1. Macroeconomics ECON 2301 Spring 2009 Marilyn Spencer, Ph.D. Professor of Economics Chapter 7

2. Assignment Deadline in One Week!!! 4 Tuesday, March 3 everyone will be turning in an assignment, BEFORE CLASS STARTS: ÜJunior Achievement: Teacher Confirmation Form (pink ½ sheets), signed by the teacher ÜEconomics in the News: First Research Paper, emailed to marilyn.spencer@tamucc.edumarilyn.spencer@tamucc.edu

3. Extra Credit Opportunity #4 4 Watch a recording, read a transcript, or read a news story, of Treasury Secretary Geithner’s new bank bailout plan. 4 Summarize the most important parts, in 50- 100 words (needn’t be in complete sentences). 4 Email this summary to me by Thurs., Feb. 26 at marilyn.spencer@tamucc.edu, for up to 4 points of extra credit.marilyn.spencer@tamucc.edu

4. Extra Credit Opportunity #5 4 Read a thorough news article that explains the provisions of the stimulus bill that President Obama just signed. 4 Summarize the most important parts, in 100-150 words (needn’t be in complete sentences). 4 Email this summary to me by Thurs., Feb. 26 at marilyn.spencer@tamucc.edu, for up to 4 points of extra credit.marilyn.spencer@tamucc.edu

5. Extra Credit Opportunity #6 4 Read a thorough news article that explains the provisions of the mortgage bailout plan for home owners. 4 Summarize the most important parts, in 50-100 words (needn’t be in complete sentences). 4 Email this summary to me by Thurs., Mar. 5, at marilyn.spencer@tamucc.edu, for up to 4 points of extra credit.marilyn.spencer@tamucc.edu

6. Chapter 7: The Macroeconomy: Unemployment, Inflation, and Deflation

7. Learning Objectives 1. Distinguish between average tax rates and marginal tax rates 2. Explain the structure of the U.S. income tax system 3. Understand the key factors influencing the relationship between tax rates and the tax revenues governments collect

8. Learning Objectives (cont'd) 4. Explain how the taxes governments levy on purchases of goods and services affect market prices and equilibrium quantities 5. Understand how the Social Security system works and explain the nature of the problems it poses for today’s students

9. Extra Credit Opportunity #4 4 Watch a recording, read a transcript, or read a news story, of Treasury Secretary Geithner’s new bank bailout plan. 4 Summarize the most important parts, in 50- 100 words (needn’t be in complete sentences). 4 Email this summary to me by Thurs., Feb. 26 at marilyn.spencer@tamucc.edu, for up to 4 points of extra credit.marilyn.spencer@tamucc.edu

10. Extra Credit Opportunity #5 4 Read a thorough news article that explains the provisions of the stimulus bill that President Obama just signed. 4 Summarize the most important parts, in 100-150 words (needn’t be in complete sentences). 4 Email this summary to me by Thurs., Feb. 26 at marilyn.spencer@tamucc.edu, for up to 4 points of extra credit.marilyn.spencer@tamucc.edu

11. Introduction How does the U.S. government measure the overall level of prices? Why doesn’t the U.S. government use Wal-Mart prices in calculating inflation? This chapter will help you answer these questions.

12. Learning Objectives - After studying this chapter, you should be able to: 4 Explain how the U.S. government calculates the official unemployment rate. 4 Discuss the types of unemployment. 4 Describe how price indexes are calculated and define the key types of price indexes. 4 Distinguish between nominal and real interest rates 4 Evaluate who looses and who gains from inflation 4 Understand key features of business fluctuations

13. Did You Know That... 4 Trying to understand and better forecast labor employment and the overall performance of the national economy is a central objective of macroeconomics? 4 This branch of economics seeks to explain and predict movements in unemployment, the average level of prices, and the total production of goods and services?

14. Unemployment 4 Unemployment ÜTotal number of adults (aged 16 years or older) willing and able to work and who are actively looking for work and have not found a job

15. Unemployment (cont'd) 4 Labor Force ÜIndividuals aged 16 years or older who either have jobs or who are looking and available for jobs; the number of employed plus the number of unemployed

16. Unemployment (cont'd) 4 Question: What are the costs of unemployment? 4 Answers: ÜLost output During early 2000s, unemployment rate rose by 2 percentage points Factory output was 80% of potential Lost output was $200 billion of goods and services that could have been produced ÜPersonal psychological impact

17. Source: U.S. Department of Labor, Bureau of Labor Statistics Figure 7-1 More Than a Century of Unemployment

18. Figure 7-2 Adult Population

19. Unemployment (cont'd) 4 The unemployment rate is the percentage of the measured labor force that is unemployed.

20. 152.7* = 145.4 + 7.3 Unemployment (cont'd) *U.S., millions of people; as of 2007 Labor force = The employed+ The unemployed Unemployment rate =  x 100 Unemployed Labor force =  x 100 = 4.8% 7.3 152.7

21. Unemployment (cont'd) 4 Stock ÜThe quantity of something, measured at a given point in time—for example, an inventory of goods 4 Flow ÜA quantity measured over time, such as the income you make per year, or the number of individuals fired every month

