Macroeconomic Fundamentals ECO 473 - Money & Banking - Dr. D. Foster

The Circular Flow of Income and Product

The Gross Domestic Product (GDP) Defined as: The total value of all final goods and services produced during a given period. Evaluated at market prices … sort of. Serves as a measure of an economy’s total output and of the total income generated (to individuals). Limitations of GDP Excludes nonmarket production. Measurement problems. Welfare interpretations. Country differences are difficult.

Components of GDP Consumption spending: Investment spending: Total household purchases of goods and services. Investment spending: Purchases of new capital goods (fixed I), and Changes in business inventories. Government spending: State/Local/Federal government expenditures. Net export spending: Exports - Imports.

Calculating Gross Domestic Product 1990 1995 2000 2005 Consumption Spending 4,770 5,433 6,739 7,803 Investment Spending 886 1,109 1,679 1,831 Government Spending 1,530 1,549 1,721 1,946 Net Export Spending -55 -71 -379 -618 Gross Domestic Product 7,112 8,031 9,817 11,003 The logo for the Bureau of Economic Analysis is hyperlinked to the most recent press release on GDP estimates.

Real GDP versus Nominal GDP Changes in nominal GDP are due to rising production and rising prices. aka Current-dollar GDP. Real GDP excludes price changes. aka Constant-dollar GDP. Derived as (nominal GDP)/(GDP price deflator). GDP price deflator (P): An overall measure of inflation, using the entire GDP as the “basket” of goods and services. CPI = Consumer Price Index; more often reported. PPI = Producer Price Index; leading indicator.

Using Inflation to find real values Example: Income in 2010 is $32,000 and in 2011 it is $33,100. Are you “better off?” Has the real purchasing power risen? Find out “real income” by looking at CPI: It was 172.2 in 2010 and 179.9 in 2011

Using Inflation to find real values So, while your nominal income rose from 2010 to 2011, your “real income” didn’t. Another way to see this is to divide $33,100 by (179.9/172.2) to get a real income (in year 2010 terms) of $31,683. Problems: Compared to the CPI . . . you don’t buy the same things you don’t buy the same proportions you make tradeoffs between goods

The Costs of Inflation If unexpected: Recipients of fixed incomes are losers . . . Payers of fixed amounts are winners . . . Distorts business investment plans. If expected . . . it shouldn’t matter, but: Repricing costs (less now with scanners). Inconvenience costs if money holdings fall. Real economic costs if workers want compensation for the uncertainty. Hardly possible to stabilize; it keeps rising.

Cycles in Economic Activity Business cycles: Real GDP varies around its long-run growth path. Recession: The decline in real GDP. lasting at least two consecutive quarters. Trough: Low point in real GDP. Expansion: The growth phase. Peak: High point of real GDP. The NBER logo is hyperlinked to their home page. The graphical image is hyperlinked to the NBER business cycle dating page.

Business Cycles - Theories External shocks. Population pressures. [Malthus vs. Simon] Schumpeter – innovation. Marx – underconsumption. “Classical school” – erratic anomalies. The image in the upper right is hyperlinked to a YouTube video called, “Fear the Boom and Bust.” Keynesian – W&P rigidity leads to overproduction. Austrian School - Induced by policy/credit.

Unemployment and the Business Cycle Unemployment rate: The % of the civilian labor force that is unemployed. Frictional unemployment: Workers are “between” jobs at any given time. New entrants, fired workers, workers that quit. Structural unemployment: Workers’ abilities/skills don’t match employers needs. Cyclical unemployment: The unemployment resulting from business-cycles. Natural rate of unemployment (U*): The frictional and structural components. The star image in the lower right is hyperlinked to the Bureau of Labor Statistics web page.

Interpreting the Ur rate. It disguises underemployment. Workers at part-time jobs that want full-time jobs. It discounts discouraged workers. Effect is to lower the measured rate!!! But, hard to imagine the severity of such an outcome. It includes people using unemployment as an excuse to collect benefits. So, this would tend to overstate the problem.

Macroeconomic Fundamentals Data Sources Bureau of Economic Analysis Federal Reserve System St. Louis Fed FRED Economic Indicators Bureau of Labor Statistics National Bureau of Economic Research Economic Report of the President This slide contains a host of hyperlinks to web sites that report macroeconomic data. ECO 473 - Money & Banking - Dr. D. Foster

Macroeconomic Fundamentals ECO 473 - Money & Banking - Dr. D. Foster