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Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 1
ECON
Designed byAmy McGuire, B-books, Ltd.
McEachern 2010-2011
5CHAPTERIntroduction to Macroeconomics
Macro
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 2
LO1
The National Economy
Gross domestic product GDP
Market value
All final goods and services
Produced in U.S.
During a
given period
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 3
LO1
The National Economy
Millions of decision makers
Some independence
Connected with the economy
Money
Medium of exchange
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 4
LO1
The National Economy
Circular flow
Money
Products
Resources
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 5
LO1
The National Economy
Flow variable
Amount per unit of time
Stock variable
Amount at a particular point in time
Testing new theories
Knowledge and performance
Essential relationships
Key variables
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 6
Economic Fluctuations and Growth
LO2
Rise and fall of economic activity Business cycles
Expansions: Output increases Contractions: Output decreases
Depression Sharp reduction in output Lasts > 1 year High unemployment
Recession Lasts > 6 months
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 7
Economic Fluctuations and Growth
LO2
Inflation Economy’s average price level increase
U.S. economic fluctuations 14 times more output than in 1929 Increased production
Quantity and quality of resources Better technology Rules of the game
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 8
LO2
Hypothetical Business CyclesExhibit 1
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Economic Fluctuations and Growth
LO2
Business cycle Peak-to-trough-to-peak Contraction
Between peak and trough Expansion
Between trough and peak Longest
10 years (March 1991 to March 2001)
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LO2
Annual Percentage Change in U.S. Real GDP Since 1929
Exhibit 2
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LO2
U.S. and U.K. Annual Growth Rates in Output Are Similar
Exhibit 3
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Leading Economic Indicators
LO2
Leading economic indicators Predict a change in economy
Recovery Downturn
Coincident economic indicators Reflect changes as they
occur Lagging economic indicators
Follow changes in economy
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Leading IndicatorsThe 10 components of the Index include:1. Average weekly hours worked by manufacturing
workers
2. Average number of initial applications for unemployment insurance
3. Number of manufacturers' new orders for consumer goods and materials
4. Speed of delivery of new merchandise to vendors from suppliers
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 14
5. Amount of new orders for capital goods unrelated to defense
6. Amount of new building permits for residential buildings
7. The S&P 500 stock index
8. Inflation-adjusted monetary supply (M2)
9. Spread between long and short interest rates (the yield curve)
10. Consumer sentiment (the Index for Consumer Expectations)
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http://www.census.gov/cgi-bin/briefroom/BriefRm
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“Economists have correctly predicted nine of the last five recessions.“
Paul Samuelson
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Coincident indicators
Number of employees on non-agricultural payrolls. Personal income less transfer payments. Industrial production. Manufacturing and trade sales.
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Lagging IndicatorsThe components are:
1. The average duration of unemployment (inverted)
2. The value of outstanding commercial and industrial loans
3. The change in the Consumer Price Index for services
4. The change in labor cost per unit of output
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 19
Lagging Indicators
5. The ratio of manufacturing and trade inventories to sales
6. The ratio of consumer credit outstanding to personal income
7. The average prime rate charged by banks
Economists' use the Index of Lagging Indicators to validate assessments of current economic conditions.
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 20
So, where are we???
http://www.bloomberg.com/news/print/2010-08-19/index-of-u-s-leading-economic-indicators-increase-0-1-in-
sign-of-slowing.html
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 21
Aggregate Demand; Aggregate Supply
Aggregate output Total amount of goods and services Produced in economy Given period Real GDP
Aggregate demand Price level Quantity of aggregate
output demanded
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 22
Aggregate Demand; Aggregate Supply
Price level Index number Base year = 100
Real GDP GDP adjusted for
price level changes
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 23
Aggregate Demand Curve
LO3
Sum of D of economic decision makers Households; Firms; Governments; Rest of the world
Inverse relationship Price level Real GDP demanded
Other things constant Price levels in other countries Exchange rates
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 24
LO3 Aggregate Demand CurveExhibit 4
Real GDP
(trillions of 2000 dollars)0 2 4 6 8 10 12 14 16
50
150
100
Pric
e le
vel (
2000
= 1
00)
AD
The quantity of aggregate output demanded is inversely related to the price level, other things constant.
This inverse relationship is reflected by the aggregate demand curve AD.
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 25
Aggregate Supply Curve
LO3
Positive relationship Price level Real GDP supplied
Other things constant Resource prices State of technology Rules of the game
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 26
LO3
Aggregate Demand and Aggregate Supply in 2008
Exhibit 5 The total output of the
economy and its price level are determined at the intersection of the Ad and AS curves.
This point reflects real GDP and the price level for 2008 using 2000 as the base year.
