Chapter 19: What Macroeconomics Is All About Copyright © 2014 Pearson Canada Inc.

Chapter Outline/Learning Objectives Section Learning Objectives After studying this chapter, you will be able to 19.1Key Macroeconomic Variables 1.define the key macroeconomic variables: national income, unemployment, inflation, interest rates, exchange rates, and net exports. 19.2Growth Versus Fluctuations 2.understand that most macroeconomic issues are about either long-run trends or short-run fluctuations, and that government policy is relevant for both. Copyright © 2014 Pearson Canada Inc. 2 Chapter 19, Slide

19.1Key Macroeconomic Variables Output and Income The production of output generates income. To measure total output in dollars, we add up the values of the many different goods produced. This gives nominal national income. With base-period prices, we get real national income. Copyright © 2014 Pearson Canada Inc. 3 Chapter 19, Slide

Fig Growth and Fluctuations in Real GDP, 1965– Chapter 19, Slide (i) The level of real GDP (ii)Annual growth rate of real GDP Copyright © 2014 Pearson Canada Inc.

Real GDP fluctuates around a rising trend: the trend shows long-run economic growth the short-run fluctuations show the business cycle 5 Chapter 19, Slide APPLYING ECONOMIC CONCEPTS 19-1 The Terminology of Business Cycles Copyright © 2014 Pearson Canada Inc.

Potential output is what the economy could produce if all resources were employed at their normal levels of utilization. often called full-employment output The output gap measures the difference between potential output and actual output. Output Gap = Y – Y* When Y < Y*, there is a recessionary gap. When Y > Y*, there is an inflationary gap. 6 Chapter 19, Slide Copyright © 2014 Pearson Canada Inc.

The Terminology of Business Cycles 7 Chapter 19, Slide Copyright © 2014 Pearson Canada Inc.

Fig Potential GDP and the Output Gap, 1985– Chapter 19, Slide (ii)The output gap(i)Potential and actual GDP Copyright © 2014 Pearson Canada Inc.

Employment, Unemployment, and the Labour Force Employment: the number of workers (15+) who hold jobs. Unemployment: the number who are not employed but are actively looking for one. Labour force: the total number of employed + unemployed. Unemployment rate: the number of unemployed expressed as a percentage of the labour force. 9 Chapter 19, Slide Copyright © 2014 Pearson Canada Inc.

Even when Y = Y*, some unemployment exists: frictional unemployment (natural turnover) structural unemployment (mismatch between jobs and workers) When Y < Y*, there is cyclical unemployment. 10 Unemployment Rate = Number of people unemployed Number of people in the labour force X 100 Chapter 19, Slide Copyright © 2014 Pearson Canada Inc.

Fig Labour Force, Employment, and Unemployment, 1960– (ii)Unemployment rate(i)Labour force and employment Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

Long-term trend: employment has grown roughly in line with the growth in the labour force. Short-term fluctuations have been substantial – from 3.4% in 1966 to 12% in Why Does Unemployment Matter? Some unemployment is desirable, as it reflects the time required for workers and firms to "find" each other so that good matches are made. But some unemployment is associated with human hardship, especially for those individuals with skills that are not in high demand by firms. Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

Productivity Productivity: a measure of output per unit of input. often measured as GDP per worker or GDP per hour of work Increases in productivity are probably the single largest determinant of long-run increases in material living standards. 13 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

Fig Canadian Labour Productivity, 1976– Real GDP per worker is measured in thousands of dollars! Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

Inflation and Price Level Price level: the average level of all prices in the economy. Inflation: the rate at which the price level is changing. The CPI is based on the price of a typical "consumption basket,” relative to the price in some base year: 15 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

Why Inflation Matters? The purchasing power of money is negatively related to the price level. Also, because it is hard to forecast accurately, inflation adds to the uncertainties of economic life. 16 APPLYING ECONOMIC CONCEPTS 19-2 How the CPI Is Constructed Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

Fig The Price Level and the Inflation Rate, 1960– Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

Interest Rates The interest rate is the price of "credit," and the flow of credit is crucial to firms and households in a modern economy. Nominal interest rate: the rate expressed in money terms. Real interest rate: the rate expressed in terms of purchasing power. 18 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

Fig Real and Nominal Interest Rates, 1965– Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

The International Economy Foreign exchange: foreign currencies or claims on foreign currencies. Exchange rate: the number of Canadian dollars required to purchase one unit of foreign currency. A depreciation of the Canadian dollar means that it is worth less on the foreign-exchange market.  a rise in the exchange rate 20 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

Fig Canadian–U.S. Dollar Exchange Rate, 1970– Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

The balance of payments accounts record all payments made in international transactions—goods, services, and assets. trade balance current account balance capital account balance For Canada, exports and imports are both very large—roughly 35% of GDP—but the trade balance is usually small. 22 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

Fig Canadian Imports, Exports, and Net Exports, 1970– Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

19.2Growth Versus Fluctuations Long-Term Economic Growth Long-term growth is considerably more important for a society’s living standards from decade to decade than short-term fluctuations. There is considerable debate regarding the ability of government to influence the economy's long-run growth rate. Copyright © 2014 Pearson Canada Inc. 24 Chapter 19, Slide

Short-Term Fluctuations Short-term fluctuations are often called business cycles. Economists debate the effectiveness of monetary and fiscal policy in influencing these fluctuations. Some economists argue that despite the "power" of policy to affect the economy, governments should not attempt "fine-tuning." 25 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

What Lies Ahead? To organize our thinking about macroeconomics, we must develop some tools. These will include: discussing measurement of national income building a simple model of the economy modifying the model to make it more realistic using our model to analyze some pertinent economic issues 26 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide