Macro Workings Macroeconomics All text in these slides is taken from https://courses.lumenlearning.com/waymakermacroxmasterfall2016/ where it is published under one or more open licenses. All images in these slides are attributed in the notes of the slide on which they appear and licensed as indicated. Cover Image: Untitled Author: Gustavo Quepon Source: https://unsplash.com/photos/pF_2lrjWiJE

Real GDP Real GDP is important because when real GDP rises, so does employment. Below is Real U.S. GDP, 1900–2012. This represents a roughly 20-fold increase in the economy’s production of goods and services since the start of the twentieth century. (Source: bea.gov).

The Business Cycle The business cycle is a series of expansions and contractions in real GDP. The cycle begins at a peak and continues through a recession, a trough, and an expansion. A new cycle begins at the next peak. Notice that the overall trend is growth in real GDP Principles of Macroeconomics Chapter 5.1. Authored by: Anonymous. Located at: http://2012books.lardbucket.org/books/macroeconomics-principles-v1.0/s08-01-growth-of-real-gdp-and-busines.html. License: CC BY-NC-SA: Attribution-NonCommercial-ShareAlike

Overheating Overheating means the economy is picking up speed leading to increased inflation It occurs when its productive capacity is unable to keep pace with growing aggregate demand It is generally characterized by an above-trend rate of economic growth, where growth is occurring at an unsustainable rate Boom periods are often characterized by overheating in the economy

Stagflation Stagflation means the simultaneous occurrence of stagnant growth (or recession) and inflation Keynesian economists thought this was impossible, but you can show it with AD/AS It is a situation where the inflation rate is high, the economic growth rate slows down, and unemployment is also high It raises a dilemma for economic policy since actions designed to lower inflation may exacerbate unemployment, and vice versa

Recessions and Depressions The National Bureau of Economic Research defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production.”   If the economy does not begin to expand again, then the economy may be considered to be in a state of depression.

Practice Question What is usually the best time in the business cycle to look for a job? start a business? buy stock or property? Trough Expansion Peak Contraction Expansion is usually the best time to look for a job or start a business. Trough is generally the best time to buy stock or property.

What is Economic Growth? Economic growth is the process through which an economy achieves an outward shift in its production possibilities curve

Two Models of Economic Growth Economists model economic growth as: an outward shift in an economy’s production possibilities curve a shift to the right in its long-run aggregate supply curve

Cyclical Change Versus Growth The use of actual values of real GDP to measure growth can give misleading results compared to the Production Possibilities Curve Principles of Macroeconomics Chapter 8.1. Authored by: Anonymous. Located at: http://2012books.lardbucket.org/books/macroeconomics-principles-v1.0/s11-01-the-significance-of-economic-g.html. License: CC BY-NC-SA: Attribution-NonCommercial-ShareAlike Previous

Differences in Growth Rates The chart suggests the significance in the long run of a small difference in the growth rate of real GDP Principles of Macroeconomics Chapter 8.1. Authored by: Anonymous. Located at: http://2012books.lardbucket.org/books/macroeconomics-principles-v1.0/s11-01-the-significance-of-economic-g.html. License: CC BY-NC-SA: Attribution-NonCommercial-ShareAlike Previous

Output per Capita An economy’s output per capita equals real GDP per person. If we let N equal population, then Output per capita= 𝑟𝑒𝑎𝑙 𝐺𝐷𝑃 𝑁 % rate of growth of output per capita ≅ % rate of growth of output − % rate of growth of population

Economic Growth, Labor Productivity and Standard of Living For economic growth to translate into a higher standard of living on average, economic growth must exceed population growth Labor productivity is essential for economic growth

Labor Productivity Depends on: Human capital - the accumulated knowledge (from education and experience), skills, and expertise that the average worker in an economy possesses Technological change is a combination of invention—advances in knowledge—and innovation, which is putting that advance to use in a new product or service Economies of scale are the cost advantages that industries obtain due to size

Aggregate Production Function A production function, which is the process of turning economic inputs like labor, machinery, and raw materials into outputs like goods and services used by consumers. In macroeconomics, the connection from inputs to outputs for the entire economy is called an aggregate production function.

