1. Chapter 19: What Macroeconomics Is All About Copyright © 2014 Pearson Canada Inc.

2. Chapter Outline/Learning Objectives Section Learning Objectives After studying this chapter, you will be able to 19.1Key Macroeconomic Variables 1.define the key macroeconomic variables: national income, unemployment, inflation, interest rates, exchange rates, and net exports. 19.2Growth Versus Fluctuations 2.understand that most macroeconomic issues are about either long-run trends or short-run fluctuations, and that government policy is relevant for both. Copyright © 2014 Pearson Canada Inc. 2 Chapter 19, Slide

3. 19.1Key Macroeconomic Variables Output and Income The production of output generates income. To measure total output in dollars, we add up the values of the many different goods produced. This gives nominal national income. With base-period prices, we get real national income. Copyright © 2014 Pearson Canada Inc. 3 Chapter 19, Slide

4. Fig. 19-1 Growth and Fluctuations in Real GDP, 1965–2011 4 Chapter 19, Slide (i) The level of real GDP (ii)Annual growth rate of real GDP Copyright © 2014 Pearson Canada Inc.

5. Real GDP fluctuates around a rising trend: the trend shows long-run economic growth the short-run fluctuations show the business cycle 5 Chapter 19, Slide APPLYING ECONOMIC CONCEPTS 19-1 The Terminology of Business Cycles Copyright © 2014 Pearson Canada Inc.

6. Potential output is what the economy could produce if all resources were employed at their normal levels of utilization. often called full-employment output The output gap measures the difference between potential output and actual output. Output Gap = Y – Y* When Y < Y*, there is a recessionary gap. When Y > Y*, there is an inflationary gap. 6 Chapter 19, Slide Copyright © 2014 Pearson Canada Inc.

7. The Terminology of Business Cycles 7 Chapter 19, Slide Copyright © 2014 Pearson Canada Inc.

8. Fig. 19-2 Potential GDP and the Output Gap, 1985–2011 8 Chapter 19, Slide (ii)The output gap(i)Potential and actual GDP Copyright © 2014 Pearson Canada Inc.

9. Employment, Unemployment, and the Labour Force Employment: the number of workers (15+) who hold jobs. Unemployment: the number who are not employed but are actively looking for one. Labour force: the total number of employed + unemployed. Unemployment rate: the number of unemployed expressed as a percentage of the labour force. 9 Chapter 19, Slide Copyright © 2014 Pearson Canada Inc.

10. Even when Y = Y*, some unemployment exists: frictional unemployment (natural turnover) structural unemployment (mismatch between jobs and workers) When Y < Y*, there is cyclical unemployment. 10 Unemployment Rate = Number of people unemployed Number of people in the labour force X 100 Chapter 19, Slide Copyright © 2014 Pearson Canada Inc.

11. Self-Test 1 Suppose the population of Etrusca is 20 million, the working age population is 15 million, the number of employed is 9 million and the number unemployed is 1 million, answer the following questions: a)What is the size of the labour force? b)What is the unemployment rate? © 2012 McGraw-Hill Ryerson Limited LO1 4-11

12. Calculating Nominal and Real GDP Year 1 (base year)Year 2 Item Qty of Output Prices Year 1 Nominal GDP Qty of Output Prices Year 2 Nominal GDP Real GDP Machines 100$100120$120 Km of Road 5030040320 Bread 50026002.50 Cars 2080025820 Totals $ $ $42 000 $ $ $ $ $49 200

13. Calculating Nominal and Real GDP Year 1 (base year)Year 2 Item Qty of Output Prices Year 1 Nominal GDP Qty of Output Prices Year 2 Nominal GDP Prices Year 1 Real GDP Machines 100$100120$120 $100 Km of Road 5030040320 300 Bread 50026002.50 2 Cars 2080025820 800 Totals $10 000 $15 000 $16 000 $ 1 000 $42 000 $14 400 $12 800 $20 500 $ 1 500 $49 200 $12 000 $12 000 $20 000 $ 1 200 $45 200

14. Types of Unemployment Frictional Unemployment unemployment caused by the fact that it takes time for people to find their first job or to move between jobs Structural Unemployment unemployment that results from a mismatch in the skills or location between jobs available and people looking for work. © 2012 McGraw-Hill Ryerson Limited 4- 14 LO2

15. Types of Unemployment Cyclical Unemployment occurs as a result of the recessionary phase of the business cycle Discouraged Worker an individual who wants work but is no longer actively seeking it because of the belief that no opportunities exist © 2012 McGraw-Hill Ryerson Limited 4- 15 LO2

16. Types of Unemployment Full Employment situation in which there is only frictional and structural unemployment cyclical unemployment is zero Natural Rate of Unemployment the unemployment rate at full employment © 2012 McGraw-Hill Ryerson Limited 4- 16 LO2

17. Fig. 19-3 Labour Force, Employment, and Unemployment, 1960–2011 17 (ii)Unemployment rate(i)Labour force and employment Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

