1. Macro Unit II: Measuring Economic Performance McConnell and Brue chapters 6, 7, and 9

2. Macroeconomic Goals and the Business Cycle An Introduction to Macroeconomic Indicators

3. Important Macroeconomic Questions O Why does output fluctuate? O What determines economic growth? O Why do we have unemployment, and why is unemployment a problem? O Why do we have inflation, and why is inflation a problem? O Which governmental policy affects output, growth, unemployment, and inflation? O How do changes in the amount of money in the economy affect output, growth, unemployment and inflation? O How do domestic economic activities affect other counties and our trade?

4. Why does output fluctuate? O As output rises and falls, amount of goods and services people have increases and decreases O Thus, standard of living rises and falls, and people are better off or worse off O Changes in output cause changes in the number of people employed O Macroeconomics looks at the determinants of output fluctuation and how these factors can be controlled

5. Unit 2 : Macroeconomics National Council on Economic Education Real GDP 1952-2001 (in billions of 1996 dollars)

6. What determines economic growth? O Just as fluctuations in output affect the standard of living from year to year, the long-run growth in output is important for society’s welfare. O Growth in an economy depends on the number of workers, the education and training of workers, the technological advances, the amount of machinery and technology labor has to work with, and the basic material resources. O Macroeconomics addresses how society can encourage the development of these factors, which determine economic growth.

7. Why do we have unemployment, and why is unemployment a problem? O The unemployed are people who are actively seeking jobs or are temporarily laid off. O The question usually arises, “Why won’t these people work for a lower wage and thus get a job?” O Some unemployed people do not have the skills firms require and are unable to find a job even at a lower wage. O Some unemployed people do have skills and want to be paid the market wage for these skills, and they are willing to continue to search for a job until they find one. O Some of these people are unemployed because firms do not have the need for additional workers because demand for their product is down. O Firms will typically not fire existing workers to hire new workers at a lower wage because doing so endangers worker loyalty and also increases the firm’s training costs.

8. Why do we have unemployment, and why is unemployment a problem? O Unemployment is not simply a problem for the unemployed. O Unemployment means that society has fewer products because these workers are not working. O Unemployment also imposes social and psychological costs on society.

9. Why do we have inflation, and why is inflation a problem? O Inflation is an increase in the average price level over time. O One of the difficulties with inflation is its unpredictability. O If people knew what inflation was going to be, they could build in adjustments for its effects. O Macroeconomics studies the causes of inflation, the misallocation of resources that result from inflation and methods for controlling inflation.

10. Which government policy affects output, growth, unemployment and inflation? O Fiscal policy is a summary of the government’s decisions about expenditures and taxation. O Government decisions about taxes and about how much it will spend affect the level of output, growth, unemployment and inflation.

11. How do changes in the amount of money in the economy affect output, growth, unemployment and inflation? O The decisions of the central bank — the Federal Reserve in the United States — determine the amount of money in the economy. O The amount of money in the system determines to a great extent the level of economic activity. O The amount of money in the economy (money supply) in conjunction with how much money society wants to use determine the interest rate. O Monetary policy is a summary of the Federal Reserve’s decisions about money and interest rates.

12. How do domestic economic activities affect other countries and our trade? O A nation’s economy does not operate independent of other countries’ economies. O Trade policies, monetary policies, and fiscal policies all affect the impact of the domestic economy on the economies of other nations. O In the next lesson the economic basis for trade is explained.

13. Think about this… O What causes output to rise and fall? O What causes unemployment to rise and fall?

14. The Business Cycle O What is it? O Recurring increases and decreases in the level of economic activity over periods of years O Consists of peak, contractionary (recession), trough, and expansionary (recovery) phases

15. The Business Cycle O The business cycle describes economic fluctuations: O the rising and falling of output in relation to potential output. O Potential output: level of output that the economy can sustain given the capital stock, technology and full employment

16. Unit 2 : Macroeconomics National Council on Economic Education Phases of the Business Cycle

17. O Recession is defined as two consecutive quarters (six months) of negative growth in real GDP. O The point at which output starts to decline is called the peak of the cycle, or the beginning of the recession. O The point at which output starts to increase is called the trough, or the end of the recession. O As the economy moves forward, the period between the trough and the next peak is called the recovery period or expansion.

18. The Business Cycle O Business cycles are defined in terms of output O However, other variables follow the movement of output O Investment and consumption both rise and fall with movements in real GDP O Inflation typically declines during recessions and increases as the economy approaches the peak. O The unemployment rate rises sharply in recessions.

19. The Business Cycle O Interesting phenomena occur with the unemployment rate over a business cycle. O Initially, the unemployment rate rises O If the recession lasts a long time, the unemployment rate remains at a high level or might actually decline as discouraged workers leave the ranks of the unemployed O As the recovery begins, the unemployment rate may remain very steady at a high level O As the economy recovers and people find jobs, other people enter the labor market looking for work and thus the unemployment rate remains steady

20. Important Points about the Business Cycle O There is no consistent length of time for each phase O Business cycles are unpredictable. After the fact, economists can identify some of the causes of business cycles but are notoriously poor at predicting the actual downturn. O Some variables are countercyclical: move in the opposite direction from real GDP. Some variables are procyclical: move in the same direction as real GDP.

21. So, how is the economy is doing right now? O Unemployment O Nationally: 5.1% (nationally) O Georgia: 5.9% (state) O Natural Rate of Unemployment: 5.05% (FY15 Q4) O Inflation O The Consumer Price Index for All Urban Consumers (CPI-U) for Atlanta down 0.1% over July-August pricing period O CPI-U up 0.6% for the year

22. The Circular Flow Model

23. What do firms provide to households? O Goods O Services

24. What do households give firms in return for the goods and services? O Payment for goods and services

25. What do households provide to firms? O Resources (all owned by households) O Land O Labor O Capital O Entrepreneurship

26. What do firms provide households in return for the resources payments for goods and services? O Wages O Rent O Interest O Profit

27. The Circular Flow O The circular flow model shows the household, business, financial, government, and international sectors of the economy, and the basic interactions among the sectors. O The value of the flow of goods and services must equal the value of the flow of resources in the circular flow model.

28. The Circular Flow and GDP O Gross Domestic Product measures the total market value of all final goods and services produced in a country in one year. O We use GDP as a measure of production in the economy because it can be measured by either the top or bottom flow. O Measuring the top flow is the expenditures approach (measuring the amount spent for goods and services), and using the bottom flow is the income approach (measuring the payments to households for resources).

29. Unit 2 : Macroeconomics National Council on Economic Education Circular Flow

30. Unit 2 : Macroeconomics National Council on Economic Education Circular Flow

31. Macroeconomic Goals Full Employment Price Stability Economic Growth In general, the goals conflict, so society is faced with trade-offs among the goals Unit 2 : Macroeconomics National Council on Economic Education

32. Full Employment O The unemployment rate is a broad measure of economic activity. O However, if policy makers are going to create and implement programs to help the unemployed, they need to know more about the unemployed: O skill level O ethnic and racial groups O age groups.

33. Price Stability O The CPI measures the price level; and from this, the inflation rate can be calculated. O The CPI is only one of several price level measures. O There is discussion about how well the CPI measures the inflation that most people experience. The CPI includes items that people don’t buy every year: house, car, etc. Thus, the CPI may overstate the actual change in the cost of living.

34. Gross Domestic Product O Gross Domestic Product (GDP) is the most widely reported measure to indicate a country’s economic performance O GDP is the market value of all final goods and services produced in a nation during a specific period of time, usually a quarter or a year

35. Points to remember when measuring GDP… O Secondhand transactions are not included (no new production) O Transfer payments are not counted i.e. welfare doesn't produce anything O Intermediate goods not included (i.e. bread yes, flour no) If any of these items were included, the measurement of economic activity would be subject to “double-counting”

36. Calculating GDP

37. Economic Growth O The growth rate in real GDP is a better measure of the change in the macroeconomic conditions than the growth rate of nominal GDP because nominal GDP includes the effects of inflation. O The growth rate in real GDP per capita captures a measure of changes in the standard of living.

38. Short-run versus long-run economic growth O Short-run growth measured in terms of fluctuations in output O Fluctuations in output are measured by the changes in real gross domestic product from quarter to quarter or year to year. O In general, fluctuations in output are caused by greater or lesser utilization of the existing capital stock and technology. O So we are actually measuring changes in real output because of more or less labor applied to the existing level of technology and plant and equipment. O Long-run economic growth refers to changes in the productive capability of the economy through changes in the amount of plant and equipment and technology.

39. Short-run versus long-run economic growth O Economists use the term economic growth to refer to long-run economic growth and fluctuations in real output to refer to the short-run phenomenon. O However, the media frequently refer to short- run changes in output as economic growth. O NOTE: The AP Macro Examination uses the term economic growth to refer to the long- run changes in the economy’s ability to produce.

40. Price Indices and Inflation

41. Prices O Name some prices that have changed in your lifetime O Prices that have increased O Prices that have decreased

42. Percentage Increase 1962-1998 Item Percentage Increase in Price Hershey bar1180% New York Times1100% First class postage700% Gasoline (gallon)284% Hamburger (McDonald's double) 861% Chevrolet (full size)790% Refrigerator freezer60% How does the quality of each item compare from 1962 to 1998?

43. What have we learned so far? O Prices can/do change dramatically in relatively short periods O Price from past can become virtually meaningless O Prices of items do not go up consistently O Some go up faster than others O Items change over time O Becomes difficult to compare prices because the items are not really

44. Inflation O Inflation: a rise in the overall price level. O While the overall level of prices in the economy increases during inflation, individual prices may go up or down during periods of inflation. O No obvious quality improvement O Okay as long a our income increases at same rate or higher O If not, not as well off as we think O Also important – financial planning O $100 today will not buy as much in 20 years

45. Inflation’s effects on $1.00

46. Anticipated versus Unanticipated Inflation O Anticipated inflation: the level of inflation people expect to occur and have built into their economic decisions O Unanticipated inflation: the level of inflation that is not expected or is unforeseen O Wage contracts and long-term loan contracts are usually the source for judging the expected inflation rate

47. Unanticipated Inflation O Unanticipated inflation causes economic costs because people have not adjusted earnings and expenditures for this level of inflation

48. Unanticipated Inflation O Some people gain and some lose from unanticipated inflation. O Great example: borrowers and lenders O Borrowers gain and lenders lose from unanticipated inflation because the money that is paid back at a later date (with interest) will not buy as much as it did before the inflation. O Also, people with fixed payments lose as a result of inflation because the payment stays the same but prices are higher after inflation. O Finally, the government is the largest borrower in the economy and therefore gains from inflation (despite the fact that it tries to prevent inflation).

49. Anticipated Inflation O People adjust to anticipated inflation by building it into their wages, interest rates, and other decisions, so no redistribution takes place. O However, high levels of anticipated inflation also have economic costs: shoe-leather costs, menu costs, and unit of account costs.

50. Anticipated Inflation O Shoe-leather costs refer to the cost of having to run around trying to avoid losses from the declining value of money (even if the “running around” happens online). O Menu costs occur when businesses have to adjust their prices upward as a result of inflation. O Unit of account costs arise because inflation makes money a less reliable measure of measurement.

51. Consumer Price Index O Way to compare prices in different years O Economists choose a “bundle” or “basket” of goods in varying proportions Components of the CPI(U) Housing41.4% Transportation17.8% Food16.2% Energy8.2% Medical Care6.4% Apparel and Upkeep6.1% Other3.9%

52. CPI Continued O The cost of the bundle is assigned an index number O The following year the cost of the same bundle is determined O CPI for that year = new cost of bundle

53. Official CPI 1990-2010CPI Year CPI 1982-84=100 1990130.7 1991136.2 1992140.3 1993144.5 1994148.2 1995152.4 1996156.9 1997160.5 1998163.0 1999166.6 2000172.2 2001177.1 2002179.9 2003184.0 2004188.9 2005195.3 2006201.6 2007207.3 2008215.3 2009214.5 O How to read the table O Used to compare prices of any two years O Example: same goods that cost $130.70 in 1990 would cost $172.20 in 2000 O So $130.70 in 1990 = $172.20 in 2000 Initial Index value = 100 and represents average CPI of 1982-84

54. Relationship Between Factors Can calculate how much more the prices of goods were in one year than another Calculate the ratio of the CPI values So, goods in 2000 cost 1.302 times more than in 1990 (on average) 2000 CPI = 170.2 = 1.302 1990 CPI 130.7

55. Converting to Constant Dollars Comparing amounts from 2 different years Can convert any money related variables ◦ Prices, wages, salaries Current prices for each year are called nominal Compare prices taking changing value of money into account Convert one price to same year as other ◦ Usually convert forward to more recent year

56. Example The price of gasoline in 1990 was $1.16 per gallon on average. In 1997, it averaged $1.22. Was gasoline more expensive or less expensive in 1997? ◦ 1990 $130.70 equivalent to $160.50 in 1997 ◦ 1997 CPI = 160.5 = 1.23 1990 CPI 130.7  So $1.00 in 1990 = $1.23 in 1997 ◦ Multiply 1990 value by 1.23 (1.16 * 1.23)  So $1.16 in 1990 = $1.42 in 1997

57. Another Example O Your boss said she made $25,000 a year at her first job out of college in 1993. That doesn't sound like a lot of money to us today, but we must consider that everything was less expensive in 1993. O What is that salary worth in today's money (in 2010)?

