Macroeconomics

• overall view of the economy
• focuses on policies (fiscal & monetary - boost economy)
  • unemployment
  • inflation
  • budget deficit
  • economic growth
  • international trade
• how policies of national govts can affect all these outcomes in a global economy
• understand trade-offs btwn goals

Key Variables

• Aggregate output (GDP)
• Aggregate employment or unemployment
• Aggregate price
• net exports

Key Goals

• Economic growth
• low unemployment (full employment)
• low inflation (stable prices)
• sustainable balance of trade

Aggregate Output (GDP)

• Total market value of final goods and services produced in an economy in a year
• GDP = P₁Q₁ + P₂Q₂ + P₃Q₃ + P_nQ_n
  

(Total market value) p = market price  q = output

• GDP doesn't show what kind of good is being produced (nor quality or quantity)
• final goods & services = value of final product
• second hand sales not included
• Can be determined either by adding up all that is spent on this year's total output (ependiture approach) or by summing up all the incomes derived from the production of this year's output (income approach)

GDP - Expenditure Approach (People Spend)

• GDP = C + Ig + G + (X-M)
• C - consumption expenditure (households)
  • durable goods (lasts longer than 2-3 years)
  • non-durable goods
  • services
• Ig - gross investment expenditure (company/factory)
  • sum of expenditures of business firms on new plant and equipment, plus the expenditures of households on new homes
• G - government expenditure
  • transfer of paynment not included in GDP (welfare)
• (X-M) - net export
  • export - import

Income Approach (People Earn)

• GDI = W + R + P + I
  • gross domestic income
• W - wage
• R - rental
• P - profit
• I - interest (for capital)
• GDP should = GDI

Limitations of GDP

1. Only market activity is included in GDP
   • work done by housewives/husbands and do-it-yourselfers certainly contributes to the nation's well-being, but it is not measure in GDP b/c it has no price tage
2. GDP places no value on leisure
   • leisure increases with increases in economic growth
3. "Bad" as well as "good" gets counted in GDP
   • natural disasters
4. Ecological costs are not netted out in the GDP
   • many activities in modern industrial economy that produces goods/services also pollute (environmental effects).  Ecological costs are not deducted from GDp
5. GDP says nothing about the welfare of average person, and the distribution of income, in general
   • per capita GDP

GDP Excludes

GDP Excludes:

1. purely financial transfers
   • private transfer payments like $ gifts
   • public transfer payments like social security benefits, welfare payments to the poor
   • security transactions
2. secondary sales - don't represent current output
3. underground economy
   • blackmarket

Nominal GDP

• Nominal GDP is a measure of national output based on the current prices of goods/services
  • the production of goods and services valued at current prices
• not desirable b/c it does not tell us whether change in GDP overtime is b/c of price change or change in real output and services
• nominal GDP = P₁Q₁ + P₂Q₂....

Real GDP

• Real GDP is a measure of national output obtained by eliminating the influence of price changes from nominal GDP statistics.
• To do this, nominal GDP is normalized using the prices of a fixed or base year
  • the production of goods and services valued at constant prices
• real = output & services
• Real GDP = Nominal GDP / price index

GDP Deflation

• (Nominal GDP / Real GDP) x 100
• gives us a figure similar to the CPI
• tells you that the % increase is due to just PRICE increases
• not the inflation rate
• ex. in 2008 = 108.5 so 8.5% is due to price increase vs. inflation rate is 2.17%

Economic Growth

• determines the standard of living for a country
• growth is important but also how much growth is even more important
  • U.S. over the past 40 years averaged about 3.2% rate of growth
  • vs. China and India @ 7-8%
• seemingly small differences in growth matters
  • especially in long term
  • exponential growth
• data shows that there actually has been a divergence (instead of a convergence) in terms of the income btwn the poor and the rich natiolns
  • rich getting richer
  • for poor countries, takes longer to catch up

Economic Growth

Catch-Up Effect

• theory would suggest it would be easier for countries that start off poor to growmore rapidly than countries that start off rich - an advantage of backwardness
• partly b/c of the law of diminishing returns and partly starting late allows you to use already existing technology
  • no need to start from scratch

Determinants of Productivity & Growth

Productivity = the quantity of goods and services produced from each unit of labor input

1. Physical Capital
   • the stock of equipment and structures that are used to produce goods and services
   • more capital equipments for workers to use = more growth
2. Human Capital
   • the knowledge and skills that workers acquire through education, training, and experience
   • worker w/ more experience & better education = more growth
3. Natural Resources
   • inputs into production that are provided by nature
   • ex. land, oil, deposits, rivers
4. Technology
   • society's understanding of the best ways to produce goods and services
   • better way of using physical capital

• "Technology refers to society's understanding about how the world works.  Human capital refers to the resources expended transmitting this understanding to the labor force."
  • in U.S., high output per hour -> 2000-2004 especially b/c of internet boom
• U.S. good @ higher levels of education (universities), and basic research (technology), stable legal system and govt (no real political turmoil)

Economic Growth and Public Policy

• what can the govt do to raise productivity and living standard?

