11.0 Introduction to Macroeconomics

We will now shift perspectives We will look at the economy as a whole

The difference between macro and micro

Macro perspective on war

Micro perspective on war

Life is lived at the micro level, But the wholeness of the social experience is aggregated into a macro picture

Macro : Micro :: Forest: Trees

However, just like a forest is more than individual trees, the macroeconomy is more than just all the individual markets put together the whole is greater than the sum of its parts

The micro system is the foundation for macro events For example – Pareto optimality in the micro system means full employment and maximum production at the national level Market power and its resulting inefficiency means unemployed resources in the macroeconomy

Basic Macro questions Why doesn ’ t the economy always produce up to its full capacity? Ex. Great Depression Why are resources (like people) unemployed? What causes this to persist? Can high unemployment happen again?

What causes the cost of living to go up? Why does inflation occur, and can it occur again? Is it possible to live in an economy with steady growth, full employment and stable prices?

On policy Most economists lie on a continuum between intervention and non-intervention Therefore, there are differing opinions as to what are appropriate policies for macro problems

Preview Same approach as before Defining terms Assembling a model Applying the model to historical and current cases

Defining terms

Gross Domestic Product (GDP) – value of all new production in the nation in the year Full, sustainable capacity GDP – greatest level of production the economy can sustain over athe long haul We ’ ll call this full GDP

Actual GDP – how much the nation is currently producing Can be near full GDP (healthy) Or fall far short of full GDP (not healthy)

Recession- 2 quarters (6 months) of falling actual GDP Depression – Prolonged period of declining GDP

GDP is a very important number, but it doesn ’ t tell the whole story Increased production may benefit only a few More production may not always be good – Ex. Harvesting all trees will definitely increase GDP What are you producing? Computer chips vs. potato chips

Labor force – all those participating in or making themselves available to participate in productive activity Voluntarily unemployed – not looking for work, not counted in the labor force

Labor force has two parts Employed – have a job Unemployed – don ’ t have a job but want one

Unemployment rate- Percentage of the labor force that is unemployed Great Depression- 25% WWII – 1% Currently- 5% There are different reasons why people are unemployed

Frictional unemployment- people are looking for work, and there are appropriate jobs, they just haven ’ t found it yet Job search process takes time Ex. Recent college graduate Frictional unemployment exists even in the best of economic times

Job search process

Structural unemployment – mismatch between people and jobs Can be caused by technological or geographic changes Always an issue in a dynamic, changing economy

Economists expect to find both frictional and structural unemployment These two together are called the natural rate of unemployment Full employment means at the natural rate Full employment does NOT mean zero percent unemployment Natural rate is generally believed to be between 4 and 7%

Demand-deficient unemployment- Not enough jobs for those who want one Loss of productive capacity, plus many other social costs 1929 – 3.2% 1933 – 25% Great Depression

Inflation – rise in the overall level of prices, or a fall in the purchasing power of money Deflation – fall in the overall level of prices, or a rise in the purchasing power of money

It is important to distinguish between relative price changes (one market) and inflation (overall level of prices)

Inflation imposes costs on an economy Efficiency cost - money loses some of the useful roles it usually plays Hyperinflation – unbelievably high inflation – Germany after WWI Money ceases to become a store of value, a medium of exchange, or a unit of account

Another cost of inflation Equity cost- when inflation causes a redistribution of wealth People with a fixed wage lose value because money is worth less and less Those who can ’ t take steps to account for inflation fall further and further behind

Indexing – automatically adjusting payments for wages/loans to account for inflation Ex. If Inflation goes up 10%, your paycheck goes up 10% COLA – cost of living adjustment Social Security is indexed

Nominal value- the actual number, the face value Real value- the underlying true value Ex. Earning $10,000 a year in 1963 vs. Earning $10,000 a year in 2006 Nominally, they are the same In real terms, 1963 was worth much more because of inflation

Knowing the difference between real and nominal values will help us compare things over time more accurately

Charts page Nominal GDP is rising However, so is price level Real GDP is falling, unemployment skyrocketing Severe recession Real is a much better measure of what is happening

Real values are immediately useful for comparisons over time Nominal values must also be accompanied by data on price level that allow you to convert to real to be useful over time

Two methods to measure the price level Price index Price deflator We ’ ll start with a price index

Most common price index- CPI – Consumer Price Index Government selects a “ market basket ” of goods that a typical household consumes Food, clothes, housing, transportation, etc. As an orientation point, the government chooses a base year Everything gets measured against the base year

Target year the year whose price level you are trying to determine

Calculating CPI P mb in target year / P mb in base year X 100 Base year will always have a value of 100 If 5095/4450 X 100 = 114 Then 114 is the price index for that target year It takes 114 cents to buy what used to cost 100 cents in the base year

The GDP deflator Measures prices for all the items in the GDP, not just consumer goods

One can use these measures to calculate the inflation rate CPI target /CPI base year X 100% 114/100 X 100% = 14% This tool allows use to transform nominal values into real values

Nominal value = (Real value) X (Price level) Or (Nominal value) / (Price level) = Real value When comparing over time, Keep it real