1. Macroeconomics CHAPTER 6 Macroeconomics: The Big Picture PowerPoint® Slides by Can Erbil © 2006 Worth Publishers, all rights reserved

2. What you will learn in this chapter: 2 An overview of macroeconomics, the study of the economy as a whole, and how it differs from microeconomics The importance of the business cycle and why policy- makers seek to diminish the severity of business cycles What long-run growth is and how it determines a country’s standard of living The meaning of inflation and deflation and why price stability is preferred What is special about the macroeconomics of an open economy, an economy that trades goods, services and assets with other countries

3. Macroeconomics vs. Microeconomics 3 To understand the scope and sweep of macroeconomics, let’s begin by looking more carefully at the difference between microeconomic and macroeconomic questions. MICROECONOMIC QUESTION MACROECONOMIC QUESTION Go to business school or take a job? How many people are employed in the economy as a whole? What determines the salary offered by Citibank to Cherie Camajo, a new Columbia MBA? What determines the overall salary levels paid to workers in a given year?

4. Macroeconomics vs. Microeconomics 4 MICROECONOMIC QUESTION MACROECONOMIC QUESTION What determines the cost to a university or college of offering a new course? What determines the overall level of prices in the economy as a whole? What government policies should be adopted to make it easier for low-income students to attend college? What government policies should be adopted to promote full employment and growth in the economy as a whole? What determines whether Citibank opens a new office in Shanghai? What determines the overall trade in goods, services and financial assets between the US and the rest of the world?

5. 5  Microeconomics focuses on how decisions are made by individuals and firms and the consequences of those decisions.  Ex.: How much it would cost for a university or college to offer a new course ─ the cost of the instructor’s salary, the classroom facilities, the class materials, and so on. Having determined the cost, the school can then decide whether or not to offer the course by weighing the costs and benefits. Macroeconomics vs. Microeconomics

6. 6  Macroeconomics examines the aggregate behavior of the economy (i.e. how the actions of all the individuals and firms in the economy interact to produce a particular level of economic performance as a whole).  Ex.: Overall level of prices in the economy (how high or how low they are relative to prices last year) rather than the price of a particular good or service. Macroeconomics vs. Microeconomics

7. Four Principal Ways that Macroeconomics Differs from Microeconomics: 7 1.In macroeconomics, the behavior of the whole macroeconomy is, indeed, greater than the sum of individual actions and market outcomes. 2.Macroeconomics is widely viewed as providing a rationale for continual government intervention to manage short-term fluctuations and adverse events in the economy.  monetary policy  fiscal policy

8. Four Principal Ways that Macroeconomics Differs from Microeconomics (cont.): 8 3.Macroeconomics is the study of long-run growth: What factors lead to a higher long- run growth rate? And are there government policies capable of increasing the long-run growth rate? 4.The theory and policy implementation focus on economic aggregates -- economic measures that summarize data across many different markets for goods, services, workers, and assets.

9. 9 The Great Depression The Great Depression precipitated a thorough rethinking of macroeconomics which gave rise to modern macroeconomics.

10. The Business Cycle 10  The business cycle is the short-run alternation between economic downturns and economic upturns.  A depression is a very deep and prolonged downturn.  Recessions are periods of economic downturns when output and employment are falling.  Expansions, sometimes called recoveries, are periods of economic upturns when output and employment are rising.

11. 11 The Unemployment Rate and Recessions Since 1948

12. FOR INQUIRING MINDS: Defining Recessions and Expansions  In many countries, economists adopt the rule that a recession is a period of at least 6 months, or two quarters, during which aggregate output falls.  sometimes too strict  In the United States, the task of determining when a recession begins and ends is assigned to an independent panel of experts at the National Bureau of Economic Research (NBER). This panel looks at a number of economic indicators, with the main focus on employment and production, but ultimately the panel makes a judgment call.  sometimes controversial 12

13. 13 What happens during a business cycle, and what can be done about it?  the effects of recessions and expansions on unemployment;  the effects on aggregate output; and  the possible role of government policy. The Business Cycle

14. Employment and Unemployment 14  Employment is the number of people working in the economy.  Unemployment is the number of people who are actively looking for work but aren’t currently employed.  The labor force is equal to the sum of employment and unemployment.

