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Econ Notes Chapter 11

Into to Macro
Macro Goal Variables
-Measures of Economys Health
-Definitions and Realistic Goals (US, for the most part)
Goal 1: Sufficient production or output
Measured by Real Gross Domestic Product (Real GDP)
Real GDP (Y) The total production or output of final goods and
services over a period of time, expressed in constant prices of a
base year.
Real Versus Nominal GDP
Nominal GDP (Unadjusted GDP) is total production at current
prices
Real GDP (GDP Adjusted for changes in prices) is the total
production at constant prices of a base year.
-Real GDP The sum total of production of final goods and services
across all markets of the economy, it measures total production or
output.
-By definition, Real GDP identically measures total income to all the
factors derived from production and sales.
Realistic Goal for Real GDP To be as high as possible without
accelerating inflation (overstimulated economy)
The Full Sustainable Level of Real GDP (YF) The maximum level of
Real GDP the economy can produce without bringing on accelerating
inflation or overstimulation.
Characterizing the Economy: Y versus YF
Y,YF Sluggish economy
Y>YF Economy with accelerating inflation
Y = YF Economy with constant inflation rate (desired state)
Characteristics of YF
Unobservable.
Has grown at 2.5% per year for the US historically since World
War II
Maybe for the US, it has grown 3% per year in most recent
decade.
Growth rate is not the same for all countries
Recession A special Case

The situation where the Level of real GDP decreases, or exhibits


negative growth, for at least two consecutive quarters.
Clearly, in a recession, Y < YF
Goal Variable #2 Inflation
Measure by the Inflation Rate The growth or percentage chagen
in the overall price level.
First, measure the price level (p)
o Consumer Price Index (CPI)
Inflation Rate = Percentage change in P
Why is inflation a problem?
Inflation erodes the purchasing power of money, causes
distortions in decision.
o Why hold money?
o Why lend money?
Inflation can erode peoples standard of living, put pressure on
labor markets.
o Fixed incomes
o Workers with insufficient raises.
Realistic Goal Inflation
Ideal Goal: Inflation Rate = 0%
Realistic Goal (US): |Inflation Rate| < 3%
Consumer Price Index (CPI)
Key measure of the price level (P)
Computed based upon a Market Basket: Comprehensive set of
goods and services purchased by consumers.
Fixed Weight Index
Computing a CPI
Example Compute the CPI for 2008 with 1992 as the base year.
CPI2008= (cost of 1992 Market Basket Purchased in 2008)/(Cost of
Actual Consumer Purchases in1992)
Computing the Inflation Rate (Given the CPI)
Example Compute the Inflation Rate for 2008, given that the
CPI for 2007 and 2008 have been calculated.
Inflation Rate2008 = (CPI2008-CPI2007)*(100%)/(CPI2007)
Biases in the CPI (as a fixed weight index)
Entry bias goods leaving and entering the market basket.
Quality Bias Different quality of the same goods over time.

Outlet Bias Retail vs. Outlet prices?


Commodity Substitution Bias changing quantities over time due
to demand response to goods that have become relatively
expensive.
The GDP Deflator
An alternative measure of the price level (P)
Market Basket: comprehensive set of goods and services
purchased by all spenders in the economy (consumers,
businesses, government, and foreigners on US exports and
imports).
Chain Weighted Index Alleviates some of the biases of the CPI
due to being a fixed weight index.
Converting Nominal GDP to Real GDP
Example find real GDP2008
Real GDP 2008 = (Nominal GDP2008)/(P2008)
Real GDP for the other years is computed the same way.
Real GDP Growth = Percentage Change in Real GDP
Goal Variable #3 Unemployment
Measured by the Unemployment Rate (u)
U = (# people unemployed)/(labor force) *100%
Unemployed those people out of work and seeking work.
Labor Force People employed + People unemployed
What

the unemployment rate does not measure


Discouraged workers, those who drop out of the labor force
Part-time versus full-time employment.
Compensation of those working
People with multiple jobs

Realistic Goal Unemployment Rate


As low as possible without inflation accelerating (over stimulated
economy).
Natural Rate of Unemployment (uN) The lowest
unemployment rate the economy can achieve without
accelerating inflation.
Realistic Goal: u = uN
Interpretation: u versus uN
u = uN => Desired State of Economy
u > uN => Sluggish Economy
u < uN => Accelerating Inflation (over stimulated economy)

Types of Unemployment
Total Unemployment = Frictional + Structural + DemandDeficient
Frictional Unemployment unemployment due to time
involved to matching unemployed and appropriate jobs
Structural Unemployment Unemployment due to a
mismatch of available workers and jobs
Demand-Deficient Unemployment Unemployment due to a
generally sluggish economy. There are not enough jobs for
everyone who wants one.
The Natural Rate of Unemployment Revisited
Natural Rate of Unemployment (uN) The unemployment rate in
which inflation has no tendency to accelerate or decelerate.
Another Interpretation -- uN is the unemployment rate with zero
demand-deficient unemployment
Economy at uN: full employment
Where is uN for the US?
Historically, uN = 5.5%
Is uN now maybe 5%?
Most other countries: uN is higher than US measure
Real GDP and the Unemployment Rate
u = uN => Y = YF, (Desired State of Economy)
u > uN => Y < YF, (Sluggish Economy)
u < uN => Y > YF, (Accelerating Economy)
Unemployment Not an Independent Problem
Real GDP Growth Increases => Employment Growth Increases
=> u decreases
Real GDP and Unemployment not independent problems
Focus of getting one of them to the desired goal, and the other
one will automatically follow (although not a perfect correlation).