58. Compare Prices in Consecutive Years O Convert entire series of prices to constant dollars

59. Electricity Prices 1986 - 1997 Electricity Prices (US city average, per KWH) YearPrice 1986$0.077 1987$0.079 1988$0.080 1989$0.082 1990$0.084 1991$0.087 1992$0.088 1993$0.092 1994$0.092 1995$0.094 1996$0.094 1997$0.094

60. As a Graph… Is this a realistic depiction of the price of electricity?

61. Huh? O Did price of electricity increase really? O Value of dollar decreased each year O Nominal cost increased O What about constant dollars? O Convert 1986 values to 1997 dollars to find out

62. CPI Graphs Time (years) Change over time Time (years) Change over time Time (years) Change over time $ increases at same rate as inflation (ex. Milk, bread, salary) $ increases slower than inflation (ex. electricity) $ increases faster than inflation (ex. Gas or cigarettes)

63. Calculating Inflation Rate O Inflation rate is defined as O the percentage change in the CPIs from the previous year to the next. O Inflation Rate in 2008 was O 2008 CPI – 2007 CPI 2007 CPI O 215.3-207.3 =.0386 or 3.86% 207.3

64. Negative Inflation (or Deflation) O When the price of goods drops over time O Good thing? Bad thing? O Not always good O Example: O 2008 new car costs $30,000 O 2009 expected value is $15,000 O 2010 expected value is $7,500 O Would you purchased a car in 2008 knowing it would cost you less in 2009 or 2010? O Result: consumers stop buying cars, wait for the price to drop more industry dwindles

65. Unemployment

66. Unit 2 : Macroeconomics National Council on Economic Education Definitions of Employed, Unemployed and Unemployment Rate Employed = everyone currently working, including part-time workers Unemployed = people looking for work or temporarily laid off from work Unemployment Rate = unemployed labor force Labor force = employed + unemployed Labor force participation rate = labor force population aged 16 and older

67. In and Out of the Labor Force O Employed O Currently holds a full- or part-time job O Includes those who are underemployed O Unemployed O Not working but actively O seeking work O Frictional O Cyclical O Structural O Children O Retired O Full-time student (not working) O Choose not to work O Not actively seeking work O Stay-at-home parent O Institutionalized O Discouraged workers IN the labor force OUT of the labor force

68. Important points to remember… O Unemployment includes people who are actively looking for work. People who have stopped looking are not counted as unemployed. O The labor force consists of the employed and the unemployed. O The labor force participation rate is the proportion of the population over age 16 who are looking for work or who are working.

69. Issues with unemployment O The definition of unemployment itself O No mention of discouraged workers: people who were looking for work but gave up because they didn’t succeed in finding a job O Unemployment rate underestimates, by the number of discouraged workers, the number of people who would like to work

70. Issues with unemployment O Underemployed workers O The underemployed are people who are working part time but would like to work full time, or who hold a job that requires a lower skill level than they possess O These people are considered employed, but they could be more productive in a different job

71. Issues with unemployment O Different groups within the economy experience vastly different rates of unemployment O The groups may be age cohorts, or race or ethnic categories O Knowing the distribution of unemployment by a particular characteristic is important in constructing policies to help the unemployed

72. Types of Unemployment O Frictional Unemployment – when people are out of work TEMPORARILY due to moves between jobs, careers, and locations O Ex.: Mr. White’s wife gets promoted, but job is now in Connecticut. Mr. White is frictionally unemployed until he finds a teaching job in CT. O Mr. Sad Class quits because he hates his job, but he hasn’t found a new job yet…   

73. Types of Unemployment O Structural Unemployment – when workers have PERMANENTLY lost their jobs in a certain industry O Many miners are now permanently out of work because machines to the jobs miners used to do

74. Types of Unemployment O Cyclical Unemployment – when there is not enough demand for all those that want to work O Due to swings in the business cycle O Ex.: autoworker laid off in recession due to dwindling demand for new cars. When demand for cars goes back up, will probably be rehired O THIS IS THE UNEMPLOYMENT MACRO POLICY MAKERS PRIMARILY ADDRESS

75. Other Employment Concepts O Natural Rate of Unemployment – level of unemployment when there is no cyclical unemployment O Frictional and structural employment still exist O Varies from country to country O In the US, the Organization for Economic Cooperation and Development (OECD) estimates natural rate of unemployment to be around 6.1%

76. Other Employment Concepts O Full Employment– level of employment when the economy is at the natural rate of unemployment O FULL EMPLOYMENT IS NOT AN UNEMPLOYMENT RATE OF ZERO!!! O By law, US is committed to full employment O According to the Full Employment and Balanced Growth Act of 1978, US is committed to an unemployment rate no greater than 4% for persons over the age of 16 O IS THIS REALISTIC???