1 Introduction to Macroeconomics Chapter 20 © 2006 Thomson/South-Western

2 The National Economy  Macroeconomics concerns the overall performance of the economy  The term economy describes the structure of economic activity in a community, a region, a country, a group of countries, or the world  Gross domestic product: the market value of final goods and services produced in the United States during a given period, typically a year

3 Flow and Stock Variables  Flow Variable  An amount per period of time  Average spending per week, hours worked per month, etc.  Stock Variable  An amount measured at a particular point in time  Amount of cash on hand you have now  Number of housing units in existence today

4 Economic Fluctuations  Economic fluctuations  The rise and fall of economic activity relative to the long-term growth trend of the economy  Business cycles  Vary in length and intensity but have some features in common

5 Components of Business Cycles  Two phases  Periods of expansion  Periods of contraction  Depression  Severe contraction  Lasting longer than one year and accompanied by high unemployment  Recession  Milder contraction  Decline in total output lasting at least two consecutive quarters

6 Exhibit 1: Hypothetical Business Fluctuations  Contraction begins after a previous expansion has reached its peak and continues until the economy reaches a trough  Long-term growth trend is shown by upward sloping straight line.  Period between a peak and a trough is a contraction  Period between a trough and subsequent peak is an expansion

7 Exhibit 2: Annual Percentage Change in U.S. Real GDP from 1929 to 2003

8 Exhibit 3: U.S. – U.K. Annual Growth Rates in Output

9 Economic Indicators  Leading economic indicators  Variables that predict, or lead to, a recession or recovery; foreshadow a turning point in economic activity and predict, or lead to, upturns and downturns  Coincident economic indicators  Those measures that reflect peaks and troughs as they occur  Lagging economic indicators  Follow or trail changes in overall economic activity

10 Aggregate Output  Aggregate output  Total amount of goods and services produced in the economy during a given period  Best measure is real gross domestic product, or real GDP  Aggregate demand  The relationship between the economy’s price level and the quantity of aggregate output demanded

11 Price Level  Average price of aggregate output is called the price level  A composite measure reflecting the prices of all goods and services in the economy relative to prices in a base year  The price level in the base year has a benchmark value of 100

12 Price Level  Price levels in other years are expressed relative to the base-year price level  Price level or price index used to make  Comparisons in prices across time  Accurate comparisons of real aggregate output over time

13 GDP Price Index  Real GDP: Gross domestic product after adjusting GDP for price changes  The GDP price index  Shows how the economy’s general price level changes over time  Can be used to convert production in different years into dollars of constant purchasing power

14 Aggregate Demand Curve  Aggregate demand curve: shows the relationship between the price level in the economy and the real GDP demanded, other things constant  Sums demands of the four economic decision makers: households, firms, governments, and the rest of the world  Among the factors held constant along a given aggregate demand curve are  The price levels in other countries  The exchange rates between the U.S. dollar and foreign currencies

15 Exhibit 4: Aggregate Demand Curve  Sums the demands of four economic decision makers: households, firms, governments, and the rest of the world  The inverse relationship reflects the fact that as the price level increases, other things constant, purchases by the four major decision makers decline

16 Aggregate Supply Curve  Shows how much output U.S. producers are willing and able to supply at each price level, other things constant  Assumed constant along an aggregate supply curve are  Resource prices, including wage rates  The state of technology  The rules of the game that provide production incentives

17 Exhibit 5:Aggregate Demand & Supply  Wage rates assumed constant along the AS curve; firms find a higher price level more profitable, so they increase real GDP supplied  Equilibrium occurs where the AD and AS curves intersect  Although employment is not measured directly, firms must usually hire more workers to produce more output

18 Exhibit 6: Decrease in Aggregate Demand from 1929 to 1933 AS AD Real GDP (billions of 2000 dollars) AD  The Great Depression can be viewed as a shift to the left of the AD curve  This resulted in a drop of both the price level and real GDP Price level (2000 = 100)

19 Short History of U.S. Economy  Age of Keynes: After the Great Depression to the Early 1970s  Federal budget deficit: amount by which federal outlays exceed federal revenues  Demand-side economics: focus was on how changes in aggregate demand could promote full employment

20 Exhibit 7: Stagflation Between AD AS AS The stagflation of the mid-1970s can be represented as a reduction in aggregate supply Real GDP (trillions of 2000 dollars) Price level (2000 = 100)

21 Short History of U.S. Economy  Experience since 1980  Supply Side economics: federal government would provide incentives to increase the supply of labor and other resources by lowering tax rates  Government debt: net accumulation of prior deficits

22 Exhibit 8: Tracking U.S. Real GDP and Price Level Since 1929