1. The Big Picture 1

2. The Problem.. Fluctuations aroundthe expected trend in economic growth 3. Business Cycles a type offluctuationfound in theaggregate economic activityof nations who organize their work mainly inbusiness enterprises : a cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly generalrecessions, contractions, and revivalsand expansions . . .; business cycles vary from more than one year to ten or twelve years . . .- Arthur F. Burns and Wesley C. Mitchell, 1946 4. The Business Cycle Cyclical Expansion Begins The Recession becomes a Contraction Peak Trough Revival 5. The Business Cycle Cyclical Expansion Begins The Recession becomes a Contraction Peak Trough Revival 6. A Recession? Business Cycle Dating CommitteeNBER The Three Ds Duration Depth Diffusion Two Months% Changein Real GDP& Un/E Rate % Industries w/ Declining Emplmt http://www.econlib.org/library/Enc1/Recessions.html 7. Prediction Conference Board

More than 250 series covering the most important aspects and sectors of the U.S. economy, such as:

Employment and unemployment;

Personal income and industrial production;

Interest rates and money supply;

Consumer price indexes

8. Prediction Conference Board

The Index of

Leading, Lagging, and Coincident

Indicators

For most industrialized countries.

6-11 measures of economics activity

Published monthly.

9. IndicatorsBCI Of a change in the direction of economic growth. Leading - new orders, backlogs, permits Coincident - employment & consumption Lagging -labor costs, interest rates 10. Output The annual aggregate value of final goods & services produced and sold at current prices. GDP D domestic factors (any)of production GNPN domestically-owned factors of production (anywhere) 11. Data GDP GNP Per ca p ita Luxemburg $ 87,000 $ 45,000 USA $ 46,000 Liberia $16 Mozambique $80 USA (2009) $ 14 trillion (2.4%) over 08 USAGovt Debt $ 13 trillion rising $ 4B/day 12. Prices The goal is stable prices.Inflation and Deflation both distort economic behavior. The CPI 1971-77 + 47.4 percent 1999-08 + 17.2 percent 2008+3.8 percent 2009 - 0.4 percent* 2010+0.9 percent in the 1 stquarter * First decline in the CPI since 1955.GDP deflator + 1.36%. 13. The C.P.I.(BLS) A weighted (by portions) index of the average prices of a basket (about 159 items) of Good & Services purchased (CES survey data) by urban households. There are 7 product groups:Food & Bev 15%, Housing42% , Apparel, Transportation17% , Medical, Recreation, Education & Communications, Other.With sub-groups & strata. Revised periodically (last 1998): added - alcohol away, parking fees, car leases, cell phones (dropped long distance charges recently). 14. Substitution Bias

Changes in relative prices causes consumers to substitute into relatively cheaper goods.

The CPI misses this substitution because it uses a fixed basket of goods.

Thus, the CPIoverstatesincreases in the cost of living. 15. Newer Goods

New goodsallow consumers to find products that more closely meet their needs, which makes each dollar more valuable.

The CPI misses this effect because it uses a fixed basket of goods.

Thus, the CPIoverstatesincreases in the cost of living. 16. Improvements increases in Quality

Improvements in thequality of goodsin the basket increase the value of each dollar.

In particular, computing devices improve while computing costs decline.

Thus, theCPIoverstates increases in the cost of living. 17.

Imported consumer goods:

• included in CPI

• excluded from GDP deflator

TheCPIand theGDPDeflator

The basket:

• CPI uses fixed basket

• GDPdeflator uses basket ofcurrently produced goods & services.

This matters if different prices arechanging by different amounts.

Capital goods:

• excluded from CPI

• included in GDP deflator (if produced domestically )

18. CPI vs. GDP deflator

The effects on theCPIand theGDPdeflator.

• Starbucks raises the price of Frappuccinos.

• Caterpillar raises the price of the industrial tractors it manufactures at its Illinois factory.

• C. Armani raises the price of the Italian jeans it sells in the U.S .

19. Answers

TheCPIandGDPdeflator both rise.

TheGDPdeflator rises, theCPIdoes not.

C. TheCPIrises, theGDPdeflator does not.

20. Comparing Dollar Figures from Different Times

Inflation makes it difficult to compare dollar amounts from different times.

We can use the CPI to adjust figures so that they can be compared.

21. The Price of Gasoline

Price of a gallon of regular unleaded gas:

• $1.42 in March 1981

• $2.50 in August 2005

To compare these figures, we will use theCPIto express the 1981 gas price in 2005 dollars. Question:what gas in 1981 would have cost if the cost of living were the same then as in 2005.

Answer:Multiply the 1981 gas price by the ratio of theCPIin 2005 to theCPIin 1981. 22. Solution: TheRealPrice of Gasoline

1981 gas price in 2005 dollars

= $1.42 x[196.4/88.5]=$3.15

After correcting for inflation, gas was more expensive in 1981.

$2.50 $3.15 Gas price in2005 dollars Ratio = 2.22 x 196.4 $2.50 2005 88.5 $1.42 1981 CPI Price per Gallon Date 23. Exercise

2000:CPI = 152.4

Starting salary for economic majors = $34,000

Today:CPI = 195.3

Starting salary for economic majors = $48,000

Are economic majors better off today thanin 2000?

