Introduction Modules 11 and 12

Module 11 – Macroeconomics Overview This module is a first introduction to macroeconomics Important topics are Potential output Production possibility curve Actual output Economic circulation Demand for the output

WHAT DO ECONOMISTS STUDY? Macroeconomic issues growth unemployment inflation balance of payments problems cyclical fluctuations 3

Potential Output Potential output is linked to the economy's supply side or productive capacity What can be produced, given the limited supply of the factors of production and the technological state of the economy Potential output will grow over time because the supply of factors of production increase and above all due to technological growth

Potential and Actual Output in Norway

Actual output Actual output is known as Gross National Product (GNP), and there are several ways to measuring the overall level of economic activity The production approach (GNP) The spending (expenditure) approach (GNE) The income approach (GNI)

The circular flow of goods and incomes

The circular flow of goods and incomes Goods and services

The circular flow of goods and incomes Goods and services £ Consumer expenditure

The circular flow of goods and incomes £ Goods and services £ Consumer expenditure Services of factors of production (labour, etc)

The circular flow of goods and incomes £ £ Goods and services £ Consumer expenditure Wages, rent dividends, etc. £ Services of factors of production (labour, etc)

The circular flow of goods and incomes £ £ Goods and services £ Consumer expenditure GOODS MARKETS FACTOR MARKETS Wages, rent dividends, etc. £ Services of factors of production (labour, etc)

Measuring the activity GNP (or more correctly GDP) as a production approach is the value of all final goods produced in the economy Demand for what is produced can conveniently be divided into various groups Private consumption (C) Private investment (I) Government (G) The foreign sector (X – Z) The factors of production receive income for their efforts GNP = GNE = GNI = Y Y = C + I + G + X – Z

Module 12 – Potential Output We have already established that potential output is closely related to the productive capacity of the economy In macroeconomics, it is frequently expressed by the production possibilitu curve (PPC) PPC shows what can be produced using all available resources as efficiently as possible

A production possibility curve Units of food Units of clothing (millions) (millions) 8m 0.0 7m 2.2m 6m 4.0m 5m 5.0m 4m 5.6m 3m 6.0m 2m 6.4m 1m 6.7m 0 7.0m Units of food (millions) Units of clothing (millions)

A production possibility curve Units of food Units of clothing (millions) (millions) a 8m 0.0 7m 2.2m 6m 4.0m 5m 5.0m 4m 5.6m 3m 6.0m 2m 6.4m 1m 6.7m 0 7.0m Units of food (millions) Units of clothing (millions)

A production possibility curve Units of food Units of clothing (millions) (millions) 8m 0.0 b 7m 2.2m 6m 4.0m 5m 5.0m 4m 5.6m 3m 6.0m 2m 6.4m 1m 6.7m 0 7.0m Units of food (millions) Units of clothing (millions)

A production possibility curve Units of food Units of clothing (millions) (millions) 8m 0.0 7m 2.2m c 6m 4.0m 5m 5.0m 4m 5.6m 3m 6.0m 2m 6.4m 1m 6.7m 0 7.0m Units of food (millions) Units of clothing (millions)

A production possibility curve Units of food Units of clothing (millions) (millions) 8m 0.0 7m 2.2m 6m 4.0m 5m 5.0m 4m 5.6m 3m 6.0m 2m 6.4m 1m 6.7m 0 7.0m Units of food (millions) Units of clothing (millions)

Increasing opportunity costs x 1 y 1 Units of food (millions) Units of clothing (millions)

Increasing opportunity costs x 1 y 1 2 Units of food (millions) z 1 Units of clothing (millions)

Making a fuller use of resources x Production inside the production possibility curve y Food v O Clothing

Growth in potential output Food Now O Clothing

Growth in potential output 5 years’ time Food Now O Clothing

The textbook does not give any thorough discussion on unemployment It is sometimes helpful to separate unemployment into two parts Equilibrium (natural) unemployment Disequilibrium (involuntary) unemployment The labour market is (almost) like any other market – supply and demand

CAUSES OF UNEMPLOYMENT Disequilibrium unemployment real-wage (classical) unemployment demand-deficient (cyclical) unemployment unemployment arising from a growth in the labour supply 10

CAUSES OF UNEMPLOYMENT Equilibrium unemployment frictional (search) unemployment structural unemployment changing pattern of demand regional unemployment technological unemployment seasonal unemployment 12

