and Deflation u Inflation is an increase in the overall price level. u Hyperinflation is a period of very rapid increases in the overall price level. Hyperinflations are rare, but have been used to study the costs and consequences of even moderate inflation. u Deflation is a decrease in the overall price level. Prolonged periods of deflation can be just as damaging for the economy as sustained inflation. u Stagflation occurs when the overall price level rises rapidly (inflation) during periods of recession or high and persistent unemployment (stagnation).

The Business Cycle u An expansion, or boom, is the period in the business cycle from a trough up to a peak, during which output and employment rise. u A contraction, recession, or slump is the period in the business cycle from a peak down to a trough, during which output and employment fall. u A positive trend line indicates long run growth. u MACRO QUESTIONS

Macroeconomic Data – Real Output Growth FIGURE 5.2 U.S. Aggregate Output (Real GDP), 1900–2014 The periods of the Great Depression and World Wars I and II show the largest fluctuations in aggregate output.

5-24 Copyright © 2017 Pearson Education, Inc. FIGURE 5.4 Aggregate Output (Real GDP), 1970 I–2014 IV Aggregate output in the United States since 1970 has risen overall, but there have been five recessionary periods: 1974 I–1975 I, 1980 II–1982 IV, 1990 III–1991 I, 2001 I–2001 III, and 2008 I  2009 II.

5-25 Copyright © 2017 Pearson Education, Inc. FIGURE 5.5 Unemployment Rate, 1970 I–2014 IV The U.S. unemployment rate since 1970 shows wide variations. The five recessionary reference periods show increases in the unemployment rate.

5-26 Copyright © 2017 Pearson Education, Inc. FIGURE 5.6 Inflation Rate (Percentage Change in the GDP Deflator, Four-Quarter Average), 1970 I–2014 IV Since 1970, inflation has been high in two periods: 1973 IV–1975 IV and 1979 I–1981 IV. Inflation between 1983 and 1992 was moderate. Since 1992, it has been fairly low.

Government Policy Options u Main policies that the government considers to influence the economy: –Fiscal policy: government policies concerning taxes and spending. –Monetary policy: tools used by the Federal Reserve to control the quantity of money in the economy. –Growth or supply-side policies: government policies that focus on stimulating aggregate supply instead of aggregate demand; includes both fiscal and monetary as well as other policies (e.g., regulatory, industrial, antitrust...) u Short term vs. Long term u Counter-the-cycle vs. Growth

The Circular Flow & National Income Accounting

National Income & Product Accounts u National income and product accounts are data collected and published by the government describing the various components of national income and output in the economy. u The U.S. Department of Commerce is responsible for producing and maintaining the “National Income and Product Accounts” that keep track of economic activity. – u Arguably the most well known of these is GDP.

GDP: Gross Domestic Product u Gross Domestic Product (GDP) is the total “dollar” market value of all final goods and services currently produced within a given period by factors of production located within a country. u About how big was it in the U.S. in 2014? $18,036.6 billion $16,397.2 billion

Important GDP Notes u Gross Domestic Product (GDP) is the total “dollar” market value of all final goods & services currently produced within a given period by factors of production located within a country. –Market value... –Final goods and services... »The term final goods and services in GDP refers to goods and services produced for final use. »Intermediate goods are goods produced by one firm for use in further processing (i.e., transformation) by another. »Value added is the difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage. »In calculating GDP, we can either sum up the value added at each stage of production, or we can take the value of final sales. –Currently produced stuff... »Current »Productive –Located within, i.e., stuff produced HERE... »Output produced by a country’s citizens, regardless of where the output is produced, is measured by Gross National Product (GNP). –It’s gross... »Refers to investment purchases of newly produced capital like housing, plants, equipment, and inventory.

GDP Observations & Limitations u Population matters... u Leisure matters... u Quality matters... u Home production matters... u Illegal markets matter... u Distribution matters... u Social Benefits/Costs matter... u What’s produced matters... u Depreciation matters... u So what do we do? –Try the best we can. –Look at various indicators and scale them or compare them in meaningful ways. u How Happy Is America? – -happy-is-america