Ragan: Economics

Sixteenth Canadian Edition

Chapter 19
What Macroeconomics Is All
About

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Chapter Outline/Learning Objectives
Section
Blank
19.1 Key Macroeconomic Variables
19.2 Growth Versus Fluctuations
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Learning Objectives
After studying this chapter, you will be able to
1. define the key macroeconomic variables:
national income, unemployment, productivity,
inflation, interest rates, exchange rates, and
net exports.
2. understand that most macroeconomic issues
are about either long-run trends or short-run
fluctuations, and that government policy is
relevant for both.
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19.1 Key Macroeconomic Variables (1 of 4)
• National Product and National Income
• The production of output generates income.
• The meaning of aggregation
– This gives nominal national income, which is total
national income measured in current dollars.

• Real national income is national income

measured in constant (base-period) dollars. It
changes only when quantities change.

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19.1 Key Macroeconomic Variables (2 of 4)
• One of the most commonly used measures of
national income is called gross domestic product
(GDP).
• GDP can be measured in real or nominal terms.
• The major movement of real GDP is a positive
trend that increased real output by approximately
four times since 1965. This is referred to as long-
term economic growth.
• Real GDP also shows short-term fluctuations
around the trend.
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Growth and Fluctuations in Real GDP,
1965–2017 Figure 19-1

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19.1 Key Macroeconomic Variables (3 of 4)
• The Business cycle
– Trough
– Recession
– Recovery
– Peak

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19.1 Key Macroeconomic Variables (4 of 4)
• Potential output (Y*)

• The output gap measures the difference

between potential output and actual output.

Output Gap = Y − Y*
• When Y < Y*, the output gap is a recessionary
gap.

• When Y > Y*, the output gap is an inflationary

gap.
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Potential GDP and the Output Gap,
1985–2017 Figure 19-2

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Why National Income Matters
• National income is an important measure of
economic performance
• Recessions are associated with unemployment
and lost output
• Booms can bring inflation
• The long-run trend in real per capita is an
important determinant of standard of living.
• Economics grow doesn’t make everyone better off

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Employment, Unemployment, and the
Labour Force (1 of 3)
• Employment
• Unemployment
• Labour force
• Unemployment rate

Number of people unemployed

Unemployment rate  100
Number of people in the labour force

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Employment, Unemployment, and the
Labour Force (2 of 3)
• Potential GDP ‒ full employment.

• Even when the economy is at full employment,

some unemployment exists because of natural
turnover in the labour market (frictional
unemployment) and the mismatch between jobs
and workers (structural unemployment).

• When real GDP is less than potential GDP, there

is cyclical unemployment.

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Labour Force, Employment, and
Unemployment, 1960–2018 Figure 19-3

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Employment, Unemployment, and the
Labour Force (3 of 3)
• Employment has grown roughly in line with the
growth in the labour force.
• The data also shows that the short-term
fluctuations in the unemployment rate have been
substantial.
• The unemployment rate has been as low as 3.4
percent in 1966 and as high as 12 percent during
the deep recession of 1982.

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Why Unemployment Matters
• Enormous social significance

• Loss of income

• Loss of output

• Crime, mental illness, and general social unrest

tend to be associated with long-term
unemployment

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Productivity
• Productivity is a measure of the amount of output
that the economy produces per unit of input.
• Labour productivity is the level of real GDP
divided by the level of employment (or total hours
worked).
• There has been a significant increase in labour
productivity over the past four decades.
• Productivity growth is the single largest cause of
rising material living standards over long periods of
time.
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Canadian Labour Productivity, 1976–2017
Figure 19-4

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Inflation and Price Level
• The price level is the average level of all prices in
the economy expressed as an index number.

• Inflation

• The Consumer Price Index (CPI)

• Rate of inflation calculation with CPI data

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Why Inflation Matters (1 of 2)
• We value money not for itself but for what we can
purchase with it.

• The purchasing power of money is the amount of

goods and services that can be purchased with a
unit of money.
• Inflation reduces the purchasing power of money.
It also reduces the real value of any sum fixed in
nominal (dollar) terms.

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Why Inflation Matters (2 of 2)
• If households and firms fully anticipate inflation over
the coming year, they will be able to adjust many
nominal prices and wages to maintain their real values.
• Unanticipated inflation generally leads to more
changes in the real value of prices and wages.
• In reality, inflation is rarely fully anticipated or fully
anticipated.
• As a result, some adjustments in wages and prices are
made but not all the adjustments that would be
required to leave the economy’s allocation of resources
unaffected.
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The Price Level and the Inflation Rate,
1960–2018 Figure 19-5

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Interest Rates
• The interest rate is the price paid per dollar
borrowed per period of time, expressed either
as a proportion (e.g., 0.06) or as a percentage
(e.g., 6 percent)
• Compare the prime interest rate to the bank rate
• Nominal interest rate vs. real interest rate
• Why do interest rates matter?
– Compare effects on savers to that on borrowers
– Impact on investment plans
• Interest rates and credit flows
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Real and Nominal Interest Rates, 1965–2018
Figure 19-6

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Exchange Rates and Trade Flows (1 of 3)
• In June 2018 you could buy 0.66 euros for each
dollar that you gave up. Or you could buy 1 euro for
1.52 dollars.
• The exchange rate
• Foreign currency
• The foreign-exchange market
• Appreciation vs. depreciation

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Canadian–U.S. Dollar Exchange Rate,
1970–2018 Figure 19-7

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Exchange Rates and Trade Flows (2 of 3)
• In Canada, the path of the trade-weighted
exchange rate is virtually identical to the
Canadian–U.S. exchange rate shown in
Figure 19-7, reflecting the very large proportion
of total Canadian trade with the United States.
• Two notable periods:
– Depreciation of CDN$ in late s1990s
– Appreciation of CDN$ during 2002‒2012

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Exchange Rates and Trade Flows (3 of 3)
• Canada has long been a trading nation
• Compare the history of the relative size of exports to
imports
• Net exports are the difference between exports and
imports and are often called the trade balance.
• Canada’s exports and imports have increased fairly
closely in step with each other over the past 45 years.
• The trade balance has fluctuated mildly over the years,
but it has stayed relatively small, as a proportion of
total GDP.
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Canadian Imports, Exports, and Net
Exports, 1970–2017 Figure 19-8

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19.2 Growth Versus Fluctuations
• Long-Term Economic Growth

– Long-term trends of rising total output and output per person

have meant rising average living standards.

– Long-term growth receives less attention in the media but has

more importance for a society’s living standards from
generation to generation.

– There is considerable debate regarding the ability of

government policy to influence the economy’s long-run
rate of growth.

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Short-Term Fluctuations
• Short-term fluctuations lead economists to study
business cycles.

• Economists debate the effectiveness of monetary

and fiscal policy in influencing these fluctuations.

• Some economists argue that despite the power of

policy to affect the economy, governments should
not attempt to “fine-tune” the economy by making
frequent changes in spending and taxing.

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