Chapter 5 macro

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


LO1

The National Economy

Gross domestic product GDP

Market value

All final goods and services

Produced in U.S.

During a

given period


LO1


Millions of decision makers

Some independence

Connected with the economy

Money

Medium of exchange


LO1


Circular flow

Money

Products

Resources


LO1


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


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



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


LO2

Hypothetical Business CyclesExhibit 1



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)


LO2

Annual Percentage Change in U.S. Real GDP Since 1929

Exhibit 2


LO2

U.S. and U.K. Annual Growth Rates in Output Are Similar

Exhibit 3


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


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


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)


http://www.census.gov/cgi-bin/briefroom/BriefRm


“Economists have correctly predicted nine of the last five recessions.“

Paul Samuelson


Coincident indicators

Number of employees on non-agricultural payrolls. Personal income less transfer payments. Industrial production. Manufacturing and trade sales.


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


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.


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


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


Aggregate Demand; Aggregate Supply

Price level Index number Base year = 100

Real GDP GDP adjusted for

price level changes


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


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.


Aggregate Supply Curve

LO3

Positive relationship Price level Real GDP supplied

Other things constant Resource prices State of technology Rules of the game


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.


Equilibrium

LO3

AD curve intersects AS curve Equilibrium price level Equilibrium real GDP

Higher real GDP More goods

and services Higher

employment


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


The Great Depression and Before

LO4

1873 – 1879: Longest contraction 80 railroads – bankrupt

1890s Contractions 18% unemployment

rate 1929: The Great

Depression


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%


What was happening during the Great Depression?

Please read “Lessons from the Great Depression” here as well!!

GREAT READ!!!


A little more about the Great Depression

What was happening???– The stock market was collapsing!!!– Real GDP was falling– Unemployment was at record highs


Dow Jones




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.



Income Taxes???– The highest branch of taxed people were taxed

at 95%, which decreased the investments into the economy.



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



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.


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


The Age of Keynes

LO4

Increase in AD Increase real GDP

Increase employment Demand-side economics WWII

Increased employment Increased government spending Federal deficits


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


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


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


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).


Since 1980

LO4

Combat stagflation Increase AS

Supply-side economics Lower price level Increase output Increase employment

Through lower taxes


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


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


LO4

Tracking U.S. Real GDP and Price Level Since 1929Exhibit 8

Technology

Chapter 5 macro