24. Solution

1980:CPI = 152.4Starting salary for econ majors = $34,000

Today:CPI = 195.3 Starting salary for econ majors = $48,000

Solution Convert 2000 salary of $34,000 todays dollars $34,000 x (195.3/152.4) = 1.28 x $34,000 = $43,520. After adjusting for inflation,salary is higher todaythan in 2000. 25. Real vs. Nominal Interest Rates

The nominal interest rate is:

• the interest rate which isnotcorrected for inflation.

The real interest rate is:

• corrected for inflation.

Real interest rate =(nominal interest rate) (inflation rate) 26. Real and Nominal Interest RatesEXAMPLE

Suppose you deposited $1,000 for one year.

Suppose nominal interest rate in that year is 9%.

Suppose during that year, inflation is 3.5%.

Calculate the real interest rate. What happened to purchasing power of your $1000 ?

Real interest rate= Nominal interest rate Inflation

=0.090.035 = 0.055=5.5%

Thus, the purchasing power of the $1000 you deposited has grown by 5.5%.

27. Real and Nominal Interest Rates in the U.S. 28. Employment Population Population > 15 but < 66Less the institutionalized (prisons, etc.), Armed Forces, stay at home parents, retired persons, some others. Labor Forceincludes the unemployed, discouraged, etc. Labor Force World 3 Billion USA 153 million 49% women 40% of employed women are in management or professional occupations. 29. Employment and the BP Spill 30. Unemployment Rate Monthly labor force surveys. 60,000 households.U1:Percentage of labor force unemployed 15 weeks or longer.U2:Percentage of labor force who lost jobs or completed temporary work.U3:Official unemployment rate per ILO definition - currently not working but arewillin g,able , andavailableto work for pay, and areactivel ysearchin g for work. U4:U3 + " discouraged workers ,U5:U4 + other "marginally attached workers.U6:U5 + Part time workers who want to work full time. 31. Types of Unemployment Frictional location & season, skill mismatch informational inefficiencies in the labor market. Cyclical- due insufficient Aggregate Demand Structural technological change and disruptions, globalization causing skill mismatch.Classical-due to rigidities in labor markets and institutional disincentives. 32. Unemployment At the end of 2009, the proportion of the unemployed who had been jobless for 27 weeks or longer wasthe highest since 1948 . On Saturday (July 3 rd ) the number of people cut from unemployment benefits will surge to 1.63 million.By mid-July, about 2 million unemployed Americans could lose their benefits. 33. Data BLSQ2 2010 Unemployment rates were higher in May than a year earlier in 222 of the 372 metropolitan areas, lower in 141 areas, and unchanged in 9 areas.In May, 270 metropolitan areas reported over-the-year decreases in nonfarm payroll employment, 95 reported increases, and 7 were unchanged.In May, employers took 1,412 mass layoff actions involving135,789 workers . 34. Data BLS Quarterly Census of Employment and Wages (QCEW)Metropolitan Area Employment and Unemployment (Monthly) Mass Layoffs (Monthly) 35. History To 1776 Mercantilists vs Smith Wealth of Nations 19 thCentury Classical Economics Says Law some fundamental I/O work 20 thCentury Great Depression 1936 Keynes General Theory later Neoclassical Economics Game Theory Significant advances in computing Today waiting for the revolution 36. The Classical View Says Law

Supply creates its own demand .

Production creates demand sufficient to purchase all goods and services produced.

Implies thatthere cannot be either

(1)a general overproduction of goods (where supply in the economy is greater than demand in the economy), or

(2)a general underproduction of goods (where demand in the economy is greater than supply in the economy).

37. A barter economy?

You produce good X only so that you can use it to demand other goods.

The act ofsupplying is motivated by the desire to demand.

Supply and demand are opposite sides of the same coin.

38. Says Law in a Money Economy

If consumption drops, then saving rises, andeconomic forces produce an equivalent increase in investment.

CS ->I

The classical economists argued thatsaving (S) is matched by an equalamount of investment (I) because ofinterest rate (i) flexibility in the creditmarket. 39. Savings and Investment are linked in the Loanable Funds market 40. If Saving rises and Consumption falls, will total spending in the economy decrease?

No.

Total spending will not decrease.

For classical economists, an increase in saving (reflected by a decrease in consumption) will lower the interest rate and stimulate investment spending.

So one spending component (consumption) goes down, and another spending component (investment) goes up.

Moreover, according to classical economists, the decrease in one spending component will be completely offset by an increase in another spending componentso that overall spending does not change.

41. What is the Classical position on prices and wages?

Prices and wages areflexible ; they move up and down in response to market conditions.

42. Policy Implication of Believing the Economy is Self-Regulating Laissez-faire Classical, new classical, and monetarist economists believe that the economy is self-regulating.For these economists, full employment is the norm:The economy always moves back to Natural Real GDP . 43. Simple Model

A 2-SectorCircular-Flow: A visual model of how dollars flow through markets among households and firms.

Two types of actors:

• households

• firms

Includes two markets:

• the market for goods and services

• the market for factors of production

CHAPTER 2THINKING LIKE AN ECONOMIST 44. Factors of Production

Thefactors of productioninclude:

• labor

• land

• capital (buildings & machines used in production)

• entrepreneur

CHAPTER 2THINKING LIKE AN ECONOMIST 45. The Circular-Flow Diagram Markets for Factors of Production Households Firms Income Wages, rent, profit Factors of production Labor, land, capital Spending G & S bought G & S sold Revenue Markets for Goods & Services