ECONOMICSECONOMICS

Unit 6Unit 6

Elements of Elements of MacroeconomicsMacroeconomics

ELEMENTS OF MACROECONOMICSELEMENTS OF MACROECONOMICSThe Study of Entire Economies

By way of review, ECONOMICS is……the study of the behavior of individuals and

institutions engaged in the production, distribution, and consumption of goods and services.

It can be divided into two broad categories……MICROECONOMICS deals with the decisions

made by individual actors. It examines the behaviors of consumers, firms, and the determination of prices; and

…MACROECONOMICS deals with the decisions made by entire economies. It seeks to identify levels of national income, output, employment, and prices.

ECONOMIC PERFORMANCEECONOMIC PERFORMANCEGROSS DOMESTIC PRODUCT

A.Measuring Economic Production with the Gross Domestic Product (GDP): the total dollar value of all final goods and services produced within a country during one calendar year (aggregate, i.e. total)

1. Final, not intermediate products—no double counting

2. Production, not sales3. Domestic, not foreign

B.Output-Expenditure Model

C + I + G + (X-M) = GDP

One person’s spending is another

person’s income

1. Personal consumption expenditures: consumer purchase of durable goods (3+ years), non-durable goods (consumables), and services

2. Gross investment is the total value of all capital goods produced through real investment as well as the changes in the dollar value of business inventories

a. Fixed investment; physical capitalb. Inventory investmentc. Not financial assets

3. Government purchases, but not transfers

4. Net exports

exports – imports = net exports

C.Income Approach to GDP: the sum of all income earned by resource suppliers in the economy

1. Value added by each firm equals that firm’s selling price minus the amount paid for intermediate goods

2. The sum of the value added at all stages equals the market value of the final good

$20 $50 $120 $200

Stage of Production

SaleValue

Cost ofIntermediate

Good

ValueAdded

Logger $20 --- $20

Miller $50 $20 $30

Manufacturer $120 $50 $70

Retailer $200 $120 $80

Market value of final good $200

McEachern

D.Adjusting GDP for Price Increases

1. Nominal GDP: expressed in current prices of the period being measured

2. Real GDP: adjusted for price differences

Year 1Nominal GDP

Year 2Nominal GDP

Year 2Real GDP

10 cars @ $20,000

100 bikes @ $100

10 cars @ $22,000

100 bikes @ $120

10 cars @ $20,000

100 bikes @ $100

GDP$210,000

GDP$232,000

GDP$210,000

Actual Misleading Adjusted

3. Price Index: a set of statistics that allows economists to compare prices over time

a. The base year provides a reference point to compare prices; all other prices are expressed relative to this year

b. To construct a price index, each year’s price is divided by the price in the base year and then multiplied by 100

Year Current Year

Base Year Price Index

2002 $1.25 $1.25 100

2003 $1.30 $1.25 104

2004 $1.40 $1.25 112

McEachern

E. Limitations of GDP

1. GDP uses estimates of prices and quantities developed over time

2. GDP measures only market transaction involving money

3. GDP cannot include underground economy

4. GDP fails to account for economic decisions that influence the nation’s overall well-being

F. Other National Income and Product Accounts (NIPA)

1. Gross National Product: the total dollar value of all final outputs produced with factors of production owned by residents of a country during a year

2. Net National Product: reducing GDP by investment spent to maintain current equipment, excluding depreciation

3. National Income: sum of employees’ and proprietors income, real and estimated rental income, corporate profits and net interest

4. Personal Income: total amount of earned income by people

5. Disposable Personal Income: total amount of income available to spend or save

BUSINESS CYCLES (fluctuations in a market system’s economic

activity)

A. Phases of the Business Cycle

1. expansion: economic growth and recovery

2. peak: point at which economy is at its strongest and most prosperous

3. contraction (recession): business slowdown

4. trough: demand, production, and employment reach

lowest levels

B. Influences on the Business Cycle

1. Business investment

2. Money and credit

3. Public expectations

4. External factors

What would indicate economic expansion?

What does it mean if people’s saving rate

decreases?

What role does emotion play in the

economy?

What prevents the business cycle from acting

in isolation?

C. Predicting the Business Cycle

1. Leading indicators anticipate the direction in which the economy is heading

2. Coincident indicators provide information about the current status of the economy

average workweek initial claims for unemployment

new orders for consumer goods stock prices

new orders for capital goodsbuilding permits for houses

3. Lagging indicators occur after an upturn or downturn in the economy and are used to predict durations of the cycle

The problem lies in not knowing the future; that is to say, we don’t always

know the stage of the cycle until after the fact.

A. Importance of Economic Growth

1. Increasing the standard of living (economic well-being of the people; what is the difference between

2. Competing in the global market

3. Increasing domestic resources

ECONOMIC GROWTH

Standard of

living

Style of living

Self-sufficient vs. interdependence

B.Requirements for Economic Growth

1. Natural resources

2. Human resources

3. Capital resources

4. Entrepreneurship

C.Labor ProductivityA measure of how much each worker

produces in a given period of time. Productivity growth is the increase in the output of each worker.

