Macroeconomics

Macroeconomics: the branch of economics that deals with the economy as ___________, including employment, gross domestic product, inflation, economic growth and the distribution of income.

Gross Domestic Product: the dollar value of all final goods and services produced within the nation’s borders in one year.

GDP excludes certain items:

1. Intermediate Goods : products used to make ______________. These require further processing before being sold to the final consumer.

2. Secondhand Sales : sales of ________ goods.

3. Nonmarket Transactions : work done for which _______________ is paid including mowing your own yard, house cleaning or other home improvements.

4. Underground Economy : unreported legal and illegal activities.

5. Financial Transactions : money paid for stocks, bonds and other financial assets.

Gross National Product (GNP): the dollar value of all final goods and services, and structures produced in one year with labor and property supplied by a nation’s residents.

To go from GDP to GNP it is necessary to _____ all payments that Americans receive from outside the U.S., and then __________ all payments made to foreign owned resources in the U.S.

Output-Expenditure Model: a macro model used to show aggregate demand by consumers, businesses, government and the foreign sector.

Aggregate Demand = _______________.

C = consumer spending by households accounts for the largest part of GDPI = investment spending by businessesG = government spending at the federal, state and local levelX = exports which are goods sold abroadM = imports which are goods purchased from abroad

(X—M) = net exports and can also be denoted by the letter (F).

If (X—M) is positive, we have a ______________ meaning we export more than we import.If (X—M) is negative, we have a _____________ meaning we import more than we export. This is what the U.S. has year after year.

GDP = C + I + G + (X—M) or GDP = C + I + G + F

Inflation: a ______ in the general/average price level over time.

To remove distortions of inflation on GDP economists must construct a price index.

Price Index: a statistical series used to measure changes in prices over time, or more simply stated it is _______________.

Base Year: a year that serves as the basis of comparison for all other years.

Market Basket: a representative selection of commonly purchased goods and services used by an urban consumer.

3 Major Price Indexes

1. Consumer Price Index (CPI) : reports on price changes for about 80,000 items in 364 categories used by a typical household.

It is used to measure the rate of inflation in the economy.

2. Producer Price Index (PPI) : measures price changes paid by domestic firms for their inputs. It can be a good indicator of inflation at the consumer level down the road.

Think back to the jeans example with the resources needed to make them.

3. Implicit GDP Price Deflator : an index of the average level of prices for all goods/services in the economy. This is the _______________ measure of inflation in the economy because it includes all the components of GDP.

Current/Nominal GDP: is GDP that has ____________ adjusted for inflation.

Real/Constant GDP: is GDP that ___________ adjusted for inflation.

To go from Nominal GDP to Real GDP you use the following formula.

Real GDP = Current GDP ÷ Price index × 100.

There are 2 ways to measure economic growth using our GDP numbers. Remember that economic growth is the ability to produce _______ goods and services _____________.

1. Changes in real GDP from 1 year to the next.2. Changes in real GDP per capita which is real GDP divided by the population.

Improvements in real GDP per capita indicate an improved __________________ and can be easily compared from 1 nation to another to see who lives better.

Economic growth is the result of more resources and/or better quality resources such as improvements in education and labor productivity.

Business Cycle: the systematic _____ and _________ in real GDP.

Phases include

1. Recession : a period during which real GDP ___________ for a minimum of 6 months.

2. Trough : the turnaround point where real GDP stops going ________.

3. Expansion/Recovery : a period of recovery from recession where real GDP is ___________.

4. Peak : the point where real GDP stops going ____.

Trend Line: shows the __________ growth in real GDP over say 50 or 100 years. It’s a process of two steps forward and one step back.

Depression: a state of the economy with large numbers of people out of work, acute shortages and excess capacity in manufacturing plants.

Index of Leading Indicators: a monthly statistical series that usually turns down before real GDP turns down, and turns up before real GDP turns up. See figure 14.2, pg 379.

It’s like trying to forecast where the economy is headed in the future by looking into your crystal ball.

Unemployment Rate: the number of unemployed people looking for work divided by the total number of persons in the civilian labor force.

UR = # unemployed but looking ÷ civilian labor force × 100 = %

Civilian Labor force: those ____ years and older who are currently ___________ or _______________.

