Macroeconomic Basics

Dr. Katherine Sauer A Citizens Guide to Economics ECO 1040

Overview:
I. Economic Fluctuations II. GDP III. Inflation IV. Unemployment V. Government Policy

I. Economic Fluctuations Economic activity is not constant.

Chart from chapter 15 in the Brief Principles of Macroeconomics textbook by Greg Mankiw.

The Parts of a Business Cycle:

RGDP Growth Rate (%RGDP)

peak

+
expansion slowdown expansion

0
contraction recovery

time

trough

The US economy has had mostly expansions and slowdowns. - troughs at positive growth

It has had very few contractions and recoveries.

A recession is 2 consecutive quarters of falling Real GDP. - contract for 2 quarters

A depression is a severe recession.

The Recent Recession:

Part 1: Housing Bubble Burst

Part 2: Financial Sector Part 3: Financial System Seizes Up Part 4: Recession Spreads Internationally

Key Facts about Economic Fluctuations

1. They are unpredictable and varied. - describing them after the fact is easy, predicting them is not 2. Many macroeconomic variables fluctuate together. - different amounts, different directions 3. As output falls, unemployment rises. 4. Fluctuations occur in both the short run and long run.

II. Gross Domestic Product (GDP)

An economy is measured by the value of the goods and services it produces. Gross Domestic Product is the market value of all final goods and services produced within a countrys borders in a given time.

2010 GDP Rank 1 2 3 4 5 6 7 8 9 10

Source: IMF

Country GDP (millions of USD) World 61,963,429 European Union 16,106,896 United States 14,624,184 China 5,745,133 Japan 5,390,897 Germany 3,305,898 France 2,555,439 United Kingdom 2,258,565 Italy 2,036,687 Brazil 2,023,528 Canada 1,563,664 Russia 1,476,912

GDP has 4 components: Consumption (C) = spending by households on goods and services Business Investment (I) = spending by firms on capital equipment, inventories, and structures Government Spending (G) = spending on goods and services by local, state, and federal government Net Exports (NX) = value of exports value of imports

There are 2 types of GDP: Real and Nominal Nominal GDP = the production of goods and services valued at current prices

Real GDP = the production of goods and services valued at base year prices. (adjusted for inflation)

GDP Growth (aka economic growth): Economic growth is measured by the percent change in RGDP over a time period. %RGDP = RGDP2 RGDP1 x RGDP1 100

Economic growth can be negative.

GDP is calculated quarterly by the Bureau of Economic Analysis. www.bea.gov

GDP is a decent measure of economic well-being. Explain:

GDP per capita tells us more about economic wellbeing than GDP does.

Using GDP as a measure of social progress has its problems.

1. unpaid economic activity

2. environmental issues 3. value judgments 4. leisure 5. distribution of income

III. Inflation
Inflation is an increase in the overall price level. The inflation rate is the percent change in the price level.

formula:
Inflation Rate = Price Level Year 2 Price Level Year 1 Price Level Year1 x 100

The Consumer Price Index is a way to measure the price level It measures changes in the overall cost of the goods and services that a typical household buys Compiled monthly by the Bureau of Labor Statistics. www.bls.gov

BLS has classified all expenditure items into more than 200 categories, arranged into eight major groups:
Contents of the Basket Housing
3.7 3.4
5.7 6.4 6.3 43.4

Transportation Food and Beverages Education and Communication Medical Care Recreation Apparel

15.7

15.3

Other Goods and Services

Source: Bureau of Labor Statistics

Calculate the inflation rate for December 2010: inflation December 2010 = 219.179 218.803 218.803

x 100

= 0.17% = 0.2% (typically round to 1 decimal place) Calculate the inflation rate from January 2000 to December 2010: inflation Jan 2000 to December 2010 = 219.179 168.8 x 100 168.8 = 29.8%

Inflation is a normal occurrence in an economy. - some inflation is just fine - high inflation erodes purchasing power It is usually the job of the central bank to keep inflation under control. In general, if a countrys economic growth rate is faster than its inflation rate, then inflation isnt very harmful.

Deflation is actually quite harmful to an economy. - consistently falling prices lead consumers to delay purchases - firms see a reduction in sales and cut back on production and employees - consumers fear job losses and so delay purchases - the cycle is very hard to break

IV. Unemployment A person is unemployed if they are available to work and are actively seeking work, but cannot find a job. - just because a person doesnt have a job, doesnt mean they are unemployed

Start with the entire population, then omit: children (age < 16) institutionalized active military

Children and institutionalized persons are not eligible to work. Active military personnel are often excluded for statistical reasons.

Of the remaining population, some people voluntarily choose not to be employed: - retirees - stay-at-home caregivers - full-time college students - other

These types of people are not unemployed. They are categorized as not in the labor force.

The Labor Force is the total number of workers in the economy, whether they are employed or unemployed. Labor Force = number employed + number unemployed
The labor force is not a fixed number of people. - It increases with the long-term growth of the population. - It responds to economic forces and social trends - Its size changes with the seasons.

The unemployment rate is the percentage of the labor force who are actively seeking employment.
unemployment rate = people looking for work x 100 people in the labor force

In January 2010, the US civilian labor force had 153,353,000 people in it. Of this, 14,842,000 were unemployed. Calculate the unemployment rate:
U = # unemployed x 100 = # labor force
= 14,842,000 x 100 153,353,000 =

= 9.7%

The unemployment rate is never zero.

Some unemployment is normal for an economy. - Even if a job exists and a person exits with matching skills, it takes time for the person to find the job and go through the hiring process. (frictional unemployment) - As an economy grows and changes, some jobs become obsolete and new industries are created. When a person loses a job due to a fundamental change in the structure of the economy, it takes time for them to get retrained for the new jobs. (structural unemployment)

The rate of unemployment that an economy normally experience is called the natural rate of unemployment. - different countries have different natural rates of unemployment - depends on the structure of the labor market - minimum wage laws - hiring/firing laws - unemployment benefits When the economy goes into a recession and unemployment rises above the natural rate, that is the bad kind of unemployment. (cyclical unemployment).

V. Government Policy Fiscal Policy is when the government taxes or spends money.

Explain the recent stimulus bill. Spending: Taxes:

In reality, fiscal policy might not be a good answer to a recession. Three requirements for successful fiscal policy: 1. 2. 3.

Monetary policy refers to the actions undertaken by the Federal Reserve, specifically the raising and lowering of interest rates.

Summary:
The economy fluctuates in the short and long run.

GDP, Inflation, and Unemployment are three basic indicators of the health of the economy.

What did you learn today? Please explain 2 concepts from todays class.