Macroeconomics II

1. Macroeconomics II Ondřej Krčál Department of Economics Office 611 Consultation hours: Tuesday 16:30 – 18:00 E-mail: krcalo@mail.muni.cz CHAPTER 1 The Science of Macroeconomics

2. Literature MANKIW, G. (2010): Macroeconomics. 7th edition. Worth Publishers. CHAPTER 1 The Science of Macroeconomics

3. Exam • Test – 40 questions a/b/c/d (1 correct answer) • Correct answer +1 p., wrong answer -0.5 p., no answer 0 p. • A: 34 - 40 points • B: 31 – 33,5 points • C: 28 – 30,5 points • D: 25 – 27,5 points • E: 22 – 24,5 points • F: 21,5 points and less CHAPTER 1 The Science of Macroeconomics

4. 1 The Science of Macroeconomics

5. Learning Objectives This chapter introduces you to • the issues macroeconomists study • the tools macroeconomists use • some important concepts in macroeconomic analysis CHAPTER 1 The Science of Macroeconomics

6. Important issues in macroeconomics Macroeconomics, the study of the economy as a whole, addresses many topical issues: • What causes recessions? Can the government do anything to combat recessions? Should it? • What is the government budget deficit? How does it affect the economy? • Why does the U.S. have such a huge trade deficit? CHAPTER 1 The Science of Macroeconomics

7. Important issues in macroeconomics Macroeconomics, the study of the economy as a whole, addresses many topical issues: • Why are millions of people unemployed, even when the economy is booming? • Why does the cost of living keep rising? • Why are so many countries poor? What policies might help them grow out of poverty? CHAPTER 1 The Science of Macroeconomics

8. 9/11/2001 First oil price shock Great Depression Second oil price shock World War II U.S. Real GDP per capita (2000 dollars) long-run upward trend… CHAPTER 1 The Science of Macroeconomics

9. U.S. inflation rate(% per year) CHAPTER 1 The Science of Macroeconomics

10. U.S. unemployment rate(% of labor force) CHAPTER 1 The Science of Macroeconomics

11. U.S. Unemployment and Property Crime Rates property crime (right scale) crimes per 100,000 population percent of labor force unemployment (left scale) Why learn macroeconomics? 1. The macroeconomy affects society’s well-being. Social problems like homelessness, domestic violence, crime, and poverty are linked to the economy. For example… CHAPTER 1 The Science of Macroeconomics

12. change from 12 mos earlier percent change from 12 mos earlier Why learn macroeconomics? 2. The macroeconomy affects your well-being. In most years, wage growth falls when unemployment is rising. CHAPTER 1 The Science of Macroeconomics

13. Why learn macroeconomics? Unemployment & inflation in election years year U rate inflation rate elec. outcome 1976 7.7% 5.8% Carter (D) 1980 7.1% 13.5% Reagan (R) 1984 7.5% 4.3% Reagan (R) 1988 5.5% 4.1% Bush I (R) 1992 7.5% 3.0% Clinton (D) 1996 5.4% 3.3% Clinton (D) 2000 4.0% 3.4% Bush II (R) 2004 5.5% 3.3% Bush II (R) 3. The macroeconomy affects politics. CHAPTER 1 The Science of Macroeconomics

14. Economic models …are simplified versions of a more complex reality • irrelevant details are stripped away …are used to • show relationships between variables • explain the economy’s behavior • devise policies to improve economic performance CHAPTER 1 The Science of Macroeconomics

15. Example of a model:Supply & demand for new cars • shows how various events affect price and quantity of cars • assumes the market is competitive: each buyer and seller is too small to affect the market price • Variables: Qd = quantity of cars that buyers demand Qs = quantity that producers supply P = price of new cars Y = aggregate income Ps = price of steel (an input) CHAPTER 1 The Science of Macroeconomics

16. D The market for cars: Demand P Price of cars The demand curve shows the relationship between quantity demanded and price, other things equal. Q Quantity of cars CHAPTER 1 The Science of Macroeconomics