1. Level of technology available

2. Quantity of capital goods available per worker

3. Education and skill level of the labor force

4. Attitudes and motivation levels of the workers

5. Percentage of workers in productive fields

ECONOMIC CHALLENGESECONOMIC CHALLENGESUNEMPLOYMENTA. Measuring Unemployment

1. What is employment?a. Worked for pay or profit for one or

more business days,b. Worked without pay in a family

business 15 or more hours, orc. Have jobs but did not work as a

result of illness, weather, vacations, or labor disputes

2. The unemployment rate is the percentage of people in the civilian work force who are unemployed

3. Problems with the unemployment ratea. It does not indicate the intensity with which people look for jobsb. It does not include people who areassumed to be unemployed

1) marginally attached workers: people who once held productive jobs but have given up looking for productive work

2) discouraged workers: people who want a job but have stopped looking

c. It does not indicate the number of underemployed workers (those who have

jobs beneath their skill level or who want full-time work but are only able to find part-time jobs)d. It generally includes part-time workers

4. Full employment is not possible nor is it necessarily gooda. Full employment does not mean zero unemploymentb. A natural business cycle implies a natural unemployment rate

Under 16 and/or institutionalized

Not in labor force

Employed

Unemployed

Tota

l pop

ula

tion

Lab

or fo

rce

267,901,000-

64,767,000

-66,837,000

129,558,000

6,739,000

136,297,000

UnemploymentRate

=

Unemployed

Labor Force

x

100

6,739,000

136,297,000

4.9%

B. Types of Unemployment1. Cyclical: unemployment that is caused by downturns in the business cycle

2. Structural: unemployment that is caused by changes in technology or the way the economy is structured

3. Seasonal: unemployment that results from seasonal variations in the economy

4. Frictional: temporary unemployment not related to the business cycle

decreased demand leads to decreased supply

assembly line worker replaced by a robot

retailers lay-off staff following Christmas

workers moving from low- to high-paying jobs

C. Costs of Unemployment

1. GDP Gap. When the economy fails to create enough jobs for all those who are able and willing to work, potential production of goods and services is lost.

2. Unequal Burdens. Unemployment distributes unequally across society, hitting some elements harder than others.

3. Noneconomic costs. A job “gives hope for material and social advancement”; severe unemployment leads to rapid and sometimes violent social and political change.

4. International Comparisons. A country’s unemployment may jeopardize its international standing.

Unemployment Rates By Demographic Group

Demographic Group 1992 1996

Overall 7.4% 5.4%

Occupation: Blue-collar

9.3% 7.1%

White-collar 4.6% 3.4%

Age: 16-19

20.2% 18.1%

Male, 20+ 7.0% 4.6%

Female, 20+ 6.3% 4.8%

Race: Black

14.1% 10.5%

White 6.5% 4.7%

Gender: Female

6.9% 5.4%

Male 7.8% 5.4%

Education: Less than high school

13.5% 10.9%

High school 7.7% 5.5%

College 2.9% 2.2%

(McConnell 158)

INFLATION

A. Examining Price Fluctuations

1. Price levela. Aggregate supply: the total amount of

goods and services produced throughout the economy

b. Aggregate demand: the total amount of spending by individuals and businesses throughout the economy

2. Inflation: an increase in the average price level of all products in an economy

3. Deflation: a decrease in the average price level of all goods and services in an economy

B. Causes of Inflation

1. Demand-pull inflation: aggregate demand increases faster than the economy’s productive capacity; quantity demanded will exceed quantity supplied; demand outpaces the available supply of goods

2. Cost-push Inflation: producers raise prices to cover higher resource costs; a determinant of price outside the laws of supply and demand

a. Supply shock: an event that increases the cost of production for all or many firms

b. Wage-price spiral: higher wages paid throughout the economy

C. Measuring Inflation

1. Consumer Price Indexa. The CPI is a measure of the average change

over time in the price of a fixed group of products

b. Market basket: a representative sample of

typically purchased consumer items

Seven Categories: housing, food and drinks, transportation, medical care, apparel and upkeep, entertainment, and “other”

Four Challenges: changing spending patterns, new products replacing old, quality improvements, sale and discount prices

2. Producer Price Index is a measure of the average change over time in the prices of goods and

services bought by producers

D. Inflation rate: the monthly or annual percentage change in prices. Hyperinflation is the worst degree of inflation; it increase at a rate of several hundred percent a year.

Global Connections

During the hyperinflation that occurred in Germany following World War I, it was reported that tavern patrons would order several beers at the beginning of the evening, before the prices went up. Therefore, the warm, flat beer was one of the costs of inflation for Germans.

In Hungary, following World War II, workers were paid three times a day. Because the Hungarian currency was being devalued at such a rapid rate, the wives of Hungarian workers had to spend much of their time running between their husbands’ workplaces and the bank to deposit paychecks before they became worthless.

E. Effects of Inflation

1. Decreased purchasing power

2. Decrease value of real wages

3. Increased interest rates

4. Decreased savings and investing

5. Increased production costs

POVERTY AND INCOME DISTRIBUTION

A. Poverty in the United States1. Poverty threshold: the lowest income that a family or household of a certain size or composition needs to maintain a basic standard of living

2006 HHS Poverty Guidelines

Persons inFamily or Household

48 ContiguousStates and D.C. Alaska Hawaii

1 $ 9,800 $12,250 $11,270

2 13,200 16,500 15,180

3 16,600 20,750 19,090

4 20,000 25,000 23,000

5 23,400 29,250 26,910

6 26,800 33,500 30,820

7 30,200 37,750 34,730

8 33,600 42,000 38,640

For each additional person, add

 3,400  4,250  3,910

SOURCE:  Federal Register, Vol. 71, No. 15, January 24, 2006, pp. 3848-3849

2. Poverty rate: the percentage of individuals or families in the total population that are living in poverty

2005: 12.7%

B. Distribution of Income

1. Differences of income are a result ofa. Economic and social backgroundb. Skills and talentsc. Market value of the goods and services a

person has to offer

2. Measuring income inequality through statistical analysis of aggregate income and actual

earned income

3. Income distribution analysis has limits because it relies on gross income, unearned income, and household- based income without differentiating household sizes or different wage-earners

C. Growing Gap in income distribution due to…

1. changes in households

2. changes in the labor market

3. rapid changes in technology

4. growth of a global economy