Chapter 1 -- The Macro Goal Variables

Measures of Economy’s “Health”Definitions, Realistic Goals, and

Recent (US) Performance

#1 -- Real Gross Domestic Product (Real GDP)

Real GDP (Y) -- The total production of final goods and services over a period of time, expressed in constant prices of a base year.

Why Real GDP (GDP in constant dollars), instead of Nominal GDP (GDP in current dollars)?

Real GDP -- Realistic Goal

Realistic Goal for Real GDP -- to be as high as possible without accelerating inflation (overstimulated economy).

Can state this goal in a more formal way.

The Natural Level of Real GDP (Potential Real GDP)

The Natural Level of Real GDP (YN) -- that level of real GDP in which inflation has no tendency to accelerate or decelerate.

Comparing Real GDP to the Natural Level of Real GDP

Y < YN -- sluggish economy with

decelerating inflation

(inflation rate) Y > YN -- economy with

accelerating inflation

Y = YN -- economy with constant

inflation rate

Characteristics of YN

UnobservableGrows at 2.5% per year for the USAffected by

-- labor productivity

-- the price of energy

-- the capital stock

-- the labor force

Getting and Keeping Y at YN: The “Two Cars”

If Y = YN, then seek annual real GDP growth = 2.5%.

If Y < YN, then seek annual real GDP growth > 2.5%, for awhile.

If Y > YN, then seek annual real GDP growth < 2.5%, for awhile.

Special Case -- The Recession

Goal Variable #2 -- The Inflation Rate

Inflation Rate -- the growth or percentage change in the overall price level.

First, measure the price level (P).

-- Consumer Price Index (CPI)

-- GDP DeflatorInflation Rate = Percentage Change in

P

Realistic Goal -- Inflation

Ideal Goal: Inflation Rate = 0%.

Realistic Goal (US):

|Inflation Rate| < 3%.

An Inflation Problem Versus Accelerating InflationInflation Problem --

|Inflation Rate| < 3%.Accelerating Inflation --

Inflation RateConsider -- Inflation Rates of 1981 versus

1985 (Y = YN)

1981 Inflation Rate = 9.0%

1985 Inflation Rate = 2.5%

Goal Variable #3 -- The Unemployment Rate (u)

u = (# of people unemployed)

(total labor force)

Does not measure

-- discouraged workers

-- part-time versus full-time

employment

-- people with multiple jobs

Types of Unemployment

Frictional Unemployment -- Unemployment due to normal labor market frictions.

Structural Unemployment -- Unemployment due to a mismatch of available workers and jobs.

Cyclical Unemployment -- Unemployment due to a generally slow economy.

Realistic Goal -- Unemployment Rate

Realistic Goal -- zero cyclical unemployment

Natural Rate of Unemployment (uN) -- The unemployment rate in which inflation has no tendency to accelerate or decelerate.

Realistic Goal: u = uN

Interpretation: u versus uN

u = uN Inflation Rate Unchanged

(Desired State of Economy)u > uN Inflation Rate

(Sluggish Economy)u < uN Inflation Rate

(Overstimulated Economy)

Real GDP and the Unemployment Rate

u = uN Y = YN,

(Desired State of Economy)u > uN Y < YN,

(Sluggish Economy)u < uN Y > YN,

(Overstimulated Economy)

Goal Variable #4 -- The Federal Budget

Budget = Tax Revenues - Government Expenditure (over a given period)

Budget = Tax Revenues - (Government purchases of goods and services + Transfer Payments + Interest on the National Debt)

Budget Definitions

Budget < 0 -- Budget DeficitBudget > 0 -- Budget SurplusBudget = 0 -- Balanced Budget

Realistic Goal -- The Federal Budget

Realistic Goal -- Balanced Budget when Y = YN.

Sluggish economies tend toward deficits.

Hierarchy of economic problems.

Goal Variable #5 -- The Balance of Trade

Balance of Trade (BOT) -- approximated by net exports.

BOT = Exports - Imports

BOT < 0 -- Balance of Trade DeficitBOT > 0 -- Balance of Trade SurplusBOT = 0 -- Balanced Trade Position

Realistic Goal -- Balance of Trade

Realistic Goal -- BOT close to zero.

Diagnosing the “Patient” --

The Current US Economy and Prospects For the Near Future