22. Unemployment (cont'd) 4 Categories of individuals without work ÜJob loser ÜReentrant ÜJob leaver ÜNew entrant

23. Unemployment (cont'd) 4 Job Loser ÜAn individual whose employment was involuntarily terminated or who was laid off 40–60% of the unemployed 4 Reentrant ÜAn individual who has worked a full-time job before but left the labor force and has now reentered it looking for a job 20–30% of the unemployed

24. Unemployment (cont'd) 4 Job Leaver ÜAn individual who voluntarily quit 10 to 15% of the unemployed 4 New Entrant ÜAn individual who has never worked a full-time job for two weeks or longer 10 to 15% of the unemployed

25. Unemployment (cont'd) 4 Duration of unemployment - ordinarily ÜMore than a third of job seekers find work within one month. ÜApproximately another third find employment within a second month. ÜAbout a sixth are still unemployed after six months. ÜAverage duration is just over 15 weeks throughout the last 15 years.

26. Figure 7-3 The Logic of the Unemployment Rate

27. Unemployment (cont'd) 4 Question ÜWhat is likely to happen to the duration of unemployment during a downturn in the economy?

28. Unemployment (cont'd) 4 Discouraged Workers ÜIndividuals who have stopped looking for a job because they are convinced they will not find a suitable one 4 Question ÜHow does the existence of discouraged workers bias the unemployment rate?

29. Unemployment (cont'd) 4 Labor Force Participation Rate ÜThe proportion of non-institutionalized working-age individuals who are employed or seeking employment

30. The Major Types of Unemployment 4 The major types of unemployment: ÜFrictional ÜStructural ÜCyclical ÜSeasonal

31. The Major Types of Unemployment (cont'd) 4 Frictional Unemployment ÜResults from the fact that workers must search for appropriate job offers ÜThis takes time, so they remain temporarily unemployed

32. The Major Types of Unemployment (cont'd) 4 Structural Unemployment ÜResults from a poor match of workers’ abilities and skills with current requirements of employers

33. The Major Types of Unemployment (cont'd) 4 Cyclical Unemployment ÜResults from business recessions that occur when aggregate (total) demand is insufficient to create full employment

34. The Major Types of Unemployment (cont'd) 4 Seasonal Unemployment ÜResults from the seasonal pattern of work in specific industries

35. International Example: Challenges of Measuring the Unemployment Rate in China 4 Measurement of China’s labor force and unemployment rate fails to encompass all of the roughly 115 million people who migrate from rural areas. 4 In addition, China’s government has not yet developed a way to determine how many millions of people laid off from state-owned firms have obtained positions with private firms.

36. Full Employment and the Natural Rate of Unemployment 4 Question: Does full employment mean that everybody has a job? 4 Full Employment ÜAn arbitrary level of unemployment that corresponds to “normal” friction in the labor market

37. Full Employment and the Natural Rate of Unemployment (cont'd) 4 Natural Rate of Unemployment ÜThe unemployment rate that is estimated to prevail in the long-run macroeconomic equilibrium ÜShould not reflect cyclical unemployment ÜWhen seasonally adjusted, the natural rate should include only frictional and structural unemployment.

38. Inflation and Deflation 4 Inflation ÜA sustained increase in the average of all prices of goods and services in an economy 4 Deflation ÜA sustained decrease in the average of all prices of goods and services in an economy

39. Inflation and Deflation (cont'd) 4 Purchasing Power ÜThe value of money for buying goods and services ÜVaries with prices and income

40. Inflation and Deflation (cont'd) 4 Nominal value ÜPrice expressed in today’s dollars 4 Real value ÜValue expressed in purchasing power, adjusted for inflation

41. Price index =  100 Cost today of market basket Cost of market basket in base year Inflation and Deflation (cont'd) 4 Measuring the rate of inflation ÜPrice Index The cost of today’s market basket of goods expressed as a percentage of the cost of the same market basket during a base year

42. Inflation and Deflation (cont'd) 4 Market Basket ÜRepresentative bundle of goods and services 4 Base Year ÜThe point of reference for comparison of prices in other years

43. Table 7-1 Calculating a Price Index for a Two-Good Market Basket

44. Inflation and Deflation (cont'd) 4 Real-world price indexes ÜConsumer Price Index (CPI) ÜProducer Price Index (PPI) ÜGDP deflator ÜPersonal Consumption Expenditure (PCE)

45. Inflation and Deflation (cont'd) 4 Consumer Price Index (CPI) ÜA statistical measure of a weighted average of prices of a specified set of goods and services purchased by wage earners in urban areas ÜMarket basket of goods and services of typical consumer

46. Inflation and Deflation (cont'd) 4 Producer Price Index (PPI) ÜA statistical measure of a weighted average of prices of goods and services that firms produce and sell ÜUsed as a short-run leading indicator (before CPI) ÜPPIs for Foodstuffs Intermediate goods Finished goods

47. Inflation and Deflation (cont'd) 4 GDP Deflator ÜA price index measuring the changes in prices of all new goods and services produced in the economy ÜBroadest measure of prices; reflects both price changes and the public’s market responses to those price changes

48. Inflation and Deflation (cont'd) 4 Personal Consumption Expenditure (PCE) Index ÜA statistical measure of average price using annually updated weights based on consumer spending ÜPrimary inflation index used by the Federal Reserve

49. Figure 7-4 Inflation and Deflation in U.S. History Source: U.S. Department of Labor, Bureau of Labor Statistics

50. Anticipated versus Unanticipated Inflation 4 Anticipated versus unanticipated inflation ÜTo determine who is hurt by inflation we distinguish between the two types. ÜThe effects of inflation on individuals depend upon which type of inflation exists.

