Chapter 1 Introduction to Macroeconomics

Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 8-2 Figure 1.1 Output of the U.S. economy, 1869–2002

Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 8-3 Figure 1.2 Average labor productivity in the United States, 1900–2002

Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 8-4 Figure 1.3 The U.S. unemployment rate, 1890–2002

Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 8-5 Figure 1.4 Consumer prices in the United States

Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 8-6 Figure 1.5 U.S. exports and imports, 1869– 2002

Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 8-7 Figure 1.6 U.S. Federal government spending and tax collections, 1869–2002

Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 8-8 The USA are, among the big countries, the area where p.c. GDP is highest. However, the share of world income produced in the USA has been steadily declining for the last fifty years. GDP (PPP bill. dollars) in 2003 Share of World GDP China 8,877 14% EU-25 12,079 19% JAPAN 4, % USA 13,049 20% The nations considered in the table above account for about 60% of world GDP. In 1950 the share of world GDP was 27.3% for the USA, 26.3% for Western Europe and only 7.5% for China and Japan combined

Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 8-9 The value of GDP is computed using current prices. However, GDP may grow over time both because more goods are produced or because prices have risen. Real GDP is the value of the final goods and services produced in the economy during a given year (or quarter) using Constant Prices, i.e., prices prevailing in a pre-specified period (base year). GDP Deflator is the ratio of nominal to real GDP, i.e., DE = GDP/GDPR = price of aggregate production during a given year relative to the price of aggregate production in the base year. A review of Nominal GDP, Real GDP and GDP Deflator

Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 8-10

Chapter 8 Business Cycles

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Figure 8.1 A business cycle

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Economic variables show comovement (they have regular and predictable patterns of behavior over the course of the business cycle) The business cycle is recurrent, but not periodic (Recurrent means the pattern of contraction–trough–expansion –peak occurs again and again) (Not being periodic means that it doesn’t occur at regular, predictable intervals)

Copyright © 2005 Pearson Addison-Wesley. All rights reserved The business cycle is persistent a.Declines are followed by further declines; growth is followed by more growth b. Because of persistence, forecasting turning points is quite important

Copyright © 2005 Pearson Addison-Wesley. All rights reserved All business cycles have features in common The cyclical behavior of economic variables direction and timing 1.What direction does a variable move relative to aggregate economic activity? Procyclical: in the same direction Countercyclical: in the opposite direction Acyclical: with no clear pattern

Copyright © 2005 Pearson Addison-Wesley. All rights reserved What is the timing of a variable’s movements relative to aggregate economic activity? Leading: in advance Coincident: at the same time Lagging: after

Copyright © 2005 Pearson Addison-Wesley. All rights reserved durable goods production is more volatile than nondurable goods and services; investment spending is more volatile than consumption Volatility:

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8-19 Table 8.1 NBER Business Cycle Turning Points and Durations of Post–1854 Business Cycles

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Great Depression of the 1930s a.Real GDP fell nearly 30% from peak in August 1929 to trough in March 1933 b. The unemployment rate rose from 3% to nearly 25% c. Thousands of banks failed, the stock market collapsed, many farmers went bankrupt, and international trade was halted d. By May 1937, output had nearly returned to its 1929 peak, but the unemployment rate was high (14%)

Copyright © 2005 Pearson Addison-Wesley. All rights reserved The Great Depression ended with the start of World War II a. Wartime production brought unemployment rate below 2% b. Real GDP almost doubled between 1939 and 1944

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Post–World War II business cycles 1.From 1945 to 1970 there were five mild contractions 2.The longest expansion on record was 106 months, from February 1961 to December Some economists thought the business cycle was dead 4.But the OPEC oil shock of 1973 caused a sharp recession, with real GDP declining 3%, the unemployment rate rising to 9%, and inflation rising to over 10%

Copyright © 2005 Pearson Addison-Wesley. All rights reserved The 1981–1982 recession was severe, with unemployment rate over 11%, but inflation declining from 11% to less than 4% 6. The 1990–1991 recession was mild and short, but the recovery was slow and erratic The “long boom” 1.From 1982 to the present, only one brief recession, from July 1990 to March Expansion from 1991 to 2002 is longest in U.S. history

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Figure 8.2 Index of industrial production, January 2000–April 2003 peak

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Figure 8.3 Total nonfarm employment, January 2000–April 2003 peak

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Figure 8.4 Cyclical behavior of the index of industrial production

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Figure 8.5 Cyclical behavior of consumption and investment

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Figure 8.6 Cyclical behavior of civilian employment

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Figure 8.7 Cyclical behavior of the unemployment rate

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Figure 8.8 Cyclical behavior of average labor productivity and the real wage

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Figure 8.9 Cyclical behavior of nominal money growth and inflation

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Figure 8.10 Cyclical behavior of the nominal interest rate

Copyright © 2005 Pearson Addison-Wesley. All rights reserved The cyclical behavior of key economic variables in other countries is similar to that in the United States International aspects of the business cycle

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Figure 8.11 Industrial production indexes in six major countries

Copyright © 2005 Pearson Addison-Wesley. All rights reserved A) What explains business cycle fluctuations? 2 major components of business cycle theories a. A description of the shocks b. A model of how the economy responds to shocks 2 major business cycle theories a. classical theory b. Keynesian theory 3. Study both theories in aggregate demand-aggregate supply (AD-AS) framework Business Cycle Analysis: A Preview

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Figure 8.12 The aggregate demand– aggregate supply model Y = F(K,L) M = kpY p

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Figure 8.13 An adverse aggregate demand shock

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Figure 8.14 An adverse aggregate supply shock

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Should the Government Try to Prevent Recessions? 2. How long it takes to get to long-run? 3. Do Recessions Have Any Positive Economic Effects? QUESTIONS