11.0 Introduction to Macroeconomics

11.1.1

We will now shift perspectives

We will look at the economy as a whole

11.1.2

The difference between macro and micro

Macro perspective on war

Micro perspective on war

Life is lived at the micro level,

But the wholeness of the social experience

is aggregated into a macro picture

11.1.3

Macro : Micro :: Forest: Trees

However, just like

a forest is more than individual trees,

the macroeconomy is more than just all the individual markets put together

the whole is greater than the sum of its parts

11.1.4

The micro system is the foundation for macro events

For example – Pareto optimality in the micro system means full employment and maximum production at the national level

Market power and its resulting inefficiency means unemployed resources in the macroeconomy

11.1.5 Basic Macro questions

Why doesn’t the economy always produce up to its full capacity?

Ex. Great Depression

Why are resources (like people) unemployed? What causes this to persist? Can high unemployment happen again?

What causes the cost of living to go up? Why does inflation occur, and can it occur again?

Is it possible to live in an economy with steady growth, full employment and stable prices?

11.1.6 On policy

Most economists lie on a continuum between

intervention and non-intervention

Therefore, there are differing opinions as to what are appropriate policies

for macro problems

11.1.7 Preview

Same approach as before

Defining terms

Assembling a model

Applying the model to historical and current cases

11.2.1

Defining terms

11.2.2

Gross Domestic Product (GDP) –

value of all new production in the nation in the year

Full, sustainable capacity GDP – greatest level of production the economy can sustain over athe long haul

We’ll call this full GDP

Actual GDP – how much the nation is currently producing

Can be near full GDP (healthy)

Or fall far short of full GDP (not healthy)

Recession-

2 quarters (6 months) of falling actual GDP

Depression –

Prolonged period of declining GDP

11.2.3

GDP is a very important number, but it doesn’t tell the whole story Increased production may benefit only a fewMore production may not always be good – Ex. Harvesting all trees will definitely

increase GDPWhat are you producing? Computer chips

vs. potato chips

11.2.4

Labor force – all those participating in or making themselves available to participate in productive activity

Voluntarily unemployed – not looking for work, not counted in the labor force

Labor force has two parts

Employed – have a job

Unemployed – don’t have a job but want one

Unemployment rate-

Percentage of the labor force that is unemployed

Great Depression- 25%WWII – 1%Currently- 5%

There are different reasons why people are unemployed

11.2.5

Frictional unemployment- people are looking for work, and there are appropriate jobs, they just haven’t found it yet

Job search process takes timeEx. Recent college graduateFrictional unemployment exists even in

the best of economic times

Job search process

$

Figure 11.2.1 - Marginal Benefits/Marginal Costs of Search and Stop Point

Search

MC

MB

Stop

11.2.6

Structural unemployment – mismatch between people and jobs

Can be caused by technological or geographic changes

Always an issue in a dynamic, changing economy

11.2.7

Economists expect to find both frictional and structural unemployment

These two together are called the natural rate of unemployment

Full employment means at the natural rateFull employment does NOT mean zero

percent unemploymentNatural rate is generally believed to be

between 4 and 7%

11.2.8

Demand-deficient unemployment-

Not enough jobs for those who want one

Loss of productive capacity, plus many other social costs

1929 – 3.2%

1933 – 25%

Great Depression

11.2.9

Inflation – rise in the overall level of prices, or a fall in the purchasing power of money

Deflation – fall in the overall level of prices, or a rise in the purchasing power of money

It is important to distinguish

between relative price changes (one market)

and inflation (overall level of prices)

11.2.10

Inflation imposes costs on an economy

Efficiency cost - money loses some of the useful roles it usually plays

Hyperinflation – unbelievably high inflation – Germany after WWI

Money ceases to become a store of value, a medium of exchange, or a unit of account

Another cost of inflation

Equity cost- when inflation causes a redistribution of wealth

People with a fixed wage lose value because money is worth less and less

Those who can’t take steps to account for inflation fall further and further behind

11.2.11

Indexing – automatically adjusting payments for wages/loans to account for inflation

Ex. If Inflation goes up 10%, your paycheck goes up 10%

COLA – cost of living adjustment

Social Security is indexed

11.2.12

Nominal value- the actual number, the face value

Real value- the underlying true valueEx. Earning $10,000 a year in 1963 vs.Earning $10,000 a year in 2006Nominally, they are the sameIn real terms, 1963 was worth much more

because of inflation

Knowing the difference between

real and nominal values will help us compare things over time more accurately

11.2.13

Charts page 170-171Nominal GDP is risingHowever, so is price levelReal GDP is falling, unemployment

skyrocketingSevere recessionReal is a much better measure of what is

happening

11.2.14

Real values are immediately useful for comparisons over time

Nominal values must also be accompanied by data on price level that allow you to convert to real to be useful over time

11.2.15

Two methods to measure the price level

Price index

Price deflator

We’ll start with a price index

Most common price index-

CPI – Consumer Price IndexGovernment selects a “market basket” of

goods that a typical household consumesFood, clothes, housing, transportation, etc.As an orientation point, the government

chooses a base yearEverything gets measured against the base

year

Target year

the year whose price level you are trying to determine

Calculating CPI

Pmb in target year / Pmb in base year X 100

Base year will always have a value of 100If 5095/4450 X 100 = 114Then 114 is the price index for that target

yearIt takes 114 cents to buy what used to cost

100 cents in the base year

The GDP deflator

Measures prices for all the items in the GDP, not just consumer goods

One can use these measures

to calculate the inflation rate

CPItarget /CPIbase year X 100%

114/100 X 100% = 14%

This tool allows use to transform nominal values into real values

11.2.16

Nominal value = (Real value) X (Price level)

Or

(Nominal value) / (Price level) = Real value

When comparing over time,

Keep it real