1. encourage SAVING and INVESTMENT
   • entails the sacrifice of current consumption
   • can't have Capital w/out Saving/Investment
   • thru incentives (tax breaks)
2. promote EDUCATION
   • investment in human capital
   • its opportunity cost is forgone wages and salaries while attending school
3. improve HEALTH
   • better nutrition
4. property rights and political stability
5. promote FREE TRADE
6. encourage BASIC RESEARCH and development
7. control population growth
   • controversial
   • 3% growth - 2% population growth = 1% econ. growth
   • vs. 2% growth - 4% population growth = -2% econ. growth
   • larger population = higher chance of genius

Measure of Unemployment

1. Civilian Labor Force
   • CLF = A - B - C
   • A = total U.S. population
   • B = population under 16, armed forces, institutionalized
   • C = homeworkers, do-it-yourselfers, people in school, retired
2. Actual Survey
   • out of the CLF, survey 50,000 each month
   • Ask:
     • are you employed?
     • if not currently employed, have you actively been seeking a job in the last week
       • if yes = UNEMPLOYED
       • if no = not in the labor force
3. Official Government Definition of Unemployment Rate
   • UR = (# of unemployed / CLF) x 100

Downsides to Unemployment Measurement

• Understates UR
  • Underemployed - some people may be working part-time b/c they cannot find a suitable full-time job
  • Discouraged Workers - unemployed person who gives up looking for work and is therefore no longer counted as part of the labor force
  • these factors tend to be magnified during recession than the period of economic recovery or prosperity
• Overstates UR
  • False Info - may claim they are looking for work for welfare/unemployment compensation

Economists' Perspective of Unemployment

(Sticy-Wage)

• for economists unemployment occurs when someone is willing to work at the going wage rate but cannot find a job
• only way this could happen is if the wage-rate is stuck above the market wage-rate
  • wage is not flexible to downward movements
  • causes:
    • government policies (minimum wages)
    • explicit labor contracts (wage agreements that last for 3 or more years)
    • implicit contracts - firms want to pay their workers steady wage rate
      • good for moral of workers
      • long term relationship and maintaining trust and loyalty btwn management and labor (theory of efficiency wages)

Types of Unemployment

Natural Rate of Unemployment

• It is unrealistic to expect ZERO unemployment rate (100% employment)

1. Natural Rate of Unemployment
   • result of the DYNAMIC ebb and flow of workers and industries
   • occurs in context of the laws and regulations that affect the incentives of employers to hire or affect the incentives of the unemployed to take jobs
     • Frictional Unemployment - people who are temporarily between jobs (characteristic of a dynamic economy)
     • Structural Unemployment - people who've lost their jobs b/c they've been displaced by AUTOMATION (skills no longer in demand)
     • Laws and regulations that affects incentives of workers or employers (ie. restrictions on workers lay-off welfare/unemployment benefits)
   • natural rate of unemployment = btwn 4-5%

Types of Unemployment

Cyclical Unemployment

• Cyclical Unemployment
  • portion of unemployment that is attributable to a decline in the economy's total production (GDP)
  • rises during recession, falls during prosperity
    • lack of demand - recession
  • primary focus of public policy
    • thru demand mangement (fiscal/monetary policy)
  • however, long-run unemployment policy may also include considerations on how to reduce the natural rate of unemployment

Costs of Unemployment

1. individual
   • loss of income, possible family problems, stress, poor health, crime, etc.
2. loss of potential output (GDP)
   • potential real GDP = output produced at the natural rate of unemployment or 'full-employment'
   • GDP_gap = Potential real GDP - Actual real GDP
     • gap represents loss of potential goods/services that might have been enjoyed if the economy was operating at capacity
   • The Okum Law: states that for every 1% that the actual unemployment rate excedes the natural rate, a 2.5% GDP gap occurs.  GDP_gap = U^0.025

Causes and Consequences of Inflation

• overall rise in the price of goods & services over years
  • not individual price (general price of oil,wheat,etc.)
• problem w/ inflation:
  • increase in price is uneven or not proportional
  • unanticipated (unpredictable)
  • erodes person's purchasing power
    • what's the point of having more money if it cannot pay for goods