Aggregate Production Functions Principles of Macroeconomics Chapter 7.2. Authored by: OpenStax College. Located at: http://cnx.org/contents/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49:2/Macroeconomics. License: CC BY: Attribution. License Terms: Download for free at http://cnx.org/donate/download/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49/pdf Previous

Output per Hour Worked in the U.S. Economy, 1947–2011 Principles of Macroeconomics Chapter 7.2. Authored by: OpenStax College. Located at: http://cnx.org/contents/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49:2/Macroeconomics. License: CC BY: Attribution. License Terms: Download for free at http://cnx.org/donate/download/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49/pdf Previous Output per Hour Worked in the U.S. Economy, 1947–2011

Productivity Growth Since 1950 Principles of Macroeconomics Chapter 7.2. Authored by: OpenStax College. Located at: http://cnx.org/contents/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49:2/Macroeconomics. License: CC BY: Attribution. License Terms: Download for free at http://cnx.org/donate/download/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49/pdf Previous

Predicting Future GDP Using Growth Rates GDP at starting date × (1 + growth rate of GDP)years = GDP at end date Future Value = Present Value × (1 + g)n

Capital Deepening When society increases the level of capital per person, the result is called capital deepening Rising levels of education for persons 25 and older show the deepening of human capital in the U.S. economy. Even today, relatively few U.S. adults have completed a four-year college degree. There is clearly room for additional deepening of human capital to occur (Source: US Department of Education, National Center for Education Statistics) in Principles of Macroeconomics Chapter 7.3. Authored by: OpenStax College. Provided by: Rice University. Located at: http://cnx.org/contents/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49:2/Macroeconomics. License: CC BY: Attribution. License Terms: Download for free at http://cnx.org/donate/download/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49/pdf

Physical Capital Deepening The value of the physical capital, measured by plant and equipment, used by the average worker in the U.S. economy has risen over the decades. The increase may have leveled off a bit in the 1970s and 1980s, which were not, coincidentally, times of slower-than-usual growth in worker productivity. We see a renewed increase in physical capital per worker in the late 1990s, followed by a flattening in the early 2000s. (Source: Center for International Comparisons of Production, Income and Prices, University of Pennsylvania) in Principles of Macroeconomics Chapter 7.3. Authored by: OpenStax College. Provided by: Rice University. Located at: http://cnx.org/contents/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49:2/Macroeconomics. License: CC BY: Attribution. License Terms: Download for free at http://cnx.org/donate/download/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49/pdf

Technology Technology is typically the most important contributor to U.S. economic growth The three components are interdependent: investing in education encourages invention and innovation for example Anything that increases the quantity or quality of factors of production or that improves the technology available to the economy contributes to economic growth

How Governments can Promote Growth Offer stable government and rule of law Legal protection of property rights and contractual rights Invest in education Invest in infrastructure Invest in scientific research Promote private savings and investment Create special economic zones: areas of the country, usually with access to a port where, among other benefits, the government does not tax trade

Why should governments promote savings? Higher saving allows more resources to be devoted to increases in physical and human capital and technological improvement

Say’s Law and the Macroeconomics of Supply Supply creates its own demand Since every sale represents income to someone, a given value of supply must create an equivalent value of demand somewhere else in the economy Over periods of some years or decades, as the productive power of an economy to supply goods and services increases, total demand in the economy grows at roughly the same pace Limitations: Does not explain short run economics or recessions well

Keynes’ Law and the Macroeconomics of Demand Demand creates its own supply The level of GDP in the economy is not primarily determined by the potential of what the economy could supply, but rather by the amount of total demand Explains the short-run well Limitations: Economies do face genuine limits to how much they can produce, with the quantity of labor, physical capital and technology

