1. Introduction to Macroeconomics
Chapter 11

2. Macroeconomics We will now shift perspectives
We will look at the economy as a whole
Micro vs. macro

3. Comparing Micro and Macro Perspectives

4. Perspectives on War – Micro:

5. Perspectives on War - Micro:

6. Perspectives on War…Macro: It’s “just” numbers …
World War II death toll …

7. Perspectives on War…Macro:

8. Perspectives on the Economy Micro:

9. Perspectives on the Economy Micro:

10. Perspectives on the Economy Macro:

11. Perspectives on the Economy Macro:

13. Introduction to Macroeconomics
In Micro we asked questions about individual …
People – How do we optimize?
Firms – How do they compete?
Markets – How do they work and function, well or badly, as a system based on price signals?

14. Introduction to Macroeconomics
In Macro we will ask questions about “aggregates” …
the summation of all the micro effects

15. Introduction to Macroeconomics
National Product:
How big a pie can society sustainably produce?
Why aren’t we always producing up to that full sustainable capacity … to our potential?

16. Introduction to Macroeconomics
Unemployment:
Why does it happen?
What causes it to persist?

17. Introduction to Macroeconomics
Inflation/Deflation:
What causes the purchasing power of our money to fall/rise?
Why are such changes a problem?

18. Introduction to Macroeconomics
Growth:
What causes the size of the economy’s potential production to grow?

19. Introduction to Macroeconomics
Method: As with Micro, we…
Define terms
Construct model
Develop the model’s capacity to address our questions

20. Macro – Defining Terms Gross Domestic Product (GDP) –
Aggregate final production in a given economy (domestic…within Nation’s borders) in a given year.
We’re going to use a “Y” to represent real GDP

21. What do you think? (Included in GDP?)
A new house?
A used house?
The realtor's fee on the used house?
All the products used to produce the new house? (nails, shingles, siding etc...)

22. What is included... A new house?...Yes A used house?...No
The realtor's fee on the used house?...Yes
All the products used to produce the new house (nails, shingles, siding etc...)?...No (secondary goods)

23. Macro – Defining Terms
Gross Domestic Product (GDP) -We’ll distinguish between:
YF – full sustainable capacity real GDP or potential GDP – how big a “pie” could sustainably be produced and…
Y - actual current real GDP – how big the “pie” is

24. Business Cycles
Period of macroeconomic expansion followed by contraction

25. Macro – Defining Terms Phases of Business Cycles
Expansion…period of economic growth measured by a rise in real GDP (Y)
Growth being a steady, long term rise in GDP (Y)
Plentiful jobs, falling unemployment
Recession: two consecutive quarters of declining Y
Depression: extended, deep decline in Y
Staglfation: decline in real GDP combined with inflation
A “caveat” or warning to keep in mind: Y is not a great measure of well being
Standard of living vs. quality of life

26. Phases of Business Cycles (cont.)
Peak…height of economic expansion
Contraction…economic decline marked by falling real GDP
Trough…bottom of contraction

27. Keeping the Cycle
Typically, a sharp rise or fall in a key indicator sparks a series of events
4 main indicators
Business investment
Interest rates and credit
Consumer expectations
External shocks (positive or negative)

28. Forecasting Business Cycles
Not easy to predict…have to predict a change in real GDP
Use leading indicators (economic variables)
Stock market
Interest rates
Orders of capital goods
Housing starts

29. Limitations of GDP

30. Economic Growth A change in GDP over time illustrates growth
For growth to occur, it should change with population
Real GDP per capita measures such growth and the standard of living

31. Capital Deepening The process of increasing capital per worker
Goal is to increase productivity
Savings and investing lead to capital deepening

32. Population
Increased population without capital deepening will lower the standard of living
Increased population without increase in production will lower the standard of living

33. Government Taxes can increase or decrease capital deepening
It is dependant upon what the taxes are spent on

34. Foreign Trade
Foreign trade and running a trade deficit can actually be good in some ways
If the goods being trading enhance capital deepening
In the long run…this capital deepening can increase productivity and help to pay back debt that results from a trade deficit

35. Labor Force and Unemployment

36. Macro – Defining Terms Labor force (LF) vs. (voluntary unemployed)
LF includes all those adults who want to be participating in the market system as a worker
By that standard: Who would be voluntarily unemployed?