How to Measure Inflation

• official measure of inflation:
  1. must establish "Fixed Market Basket" of goods/services
     • what are the typical goods/services that consumers buy
     • ex. housing, food/beverage, education, recreation, health care, transportation
  2. find the prices of the Fixed Basket (value)
     • CPI = consumer price index
     • (price of the fixed basket on the base year ÷ price/value of the fixed basket of the current year) x 100
     • CPI = $ FB base / $ FB current x 100
  3. compute the cost of the fixed basket in each year
     • multiply quantity of good x price in each year
  4. choose base year
     • then compute the CPI
  5. use CPI to compute inflation rate
     • change btwn the two years
     • [(CPI₂₀₀₈ - CPI₂₀₀₇) / CPI₂₀₀₇] x 100

Problems w/ this Measure of Inflation

• fixed basket = problem
  1. substitution
  2. introduction of new products/technology
  • goods/services change in relevance over the years
  • fixed basket doesn't account for these 2

Causes of Inflation

• Demand Push
  • demand > supply
    • aggregate demand therefore price increases
  • too much money chasing too few goods
• Cost-Push Inflation
  • cost of producing goods & services increases
    • oil cartel (pushes cost of oil up)
  • often result of monopoly prices, unions, govt regulation (cause inflation to go up)

Bad About Inflation

Distribution Effect - hurts some, benefits others

• people w/ fixed incomes (reitrees) or w/ contract incomes (unions)
  • incomes stay same while cost of living increases
• crediters
  • borrowing/lending $ -> value of $ is less than when borrowed
  • good for borrowers but bad for lenders
• cash holders
• Resource Allocation Effects
  • menu costs - stores have to keep changing prices to keep up w/ inflation rates
    • cost of changing prices
    • high level of inflation (hyperinflation)
  • shoe leather cost - how much is costs you to go to the bank
    • resources wasted when inflation encourages people to reduce their money holdings
• money as a store & exchange value = very bad, dollar losing value

Protecting from Inflation

• indexing:
  • ex. Adujstable Home - Mortgage Loan
    • not fixed mortgage rate
    • accounts for inflation
• COLA:
  • cost of living adjustment
  • retirees -> their yearly fixed earning increases (at least) at same rate of inflation rate
  • matches income w/ increase in inflation
  • unions -> contracts state that their incomes is adjustable

Inflation Doves

• economists who think that inflation is natural in the market and tolerable
• don't live in fixed market
• inflation based on the price fluctuations

Inflation Hawks

• conpletely anti-inflation
• w/ govt policies -> review it to watch out for inflation

How to Change Inflation

• must slow economic growth to reduce inflation
• save more, buy/consume less
• no inflation = higher unemployment

The Balance of Trade

• balance btwn exporting and importing
• Balance of Payments (BOP):
  • measures payment that flows btwn any individual country and all other countries
  • summarizes all international economic transactions for that country in specific time period
  • exports and imports of goods & services, financial capital, and financial transfers
  • reflects all payments and liabilities to foreigners (debts) and all payments and obligation received from foreigners (credits)

Measuring BOP

Merchandise Trade Balance

• refers to gap btwn exports and imports of GOODS
• represents the actual flow of physical goods and among countries

Measuring BOP

Current Account Balance

• single statistic that captures a comprehensive picture of a nation's trade
• includes goods, serives, investment, income and unilateral transfers (foreign aid)

National Savings & Investment Identity

• Domestic Savings + Inflow of Foreign Capital = Domestic Investment + Government Borrowing
• trade deficit = outflow of $
• when Japan sells us Toyotas they use the U.S. $ and invest it in the U.S. (stocks, land, bonds)
  • we're becoming dependent on foreign countries for investment
• DS (households) + IFC = SUPPLY
• DI (private, companies) + GB = DEMAND
• govt deficit - govt spending more than we have to make it go away
  • DS must ↑ or IFC ↑ while DI ↓
  • Crowding-Out when govt borrowing takes away from domestic investment
• economic growth comes mostly from domestic investment
• currently U.S. = net debtor
  • being debt ≠bad if money is being used for advancement/improvement (building infrastructure)
  • problem = borrowing money to buy more foreign goods (for short term rather than long)

Business Cycle

• capitalist = good b/c dynamic, allow for fluctuations
• business cycle:
  • refers to recurrent ups and downs in the level of economic activity which extends over several years
  • involves fluctuations in business activity around a long-run growth trend

Business Fluctuations

• business fluctuations:
  • refers to the ups and downs in overall business activity, as evidenced by changes in national income, employment, and prices

Recession

• period of time when rate of growth in business activity is consistently less than its long-term trend, or is negative
• below normal trend

Causes for Business Fluctuations

1. innovation theory
   • contends that major innovations (railroads, cars, computer) have a great impact on investment and consumption spending, therfore upon output, employment and the price level
     • however, these occur irregularly and thus contributing to the variability of economic activity
   • shock to economy
   • boom of innovation = good for economy but irregular
2. political & random events
   • war, election periods for major political office, economic embargos, etc.
3. deficiency in total (aggregate) expenditure
   • in a market economy, periodically what businesses planned to to produce and sell tend to fall short of expectations

Aggregate Demand

• shows the quantity of national product (goods + services) that's demanded @ each possible value of price-level
• inverse relation for price of good & real GDP
• exogeneous factors:
  • M‾ = money supply in economy
  • t‾ = taxes
• AD = C + I + G + (X-M)

Aggregate Supply

• shows for each possible price level, the quantity of goods and services that all the nations' businesses are willing to produce, holding all other factors constant.
• P (price) - C (cost of production) = profit
  • thus, P↑ - C = ↑profit
  • in Keynesian range when P↑, cost stays same
  • in classical range when P↑, cost ↑
• exogenous factors:
  • technology
  • productivity
    • education/training
  • government policy (incentives)/ regulations

Macroeconomics Stabilization Policy

Demand Management

• how do you go from recessional output to full employment
• recession or inflation

Demand Management:

• want to manipulate aggregate demand (short term)

1. Fiscal Policy
   • change tax rate (increase/decrease)
   • change government expenditure
2. Monetary Policy
   • change money supply (M‾)

• expansionary is to stimulate economy during a recession
• contractionary is to stimulate economy when inflation is too high

Expansionary Fiscal Policy-

• when there's a prob. of RECESSION:
  • reduce taxes (increases income, thus people spend more $)   T↓
  • increase govt expenditure    G↑

Expansionary Monetary Policy-

• when there's a prob. of RECESSION
  • increase in money supply  M↑

Contractionary Fiscal Policy-

• when there's prob. of INFLATION
  • increase taxes    T↑
  • decrease govt expenditure     G↓

Contractionary Monetary Policy-

• when there's prob. of INFLATION
  • decrease money supply    M↓

Classical Theory of Employment

• in a capitalist society, there is always full-employment
• supply curve would be vertical
• no unemployment (anyone who is able and willing to work at the market price, is workijng)
• Says Law:
  • supply always creates demand
  • C (consumption) + S (saved) = C + I (income spent)
  • S = I or Income Earned = Income Spent
• Defficiency in Spending
  • impossible according to classical economists
  • means that AD < AS
  • people saving > spending
  • leakage = income not used to buy goods + services
• Why govt does not need to intervene:
  1. financial/monetary market
     • don't need stabilization policies or govt b/c market will always correct itself
     • what is being saved by the households will be demanded by the firms
  2. price & wage are flexible
     • thus market will always return to market equilibrium
     • if AD < AS then prices go down to compensate for surplus and equilibrium is gound
• govt. should only increase the capacity of the market (economic growth) - increase AS

Keynesian Theory of Employment

• said Says Law is wrong
  • Great Depression occurred
• AD >< AS --> economic fluctuation is normal

Keyne's Law:

• demand creates supply
• AD < AS .....   S > I  (savings > investment)  possibility
  • can have unemployment, recession, depression
• financial market may not be able to say S = I
• planned S > I
• price & wages = STICKY for downward movement
• Govt has a major role in stabilizing economy thru demand management
• pro-employment (prob. of employment is bigger than prob. of inflation)
• increase AD thru taxes & increasing govt. expenditure
• Problems w/ Keyne's Theory:
  • inflation
    • increase in employment = increase in inflation
  • budget deficit
    • created by trying to stimulate economy

Trade-Offs Between Inflation & Unemployment

The Phillips Curve

• inverse relationship btwn inflation and unemployment
• if fluctuations in economy's real rate of growth from year to year are caused primarily by variations in the rate @ which the aggregate demand curve shifts outward, then the data should show that low unemployment rates (high aggregate output) are associated with high inflation rates, and high employment rates are associated w/ low inflation.
• impossible to achieve full-employment without inflation
• must choose btwn inflation or recession
• stagflation:
  • when inflation and unemployment occurs @ same time
  • supply shrink - shift of the supply curve

Supply-Side Economy

• new version of classical economists
• Reagan era
• want to push AS outwards
• How:
  • cuts in marginal tax rate
  • decrease govt expenditure
  • deregulation
    • environmental regulation (let them pollute)
    • deregulation in transportation sectors (airlines)
  • downsize the public sector
  • favor policies that will create incentives to work, to save, and invest
• tries to lower cost of production for firms
• more interested in long term