17. P Price of cars S The supply curve shows the relationship between quantity supplied and price, other things equal. D Q Quantity of cars The market for cars: Supply CHAPTER 1 The Science of Macroeconomics

18. P Price of cars S equilibrium price Q Quantity of cars D equilibriumquantity The market for cars: Equilibrium CHAPTER 1 The Science of Macroeconomics

19. P Price of cars S P2 P1 D2 D1 Q Quantity of cars Q1 Q2 The effects of an increase in income An increase in income increases the quantity of cars consumers demand at each price… …which increases the equilibrium price and quantity. CHAPTER 1 The Science of Macroeconomics

20. P Price of cars S2 S1 P2 P1 D Q Quantity of cars Q2 Q1 The effects of a steel price increase An increase in Ps reduces the quantity of cars producers supply at each price… …which increases the market price and reduces the quantity. CHAPTER 1 The Science of Macroeconomics

21. Endogenous vs. exogenous variables • The values of endogenous variables are determined in the model. • The values of exogenous variables are determined outside the model: the model takes their values & behavior as given. • In the model of supply & demand for cars, CHAPTER 1 The Science of Macroeconomics

22. A multitude of models • No one model can address all the issues we care about. • e.g., our supply-demand model of the car market… • can tell us how a fall in aggregate income affects price & quantity of cars. • cannot tell us why aggregate income falls. CHAPTER 1 The Science of Macroeconomics

23. A multitude of models • So we will learn different models for studying different issues (e.g., unemployment, inflation, long-run growth). • For each new model, you should keep track of • its assumptions • which variables are endogenous, which are exogenous • the questions it can help us understand, and those it cannot CHAPTER 1 The Science of Macroeconomics

24. Chapter Summary • Macroeconomics is the study of the economy as a whole. • Macroeconomists attempt to explain the economy and to devise policies to improve its performance. • Economists use different models to examine different issues. CHAPTER 1 The Science of Macroeconomics slide 23

25. 2 The Data of Macroeconomics

26. In this chapter, you will learn… …the meaning and measurement of the most important macroeconomic statistics: • Gross Domestic Product (GDP) • The Consumer Price Index (CPI) • The unemployment rate CHAPTER 1 The Science of Macroeconomics

27. Gross Domestic Product: Expenditure and Income Two definitions: • Total expenditure on domestically-produced final goods and services. • Total income earned by domestically-located factors of production. Expenditure equals income because every dollar spent by a buyer becomes income to the seller. CHAPTER 1 The Science of Macroeconomics

28. Income ($) Labor Goods Expenditure ($) The Circular Flow Firms Households CHAPTER 1 The Science of Macroeconomics

29. The expenditure components of GDP • consumption • investment • government spending • net exports CHAPTER 1 The Science of Macroeconomics

30. Consumption (C) definition: The value of all goods and services bought by households. Includes: • durable goodslast a long time ex: cars, home appliances • nondurable goodslast a short time ex: food, clothing • serviceswork done for consumers ex: dry cleaning, air travel. CHAPTER 1 The Science of Macroeconomics

31. U.S. consumption, 2006 $ billions % of GDP Consumption Durables 1,070.3 8.1 Nondurables 2,714.9 20.5 Services 5,483.7 41.4 $9,268.9 70.0% CHAPTER 1 The Science of Macroeconomics

32. Investment (I) Definition 1: Spending on [the factor of production] capital. Definition 2: Spending on goods bought for future use Includes: • business fixed investmentSpending on plant and equipment that firms will use to produce other goods & services. • residential fixed investmentSpending on housing units by consumers and landlords. • inventory investmentThe change in the value of all firms’ inventories. CHAPTER 1 The Science of Macroeconomics

33. U.S. investment, 2006 $ billions % of GDP Investment Business fixed 1,396.2 10.5 Residential 766.7 5.8 Inventory 49.6 0.4 $2,212.5 16.7% CHAPTER 1 The Science of Macroeconomics