15. Employment and Unemployment  Discouraged workers are non-working people who are capable of working but are not actively looking for a job.  Underemployment is the number of people who work during a recession but receive lower wages than they would during an expansion due to smaller number of hours worked, lower-paying jobs, or both.  The unemployment rate is the ratio of the number of people unemployed to the total number of people in the labor force, either currently working or looking for jobs. 15

16. Underemployment 16

17. The Effects of Recessions and Expansions on Unemployment and Aggregate Output: In general, the unemployment rate rises during recessions and falls during expansions. It moves in the direction opposite to aggregate output, which falls during recessions and rises during expansions. 17

18. 18 Growth in Aggregate Output, 1948–2004 Real GDP is a measure of aggregate output, the output of the economy as a whole.

19. 19 Growth in Aggregate Output, 1948–2004

20. Taming the Business Cycle 20 Policy efforts undertaken to reduce the severity of recessions are called stabilization policy.  One type of stabilization policy is monetary policy, changes in the quantity of money or the interest rate.  The second type of stabilization policy is fiscal policy, changes in tax policy or government spending, or both.

21. ECONOMICS IN ACTION: Has the Business Cycle Been Tamed? Has progress in macroeconomics made the economy more stable? 21 Answer: “Sort of”

22. Long-Run Economic Growth 22 Secular long-run growth, or long-run growth, is the sustained upward trend in aggregate output per person over several decades. A country can achieve a permanent increase in the standard of living of its citizens only through long-run growth. So a central concern of macroeconomics is what determines long-run growth.

23. 23 U.S. real gross domestic product per person from 1900 to 2004

24. Aggregate Price Level 24  A nominal measure is a measure that has not been adjusted for changes in prices over time.  A real measure is a measure that has been adjusted for changes in prices over time.  The aggregate price level is the overall level of prices in the economy.

25. 25 Consumer price index from 1913 to 2004

26. Inflation and Deflation  A rising aggregate price level is inflation.  A falling aggregate price level is deflation.  The inflation rate is the annual percent change in the aggregate price level.  The economy has price stability when the aggregate price level is changing only slowly. 26

27. 27 Inflation and deflation since 1929

28. ECONOMICS IN ACTION: A Fast (Food) Measure of Inflation ▪ McDonald’s opened in 1954: Hamburgers cost only 0.15 cents ─ 25 cents with fries. ▪ Today a hamburger at a typical McDonald’s costs five times as much ─ between $0.70 and $0.80. ▪ Too expensive? ▪ No ─ in fact, a burger is, compared with other consumer goods, a better bargain than it was in 1954. Burger prices have risen about 400%, from $0.15 to about $0.75, over the last half century. But the overall consumer price index has increased more than 600%. ▪ If McDonald’s had matched the overall price level increase, a hamburger would now cost between 90 cents and $1.00. 28

29. The Open Economy 29  A closed economy is an economy that does not trade goods, services, and assets.  Open-economy macroeconomics is the study of those aspects of macroeconomics that are affected by movements of goods, services, and assets across national boundaries.

30. The Open Economy 30  One of the main concerns introduced by open-economy macroeconomics is the exchange rate, the price of one currency in terms of another.  Exchange rates can affect the aggregate price level.  They can also affect aggregate output through their effect on the trade balance, the difference between the value of the goods and services a country sells to other countries and the value of the goods and services it buys in return.  Economists are also concerned about capital flows, movements of financial assets across borders.

31. 31 Movements of the exchange rate between the U.S. dollar and the euro

32. The End of Chapter 6 32 coming attraction: Chapter 7: Tracking the Macroeconomy

33. Macroeconomics CHAPTER 7 Tracking the Macroeconomy PowerPoint® Slides by Can Erbil © 2006 Worth Publishers, all rights reserved

34. What you will learn in this chapter: 34 How economists use aggregate measures to track the performance of the economy. What gross domestic product, or GDP, is and the three ways of calculating it The difference between real GDP and nominal GDP and why real GDP is the appropriate measure of real economic activity The significance of the unemployment rate and how it moves over the business cycle What a price index is and how it is used to calculate the inflation rate.

