Chapter 1 -- The Macro Goal Variables zMeasures of Economy’s “Health” zDefinitions, Realistic Goals, and Recent (US) Performance

#1 -- Real Gross Domestic Product (Real GDP) zReal GDP (Y) -- The total production of final goods and services over a period of time, expressed in constant prices of a base year. zWhy Real GDP (GDP in constant dollars), instead of Nominal GDP (GDP in current dollars)?

Real GDP -- Realistic Goal zRealistic Goal for Real GDP -- to be as high as possible without accelerating inflation (overstimulated economy). zCan state this goal in a more formal way.

The Natural Level of Real GDP (Potential Real GDP) zThe Natural Level of Real GDP (Y N ) -- that level of real GDP in which inflation has no tendency to accelerate or decelerate.

Comparing Real GDP to the Natural Level of Real GDP Y < Y N -- sluggish economy with decelerating inflation (inflation rate  ) Y > Y N -- economy with accelerating inflation Y = Y N -- economy with constant inflation rate

Characteristics of Y N zUnobservable zGrows at 2.5% per year for the US zAffected by -- labor productivity -- the price of energy -- the capital stock -- the labor force

Getting and Keeping Y at Y N : The “Two Cars” zIf Y = Y N, then seek annual real GDP growth = 2.5%. zIf Y 2.5%, for awhile. zIf Y > Y N, then seek annual real GDP growth < 2.5%, for awhile. zSpecial Case -- The Recession

Goal Variable #2 -- The Inflation Rate zInflation Rate -- the growth or percentage change in the overall price level. zFirst, measure the price level (P). -- Consumer Price Index (CPI) -- GDP Deflator zInflation Rate = Percentage Change in P

Realistic Goal -- Inflation zIdeal Goal: Inflation Rate = 0%. zRealistic Goal (US): |Inflation Rate| < 3%.

An Inflation Problem Versus Accelerating Inflation zInflation Problem -- |Inflation Rate| < 3%. zAccelerating Inflation -- Inflation Rate  zConsider -- Inflation Rates of 1981 versus 1985 (Y = Y N ) 1981 Inflation Rate = 9.0% 1985 Inflation Rate = 2.5%

Goal Variable #3 -- The Unemployment Rate (u) u = (# of people unemployed) (total labor force) Does not measure -- discouraged workers -- part-time versus full-time employment -- people with multiple jobs

Types of Unemployment zFrictional Unemployment -- Unemployment due to normal labor market frictions. zStructural Unemployment -- Unemployment due to a mismatch of available workers and jobs. zCyclical Unemployment -- Unemployment due to a generally slow economy.

Realistic Goal -- Unemployment Rate zRealistic Goal -- zero cyclical unemployment zNatural Rate of Unemployment (u N ) -- The unemployment rate in which inflation has no tendency to accelerate or decelerate. zRealistic Goal: u = u N

Interpretation: u versus u N zu = u N  Inflation Rate Unchanged (Desired State of Economy) zu > u N  Inflation Rate  (Sluggish Economy) zu < u N  Inflation Rate  (Overstimulated Economy)

Real GDP and the Unemployment Rate zu = u N  Y = Y N, (Desired State of Economy) zu > u N  Y < Y N, (Sluggish Economy) zu Y N, (Overstimulated Economy)

Goal Variable #4 -- The Federal Budget zBudget = Tax Revenues - Government Expenditure (over a given period) zBudget = Tax Revenues - (Government purchases of goods and services + Transfer Payments + Interest on the National Debt)

Budget Definitions zBudget < 0 -- Budget Deficit zBudget > 0 -- Budget Surplus zBudget = 0 -- Balanced Budget

Realistic Goal -- The Federal Budget zRealistic Goal -- Balanced Budget when Y = Y N. zSluggish economies tend toward deficits. zHierarchy of economic problems.

Goal Variable #5 -- The Balance of Trade zBalance of Trade (BOT) -- approximated by net exports. zBOT = Exports - Imports zBOT < 0 -- Balance of Trade Deficit zBOT > 0 -- Balance of Trade Surplus zBOT = 0 -- Balanced Trade Position

Realistic Goal -- Balance of Trade zRealistic Goal -- BOT close to zero.

Diagnosing the “Patient” -- The Current US Economy and Prospects For the Near Future