1. Macroeconomics

2. Macroeconomics vs. Microeconomics Major issues: –Determination of aggregate production, income, prices, and employment –Improving the performance of the macroeconomy Long-run: Economic growth and price stability Short-run: Reducing fluctuations in output, production and employment/unemployment Circular Flow: A model that demonstrates the relationships in the macroeconomy.

3. Figure 1 The Circular Flow Copyright © 2004 South-Western Spending Goods and services bought Revenue Goods and services sold Labor, land, and capital Income = Flow of inputs and outputs = Flow of dollars Factors of production Wages, rent, and profit FIRMS Produce and sell goods and services Hire and use factors of production Buy and consume goods and services Own and sell factors of production HOUSEHOLDS Households sell Firms buy MARKETS FOR FACTORS OF PRODUCTION Firms sell Households buy MARKETS FOR GOODS AND SERVICES

4. Macroeconomic Variables The circular flow diagram demonstrates that the important variables are –Output and income: real and nominal gross domestic product (GDP) Important implication from the circular flow diagram: Value of output=Aggregate expenditures or demand=Aggregate Income –Aggregate Prices – Inflation –Employment/Unemployment

5. The Measurement of Aggregate Output and Income By definition, aggregate output is equal to aggregate income. The value of output is equal to the income (wages, interest, rents and profits) received by the factors. There are Various measures of aggregate output but we will use the concept of: –Gross domestic product (GDP)

6. Gross Domestic Product GDP is the market value of all final goods and services produced within a country in a given period of time. –Market value – prices, illegal, household –All – imputed values for rent –Final goods and services– intermediate goods are not double counted –Produced (newly) - products resold, inventory –Within the country – Excludes US production abroad includes ROW production with the US –Given period of time (generally yearly or quarterly)

7. Components of GDP Since aggregate production equals aggregate income, let’s call GDP = Y Y can be broken up into the following parts –Consumption – HH spending on G&S (except new housing) –Investment – Business spending on K but includes HH of new housing –Government Purchases of G&S –Net Exports (= Exports – Imports) Net addition (subtraction) attributable to purchases by ROW. Y = C + I + G + NX

8. GDP10,480 C7,38570% Durable91112% Non-Dur2,08629% Services4,38858% I1,58915% Non-Res1,08068% Res50432% Chg Inv50% G1,93218% F67935% S&L1,25365% NX-426-4% X1,00610% I1,43314% BEA 2002

9. GDP Data The US Department of Commerce’s Bureau of Economic Analysis has data on line: –http://www.bea.doc.gov/http://www.bea.doc.gov/ Economic Report of the President –http://w3.access.gpo.gov/eop/http://w3.access.gpo.gov/eop/ Graphs and Data –http://www.econmagic.comwww.econmagic.com

10. Real GDP

11. Real Versus Nominal GDP Remember from micro: –Expenditures or Revenue = PxQ –Total Expenditures or Revenue = Σ PxQ Total can increase either because prices go up or quantities increase Nominal GDP is measured in current dollars Real GDP corrects for increases in prices and tries to measure the total quantity of goods

12. The GDP Deflator The GDP deflator is a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100. It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced.

13. The Nominal GDP, Real GDP, and the GDP Deflator Converting Nominal GDP to Real GDP –Nominal GDP is converted to real GDP as follows:

14. Percentage Changes and Growth Rates GDP and changes in the GDP deflator (aggregate prices) are most often presented as growth rates or percentage changes. Growth rate of GDP = %ΔY/Y = (Y new -Y old )/ Y old Growth rate of Prices (inflation) = %ΔP/P = (P new -P old )/ P old

15. Percentage Changes in Nominal GDP, Real GDP and the GDP Deflator

17. Real GDP Growth 2001-2003III

18. Tuesday, December 23, 2003 ECONOMIC GROWTH SURGED IN THE THIRD QUARTER Revised estimates of GDP and profits Estimates released today by the U.S. Bureau of Economic Analysis confirm that in the July- September period U.S. economic growth surged, profits increased, and inflation was moderate. Gross domestic product (GDP), the most comprehensive measure of U.S. economic activity, is estimated to have increased at an inflation-adjusted annual rate of 8.2 percent in the third quarter, the same rate as was shown in last month’s “preliminary” estimate for the quarter. A modest upward revision to consumer spending offset a modest downward revision to inventory investment. In the third quarter, consumer spending on durable goods, on nondurable goods, and on services were all stronger than in the second quarter. A jump in real disposable income—largely reflecting the lower withholding rates and the advance payments of child tax credits associated with this year’s tax cut—helped finance the step-up in spending. Business investment in equipment and software increased about twice as much as in the second quarter; investment in structures, however, decreased a little after a small increase. Residential investment posted its biggest increase in 11 years. Single-family and multifamily construction and brokers’ commissions on house sales all were stronger than in the second quarter.

19. An improvement in the trade balance reflected a bigger increase in exports than in imports. Businesses liquidated inventories at a slightly faster pace than in the second quarter. Government spending increased modestly, mainly on the basis of construction spending by states and localities. Federal defense spending decreased slightly after increasing sharply in the second quarter. Corporate profits increased about 10 percent (quarterly rate) in the third quarter; they had posted a similar increase in the second quarter. Third-quarter profits were 25 percent higher than a year earlier. Prices paid by U.S. residents increased 1.8 percent in the third quarter after increasing only 0.4 percent in the second. The step-up partly reflected an upturn in energy prices. __________________________________________________________________________________ _________________ BEA's data—including GDP, personal income, the balance of payments, foreign direct investment, the input-output accounts, and economic data for states and industries—are available on its Web site:. NOTE: The “advance” estimate of GDP for the fourth quarter of 2003 will be released on January 30, 2004. Contact: Larry Moran 202-606-9691 Bureau of Economic Analysis U.S. Department of Commerce Real GDP growth is measured at seasonally adjusted annual rates. Source: U.S. Bureau of Economic Analysis

20. GDP AND ECONOMIC WELL-BEING GDP is probably a good measure of the economic well- being of a society. GDP per capita (or person) =GDP/Populations it shows the income and expenditure of the average person in an economy. Higher GDP per person indicates a higher standard of living. GDP is not a perfect measure of the happiness or quality of life, however. Some things that contribute to well-being are not included in GDP. –The value of leisure. –The value of a clean environment. –The value of almost all activity that takes place outside of markets, such as the value of the time parents spend with their children and the value of volunteer work.

21. Table 3 GDP, Life Expectancy, and Literacy Copyright©2004 South-Western

22. Economic Growth Economic growth is something that is very important in improving the standard of living of a population. The Rule of 70 illustrates how small changes in growth rates can affect the standard of living. Doubling Time = 70/(% growth rate) –Examples: Growth Rate → Doubling time – 2% → 35 years – 4% → 15 years – 6% → 11.5 years – 10% → 7 years Now, China has been growing pretty close to 10% for the last 20 or so years so the GDP has doubled once, doubled again, and doubled a third time, so it is 2x2x2=8 times larger than it was 20 years ago!

23. Figure 2 The Growth in Real GDP per Person

24. Determinants of Economic Growth Remember our production possibilities curve and the first week! Increased number of resources: L, K, NR, E –Investment –Growth in Labor Force Increased productivity of resources: –Work Ethic –Technology –Education –Risk-taking and innovation Social system that allows the efficient use of resources and promotes productivity –Market system and self-interest –Laws, property rights, and public order –Political and economic freedom

25. Table 1 The Variety of Growth Experiences Copyright©2004 South-Western

26. Figure 1a Growth and Investment

27. Figure 1b Growth and Investment