Unemployment rates in selected industrial countries UK

Unemployment rates in selected industrial countries UK

Unemployment rates in selected industrial countries UK France

Unemployment rates in selected industrial countries UK France

Unemployment rates in selected industrial countries UK Germany France

Unemployment rates in selected industrial countries UK Germany France

Unemployment rates in selected industrial countries UK Germany France USA

Unemployment rates in selected industrial countries UK Germany France USA

Unemployment rates in selected industrial countries UK Germany Japan France USA

Unemployment rates in selected industrial countries UK Germany Japan France USA

Unemployment rates in selected industrial countries UK Germany Japan France USA OECD

Unemployment rates in selected industrial countries UK Germany Japan France USA OECD

Disequilibrium unemployment ASL Average (real) wage rate We Qe ADL O No. of workers

Disequilibrium unemployment ASL Average (real) wage rate B A W2 Q2 Q1 We ADL O No. of workers

Equilibrium and disequilibrium unemployment ASL Average (real) wage rate e We ADL O Qe No. of workers

Equilibrium unemployment ASL N Average (real) wage rate e d We Q2 ADL O Qe No. of workers

Equilibrium and disequilibrium unemployment ASL Disequilibrium unemployment Average (real) wage rate b a W2 e We ADL O No. of workers

Equilibrium and disequilibrium unemployment ASL N Disequilibrium unemployment Average (real) wage rate b a c W2 Equilibrium unemployment e We ADL O No. of workers

Real-wage unemployment ASL Average (real) wage rate b b’ a W1 Q2 Q1 We ADL 2 ADL O Qe No. of workers

Demand-deficient unemployment ASL Average (real) wage rate W1 Q2 W2 ADL 1 ADL 2 O Q1 No. of workers

Arthur Okun The connection between unemployment and GDP growth is often formally summarised by the statistical relationship known as "Oakum's law" as developed by the late economist Arthur Oakum in 1962, the "law" related decreases in the unemployment rate to increases in output growth. In his original research, Oakum found that a 1-percentage-point decline in the unemployment rate was, on average, associated with additional output growth of about 3 percentage points Oakum's law is now widely accepted as stating that a 1-percentage-point decrease in the unemployment rate is associated with additional output growth of about 2 percent The negative correlation between changes in the unemployment rate and changes in GDP growth is viewed as one of the most consistent relationships in macroeconomics.

RELATIONSHIP BETWEEN INFLATION AND UNEMPLOYMENT Aggregate demand and inflation and unemployment effects of increases in aggregate demand (relative to potential output) how the objectives vary with the course of the business cycle The Phillips curve the original curve the apparent policy implications 6

The original Phillips curve Wage inflation (%) Unemployment (%)

The breakdown of the Phillips curve? Inflation (%) The breakdown of the Phillips curve? 65 62 66 61 64 67 63 60 Unemployment (%)

Original Phillips curve Inflation (%) The breakdown of the Phillips curve? Original Phillips curve 65 62 66 61 64 67 63 60 Unemployment (%)

The breakdown of the Phillips curve? Inflation (%) The breakdown of the Phillips curve? 74 71 73 72 70 69 65 62 68 66 61 64 67 63 60 Unemployment (%)

The breakdown of the Phillips curve? Inflation (%) The breakdown of the Phillips curve? 75 76 74 77 79 71 73 78 72 70 69 65 62 68 66 61 64 67 63 60 Unemployment (%)

The breakdown of the Phillips curve? Inflation (%) The breakdown of the Phillips curve? 75 80 76 74 77 79 81 71 73 82 78 72 70 85 69 84 65 62 68 83 66 61 64 67 63 60 Unemployment (%)

The breakdown of the Phillips curve? Inflation (%) The breakdown of the Phillips curve? 75 80 76 74 77 79 81 90 71 73 82 78 89 72 70 91 85 69 84 65 88 62 68 83 87 66 95 92 86 61 64 67 94 63 93 60 Unemployment (%)

The breakdown of the Phillips curve? Inflation (%) The breakdown of the Phillips curve? 75 80 76 74 77 79 81 90 71 73 82 78 89 72 70 91 85 69 84 65 88 68 83 62 98 87 66 00 97 95 92 86 61 64 67 94 01 96 63 99 93 02 60 Unemployment (%)