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 27
Equilibrium
LO3
AD curve intersects AS curve Equilibrium price level Equilibrium real GDP
Higher real GDP More goods
and services Higher
employment
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 28
Short History of the U.S. Economy
LO4
1. Before and during Great Depression2. After Great Depression to early 1970s
The Age of Keynes3. From early 1970s to early 1980s
Stagflation4. Since early 1980s
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 29
The Great Depression and Before
LO4
1873 – 1879: Longest contraction 80 railroads – bankrupt
1890s Contractions 18% unemployment
rate 1929: The Great
Depression
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 30
The Great Depression and Before
LO4
1929 - 1933: Deepest economic contraction Stock market crashed; Investment dropped Consumer spending fell; Banks failed Money supply dropped by 1/3 High tariffs – restricted trade
Big decline in AD Real GDP dropped 27% Price level dropped 26% Unemployment rate 33%
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 31
What was happening during the Great Depression?
Please read “Lessons from the Great Depression” here as well!!
GREAT READ!!!
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 32
A little more about the Great Depression
What was happening???– The stock market was collapsing!!!– Real GDP was falling– Unemployment was at record highs
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 33
Dow Jones
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Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 36
A few other thoughts
Money Supply?!?– The Federal Reserve decreased the money
supply by 1/3, meaning there was NO money left to invest in the economy.
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 37
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 38
Income Taxes???– The highest branch of taxed people were taxed
at 95%, which decreased the investments into the economy.
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Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 40
A few policies, pigs anyone?– The Hoover Administration destroyed crops
and killed livestock trying to get the price levels to increase and not deflate
– The prices did not increase and people where left hungry
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 41
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 42
LO4
The Decrease in Aggregate Demand from 1929 to 1933
Exhibit 6
8.9
12.0
Pric
e le
vel (
2000
= 1
00)
AD1929
AS
Real GDP
(billions of 2000 dollars)0 865636
AD1933
The Great Depression of the 1930s can be represented by the shift to the left of the AD curve, from AD1929 to AD1933.
In the resulting depression, real GDP fell from $865 billion to $636 billion, and the price level dropped from 11.9 to 8.9, measured relative to a price level of 100 in the base year 2000.
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 43
The Age of Keynes
LO4
After the Great Depression to early 1970s 1936 John Maynard Keynes
The general theory of employment, interest, and money
AD – inherently unstable Government - increase AD
Expansionary fiscal policy Increase government spending Cut taxes
Federal budget deficit
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 44
The Age of Keynes
LO4
Increase in AD Increase real GDP
Increase employment Demand-side economics WWII
Increased employment Increased government spending Federal deficits
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 45
The Age of Keynes
LO4
Employment act of 1946 1950s: Prosperity, no fiscal policy 1960s: Golden age Keynesian economics
Fiscal policy ‘ fine tune’ Low unemployment; Healthy growth Modest inflation
Early 1970s Recession High inflation
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 46
Stagflation: 1973 to 1980
LO4
1970 Inflation rate: 5.3% 1971 Ceilings: prices, wages 1973 Crop failures
Soaring grain prices OPEC cut oil supply
Increased oil prices
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 47
Stagflation: 1973 to 1980
LO4
1973 - 1975: Decrease in AS Stagflation
Stagnation or contraction in output Inflation
Real GDP decreased Unemployment increased to 8.5% Price level increased 19%
1979 - 1980: Stagflation; decrease AS OPEC cutbacks
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 48
LO4
Stagflation from 1973 to 1975
Exhibit 7
38.0
31.9
Pric
e le
vel (
2000
= 1
00)
AD
AS1973
Real GDP
(trillions of 2000 dollars)0 4.344.31
AS1975The stagflation of the mid-1970s can be represented as a leftward shift of the AS curve from AS1973 to AS1975.
Aggregate output fell from $4.34 trillion in 1973 to $4.31 trillion in 1975, for a decline of about $30 billion (stagnation).
The price level rose from 31.9 to 38.0, for a growth of 19% (inflation).
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 49
Since 1980
LO4
Combat stagflation Increase AS
Supply-side economics Lower price level Increase output Increase employment
Through lower taxes
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 50
Since 1980
LO4
1981: Recession Unemployment rate 10% Lower output
Economic growth for 10 years Federal budget deficit
1990: higher taxes 1993: higher taxes 1995: slower growth in federal spending Lower federal deficits
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 51
Since 1980
LO4
1998: Federal budget surplus Longest expansion: 1991-2001
22 millions new jobs Unemployment rate 4.2% Modest inflation
2001: Recession (8 months) Slow recovery 2003, unemployment rate 6.3%
Tax cuts Increased output Federal budget deficit
December 2007: Recession 2.5 million jobs lost in 2008 2008 Federal deficit: $450 billion
Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 52
LO4
Tracking U.S. Real GDP and Price Level Since 1929Exhibit 8
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