Introduction to Macroeconomics

1. Introduction to Macroeconomics

2. Learning Objectives • Define gross domestic product and explain how it is measured using the expenditure approach. • Explain the difference between nominal and real GDP.

3. GDP Dating Exercise • Describe the empirical facts before you (ie. GDP generally increases). • Identify peaks, valleys what happened. • Is there regularity in the frequency of changes?

4. Expansion and Contraction:The Business Cycle • An expansion, or boom, is the period in the business cycle from a trough up to a peak, during which output and employment rise. • A contraction, recession, or slump is the period in the business cycle from a peak down to a trough, during which output and employment fall.

5. Real GDP, 1900-2002

6. Real GDP, 1970 I-2003 II

7. Introduction to Macroeconomics • Microeconomics examines the behavior of individual decision-making units—business firms and households. • Macroeconomics deals with the economy as a whole; it examines the behavior of economic aggregates such as aggregate income, consumption, investment, and the overall level of prices. • Aggregate behavior refers to the behavior of all households and firms together.

8. Introduction to Macroeconomics • Microeconomists generally conclude that markets work well. Macroeconomists, however, observe that some important prices often seem “sticky.” • Sticky prices are prices that do not always adjust rapidly to maintain the equality between quantity supplied and quantity demanded.

9. The Roots of Macroeconomics • The Great Depression was a period of severe economic contraction and high unemployment that began in 1929 and continued throughout the 1930s.

10. The Roots of Macroeconomics • Classical economists applied microeconomic models, or “market clearing” models, to economy-wide problems. • However, simple classical models failed to explain the prolonged existence of high unemployment during the Great Depression. This provided the impetus for the development of macroeconomics.

11. The Roots of Macroeconomics • In 1936, John Maynard Keynes published The General Theory of Employment, Interest, and Money. • Keynes believed governments could intervene in the economy and affect the level of output and employment. • During periods of low private demand, the government can stimulate aggregate demand to lift the economy out of recession.

12. Recent Macroeconomic History • Fine-tuning was the phrase used by Walter Heller to refer to the government’s role in regulating inflation and unemployment. • The use of Keynesian policy to fine-tune the economy in the 1960s, led to disillusionment in the 1970s and early 1980s.

13. Recent Macroeconomic History • Stagflation occurs when the overall price level rises rapidly (inflation) during periods of recession or high and persistent unemployment (stagnation).

14. Macroeconomic Concerns • Three of the major concerns of macroeconomics are: • Inflation • Unemployment • Output growth

15. Output Growth:Short Run and Long Run • The business cycle is the cycle of short-term ups and downs in the economy. • The main measure of how an economy is doing is aggregate output: • Aggregate output is the total quantity of goods and services produced in an economy in a given period.

16. Output Growth:Short Run and Long Run • A recession is a period during which aggregate output declines. Two consecutive quarters of decrease in output signal a recession. • A prolonged and deep recession becomes a depression. • Policy makers attempt not only to smooth fluctuations in output during a business cycle but also to increase the growth rate of output in the long-run.

17. Aggregate Supply andAggregate Demand • Aggregate demand is the total demand for goods and services in an economy. • Aggregate supply is the total supply of goods and services in an economy. • Aggregate supply and demand curves are more complex than simple market supply and demand curves.

18. Government in the Macroeconomy • There are three kinds of policy that the government has used to influence the macroeconomy: • Fiscal policy • Monetary policy • Growth or supply-side policies

19. The Components ofthe Macroeconomy • Everyone’s expenditure is someone else’s receipt. Every transaction must have two sides.

20. An Overview of National Income and Product Accounting (NIPA) • Detailed calculations were first worked out by Simon Kuznets during the Great Depression • Large quantities of data collected and organized from a variety of sources around the country • These data are summarized, assembled into a coherent framework, and reported by the government

21. Gross Domestic Product and Gross National Product • GDP is the market value of all newly produced final goods and services produced by resources located in the United States, regardless of who owns those resources

22. Final and Intermediate Goods and Services • Final goods and services sold to ultimate, users • Cotton shirts are a final good • Intermediate goods and services are purchased for further reprocessing and resale • Cotton is intermediate good • Keeping final goods and intermediate goods separate in our thinking allows us to avoid double counting

23. Calculating GDP GDP can be computed in two ways: • The expenditure approach: A method of computing GDP that measures the total amount spent on all final goods during a given period. • The income approach:

24. The Expenditure Approach • The expenditure approach calculates GDP by adding together the four components of spending. In equation form:

25. X-M consumption (C) Investment (I) Financial markets S C+I+G+X-M Gov’t (G) transfer payments aggregate income = GDP taxes Disposable income The Circular Flow of Income and Expenditure

26. Categories of Expenditures • Consumption (C) • All household purchases (blue jeans, twinkies, etc.) • Investment (I) • Purchases not used for current consumption (newly built homes,plant, new inventories) • Government Purchases (G) • Examples include missile systems and paper clips • Net Exports (X - M) • Net exports = exports (X) - imports (M)

27. Personal Consumption Expenditures • Personal consumption expenditures (C) are expenditures by consumers on the following: • Durable goods: Goods that last a relatively long time, such as cars and appliances. • Nondurable goods: Goods that are used up fairly quickly, such as food and clothing. • Services: Things that do not involve the production of physical things, such as legal services, medical services, and education.

