TM 5-1 Copyright © 1998 Addison Wesley Longman, Inc. CHAPTER 5 A First Look at Macroeconomics...

TM 5-1Copyright © 1998 Addison Wesley Longman, Inc.

CHAPTER 5A First Look at

Macroeconomics

CHAPTER 5A First Look at

MacroeconomicsChapter 22 in EconomicsChapter 22 in EconomicsChapter 22 in EconomicsChapter 22 in Economics

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Learning Objectives

• Describe the origins of macroeconomics and the problems it deals with

• Describe the long-term trends and short-terms fluctuations in economic growth, unemployment, inflation, and government and international deficits

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Learning Objectives (cont.)

• Explain why economic growth, unemployment, inflation, and deficits matter

• Identify the macroeconomic policy challenges and describe the tools available for meeting them

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Learning Objectives

• Describe the origins of macroeconomics and the problems it deals with

• Describe the long-term trends and short-terms fluctuations in economic growth, unemployment, inflation, and government and international deficits

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Origins and Issues of Macroeconomics

• Modern macroeconomics emerged during the Great Depression.

• People began to doubt the free market economy.

• John Maynard Keynes, in 1936, published The General Theory of Employment, Interest, and Money.

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Origins and Issues of Macroeconomics

• Macroeconomic Problems

1) Economic Growth

2) Unemployment

3) Inflation

4) Deficits

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Origins and Issues of Macroeconomics

• Short-Term Versus Long-Term Goals

• Keynes focused on the short-term primarily• He felt the depression was caused by insufficient

private spending

• Government should increase its spending

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Origins and Issues of Macroeconomics

• Short-Term Versus Long-Term Goals

• Long-term consequences were virtually disregarded• “In the long run, we’re all dead”

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Origins and Issues of Macroeconomics

• Short-Term Versus Long-Term Goals

• Today, macroeconomics is concerned with:• Long-term economic growth and inflation

• Short-term business fluctuations and unemployment

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Origins and Issues of Macroeconomics

• The Road Ahead

• The focus of macroeconomics has shifted:• Depression

• Inflation of the 1970’s

• International economics of today

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Learning Objectives

• Describe the origins of macroeconomics and the problems it deals with

• Describe the long-term trends and short-term fluctuations in economic growth, unemployment, inflation, and government and international deficits

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Economic Growth

• Economic growth is the expansion of the economy’s production possibilities.

• Measured by real gross domestic product (Real GDP)

• The value of the total production of all the nation’s farms, factories, shops, and offices linked back to the prices of a single year (1992)

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Economic Growth in theUnited States

• The Growth of Potential GDP

• When an economy’s labor, capital, land, and entrepreneurial ability are fully employed

• Real GDP fluctuates around potential GDP

• Growth slowed during the 1970s

• Productivity growth slowdown

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Economic Growth in theUnited States

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Economic Growth in theUnited States

• Fluctuations Around Potential GDP

• The business cycle is the periodic but irregular up-and-down movement in production.

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Economic Growth in theUnited States

• Phases of the Business Cycle

• Recession• Period during which real GDP decreases for two

successive quarters

• Expansion• Period during which real GDP increases

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Economic Growth in theUnited States

• Turning Points

• Peak• Expansion ends, recession begins

• Trough• Recession ends, expansion begins

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The Most Recent U.S. Business Cycle

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Long-Term Economic Growthin the United States

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Economic Growth Aroundthe World

• Real GDP per person

• The growth rate of real GDP divided by the population is used to compare growth rates over time and across countries.

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Economic Growth Aroundthe World

• Growth rates in the U.S., Germany, and Japan have features that are distinct

• Similar productivity growth slowdowns

• Similar business cycles

• Different long-term trends in potential GDP

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Economic Growth inThree Large Economies

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Growth Rates Around the World

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Learning Objectives (cont.)

