ECON 2630 Principles of Macroeconomics

1. ECON 2630Principles of Macroeconomics Instructor: Dr. Ou Hu

2. Principles of Macroeconomics • Macroeconomics studies the behaviors of overall economy. • Goals of Macroeconomics • Sustainable economic growth • Full employment • Stable price

3. Topic 1 Spending, Income, and GDP Principles of Macroeconomics 3

4. Gross Domestic Product, GDP: A Definition • A nation’s gross domestic product (GDP) • Total value of all final goods and services produced for the marketplace during a given period within the nation’s borders

5. Gross Domestic Product, GDP: A Definition • The total value • Approach of GDP is to add up dollar value of every good or service—the number of dollars each product is sold for • GDP must be adjusted to take away the effects of inflation • Nominal GDP vs. Real GDP • …of all final… • When measuring production, we do not count every good or service produced in the economy • Only those that are sold to their final users • Avoids over-counting intermediate products when measuring GDP • Value of all intermediate products is automatically included in value of final products they are used to create

6. Gross Domestic Product, GDP: A Definition • …goods and services… • Goods: cars, furniture, computers, beer, etc. • Services: medical, financial, educational, etc. • …produced… • In order to contribute to GDP, something must be produced. Q: should stocks or bonds be included in the calculation of GDP?

7. Gross Domestic Product, GDP: A Definition • …for the marketplace… • GDP does not include all final goods and services produced in the economy • Includes only the ones produced for the marketplace—that is, with the intention of being sold • …during a given period… • GDP measures production during some specific period of time • Only goods produced during that period are counted how about used goods? • GDP is actually measured for each quarter, and then reported as an annual rate for the quarter • Once fourth quarter figures are in, government also reports official GDP figure for entire year

8. Gross Domestic Product, GDP: A Definition • …within the nation’s borders • U.S. GDP measures output produced within U.S. borders • Regardless of whether it was produced by Americans • Americans abroad are not counted • However, foreigners producing goods or services within the country are included: Chinese Acrobat Team, Honda, Rolling Stones

9. The Expenditure Approach to GDP • Expenditure approach divides output into four categories according to which group in the economy purchases it as final users • Consumption goods and services (C)—purchased by households • Private investment goods and services (I)—purchased by businesses • Government goods and services (G)—purchased by government agencies • Net exports (NX)—purchased by foreigners

10. The Expenditure Approach to GDP • When we add up the purchases of all four groups we get GDP GDP = C + I + G + NX

11. Consumption Spending • Consumption is the part of GDP purchased by households as final users • Almost everything households buy during the year is included as part of consumption spending when we calculate GDP • One exception is construction of new homes • Counted as private investment

12. Private Investment • Private investment has three components • Business Purchases of Plant, Equipment, and Software • A firm’s plant, equipment, and software are intended to last for many years—only a small part of them is used up to make the current year’s output • Are regarded as final goods, and firms that buy them as final users of those goods • New Home Construction • Residential housing is an important part of nation’s capital stock • House will continue to provide services into the future • Changes in Inventories • We count the change in firms’ inventories as part of investment in measuring GDP • Why? • When goods are produced but not sold during the year, they end up in some firm’s inventory stocks • Part of the nation’s capital stock • Will provide services in the future, when they are finally sold and used

13. Government Purchases • Purchases by state, local governments and federal government are included • Government purchases include • Goods • Fighter jets, police cars, school buildings, spy satellites, etc. • Services • Such as those performed by police, legislators, and military personnel • Government is considered to be a purchaser even if it actually produces the goods or services itself

14. Government Purchases • Exclude transfer payments • Transfer payments represent money redistributed from one group of citizens (taxpayers) to another (poor, unemployed, elderly) • While transfers are included in government budgets as outlays they are not purchases of currently produced goods and services • Exclude interest paid on government debt

15. Net Exports • Once we recognize dealings with the rest of the world, we must correct an inaccuracy in our measure of GDP • Deduct all U.S. imports during the year, leaving us with just output produced in United States • To properly account for output sold to, and bought from, foreigners • We must include net exports—difference between exports and imports—as part of expenditure in GDP

16. U.S. GDP 2007 (in billions)

17. Other Approaches to GDP: The Value-Added Approach • Value added • Firm’s contribution to a product or • Revenue it receives for its output • Minus cost of all the intermediate goods that it buys • GDP is sum of values added by all firms in economy

18. Other Approaches to GDP: The Factor Payments Approach • In any year, value added by a firm is equal to total factor payments made by that firm • Thus, GDP must equal total factor payments made by all firms in the economy • All of these factor payments are received by households in the form of wages and salaries, rent, interest or profit • GDP is measured by adding up all of the income—wages and salaries, rent, interest, royalties,and profit—earned by all households in the economy • Gives us an important insight into the macroeconomy • Total output of economy (GDP) is equal to total income earned in the economy

