What Is Macroeconomics? Chapter 1 What Is Macroeconomics?

How Macroeconomics Affects our Everyday Lives Macroeconomics is concerned with the big economic issues that determine our economic well-being. Macroeconomic issues involves the overall economic performance of the nation. There are three central concepts in macroeconomics; the unemployment rate, the inflation rate and productivity growth. The basic task of macroeconomics is to study the causes of good or bad performance of these three concepts, and how the government can do to improve macroeconomic performance.

The “Big Three” Concepts of Macroeconomics The unemployment rate The higher the overall unemployment rate, the harder for individuals who want to work to find work. Unemployed people will not be able to pay their bills. When unemployment is high, crime, mental illness and suicide also increase. There is a consensus that unemployment is the single most important macroeconomic issue. “Indolence is justly considered the mother of misery”, Robert Burton said (1621). U = (# of Unemployed) / Labor Force

Unemployment and recessions (June)

US Unemployment rate Aug 2101

US Unemployment rate Aug 2101

US Unemployment rate Aug 2101

Unemployment in Europe

Unemployment in Europe

The “Big Three” Concepts of Macroeconomics The Inflation Rate A high inflation means that prices, on average are rising rapidly. A zero inflation rate means that prices remain the same. In inflationary periods, retired people lose the most, as their savings buy less as prices go up. While inflation harms savers, it helps borrowers, i.e inflation redistributes income. Inflation increases uncertainty about the future ∏ = %ΔP = (P1 – P0) / P0

The “Big Three” Concepts of Macroeconomics Productivity growth Productivity is the average output per hour of work that a nation produces in total goods and services ($61 in USA in 2010). The faster average productivity grows, the easier is for individuals to raise their standards of living, i.e., there will be more houses, roads, cars, hospitals, schools ..etc. An economy with no productivity growth is called the “zero sum society” (the rate of growth is zero), any extra good or service enjoyed by one person requires that something else is taken from someone else. For example in order to build more houses, the economy has to sacrifice building fewer hospitals.

Macroeconomics vs. Microeconomics Macroeconomics deals with the totals, or aggregates, of the economy such as: The unemployment rate (of all U.S. workers) Inflation (i.e. the rise of all prices in the U.S.) Microeconomics deals with parts of the economy like: The unemployment rate of low-skilled workers in a certain state The price of cars Economic theory helps us understand the economy by simplifying complexity, by examining the behavior of aggregates. By learning a few basic relations we can tell where the economy is going

Actual and Natural Real GDP The official measure of the economy is “the real GDP” includes all currently produced goods and services sold on the market within a given time period, i.e., reflects the quantity produced corrected for any changes in prices. Actual real GDP is the amount an economy actually produces at any given time. Too much production of real GDP causes inflation, while too little causes a waste of resources. Neither are desirable. Natural real GDP is the actual real GDP when inflation rate is constant with no tendency to accelerate or decelerate (when actual and natural GDP are equal)

Figure 1-1 The Relation Between Actual and Natural Real GDP and the Inflation Rate

Note: When real GDP equals natural GDP the inflation rate will be constant. During periods of low actual real GDP, inflation slows down. During periods of high actual real GDP, inflation accelerates (excessive actual real GDP is called overheating the economy).

Unemployment: Actual and real Actual Unemployment (U) is the unemployment rate observed in the economy. The Natural Rate of Unemployment (U*) is the rate of unemployment at which there is no tendency for inflation to rise or fall. If U < U*  ∏ rises If U > U*  ∏ falls

Figure 1-2 The Behavior Over Time of Actual and Natural Real GDP and the Actual and Natural Rates of Unemployment

GDP gap is the percentage difference between actual real GDP and natural real GDP, sometimes is called output gap. Unemployment gap is the difference between the actual unemployment and the natural rate of unemployment.

Unemployment: Actual and real When actual real GDP is low, actual unemployment rate rises above its natural level (note that inflation slows down here). When actual real GDP is high, actual unemployment rate falls below its natural level (inflation accelerates). Whenever actual real GDP equals natural real GDP actual unemployment equals natural rate of unemployment NRU. NRU corresponds exactly to natural real GDP. A situation in which there is no tendency for inflation to change.

Figure 1-6 Actual and Natural GDP and Unemployment, 1900–2010 (1 of 2)

Figure 1-6 Actual and Natural GDP and Unemployment, 1900–2010 (2 of 2) Sources: See Appendix A-1 and C-4.

Macroeconomics in the Short Run and Long Run The “short run” lasts from 1-5 years and the main issue is the stability of the economy. The ups and downs (or “economic fluctuations”) of an economy are part of the business cycle. Consist of expansions occurring at about the same time in many economic activities, followed by similarly general recessions and recoveries. The business cycle has the following phases: Expansion Contraction The “long run” ranges from one to several decades and is concerned with economic growth. Knowledge of growth helps us predict whether successive generations will be better off than their predecessors

Figure 1-4 Basic Business-Cycle Concepts

The short run business cyles The concern of macroeconomists in the short run is to minimize fluctuations in economic activity. The stabilia case: both actual and natural GDP are almost identical. The volatilia case: large gaps between actual and natural GDP. Two schools. Activists, do something. Non-activists. Do nothing or hands off policies.

Figure 1-3 Business Cycles in Volatilia and Stabilia

Figure 1-5 Economic Growth in Stag-Nation and Speed-Nation

Taming Business Cycles Macroeconomic analysts have two main tasks: Analyze the causes of changes in macroeconomic variables Predict the consequences of alternative policy changes Macroeconomic target variables are important to analysts and policy makers include: Inflation Unemployment Long-term growth of productivity

The Role of Stabilization Policy A Stabilization Policy is any policy that seeks to influence the level of aggregate demand. Monetary policy tries to influence aggregate demand by changing the money supply and/or interest rates. Fiscal policy tries to influence aggregate demand by changing government spending and/or tax rates. New Challenges: The global economic crisis has brought forth novel and controversial strategies in both monetary and fiscal policy (see Chapters 5 and 6).

The “Internationalization” of Macroeconomics A closed economy has no trade in goods, services or financial assets with any other nations. In the 1940s and 50s, the U.S. was relatively closed: Trade was 5% of the U.S. economy Exchange rates were fixed Financial flows to and from the U.S. were restricted An open economy exports and imports goods and services to and from other nations, and has financial flows to and from foreign nations. Today the U.S. is increasingly open: Imports equal 17% of U.S. GDP Since 1973, the exchange rate of the $ has been flexible International financial flows are massive and almost instantaneous