37. Macro – Defining Terms LF
Within the Labor force (LF) some are employed (EMP) and some are unemployed (UEMP), so… LF
UNEMP
EMP
Unemployment Rate is the % of the LF that is UNEMP

39. Unemployment
Within the unemployed (UEMP), there are several sources/types of unemployment:
Structural Unemployment
Frictional Unemployment
Demand Deficient (Cyclical) Unemployment

40. Structural Unemployment
There is a job available
There is a worker looking for a job, but …
the worker’s skills don’t match the job’s requirements
How could this happen in significant numbers?

41. Structural Unemployment
Due to technological change the workers’ skills become outdated …
We expect this to happen in a growing, dynamic economy
There will always be some structural unemployment in a healthy, growing economy
It would only disappear in a stagnant economy, and we don’t want that

42. Frictional Unemployment
There is a job available
There is a worker with the right skills looking for a job, but …
the worker is still searching for the job.
How could this happen in significant numbers?

43. Frictional Unemployment
Job search takes time …
This time spent searching is beneficial to the individual and to a growing, dynamic economy
We want individuals to find the right job for their skills, not just take the first job they find
This is more productive for the individual and society.

44. Frictional Unemployment
We can help facilitate workers’ search process
But there will always be some frictional unemployment in a healthy, growing economy…
It would only disappear in a stagnant economy, and we don’t want that.

45. Demand Deficient Unemployment
Demand Deficient (Cyclical) Unemployment
This represents the unemployment caused by a lack of job opportunities …
Not enough jobs for the workers who want to be employed
No amount of training or search will solve this problem.

46. Demand Deficient Unemployment
Demand Deficient Unemployment is NOT a part of a healthy, growing economy
It represents wasted resources and lower standard of living
This is a Macro problem that urgently needs attention

47. Unemployment Types and Rate
Recall the UR is the % of the LF that is UNEMP
Of the three kinds of UNEMP two, structural and frictional, are a natural part of a healthy and growing economy.
Since structural and frictional unemployment are a natural part of a healthy and growing economy…
We call that part of the overall UR that consists of structural and frictional unemployment the:
Natural Rate of Unemployment

48. Natural Rate of Unemployment
So suppose the government’s reported unemployment rate is 7%...
If the natural rate is 5%, that means that there’s 2% that is not part of a healthy growing economy… so that 2% must be demand deficient unemployment.

49. Natural Rate
The Natural Rate (NR) plays a central role policy discourse for it represents the unemployment condition we’d find in a healthy, growing economy
As such, by comparing the actual UR to the NR, we can see how close/far the economy is from a healthy, growing condition

50. Natural Rate
The problem with this standard of macro economic health is that there is disagreement about the standard.
Some economists argue that the NR is %...
Others put it at %
It’s very difficult to directly measure the NR, thus the potential for differences

51. Natural Rate
Given these different views of the NR it’s possible for two economists to look at the same reported UR, say 5.5%, and for one to say the UR is above the NR so we have demand deficient unemployment and therefore slack in the economy …
And the other to say that the UR is below the NR (which we’ll see is possible) and thus, as we will see, we are putting too much pressure on the economy

52. Unemployment Terms LF UNEMP EMP YF So … Demand Deficient Structural
Frictional
Natural Rate YF
The NR is achieved
when the economy
is effectively
using all its resources
The economy is at YF
when all resources are
being used effectively
So …

53. Natural Rate Natural Rate YF
When the economy is at the Natural Rate then we know that it’s also at YF - Full sustainable capacity real GDP …
and vice versa
Thus they are proxies for one another

54. Macro –Arranging Terms
When the economy is at the Natural Rate…at YF…it’s using its resources most efficiently and effectively
There’s no “slack”
There is a micro condition that must be true for this macro case to be true…
What is it??
General Competitive Equilibrium (GCE)

