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Economics 2 Professor Christina Romer Spring 2016 Professor David Romer

LECTURE 17

MACROECONOMIC VARIABLES AND ISSUES

March 17, 2016

I. MACROECONOMICS VERSUS MICROECONOMICS

II. REAL GDP

A. Definition

B. Nominal GDP and real GDP

C. A little about measuring GDP

D. Facts

1. Strong upward trend

2. Huge differences across countries

3. Short-run fluctuations

III. UNEMPLOYMENT A. Measurement B. Facts

1. The normal unemployment rate is not zero

2. Fluctuations in unemployment are negatively correlated with real GDP growth

IV. INFLATION

A. Measurement

B. Facts

C. Why do we care about inflation?

D. Adjusting for price changes

E. Unmeasured quality changes

V. OVERVIEW OF MACRO FRAMEWORK

LECTURE 17 Macroeconomic Variables and Issues

March 17, 2016

Economics 2 Christina Romer Spring 2016 David Romer

Announcements

• Problem Set 4 is being distributed:

• Due Thursday, March 31st.

• Same ground rules apply.

• There will be a problem set work session on Tuesday, March 29th, 5–7 p.m. in 648 Evans Hall.

Announcements (continued)

• Research reading for Tuesday, March 29 (by William Nordhaus):

• Read only the assigned pages.

• Read for approach and findings; think about relevance for the measurement of inflation and growth in standards of living.

I. MACROECONOMICS VERSUS MICROECONOMICS

Macroeconomics

• Definition:

• The study of the aggregate economy.

• Concerned with:

• Total output.

• Aggregate price level and inflation.

• The unemployment rate.

• The overall level of interest rates; the exchange rate; overall exports and imports.

II. REAL GDP

Real Gross Domestic Product (Real GDP)

• The market value of the final goods and services newly produced in a country during some period of time, adjusted for price changes.

Nominal GDP

• Nominal GDP: The market value of the final goods and services newly produced in a country during some period of time, not adjusted for price changes.

• Thus, for the United States, it is measured in dollars.

• Example: Nominal GDP in 2015 = ∑ Pi,2015 • Qi,2015,i

where i represents each possible good in the economy (and ∑ is the symbol for a sum).

• Note that we use 2015 prices in computing 2015 nominal GDP, 2014 prices in computing 2014 nominal GDP, ….

Calculating Real GDP

• Choose a base year (for example, 2009), and always use prices from the base year to multiply the quantities.

• Example: If 2009 is the base year:

2015 real GDP = ∑ Pi,2009 • Qi,2015.i

• That is, if 2009 is the base year, 2015 real GDP is the answer to the question, “How much would all the final goods and services newly produced in the United States in 2015 have been worth at 2009 prices?”

Growth Rate of Real GDP

• The percentage change in real GDP from one year to the next.

A Little about Measuring GDP

• Key points:

• Final goods and services.

• Newly produced.

• Within the country.

3 Approaches to Measuring GDP

• Expenditure: Use market prices and the quantities of final goods.

• Can divide into consumption (C), investment (I), government purchases (G), and net exports (NX).

• Production (value added): follow goods through each stage of production.

• Income: Income from producing new goods and services within the country.

• Can divide into labor income and capital income.

Real GDP in the United States, 1950–2015

Source: FRED (Federal Reserve Economic Data); data from Bureau of Economic Analysis.

Real GDP per Capita in the U.S., 1950–2015

Source: FRED; data from Bureau of Economic Analysis.

GDP per Capita over Time and Regions

Source: Bloom and Sachs, “Geography, Demography, and Economic Growth in Africa.”

U.S. Real GDP, 2004–2011

Source: FRED; data from Bureau of Economic Analysis.

U.S. Real GDP, 1929–1940

Source: FRED; data from Bureau of Economic Analysis.

U.S. Real GDP, 2011–2015

Source: FRED; data from Bureau of Economic Analysis.

III. UNEMPLOYMENT

Definitions

• Employed: The number of people who are working.

• Unemployed: The number of people who are not working and who are actively looking for work.

• Labor force: Employed + unemployed.

• Unemployment rate:

u = UnemployedLabor force

• 100.

The U.S. Unemployment Rate, 1948–2016

Source: FRED; data from Bureau of Labor Statistics.

The Natural Rate of Unemployment

• The economy’s normal or usual unemployment rate.

• The natural rate of unemployment is more than zero.

Real GDP Growth (Percent, Red) and Change in the Unemp. Rate (Percentage Points, Blue), 1961–2015

Source: FRED; data from Bureau of Economic Analysis and Bureau of Labor Statistics.

IV. INFLATION

Definitions

• Consumer price index:

CPIt = Price of market basket in year t

Price of market basket in base year• 100.

• Inflation: The percent change in a price index.

Example: the inflation rate from 2014 to 2015 is:

π2015 = P2015 − P2014

P2014• 100.

• Deflation: A negative rate of inflation.

U.S. Inflation (Percent Change in the Price Index for Personal Consumption Expenditures), 1953–2015

Source: FRED; data from Bureau of Economic Analysis.

Price Index for Personal Consumption Expenditures, 1929–1937

Source: FRED; data from Bureau of Economic Analysis. Note: The graph shows a measure of prices, not inflation. Thus, a decline corresponds to deflation.

Adjusting Variables for Price Changes • What would $X in Year A be equivalent to in terms of

Year B dollars?

$XPBPA

,

where PA and PB are the price index in year A and year B.

• Example: What was Richard Nixon’s final salary equivalent to in today’s dollars?

• His salary was $200,000; the CPI in August 1974 was 45; the CPI now is 237.7. Thus:

$200,000237.745.0

= $1,056,000.

V. OVERVIEW OF MACRO FRAMEWORK

Determinants of the Long-Run Trend

• Potential Output:

The amount of output (real GDP) that the economy can produce when using its resources at normal rates.

• Key resources:

• Labor

• Capital

• Technology

Determinants of Short-Run Fluctuations • Aggregate demand:

The total demand for final goods and services.

• Key features of the short-run model:

• In the short run, output depends on aggregate demand.

• Developments in the private sector, monetary policy, and fiscal policy all affect aggregate demand.

• The level of output relative to potential affects inflation, which in turn affects aggregate demand through monetary policy.

International Macroeconomics

• Interactions between aggregate economies.

• Key issues:

• Exchange rates

• The trade deficit or surplus

Real Broad Effective Exchange Rate for the U.S., 1994–2016

Source: FRED; data from Bank of International Settlements.

Net Exports as a Share of GDP, 1975–2015

Source: FRED; data from Bureau of Economic Analysis.

The Federal Funds Rate, 1954–2016

Source: FRED; data from Board of Governors of the Federal Reserve System.