18. Long-term trend: employment has grown roughly in line with the growth in the labour force. Short-term fluctuations have been substantial – from 3.4% in 1966 to 12% in 1982. 18 Why Does Unemployment Matter? Some unemployment is desirable, as it reflects the time required for workers and firms to "find" each other so that good matches are made. But some unemployment is associated with human hardship, especially for those individuals with skills that are not in high demand by firms. Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

19. Productivity Productivity: a measure of output per unit of input. often measured as GDP per worker or GDP per hour of work Increases in productivity are probably the single largest determinant of long-run increases in material living standards. 19 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

20. Fig. 19-4 Canadian Labour Productivity, 1976–2011 20 Real GDP per worker is measured in thousands of dollars! Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

21. Inflation A persistent rise in the general level of prices Measured using a price index Most widely used: Consumer Price Index (CPI) GDP Deflator © 2012 McGraw-Hill Ryerson Limited 4- 21 LO3

22. Inflation and Price Level Price level: the average level of all prices in the economy. Inflation: the rate at which the price level is changing. The CPI is based on the price of a typical "consumption basket,” relative to the price in some base year: 22 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

23. Measuring Inflation Consumer Price Index (CPI) a measurement of the average level of prices of the goods and services that a typical Canadian family consumes © 2012 McGraw-Hill Ryerson Limited 4- 23 LO3 CPI = cost of basket in a given year x 100 cost of basket in a base year Inflation rate = index Year 2 – index Year 1 x 100 index Year 1

24. Why Inflation Matters? The purchasing power of money is negatively related to the price level. Also, because it is hard to forecast accurately, inflation adds to the uncertainties of economic life. 24 APPLYING ECONOMIC CONCEPTS 19-2 How the CPI Is Constructed Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

25. Fig. 19-5 The Price Level and the Inflation Rate, 1960–2012 25 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

26. Interest Rates The interest rate is the price of "credit," and the flow of credit is crucial to firms and households in a modern economy. Nominal interest rate: the rate expressed in money terms. Real interest rate: the rate expressed in terms of purchasing power. 26 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

27. Self-Test © 2012 McGraw-Hill Ryerson Limited LO4 4-27 If you borrowed a sum of money for one year at a nominal rate of interest of 11 percent and during that same year the inflation rate was 4 percent, what real rate of interest did you pay?

28. Fig. 19-6 Real and Nominal Interest Rates, 1965–2012 28 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

29. The International Economy Foreign exchange: foreign currencies or claims on foreign currencies. Exchange rate: the number of Canadian dollars required to purchase one unit of foreign currency. A depreciation of the Canadian dollar means that it is worth less on the foreign-exchange market.  a rise in the exchange rate 29 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

30. Fig. 19-7 Canadian–U.S. Dollar Exchange Rate, 1970–2012 30 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

31. The balance of payments accounts record all payments made in international transactions—goods, services, and assets. trade balance current account balance capital account balance For Canada, exports and imports are both very large—roughly 35% of GDP—but the trade balance is usually small. 31 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

32. Fig. 19-8 Canadian Imports, Exports, and Net Exports, 1970–2011 32 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

33. 19.2Growth Versus Fluctuations Long-Term Economic Growth Long-term growth is considerably more important for a society’s living standards from decade to decade than short-term fluctuations. There is considerable debate regarding the ability of government to influence the economy's long-run growth rate. Copyright © 2014 Pearson Canada Inc. 33 Chapter 19, Slide

34. Short-Term Fluctuations Short-term fluctuations are often called business cycles. Economists debate the effectiveness of monetary and fiscal policy in influencing these fluctuations. Some economists argue that despite the "power" of policy to affect the economy, governments should not attempt "fine-tuning." 34 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

35. What Lies Ahead? To organize our thinking about macroeconomics, we must develop some tools. These will include: discussing measurement of national income building a simple model of the economy modifying the model to make it more realistic using our model to analyze some pertinent economic issues 35 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide

36. Review 1. Consider an economy in which existing capital is being used at a high degree, shortages in labour and goods markets are developing, and costs are rising. Which of the following terms best describes this stage of the business cycle? A) peak B) trough C) slump D) recession E) recovery 36 © 2014 Pearson Education Canada Inc.

37. Review 2. If a country's labour force is 15 million people, and 0.5 million are unemployed, the country's unemployment rate is A) 2.5 percent. B) 3.3 percent. C) 4.5 percent. D) 6.7 percent. E) 9.0 percent. 37 © 2014 Pearson Education Canada Inc.

38. Review If the Consumer Price Index changes from 120 in year one to 150 in year two, the rate of inflation in the intervening year is A) 10 percent. B) 12.5 percent. C) 20 percent. D) 25 percent. E) 30 percent. 38 © 2014 Pearson Education Canada Inc.

39. Review An output gap, where Y < Y*, A) tends to force prices up. B) is desirable because it keeps wage costs low. C) is known as an inflationary boom. D) results in a dead-weight loss of unemployed resources that cannot be recovered. E) occurs when there is excess demand. 39 © 2014 Pearson Education Canada Inc.