Combining Supply and Demand Both supply and demand need to be taken into account. Keynes’ law applies more accurately in the short run and Say’s law applies more accurately in the long run, the tradeoffs and connections between the three goals of macroeconomics may be different in the short run and the long run

The Aggregate Supply Curve and Potential GDP Aggregate supply (AS) slopes up, because as the price level for outputs rises, with the price of inputs remaining fixed, firms have an incentive to produce more and to earn higher profits. The potential GDP line shows the maximum that the economy can produce with full employment of workers and physical capital Principles of Macroeconomics Chapter 11.2. Authored by: OpenStax College. Located at: http://cnx.org/contents/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49:2/Macroeconomics. License: CC BY: Attribution. License Terms: Download for free at http://cnx.org/donate/download/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49/pdf

Aggregate Demand An aggregate demand curve (AD) shows the relationship between the total quantity of output demanded (measured as real GDP) and the price level (measured as the implicit price deflator). At each price level, the total quantity of goods and services demanded is the sum of the components of real GDP, as shown in the table. There is a negative relationship between the price level and the total quantity of goods and services demanded, all other things unchanged Principles of Macroeconomics Chapter 7.1. Authored by: Anonymous. Located at: http://2012books.lardbucket.org/books/macroeconomics-principles-v1.0/s10-01-aggregate-demand.html. License: CC BY-NC-SA: Attribution-NonCommercial-ShareAlike

Aggregate Supply and Aggregate Demand The intersection of the aggregate supply and aggregate demand curves shows the equilibrium level of real GDP and the equilibrium price level in the economy Principles of Macroeconomics Chapter 11.2. Authored by: OpenStax College. Located at: http://cnx.org/contents/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49:2/Macroeconomics. License: CC BY: Attribution. License Terms: Download for free at http://cnx.org/donate/download/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49/pdf

Equilibrium: GDP, Inflation, and Unemployment If equilibrium occurs in the flat range of AS, then economy is not close to potential GDP and will be experiencing unemployment, but stable price level. If equilibrium occurs in the steep range of AS, then the economy is close or at potential GDP and will be experiencing rising price levels or inflationary pressures, but will have a low unemployment rate.

Potential Output Potential output is the level of output an economy can achieve when labor is employed at its natural level. When an economy fails to produce at its potential, the government or the central bank may try to push the economy toward its potential.

AD Curve Slope and Shifts The AD curve slopes downward because of the wealth effect on consumption, the interest rate effect on investment, and the international trade effect on net exports The AD curve shifts when the quantity of real GDP demanded at each price level changes

Shifts in AD

The Multiplier The multiplier is the number by which we multiply an initial change in aggregate demand to obtain the amount by which the aggregate demand curve shifts at each price level as a result of the initial change: Δ real GDP demanded at each price level=multiplier×initial Δ(component of AD)

Graphing The Multiplier

Shifts in Aggregate Supply Principles of Macroeconomics Chapter 11.3. Authored by: OpenStax College. Provided by: Rice University. Located at: http://cnx.org/contents/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49:2/Macroeconomics. License: CC BY: Attribution. License Terms: Download for free at http://cnx.org/donate/download/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49/pdf

Shifts in AD such as Change in Consumer or Business Confidence Principles of Macroeconomics Chapter 11.4. Authored by: OpenStax College. Provided by: Rice University. Located at: http://cnx.org/contents/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49:2/Macroeconomics. License: CC BY: Attribution. License Terms: Download for free at http://cnx.org/donate/download/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49/pdf