35. An Expanded Circular-Flow Diagram: The Flows of Money Through the Economy 35

36. The National Accounts 36  Almost all countries calculate a set of numbers known as the national income and product accounts.  The national income and product accounts, or national accounts, keep track of the flows of money between different parts of the economy.

37. 37  Households earn income via the factor markets from wages, interest on bonds, dividends on stocks, and rent on land.  In addition, they receive government transfers from the government.  Disposable income, total household income minus taxes, is either expended as consumer spending (C) or goes into private savings. The National Accounts

38. 38  Via the financial markets, private savings is channeled to firms for investment spending (I).  Government purchases of goods and services (G) is paid for by tax receipts as well as by government borrowing.  Exports (X) generate an inflow of funds into the country from the rest of the world, while imports (IM) lead to an outflow of funds to the rest of the world. Foreigners can also buy stocks and bonds in the U.S. financial markets. The National Accounts

39. Gross Domestic Product 39 Gross domestic product or GDP measures the value of all final goods and services produced in the economy. It does not include the value of intermediate goods.

40. Calculating Gross Domestic Product 40 GDP can be calculated three ways:  add up the value added of all producers;  add up all spending on domestically produced final goods and services, leading to the equation GDP = C+I+G+X-IM;  add up the all income paid to factors of production.

41. Calculating GDP 41

42. Pitfalls: GDP: WHAT’S IN AND WHAT’S OUT Included Domestically produced final goods and services (including capital goods) New construction of structures Changes to inventories Not Included Intermediate goods and services Inputs Used goods Financial assets like stocks and bonds Foreign-produced goods and services 42

43. U.S. GDP in 2004: Two Methods of Calculating GDP 43

44. Real vs. Nominal GDP 44  Real GDP is the value of the final goods and services produced calculated using the prices of some base year.  Except in the base year, real GDP is not the same as nominal GDP, output valued at current prices.  Real GDP per capita is a measure of average output per person, but is not by itself an appropriate policy goal.

45. Calculating GDP and Real GDP in a Simple Economy 45

46. Real vs. Nominal GDP 46

47. Real vs. Nominal GDP 47

48. 48 The Unemployment Rate  The unemployment rate is an indicator of the state of the labor market, but should not be taken literally as a measure of the fraction of people who want to work but can’t find jobs.  It may overstate the true level of unemployment because a person typically spends time unemployed while in search of a job before finding one.  It also may understate the true level of unemployment because it does not include discouraged workers.

49. Unemployment Rate 49

50. Growth and Unemployment 50 There is a strong relationship between growth in aggregate output and changes in the unemployment rate: when growth is above average, the unemployment rate falls, when it is below average, the unemployment rate rises.

51. The Relationship between Real GDP and Unemployment, 1949-2004 51

52. Price Indexes and the Aggregate Price Level 52  To measure the aggregate price level, economists calculate the cost of purchasing a market basket.  A price index is the ratio of the current cost of that market basket to the cost in a base year, multiplied by 100.

53. Calculating the Cost of a Market Basket 53

54. Inflation Rate, CPI and other Indexes 54 The inflation rate is the yearly percentage change in a price index, typically based upon Consumer Price Index, or CPI, the most common measure of the aggregate price level. The consumer price index, or CPI, measures the cost of the market basket of a typical urban American family.

55. The Makeup of the Consumer Price Index in 2004 55

56. The CPI, 1913–2004 56

57. Other Price Measures A similar index to CPI for goods purchased by firms is the producer price index. Economists also use the GDP deflator, which measures the price level by calculating the ratio of nominal to real GDP. The GDP deflator for a given year is 100 times the ratio of nominal GDP to real GDP in that year. 57

58. The CPI, the PPI, and the GDP Deflator 58

59. The End of Chapter 7 59