19. Measuring GDP: A Summary • Different ways to calculate GDP • Expenditure Approach • GDP = C + I + G + NX • Value-Added Approach • GDP = Sum of value added by all firms • Factor Payments Approach • GDP = Wages and Salaries + interest + rent + profit Therefore, Total output = Total household income

20. GDP Global Perspective • List of countries by total nominal GDP • List of countries by nominal GDP per capita • List of countries by GDP per capital adjusted by Purchasing Power Parity

21. Problems With GDP • Quality Changes • Underground Economy • Non-market Production • Not a perfect measure of economic well-being

22. Quality Change • While BEA includes impact of quality changes for many goods and services (such as automobiles and computers) • Does not have the resources to estimate quality changes for millions of different goods and services By ignoring these quality improvements, GDP probably understates true growth from year to year.

23. The Underground Economy • Some production is hidden from government authorities • Either because it is illegal or • Drugs, prostitution, most gambling • Because those engaged in it are avoiding taxes • Production in these hidden markets cannot be measured accurately

24. Non-Market Production • GDP does not include non-market production • Goods and services that are produced, but not sold in the marketplace • Whenever a non-market transaction becomes a market transaction GDP will rise • Even though total production has remained the same • Can exaggerate the growth in GDP over long periods of time • What do these problems tell us about value of GDP? • For certain purposes—especially interpreting long-run changes in GDP—we must exercise caution

25. Not a perfect measure of economic well-being • No value measured on leisure • “Bad” things can raise GDP. Disasters, wars, etc. • Externality – ecological cost

26. The Business Cycle • Alternating increases and decreases in economic activity over time • Phases of the business cycle • Peak • Recession • Trough • Expansion

27. Figure 1: The Business Cycle

28. The Business Cycle Source: National Bureau of Economic Research and Minneapolis Federal Reserve Bank. Output data are in 2000 dollars

29. Types of Unemployment • In United States, people are considered unemployed if they are not working AND actively seeking a job • Unemployment can arise for a variety of reasons, each with its own policy implications • This is why economists have found it useful to classify unemployment into four different categories • Frictional unemployment • Seasonal unemployment • Structural unemployment • Cyclical unemployment

30. Frictional Unemployment • Short-term joblessness experienced by people who are between jobs or who are entering the labor market for first time or after an absence • Because frictional unemployment is, by definition, short-term, it causes little hardship to those affected by it • By spending time searching rather than jumping at the first opening that comes their way • People find jobs for which they are better suited and in which they will ultimately be more productive

31. Seasonal Unemployment • Joblessness related to changes in weather, tourist patterns, or other seasonal factors • Is rather benign • Short-term • predictable • Workers are often compensated in advance for unemployment they experience in off-season • To prevent any misunderstandings, government usually reports the seasonally-adjusted rate of unemployment

32. Structural Unemployment • Joblessness arising from mismatches between workers’ skills and employers’ requirements • Or between workers’ locations and employers’ locations • Generally a stubborn, long-term problem • Often lasting several years or more

33. Cyclical Unemployment • When the economy goes into a recession and total output falls, the unemployment rate rises • Since it arises from conditions in the overall economy, cyclical unemployment is a problem for macroeconomic policy

34. Figure 2: Monthly U.S. Unemployment Rate, 1948:01–2015:03

35. Figure 3: Unemployment in Western Europe, 1980 - 2007

36. High Unemployment in Europe • Unemployment rates have increased since 1980 • 2007 unemployment rates Structural rigidities explain persistently high rates • Regulated labor markets • High minimum wages • Generous unemployment benefits • Powerful labor unions

37. Definition of Full Employment • Natural Rate of Unemployment (NRU) • Full employment level of unemployment • Can vary over time • Demographic changes • Changing job search methods • Public policy changes • Actual unemployment can be above or fall below the NRU

38. Economic Cost of Unemployment • GDP Gap • GDP gap = actual GDP – potential GDP • Can be negative or positive • Okun’s Law • Every 1% of cyclical unemployment creates a 2% GDP gap

39. How Unemployment is Measured • The unemployed are those willing and able to work, and who are actively searching for jobs • Others were able to work, but preferred not to • Including millions of college students, homemakers, and retired people • Still others not counted when calculating civilian employment statistics In the military, in hospital, and in prison

40. Figure 4: Employment Status of the U.S. Population – An Illustration

41. Figure 5: How BLS Measures Employment Status

42. US Employment Data, Jan 2008

43. Problems In Measuring Unemployment • Treatment of involuntary part-time workers • Some economists have suggested that involuntary part-time workers should be regarded as partially employed and partially unemployed • Treatment of discouraged workers • Individuals who would like to work but, because they feel little hope of finding a job, have given up searching

44. Some Data Sources • Bureau of Economic Analysis • Federal Reserve Bank of St. Louis