Recession and Full Employment Whether the economy is in a recession is illustrated in the AS– AD model by how close the equilibrium is to the potential GDP line. In this example, the level of output Y0 at the equilibrium E0 is relatively far from the potential GDP line, so it can represent an economy in recession, well below the full employment level of GDP. In contrast, the level of output Y1 at the equilibrium E1 is relatively close to potential GDP, and so it would represent an economy with a lower unemployment rate Principles of Macroeconomics Chapter 11.4. Authored by: OpenStax College. Provided by: Rice University. Located at: http://cnx.org/contents/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49:2/Macroeconomics. License: CC BY: Attribution. License Terms: Download for free at http://cnx.org/donate/download/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49/pdf

Inflation in the AS/AD Model Principles of Macroeconomics Chapter 11.5. Authored by: OpenStax College. Provided by: Rice University. Located at: http://cnx.org/contents/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49:2/Macroeconomics. License: CC BY: Attribution. License Terms: Download for free at http://cnx.org/donate/download/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49/pdf

Natural Employment and Long-Run Aggregate Supply When the economy achieves its natural level of employment, as shown in Panel (a) at the intersection of the demand and supply curves for labor, it achieves its potential output, as shown in Panel (b) by the vertical long-run aggregate supply curve LRAS at YP. In Panel (b) we see price levels ranging from P1 to P4. Higher price levels would require higher nominal wages to create a real wage of ωe, and flexible nominal wages would achieve that in the long run Principles of Macroeconomics Chapter 7.2. Authored by: Anonymous. Located at: http://2012books.lardbucket.org/books/macroeconomics-principles-v1.0/s10-02-aggregate-demand-and-aggregate.html. License: CC BY: Attribution. License Terms: Download for free at http://cnx.org/donate/download/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49/pdf

How Can the Long Run Supply Curve be a Vertical Line? In the long run the economy can achieve its natural level of employment and potential output at any price level. This conclusion gives us our long-run aggregate supply curve. With only one level of output at any price level, the long-run aggregate supply curve is a vertical line at the economy’s potential level of output of YP

Long-Run Equilibrium Long-run equilibrium occurs at the intersection of the aggregate demand curve and the long-run aggregate supply curve. For the three aggregate demand curves shown, long-run equilibrium occurs at three different price levels, but always at an output level of $12,000 billion per year, which corresponds to potential output Principles of Macroeconomics Chapter 7.2. Authored by: Anonymous. Located at: http://2012books.lardbucket.org/books/macroeconomics-principles-v1.0/s10-02-aggregate-demand-and-aggregate.html. License: CC BY: Attribution. License Terms: Download for free at http://cnx.org/donate/download/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49/pdf

Deriving the Short-Run Aggregate Supply Curve The economy shown here is in long-run equilibrium at the intersection of AD1 with the long-run aggregate supply curve. If aggregate demand increases to AD2, in the short run, both real GDP and the price level rise. If aggregate demand decreases to AD3, in the short run, both real GDP and the price level fall. A line drawn through points A, B, and C traces out the short-run aggregate supply curve SRAS. Principles of Macroeconomics Chapter 7.2. Authored by: Anonymous. Located at: http://2012books.lardbucket.org/books/macroeconomics-principles-v1.0/s10-02-aggregate-demand-and-aggregate.html. License: CC BY: Attribution. License Terms: Download for free at http://cnx.org/donate/download/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49/pdf

Changes in Short-Run Aggregate Supply A reduction in short-run aggregate supply shifts the curve from SRAS1 to SRAS2 in Panel (a). An increase shifts it to the right to SRAS3, as shown in Panel (b). Principles of Macroeconomics Chapter 7.2. Authored by: Anonymous. Located at: http://2012books.lardbucket.org/books/macroeconomics-principles-v1.0/s10-02-aggregate-demand-and-aggregate.html. License: CC BY: Attribution. License Terms: Download for free at http://cnx.org/donate/download/4061c832-098e-4b3c-a1d9-7eb593a2cb31@10.49/pdf

Quick Review What is the business cycle? What are the primary phases of the business cycle and what happens in each phase? What is economic growth? How do economists use the AD-AS model to explain the equilibrium levels of real GDP and price level?