34. Flow Stock Stocks vs. Flows A stock is a quantity measured at a point in time. E.g., “The U.S. capital stock was $26 trillion on January 1, 2006.” A flow is a quantity measured per unit of time. E.g., “U.S. investment was $2.5 trillion during 2006.” CHAPTER 1 The Science of Macroeconomics

35. Stocks vs. Flows - examples stock flow a person’s wealth a person’s annual saving # of people with college degrees # of new college graduates this year the govt debt the govt budget deficit CHAPTER 1 The Science of Macroeconomics

36. Government spending (G) • G includes all government spending on goods and services.. • G excludes transfer payments (e.g., unemployment insurance payments), because they do not represent spending on goods and services. CHAPTER 1 The Science of Macroeconomics

37. U.S. government spending, 2006 926.6 7.0 305.6 2.3 621.0 4.7 1,601.1 12.1 $ billions % of GDP Govt spending $2,527.7 19.1% Federal Non-defense Defense State & local CHAPTER 1 The Science of Macroeconomics

38. Net exports: NX = EX – IM def: The value of total exports (EX) minus the value of total imports (IM).

39. aggregate expenditure value of total output An important identity Y = C + I + G + NX CHAPTER 1 The Science of Macroeconomics

40. A question for you: Suppose a firm • produces $10 million worth of final goods • but only sells $9 million worth. Does this violate the expenditure = output identity? CHAPTER 1 The Science of Macroeconomics

41. Why output = expenditure • Unsold output goes into inventory, and is counted as “inventory investment”… …whether or not the inventory buildup was intentional. • In effect, we are assuming that firms purchase their unsold output. CHAPTER 1 The Science of Macroeconomics

42. GNP vs. GDP • Gross National Product (GNP):Total income earned by the nation’s factors of production, regardless of where located. • Gross Domestic Product (GDP):Total income earned by domestically-located factors of production, regardless of nationality. (GNP – GDP) = (factor payments from abroad) – (factor payments to abroad) CHAPTER 1 The Science of Macroeconomics

43. (HNP – HDP) jako %HDP vybrané země, 2005 ČR: 2010 zdroje: World Development Indicators, World Bank Makroekonomická predikce MFČR CHAPTER 1 The Science of Macroeconomics

44. Real vs. nominal GDP • GDP is the value of all final goods and services produced. • nominal GDP measures these values using current prices. • real GDPmeasure these values using the prices of a base year. CHAPTER 1 The Science of Macroeconomics

45. Practice problem, part 1 • Compute nominal GDP in each year. • Compute real GDP in each year using 2006 as the base year. CHAPTER 1 The Science of Macroeconomics

46. Answers to practice problem, part 1 nominal GDPmultiply Ps & Qs from same year2006: $46,200 = $30  900 + $100  192 2007: $51,400 2008: $58,300 real GDPmultiply each year’s Qs by 2006 Ps2006: $46,2002007: $50,000 2008: $52,000 = $30  1050 + $100  205 CHAPTER 1 The Science of Macroeconomics

47. Real GDP controls for inflation Changes in nominal GDP can be due to: • changes in prices. • changes in quantities of output produced. Changes in real GDP can only be due to changes in quantities, because real GDP is constructed using constant base-year prices. CHAPTER 1 The Science of Macroeconomics

48. U.S. Nominal and Real GDP, 1950–2007 Real GDP(in 2000 dollars) Nominal GDP CHAPTER 1 The Science of Macroeconomics

49. GDP Deflator • The inflation rateis the percentage increase in the overall level of prices. • One measure of the price level is the GDP deflator, defined as CHAPTER 1 The Science of Macroeconomics

50. Practice problem, part 2 • Use your previous answers to compute the GDP deflator in each year. • Use GDP deflator to compute the inflation rate from 2006 to 2007, and from 2007 to 2008. CHAPTER 1 The Science of Macroeconomics