Criticisms of the UR

1. Discouraged Workers : people who have become frustrated with looking for a job and ______________. This tends to understate the actual rate of unemployment.

2. Part time Workers : these workers are counted the same as full time workers. Again, this tends to understate the true rate of unemployment.

If the official UR is say 9.8%, when we add in both discouraged workers and part time workers the actual UR may be closer to 16% or 17%.

Kinds of Unemployment

1. Frictional Unemployment : workers who are ______________ for one reason or another. It is also called search and wait unemployment. This type of unemployment can be beneficial for the economy.

2. Structural Unemployment : this is unemployment caused when a fundamental change in the economy __________________ for workers and their skills. This is often caused by changes in technology. In essence the workers skills are obsolete and won’t be able to find work without going back to school or getting some kind of training.

3. Cyclical Unemployment : this is unemployment related to swings in the business cycle when a ____________ occurs.

4. Seasonal Unemployment : unemployment resulting from changes in the _________ or changes in demand for certain products at regular intervals each year.

Full Employment: the lowest possible unemployment rate with the economy growing and all factors of production being used as efficiently as possible.

Our estimate is _______ for the United States.

The first 4.5% represents frictional and structural unemployment. Anything over and above that is cyclical.

Price Level: measures the relative magnitude of prices at a point in time using the Consumer Price Index (CPI).

The inflation rate can be measured using the following formula. We simply insert the appropriate index numbers into the formula.

Inflation Rate = Δ in price index ÷ beginning price index × 100 = %

We want to keep the inflation rate between 1-3%.

Deflation: a ____________ in the general/average price level as measured by an index number. The effects of deflation are the opposite of inflation.

The immediate result of inflation is a decrease in the __________________ of the dollar.

2 Types of Inflation

1. Demand-pull Inflation : when different groups such as consumers, businesses or the government __________________ beyond what the economy can produce. This is referred to as “Too many dollars chasing too few goods”.

2. Cost-push Inflation : when ________ for producers ‘_______ they will raise prices to compensate for higher costs. This could come primarily from wages or energy/oil prices.

Inflation also causes a _____________________ from some people to others. Some will benefit from inflation while others will be hurt.

Winners Losers_____________ __________________________ _____________ _____________

In 1913 Congress created the ___________________ or the “Fed” as our nation’s central bank. Because everyone uses money, and because interest rates affect the overall level of economic activity, the Fed’s activities affect us all.

Figure 15.1, illustrates how the Fed is organized.

Board of Governors 7 members Appointed by the president and confirmed by the senate Serve 14 year terms Set the general policies for the Fed and banks to follow

Federal Open Market Committee 12 members Meets 8 times a year Makes decisions about the growth of money supply and interest rates Is the Feds primary policymaking body

District Banks

Figure 15.1Figure 15.1

12 district banks and 25 branches District banks accept deposits from and make loans to other banks

Member Banks Commercial banks that are members of and hold stock in the Fed bank in their

district These are the banks we use

Monetary Policy: the expansion or contraction of the ____________ in order to influence the cost and availability of credit which is the ______________.

The Fed does this to create greater stability within the economy. Its goal is to promote economic growth, full employment and price level stability. This means GDP is growing, unemployment is low, 4.5% and inflation is low, 1-3%.

Fractional Reserve System: a system that requires banks and other depository institutions to keep a fraction of their deposits in the form of legal reserves.Let’s look at a bank’s balance sheet.

Reserve Requirement: a rule stating that a percentage of every customer deposit be set aside as legal reserves. See figure 15.3, pg 417.

ExampleA customer deposits of $100 with a reserve requirement of 10%. The bank must set aside $10 as a required reserve and then may loan the remaining $90 which is called excess reserves. It is logical to assume the bank will want to loan that money because banks earn interest on the loan.

The fractional reserve system will allow the money supply to grow to several times the size of the excess reserves the banking system keeps.

ExampleFred deposits $1,000 in a bank with a reserve requirement of 20%.How much will the money supply expand?$1,000 ÷ .20 = $5,000 ( money supply) or 1 ÷ rr = Δ in reserves. 1 ÷ .20= 5 × $1,000 = $5,000

The Fed has 3 main tools it uses to conduct monetary policy. Each tool affects the amount of ______________ in the banking system.

