Macro Economic Environment - Unemployment, Inflation 6th of May

Macroeconomic Objectives The major macroeconomic issues economic growth unemployment inflation balance of payments and exchange rates 2

Economic Growth Actual growth: Percentage annual increase of national output or ‘GDP’ (Gross Domestic Product. Potential growth: The speed at which the economy could grow. It is the percentage annual increase of economic capacity to produce Potential output: The output that could be produced in the economy if all firms were operating at their normal level of capacity utilisation. 4

The business cycle The periodic fluctuations of national output round its long-term trend the phases of the business cycle the upturn – growth of actual output resumes the expansion – periods of economic growth the peaking out – growth slows down or even ceases the slowdown or recession – periods of negative or no growth

The business cycle National output Time Full-capacity output Trend Actual output O Time

Growth rates in selected industrial countries Notes: 2013 and 2014 based on forecasts; EU-15 = the member countries of the European Union prior to 1 May 2004 Source: based on data in AMECO Database, European Commission, DGECFIN 6

Measuring a nation’s income Macroeconomics answers questions like the following: Why is average income high in some countries and low in others? Why do prices rise rapidly in some periods of time while they are more stable in other periods? Why do production and employment expand in some years and contract in others? 7

The economy’s income and expenditure For an economy as a whole, income must equal expenditure because: Every transaction has a buyer and a seller. Every dollar of spending by some buyer is a dollar of income for some seller. 8

The measurement of GDP Y = C + I + G + NX “GDP is the market value of all final goods and services produces within a country in a given period of time” Y = C + I + G + NX Y = GDP C – Consumption I – Investment G – Government Purchases NX – Net Exports 9

The measurement of GDP Final A greeting card is a final product GDP is the Market Value Since market prices measure the amount people are willing to pay for different goods they accurately reflect their value If a price of an apple is twice that of an orange, the apple contributes twice as much to GDP as the orange Of All GDP tries to be comprehensive. Includes all items produced in the economy and sold legally in the market GDP also includes the market value of housing services. If people own their houses the govt estimates rent. GDP excludes illegal items (drugs) GDP excludes items that are produced and consumed at home (Vegetable Gardens) Final A greeting card is a final product Paper used to make the greeting card is an intermediate product. (This is not calculated in the GDP) The exception is when the “paper” is kept in inventory after being processed. Only FINAL goods are calculated in GDP Goods and Services GDP includes both tangible and intangible goods. Produced GDP includes goods and services currently produced. (Used cards don’t count) Within a country GDP measures the value of production within the geographic confines of a country. In a given period of time GDP measures the value of production that takes place within a specific interval of time 10

The components of GDP Consumption (C): Investment (I): The spending by households on goods and services, with the exception of purchases of new housing. Investment (I): The spending on capital equipment, inventories and structures, including household purchases of new housing. 11

The components of GDP Government purchases (G): Net exports (NX): The spending on goods and services by local, state and federal governments. Does not include transfer payments because they are not made in exchange for currently produced goods or services. Net exports (NX): Exports minus imports. 12

Real versus nominal GDP Nominal GDP values the production of goods and services at current prices. Real GDP values the production of goods and services at constant prices. 13

GDP and economic wellbeing GDP is the best single measure of the economic well being of a society. GDP per person tells us the income and expenditure of the average person in the economy. 14

GDP and economic wellbeing Higher GDP per person indicates a higher standard of living. However, GDP is not a perfect measure of the happiness or quality of life. 15

GDP and economic wellbeing Some things that contribute to wellbeing are not included in GDP. The value of leisure. The value of a clean environment. The value of almost all activity that takes place outside of markets, such as the value of the time parents spend with their children and the value of volunteer work. 16

Inflation Inflation refers to a situation in which the economy’s overall price level is rising. The inflation rate is the percentage change in the price level from the previous period. 17

The consumer price index The consumer price index (CPI) is a measure of the overall cost of the goods and services bought by a typical consumer. 18

How the CPI is calculated Fix the basket: Determine which prices are most important to the typical consumer. 2. Find the prices: Find the prices of each of the goods and services in the basket for each point in time. 3. Calculate the basket’s cost: Use the data on prices to calculate the cost of the basket of goods and services at different times. 4. Choose a base year and compute the index: Designate one year as the base year, making it the benchmark against which other years are compared. 5. Compute the inflation rate: The inflation rate is the percentage change in the price index from the preceding period 19

What’s in the CPI’s basket? Copyright©2004 South-Western 20

Real and nominal interest rates The nominal interest rate is the interest rate usually reported and not corrected for inflation. It is the interest rate that a bank pays. The real interest rate is the nominal interest rate that is corrected for the effects of inflation. 21

Real and nominal interest rates You borrowed $1,000 for one year. Nominal interest rate was 15%. During the year inflation was 10%. Real interest rate = Nominal interest rate – Inflation = 15 percent − 10 percent = 5 percent 22

Unemployment Labor Force – the total numbers of worker including both the unemployed and the employed. Unemployment rate – the % of the labor force that is unemployed Unemployment rate = Number of unemployed *100 Labor Force Employed Paid/unpaid Part time/full time Unpaid workers in a family business Unemployed People who are available to work People who are trying to find work Not in the labor force Full time students Home makers People who have given up looking for jobs.

Frictional unemployment Unemployment that results because it takes time for workers to search for the jobs that best suit their tastes and skills

Natural rate of unemployment The normal rate of unemployment which unemployment rate fluctuates. Why is there always unemployment Frictional unemployment Minimum wage laws Unions Unemployment insurance Wages Efficiency wage theory suggest that firms maybe better off paying more that the equilibrium wage. Healthier workforce. Lower turnover Worker Quallity