Macroeconomics Macroeconomics, the study of how the economy works as a whole. key variables to measure the “health” of an economy, and briefly discusses how the variables are measured and interpreted.

Microeconomics Versus Macroeconomics Microeconomics -- the “web of connections” of all the individual interdependent markets that make up an economy. Macroeconomics – putting the microscope away and looking at the overall economy as its own entity, imperfections and all.

The Macro Goal Variables Measures of Economy’s “Health” Definitions and Realistic Goals (US, for the most part).

Goal #1 – Sufficient Production or Output Measured by Real Gross Domestic Product (Real GDP). Real GDP (Y) -- The total production or output of final goods and services over a period of time, expressed in constant prices of a base year.

Real Versus Nominal GDP Nominal GDP (unadjusted GDP) -- Total production at current prices. Real GDP (GDP adjusted for changes in prices) -- Total production at constant prices of a base year.

Why is Production or Output Important? Real GDP – the sum total of production of final goods and services across all markets of the economy, it measures total production or output. By definition, Real GDP identically measures total income to all the factors derived from production and sales.

Real GDP -- Realistic Goal Realistic Goal for Real GDP -- to be as high as possible without accelerating inflation (overstimulated economy).

The Full Sustainable Level of Real GDP (Potential GDP) The Full Sustainable Level of Real GDP (YF) – the maximum level of Real GDP the economy can produce without bringing on accelerating inflation or overstimulation.

Characterizing the Economy: Y versus YF Y < YF -- sluggish economy Y > YF -- economy with accelerating inflation Y = YF -- economy with constant inflation rate (desired state)

Characteristics of YF Unobservable. Has grown at 2.5% per year for the US historically since World War II. Maybe for the US, it has grown 3% per year in most recent decade. Growth rate is not the same for all countries (Europe, Canada is less).

Recession -- A Special Case Recession -- The situation where the level of real GDP decreases, or exhibits negative growth, for at least two consecutive quarters. Clearly, in a recession, Y < YF.

Goal Variable #2 -- Inflation Measured by the Inflation Rate -- the growth or percentage change in the overall price level. First, measure the price level (P): Consumer Price Index (CPI). Inflation Rate = Percentage Change in P.

Why is Inflation a Problem? Inflation erodes the purchasing power of money, causes distortions in decisions. -- Why hold money? -- Why lend money? Inflation can erode people’s standard of living, put pressure on labor markets. -- Fixed incomes. -- Workers with insufficient raises.

Realistic Goal -- Inflation Ideal Goal: Inflation Rate = 0%. Realistic Goal (US): |Inflation Rate| < 3%.

The Consumer Price Index (CPI) Key measure of the price level (P). Computed based upon a Market Basket: comprehensive set of goods and services purchased by consumers. Fixed Weight Index

Computing a CPI Example -- Compute the CPI for 2008 with 1992 as the base year. CPI2008 = (Cost of 1992 Market Basket Purchased in 2008) (Cost of Actual Consumer Purchases in 1992)

Computing The Inflation Rate (Given the CPI) Example -- Compute the Inflation Rate for 2008, given that the CPI for 2007 and 2008 have been calculated. Inflation = CPI2008 – CPI2007 x 100% Rate2008 CPI2007

Converting Nominal GDP to Real GDP Example -- find Real GDP2008 Real GDP2008 = Nominal GDP2008 P2008 Real GDP for other years is computed the same way. Real GDP Growth = Percentage Change in Real GDP.

Goal Variable #3 -- Unemployment Measured by the Unemployment Rate (u). u = (# of people unemployed) x 100% (labor force) Unemployed -- those people out of work and seeking work. Labor Force -- people employed + people unemployed

What the Unemployment Rate Does Not Measure discouraged workers, those who drop out of the labor force part-time versus full-time employment compensation of those working people with multiple jobs

Realistic Goal -- Unemployment Rate Realistic Goal -- as low as possible without inflation accelerating (overstimulated economy). Natural Rate of Unemployment (uN) -- The lowest unemployment rate the economy can achieve without accelerating inflation. Realistic Goal: u = uN

Interpretation: u versus uN u = uN  Desired State of Economy u > uN  Sluggish Economy u < uN  Accelerating Inflation (Overstimulated Economy)

Types of Unemployment Total Unemployment = Frictional + Structural + Demand-Deficient Frictional Unemployment -- Unemployment due to time involved to matching unemployed and appropriate jobs.

Structural and Demand-Deficient Unemployment Structural Unemployment -- Unemployment due to a mismatch of available workers and jobs. Demand-Deficient Unemployment -- Unemployment due to a generally sluggish economy. There are not enough jobs for everyone who wants one.

Where is uN for the US? Historically, uN = 5.5% Is uN now maybe 5%? Most other countries: uN is higher than US measure.

Real GDP and the Unemployment Rate u = uN  Y = YF, (Desired State of Economy) u > uN  Y < YF, (Sluggish Economy) u < uN  Y > YF, (Accelerating Inflation)