1. Lecture Four Macroeconomic Concerns: Unemployment, Inflation, and Growth

2. Macroeconomic Concerns  Aggregate Price Level  Aggregate Output  Total Employment  Rest of the World

3. Inflation and Prices  Price level  Price level: a measure of the behavior of all prices in the economy  Price level is a yardstick -- a tool for comparison of prices over time.  Inflation  Inflation: the rate of change in the price level

5. Measuring the Price Level: Price Indexes  CPI  CPI: Consumer Price Index: a measure of the price of a market basket of goods purchased monthly by the typical urban consumer.  GDP deflator  GDP deflator: a measure of the prices of all goods produced in GDP basket.  PPI  PPI: Producer Price Index: a measure of prices that producers receive for products at all stages in the production process.

6. Production in Muletown  In Muletown, three goods are produced: –Mule hides; –Espresso; –Sandals.  A market basket is 2 Mule hides, 5 Espressos, and 1 pair of sandals.

7. Production in Muletown 1997 Price Quantity $310 $515 $720 Mule hides Espresso Sandals 1998 Price Quantity $420 $410 $2015 What is the price level in Muletown?

8. Calculating the CPI  Multiply the price of the good by the quantity in the market basket and add over all goods.  In 1997: $3(2) + $5(5) + $7(1) = $38  In 1998: $4(2) + $4(5) + $20(1) = $48  Rate of Inflation: –($48 - $38)/$38 = 26%.

9. GDP Deflator  Nominal GDP: GDP measured in current year prices  Real GDP: GDP measured in constant prices (prices derived from a base year)

10. GDP in Muletown Nominal GDP Real GDP GDP deflator 1997 $245 1998 $245 = $3(10) + $5(15) + $7(20)

11. GDP in Muletown Nominal GDP Real GDP GDP deflator 1997 $245 1998 $420 $420 = $4(20) + $4(10) + $20(15)

12. GDP in Muletown Nominal GDP Real GDP GDP deflator 1997 $245 1998 $420 $245 = $3(10) + $5(15) + $7(20)

13. GDP in Muletown Nominal GDP Real GDP GDP deflator 1991 $245 1992 $420 $215 $215 = $3(20) + $5(10) + $7(15)  Note that we have used 1991 prices.

14. GDP in Muletown Nominal GDP Real GDP GDP deflator 1991 $245 100 1992 $420 $215 100 = 100 * $245/$245

15. GDP in Muletown Nominal GDP Real GDP GDP deflator 1991 $245 100 1992 $420 $215 195 195 = 100*$420/$215

16. GDP in Muletown Nominal GDP Real GDP GDP deflator 1991 $245 100 1992 $420 $215 195 Rate of Inflation = (195 - 100)/100 = 95%

17. The Real/Nominal Relationship Real Quantity = Nominal Quantity Price Level/100

18. Costs of Inflation  Changing distribution of income – indexed income: income rises with the rate of inflation  Lending distortions  Administrative costs and inefficiencies

19. Aggregate Output (GDP) Gross Domestic Product final Gross Domestic Product (GDP) is the dollar value of all final goods and services produced. Final good Final good: a product which is ready to be used by consumers Final good Final good: a product which is ready to be used by consumers

20. Business Cycle  Periodic movements in output, prices, and employment  Business cycles are not created equal. –Duration –Severity

21. Business Cycle  GDP rises and falls over short spans of time  At any point in time, it may be above or below its long run trend business cycle  These fluctuations define the business cycle

22. Parts of the Business Cycle Peak Trough Recession Expansion Aggregate Output time

23. Recession-1 recession  A recession is a period in which real GDP declines for at least two consecutive quarters.  Most recessions are marked by falling output and rising unemployment.

24. Recession-2  Growth rate of GDP falls  Firms decrease production  Unemployment rises GDP Unemploy- ment

25. The Recession of 1980-1982 Unemployment GDP Growth

26. Depression  Depression  Depression: a prolonged and deep recession Great Depression: 1929-1933 Great Depression The Great Depression was a period of severe economic contraction and high unemployment that began in 1929 and continued throughout the 1930’s.

27. Great Depression Unemployment GDP Growth

28. Expansion  GDP growth rate rises  Firms increase production  Unemployment falls GDP Unemploy- ment

29. Real GDP in the U.S., 1959 - 1994 1,500.0 2,000.0 2,500.0 3,000.0 3,500.0 4,000.0 4,500.0 5,000.0 5,500.0 195919631967197119751979198319871991 Year Real GDP 1994

30. Real GDP in the U.S., 1959 - 1994 1,500.0 2,000.0 2,500.0 3,000.0 3,500.0 4,000.0 4,500.0 5,000.0 5,500.0 195919631967197119751979198319871991 Year Real GDP Trend Line 1994

31. Unemployment unemployment rate The unemployment rate refers to the percentage of people in the labor force who can’t find a job. Labor Force Labor Force: people who are actively seeking or are currently holding a job Labor Force Labor Force: people who are actively seeking or are currently holding a job

33. Unemployment Rate in Selected Countries

34. Defining Unemployment - 1 Employed Employed: Any person 16 years old or older, (1) who works for pay, either for someone else or in their own business, for one or more hours a week, (2) who works without pay for 15 hours a week in a family business, or (3) who has a job but has been temporarily absent, with or without pay.

35. Defining Unemployment - 2 Unemployed Unemployed: A person 16 years or older who is not working, is available for work, and has made specific efforts to find work during the previous four weeks. Labor force Labor force: The number of people employed plus the number of unemployed.

36. Defining Unemployment - 3 Labor Force  Labor Force = Employed + Unemployed Population  Population = Labor Force + Not in Labor Force Unemployment Rate  Unemployment Rate = Labor Force Participation Rate  Labor Force Participation Rate = Unemployed Labor Force Population

37. Unemployment Pool Entrants 5% Unemployment  Job Finders  Discouraged Workers  Labor Force Leavers  New Entrants: 11%  Re-entrants: 26%  Job Leavers: 12%  Job Losers: 63%

38. Types of Unemployment  Cyclical –due to business cycle movements in GDP  Frictional –due to job search activities  Structural –due to changes in economic institutions –geographic displacement, technological change, discrimination

39. Natural Rate of Unemployment natural rate of unemployment full employment The natural rate of unemployment refers to the unemployment that occurs as a normal part of the functioning of the economy. Sometimes taken as the sum of frictional unemployment and structural unemployment. (The rate of unemployment that occurs at full employment).

40. Costs of Unemployment  Personal costs  Societal costs  Economic costs

41. Government Policies for Influencing the Macroeconomy  Fiscal Policy  Fiscal Policy: Government policies regarding taxes and expenditures  Monetary Policy  Monetary Policy: The tools used by the Federal Reserve to control the money supply  Supply-side Policies  Supply-side Policies: policies that focus on aggregate supply and increasing production

42. Aggregate Demand Aggregate demand Aggregate demand represents the total demand for goods and services in an economy.

43. Aggregate Demand Curve Price Level Aggregate Output P 1 Y1Y1 AD

44. Aggregate Supply Aggregate supply Aggregate supply represents the total supply of goods and services in an economy.

45. Aggregate Supply Curve Price Level Aggregate Output P1P1 Y1Y1 AS

46. Equilibrium equilibrium Aggregate equilibrium is a level of prices and GDP such that the quantity of goods and services purchased equals the overall quantity of goods and services produced

47. Equilibrium Price Level Aggregate Output P*P* Y*Y* AS AD Equilibrium