Macroeconomics What is Macroeconomics? Important Macro Variables What is GDP? Macroeconomic Policy

What is Macroeconomics? Microeconomics – studies individual markets and industries. “How to divide up Pie” Macroeconomics – studies the general conditions of the overall economy. “Size of the Pie”

Macroeconomics involves aggregation – adding up parts of economy to get whole picture. Example: National Crime Index Serious Crime (violent + property) per 100,000 people: 1992:5, :4,600

- Serious crime rate down 19% - Murder rate down 31% - Aggregation may obscure real picture - Aggregation gives overall picture of crime which may or may not be represented by your neighborhood. (i)Amount of aggregation depends on your objective. (ii)Variables that make up the aggregate tend to move together.

Important Macroeconomic Variables (1)National Output – How much total output a country produces over a period of time (GDP). U.S. GDP for 2005 is $11.8 Trillion ($11,800,000,000,000)

Figure 2 Real Gross Domestic Product (GDP) Since 1959

A Growing Economy…  U.S. GDP 4.4 times larger in 2004 versus 1959  U.S. GDP per capita is 2.7 times larger But with Bumps along the Way Growth is irregular from year to year Periods of boom and bust (recession) known as business cycles or economic fluctuations.

GDP is produced from labor (“who”) and capital (“what”). Labor – measured in number of workers or total hours worked Capital – the value of productive assets used by businesses to produce goods and services.

(2)Unemployment Rate – fraction of all people who are willing and able to work who don’t have jobs. U.S. Unemployment Rate is 4.7%

FIGURE 4: Unemployment Rate in the U.S., Copyright© 2006 South-Western/Thomson Learning. All rights reserved Percentage of Civilian Workers Who are Unemployed Great Depression World War II 1960s boom recession recessions 1980s boom 1990s boom Percentage of Civilian Workers Who are Unemployed

Inflation Rate – the rate of increase of overall (economy-wide) prices. U.S. inflation rate in 2005 is around 3.8%

Figure 6 The Inflation Rate in the United States since 1870

Structure of the American Economy A Private Enterprise Economy  Most production completed by private enterprises in free markets  Gross Domestic Product (GDP): standard measure of the economy’s output  Government spending accounts for about 18 percent of GDP.

Circular Flow of Goods and Money Households (Consumers): Supplies Labor and Capital Receives Goods and Services Earns and Spends Income  Businesses: Receives Capital and Labor Produces Goods and Services Earns sales receipts and pays for capital and labor.

Figure 11 The Circular Flow of Goods and Money

What’s Missing from the Picture? Government The Government as a Referee  Enforce laws and act as an arbitrator The Government as Business Regulator  Government activity designed to improve market activity Antitrust laws Environmental regulation

What’s Missing from the Picture? Government Government Expenditures  Government spending on Pensions and income security programs (Social Security and unemployment compensation Health-care expenditures (Medicare and Medicaid) National defense Interest on national debt

Taxes in America  By international standards, Americans pay a small share of income to taxes The Government as a Redistributor  Socialist idea – equal distribution of income overrides the decision of the market  Liberal idea – use progressive taxes and transfer payments to reduce income inequality

GDP: What It Is and What It’s Not Gross Domestic Product (GDP) is the total market (dollar) value of all final goods and services currently and domestically produced within a period of time (e.g., a year). (1) Production (2) Market Value (3) Final goods (4) Current (5) Domestic

Income-Output-Expenditures Identity GDP = Y = Total Output = Total Income = Total Expenditures

Is that Real?? GDP and other economic quantities are usually expressed as (i)Nominal - quantities measured in current prices or current dollars (nominal GDP is sometimes called money GDP) (ii)Real- quantities measured at fixed prices or constant dollars.

Nominal = (prices)x(quantities) Real = quantities  Examples:Apples Movie Box Office Sales  Changes in real GDP measures the overall change in national production.

Shortcomings of GDP GDP is not necessarily a perfect indicator of the well-being of a nation. (1)Includes Only Market Activities (2)No Value for Leisure (3) Some “Goods” are also “Bads”

Macroeconomic Policy Macroeconomic policies are policies designed by the government to affect the direction and performance of the economy. Two types of macroeconomic policies: (i)Fiscal policy: - Control of Federal Budget:government spending and taxes. - Carried Out by President and Congress.

(ii)Monetary policy: - Control of the Nation’s Money Supply - Carried out by the Federal Reserve System

Historical Record of the U.S. Economy 20 th Century Events (1)Great Depression ( ) - largest economic downturn in U.S. history - Real GDP fell by 30% - Unemployment rate increased to 25% - Stock Market lost 80% of value - Bank failures and huge deflation

(2)WWII – economic expansion and full employment - Short and moderate recessions - Low inflation (increases in booms, decreases in recessions) (3)The “Great Stagflation”, historical high inflation from oil price shocks - Stagflation: High inflation (11%) and high unemployment (13%)

(4) The Regan Expansion, Low inflation (3%) and economic expansion - Large budget deficits due to tax cuts and increased military spending. (5)The New Economy, Gulf War, Bush recession, and Clinton years - Longest peacetime economic expansion - Low unemployment and low inflation. - New economy driven by technological progress and internet revolution.

(6)Economy in Transition, 2001-Present - decreasing unemployment following recession ( ) - low inflation, low but rising interest rates -Wartime government spending and record high budget deficits ($400 Billion)

Figure 5 The Growth Rate of U.S. Real Gross Domestic Product since 1870

Figure 6 The Inflation Rate in the United States since 1870

The Latest Economic Numbers Real GDP Growth: 4.1% annual for 2005:Q3 Civilian Unemployment Rate for Dec: 4.9% (down). Inflation: 3.8% for Prime Interest Rate: 7.15%  Federal Budget Deficit: $400 billion + (annual)  Foreign Trade Deficit: -$600 billion + (annual)