28. Gross Private Domestic Investment • Investment refers to the purchase of new capital. • Total investment by the private sector is called gross private domestic investment. It includes the purchase of new housing, plants, equipment, and inventory by the private sector.

29. Gross Private Domestic Investment • Nonresidential investment includes expenditures by firms for machines, tools, plants, and so on. • Residential investment includes expenditures by households and firms on new houses and apartment buildings. • Change in inventories computes the amount by which firms’ inventories change during a given period. Inventories are the goods that firms produce now but intend to sell later.

30. Government Consumptionand Gross Investment • Government consumption and gross investment (G) counts expenditures by federal, state, and local governments for final goods and services.

31. Net Exports • Net exports (EX – IM) is the difference between exports and imports. The figure can be positive or negative. • Exports (EX) are sales to foreigners of U.S.-produced goods and services. • Imports (IM) are U.S. purchases of goods and services from abroad).

32. Classify each of these scenarios • You buy an old house • You buy some marijuana from a friend • You buy stock in GM • A Japanese firm buys City Brewery • The government makes a welfare payment • You buy a used car • A business fails to sell some of its inventory • A business buys a new truck

34. Current and Historical Data • US data (BEA) • http://www.bea.doc.gov/bea/newsrel/gdp499p.htm • Historical US Data • http://eh.net/hmit/gdp/ • International • http://www.stls.frb.org/publications/iet/ • http://www.odci.gov/cia/publications/factbook/

35. GDP and Social Welfare • Society is better off when crime decreases, however, a decrease in crime is not reflected in GDP. • An increase in leisure is an increase in social welfare, but not counted in GDP. • Nonmarket and household activities are not counted in GDP even though they amount to real production.

36. GDP and Social Welfare • GDP accounting rules do not adjust for production that pollutes the environment. • GDP has nothing to say about the distribution of output. Redistributive income policies have no direct impact on GDP. • GDP is neutral to the kinds of goods an economy produces.

37. The Underground Economy • The underground economy is the part of an economy in which transactions take place and in which income is generated that is unreported and therefore not counted in GDP.

38. Gross National Income per Capita • To make comparisons of GNP between countries, currency exchange rates must be taken into account. • Gross National Income (GNI) is a measure used to make international comparisons of output. GNI is GNP converted into dollars using an average of currency exchange rates over several years adjusted for rates of inflation. • GNI divided by population equals gross national income per capita.

40. Accounting for Price Changes

41. Nominal Versus Real GDP • Nominal GDP is GDP measured in current dollars, or the current prices we pay for things. Nominal GDP includes all the components of GDP valued at their current prices. • When a variable is measured in current dollars, it is described in nominal terms.

42. Real GDP • Real GDP is the value of GDP measure in terms of dollars of fixed purchasing power • Real GDP is measured in the dollars of the base year • The base year is a reference year against which other years are measured

43. The Simplest Example of a Price Index (One Product)

44. The GDP Price Index, Nominal GDP, and Real GDP • The GDP price index is a comprehensive price index of all goods and services included in the gross domestic product

45. Calculating Real GDP • A weight is the importance attached to an item within a group of items. • A base year is the year chosen for the weights in a fixed-weight procedure. • A fixed-weight procedure uses weights from a given base year.

46. Calculating Real GDP

47. The Problems of Fixed Weights • Structural changes in the economy. • Supply shifts, which cause large decreases in price and large increases in quantity supplied. • The substitution effect of price increases. The use of fixed price weights to estimate real GDP leads to problems because it ignores:

48. Hypothetical Data Used to Develop Chain-Weighted Indexes

49. Calculating the GDP Deflator • The GDP deflator is one measure of the overall price level. The GDP deflator is computed by the Bureau of Economic Analysis (BEA). • Overall price increases can be sensitive to the choice of the base year. For this reason, using fixed-price weights to compute real GDP has some problems.

50. Appendix • Slides after this point will most likely not be covered in class. However they may contain useful definitions, or further elaborate on important concepts, particularly materials covered in the text book. • They may contain examples I’ve used in the past, or slides I just don’t want to delete as I may use them in the future.