55. Micro/Macro Connection
Macro is just the aggregate condition that is created by all the micro conditions so it follows that for the macro economy to be healthy (NR/YF), the micro economy must be healthy (at GCE)

56. Macro Conditions: Y = YF UNEMP = NR The Goal (GCE) Y < YF
Slack
Y > YF
UNEMP < NR
Pressure

57. Inflation and Prices

58. Price Levels Price Level – the cost of living
Measured by the market basket…
The aggregate cost of the “things” we buy.
When the cost of that market basket goes up, that’s inflation
When the cost of that market basket goes down, that’s deflation

60. Inflation/Deflation - Problems
Inflation – very corrosive to national “psyche” if it is too fast…
many are making desperate efforts to keep up with “cost of living”
discourages investment
it raises interest rates because …
lenders charge higher interest to cover the anticipated loss of buying power in the dollars they’ll receive in the future

61. Inflation/Deflation - Problems
Inflation – Distributive effects
There are winners and losers –
those who can keep up do fine, but those who can’t see their standard of living fall

62. Inflation/Deflation - Problems
Discourages consumption
Individuals hold back on buying in anticipation of lower prices in the future
Discourages investment
Borrowers will have to pay back in more valuable dollars (dollars with more buying power) than the ones they borrowed
Distributive effects
Those who need to borrow are in a very difficult position

63. Measuring Price Level to Determine Inflation/Deflation
Consumer Price Index (CPI) – one measure of the price level
“A dollar doesn’t buy what it used to!

64. Measuring Price Level to Determine Inflation/Deflation
Calculating the CPI:
Government determines what’s in a “standard market basket” (food, entertainment, housing, recreation) of a “normal” family of four and it identifies a “base year”
a year that will be the reference or orientation year in which a dollar is worth its full value, in real purchasing power

65. Measuring Price Level in a Target Year
Cost basket in base year: CB
Cost of basket in target year CT

66. Measuring Consumer Price Index in Target Year
CPIT = (CT/CB) × 100
CT = 250
CB = 125
Then…CPIT = 200

67. Consumer Price Index
Consumer Price Index (CPI) – What it represents in our example:
If in the base year a dollar is worth 100 cents in purchasing power, in the target year it takes 200 cents to buy the same market basket

68. CPI and Inflation/Deflation
Consumer Price Index (CPI) and measuring Inflation/Deflation
Measuring % Change in price level from year X to year Y
% Change in price level = [(CPIY – CPIX) ⁄ CPIX] × 100
If CPIX = 100 and CPIY = 125, then % Change in Price Level = [(125 – 100) ⁄ 100] × 100 = 25%

69. Real vs. Nominal
Real values reflect what is actually so while nominal values only reflect what is apparently so…
A non-economic example???

70. Real vs. Nominal
Comparing economic data over time measured in current (nominal) dollars, these nominal values may not reflect the underlying real changes, because the dollar itself is constantly changing in value
Using nominal values as a measure is like using ruler that is constantly changing length

71. Real vs. Nominal
Comparing economic data, measured in dollars (or any currency), across time:
Supposed the measured GDP changed from $5,000 to $10,000
You have to ask yourself:
Does this increase really reflect a bigger pie … more actual, real GDP or does this increase simply reflect a rise in the price level that doubled the apparent, nominal GDP?

72. Real vs. Nominal
Nominal values include both real and price effects, because …
Nominal value = Real value × Price level
How much of the nominal change is real depends on how much of the nominal change is caused by a change in the price level
To determine that …

73. Real vs. Nominal We divide out the price effect:
Nominal value ⁄ Price level = Real value
When looking at economic data measured in dollars, you should always ask yourself:
Is this real or nominal data?

74. Real vs. Nominal
If it’s real data, intertemporal comparisons are valid because the price effects have been divided out
If it’s nominal data intertemporal comparisons are meaningless because you can’t determine how much of the change is real and how much is the effect of a changing price level