These tools are used within 2 broad policies.

Easy Money Policy: the Fed allows the money supply to _________ and interest rates to fall which normally stimulates the economy. This policy is used when the economy is in a _____________.

Tight Money Policy: the Fed ____________ the money supply which increases interest rates and slows the economy down. This policy is used when the economy is experiencing ____________.

Tools

1. Reserve Requirement : the amount that banks must set aside for every dollar deposited.

The following chart shows how a change in the reserve requirement will change the money supply.

2. Open Market Operations : this is the most popular tool of monetary policy. It involves the _________ and __________ of government securities/bonds.

When the Fed buys bonds the money supply expands.When the Fed sells bonds the money supply shrinks.

3. Discount Rate : this is the interest rate the Fed charges on loans to other banks.

Lowering the discount rate will expand the money supply.Raising the discount rate will reduce the money supply.

Figure 15.5Figure 15.5

Summary of Fed Tools and Policies

Misery Index: also called the ________________ is the sum of the monthly inflation and unemployment rates.

When we studied markets in unit 2 we used the tools of supply and demand to show how the equilibrium price and quantity of output were determined. When we study the economy as a whole, we can use the concepts of supply and demand in much the same way.

Aggregate Supply: the _________ value of goods and services that all firms would produce in a specific period of time at various price levels.

Aggregate = total

The AS curve is _____________ and can also increase or decrease. When costs go _________ producers are willing to __________ output so AS shifts _________. When costs _______ the AS curve shifts ________.

The factors that shift the AS curve include the following.

Cost of inputs productivityTechnology taxesSubsidies government regulationsNumber of sellers

Stagflation: a period of stagnant growth combined with inflation. This is caused by a leftward shift in the AS curve due to say rising oil prices or wages. This is the same as cost-push inflation.

Aggregate Demand: the _________ quantity of goods and services demanded at different price levels.

Aggregate = total

The AD curve is ______________ and can also increase or decrease. It consists of the following components; consumption, investment, government and foreign spending.

AD = C + I + G + (X-M)Factors that shift the AD curve include the following

Consumer wealth taxesExpectations interest ratesExchange rates incomes

Figure 16.4aFigure 16.4a

Figure 16.4bFigure 16.4b

Macroeconomic Equilibrium: this represents the level of real GDP consistent with a given price level as determined by the ___________ of the AS and AD curves.

Fiscal Policy: the federal government attempts to stabilize the economy by _________ and ___________ decisions. The stimulus package passed in February 2009 by Congress is a good example.

Here are the government’s options.

Recession ( increase AD)Lower taxesIncrease spending

Inflation ( Decrease AD)Raise taxesLower spending

When (AD) shifts to the right real GDP increases, employment increases, but we may see some inflation too.

A second part of fiscal policy uses automatic stabilizers which are programs that trigger benefits if changes in the economy threaten income. These programs do not require Congress to act. They simply take effect whenever the economy moves toward recession or inflation.

ExamplesUnemployment compensationEntitlement programsIncome taxes

Supply-Side Economics/Reagonomics

Supply-Side Economics attempts to create greater stability in the economy by shifting the (AS) curve rather than the (AD) curve. It does this by:

1. Reducing marginal tax brackets to give people the incentive to work longer and harder which in turn increases our productive capacity.

2. Reducing government regulations on businesses so they can produce output more efficiently.

The goal of Supply-Side policies is to shift the (AS) curve to the right. This increases real GDP and employment and also creates stable prices.

The government’s budget has 3 possible outcomes.

1. Balanced Budget : tax revenues exactly _________ spending for a given year.

2. Budget Surplus : tax revenues are _________ than spending for a given year.

3. Budget Deficit : tax revenues are __________ spending for a given year.

The main problem with fiscal policy when fighting a recession is that the increase in government spending and reduction in taxes will push the government’s budget toward __________.

In essence we are spending money we don’t have and therefore must borrow. Since WWII our federal budget has been in deficit 85% of the time.

Deficit Spending: when government spending is _____________ revenues collected for a given year.

Federal Debt: the total amount __________ to finance the government’s deficit spending. You simply add up the yearly deficits to get the total debt.

Let’s put the federal debt into perspective.

The U.S. Federal Debt is now approximately $15 trillion.