51. Anticipated versus Unanticipated Inflation (cont'd) 4 Anticipated Inflation ÜThe inflation rate that we believe will occur 4 Unanticipated Inflation ÜInflation at a rate that comes as a surprise

52. Anticipated versus Unanticipated Inflation (cont'd) 4 Inflation and interest rates ÜNominal Rate of Interest The market rate of interest expressed in today’s dollars ÜReal Rate of Interest The nominal rate of interest minus the anticipated rate of inflation

53. Anticipated versus Unanticipated Inflation (cont'd) 4 Real interest rate ÜNominal interest rate = 10% ÜExpected inflation rate = 6% ÜReal rate = 10% – 6% = 4%

54. Anticipated versus Unanticipated Inflation (cont'd) 4 Does inflation necessarily hurt everyone? ÜInflation affects people differently 4 Unanticipated inflation ÜCreditors lose ÜDebtors gain

55. Anticipated versus Unanticipated Inflation (cont'd) 4 Protecting against inflation ÜCost-Of-Living Adjustments (COLAs) Clauses in contracts that allow for increases in specified nominal values to take account of changes in the cost of living

56. Anticipated versus Unanticipated Inflation (cont'd) 4 The resource cost of inflation ÜRepricing or Menu Cost of Inflation The cost associated with recalculating prices and printing new price lists when there is inflation

57. Changing Inflation and Unemployment: Business Fluctuations 4 Business Fluctuations ÜThe ups and downs in business activity throughout the economy

58. Changing Inflation and Unemployment: Business Fluctuations (cont'd) 4 Expansion ÜA business fluctuation in which the pace of national economic activity is speeding up 4 Contraction ÜA business fluctuation in which the pace of national economic activity is slowing down

59. Changing Inflation and Unemployment: Business Fluctuations (cont'd) 4 Recession ÜA period of time during which the rate of growth of business activity is consistently less than its long-term trend or is negative 4 Depression ÜAn extremely severe recession

60. Figure 7-5 The Idealized Course of Business Fluctuations

61. Figure 7-6 National Business Activity, 1880 to the Present

62. Changing Inflation and Unemployment: Business Fluctuations (cont'd) 4 Leading Indicators ÜEvents that have been found to occur before changes in business activity Economic downturns often follow:  Reduction in the average workweek  Rise in unemployment insurance claims  Decrease in prices of raw materials  Drop in the quantity of money circulating

63. Issues and Applications: Wal-Mart, Product Quality, and the CPI 4 Wal-Mart offers lower prices on most food items. 4 The Bureau of Labor Statistics (BLS) uses prices charged at a nearby Kroger. 4 As far as the BLS is concerned, lower Wal-Mart prices must reflect lower quality. 4 BLS quality adjustments may result in an upward bias in the rate of CPI inflation.

64. Summary of Learning Objectives 4 How the U.S. government calculates the official unemployment rate ÜPercentage of the total number of adults willing and able to work who are actively looking for work but have not found a job 4 The major types of unemployment ÜFrictional ÜStructural ÜCyclical ÜSeasonal

65. Summary of Learning Objectives (cont'd) 4 Full employment ÜArbitrary level of unemployment Corresponds to “normal” friction in labor market 4 Natural rate of unemployment ÜEstimated to prevail in the long-run macroeconomic equilibrium All workers and employers adjust to any changes in economy

66. Summary of Learning Objectives (cont'd) 4 How price indexes are calculated and key price indexes ÜMultiply 100 times the ratio of the cost of a market basket of goods in the current year to the cost of the same basket in a base year ÜKey price indexes CPI PPI GDP deflator PCE

67. Summary of Learning Objectives (cont'd) 4 Nominal versus real interest rates ÜNominal rate is the market rate expressed in current dollars. ÜReal rate is net of inflation. ÜHence the real interest rate equals the nominal interest rate minus the expected inflation rate.

68. Summary of Learning Objectives (cont'd) 4 Losers and gainers from inflation ÜCreditors lose as a result of unanticipated inflation. ÜBorrowers gain as a result of unanticipated inflation.

69. Summary of Learning Objectives (cont'd) 4 Key features of business fluctuations ÜIncreases and decreases in business activity Expansion from previous trough to new peak Contraction from previous peak to new trough

70. Assignment to be completed before class March 5: Read Chapter 8 & also read end-of- chapter Problems 8-2, 8-5, 8-6, 8-8, 8-10, 8-11 & 8-16 on pp. 209-211.