• Explain why economic growth, unemployment, inflation, and deficits matter

• Identify the macroeconomic policy challenges and describe the tools available for meeting them

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Benefits and Costs ofEconomic Growth

• Benefits

• Expanded production possibilities• health care

• medical research

• space exploration

• roads

• environmental improvements (if resources are devoted to solving environmental problems)

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Benefits and Costs ofEconomic Growth

• Costs

1) Foregone consumption

2) Depletion of natural resources

3) Increased pollution

4) More frequent job and location changes

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Jobs and Unemployment

• Jobs

• In 1996, 127 million people had jobs.• An increase of 20 million over 1985 and 23 million

over 1975

• On average, 1.8 million new jobs are created every year

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Jobs and Unemployment

• Unemployment

• On average, 7 million people are unemployed in the U.S.

• Unemployed worker

• One who does not have a job but is available for work, is willing to work, and has made some effort to find work within the previous four weeks

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Jobs and Unemployment

• Labor Force

• Sum of the people who are unemployed and the people who are employed

• Unemployment Rate

• The percentage of the labor force who are unemployed

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Jobs and Unemployment

• Discouraged Worker

• A person who does not have a job, is available for work, and is willing to work but who has given up the effort to find work

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Jobs and Unemployment

• The unemployment rate may be misleading because:

• Discouraged workers are excluded

• Part-time workers who want full-time jobs are considered employed

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Unemployment in theUnited States

• Important Features

1) The unemployment rate during the Depression peaked in 1933 at 25%.

2) After 1934, the unemployment rate overstated the true rate because

it counts the people who had make-work jobs.

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Unemployment in theUnited States

• Important Features

3) Unemployment rates have reached high levels in recent years during

recessions.

4) The unemployment rate never falls to zero.

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Unemployment in theUnited States

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Unemployment inIndustrial Economies

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Why Unemploymentis a Problem

• Lost Production and Incomes

• Lost Human Capital

• Prolonged unemployment can hurt a person’s job prospects.

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Inflation

• Inflation is a process of rising prices.

• The inflation rate is measured as a percentage change in the average level of prices or the price level.

• Consumer Price Index (CPI)

• Deflation is negative inflation, the price level is falling.

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Inflation

• In December 1995, the CPI was 153.5 and in December 1996 it was 158.6.

How would the inflation rate for 1996 be calculated?

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Inflation

• The inflation rate for 1996 was:

Inflation = 158.6 – 153.5

153.5

= 3.3%

100

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Inflation in the United States

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Inflation Around the World

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Inflation Around the World

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Is Inflation a Problem?

• Predictability of inflation rates creates problems

• High, unpredictable inflation causes resources to be diverted to predicting inflation rates.

• This is a wasteful use of resources

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Is Inflation a Problem?

• Hyperinflation

• Inflation in excess of 50% per month

• Workers are paid daily• Money loses value rapidly

• Workers spend their incomes quickly

• 1994• Zaire — 76% per month

• Brazil — 40% per month

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Is Inflation a Problem?

• Policies that reduce the inflation rate increase the unemployment rate.

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Deficits

• A government budget deficit exists if the federal government spends more than it collects in taxes.

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Government Budget and International Deficits

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Deficits

• An international deficit exists if our imports exceed our exports.

• Current Account

• Our exports minus our imports; but it also takes interest payment paid to and received from the rest of the world into account.

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Government Budget and International Deficits

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Do Deficits Matter?

• Governments must borrow if it spends more than it earns in tax revenue.

• If the borrowed funds are used to purchase assets that earn a profit, the investment may be sound.

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Learning Objectives (cont.)

• Explain why economic growth, unemployment, inflation, and deficits matter

• Identify the macroeconomic policy challenges and describe the tools available for meeting them

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Macroeconomic Policy Challenges and Tools

• Policy Challenges

1) Boost economic growth

2) Stabilize the business cycle

3) Reduce unemployment

4) Keep inflation low

5) Reduce the government and international deficits

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Macroeconomic Policy Challenges and Tools

• Policy Tools

1) Fiscal policy• Making changes in taxes and government spending

• Long term growth• Smooth the business cycle

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Macroeconomic Policy Challenges and Tools

• Policy Tools

2) Monetary policy• Changing interest rates and the amount of money in

the economy• Control inflation• Smooth business cycle