11.0 introduction to macroeconomics. 11.1.1 we will now shift perspectives we will look at the...
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11.0 Introduction to Macroeconomics
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11.1.1
We will now shift perspectives
We will look at the economy as a whole
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11.1.2
The difference between macro and micro
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Macro perspective on war
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Micro perspective on war
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Life is lived at the micro level,
But the wholeness of the social experience
is aggregated into a macro picture
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11.1.3
Macro : Micro :: Forest: Trees
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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
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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
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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?
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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?
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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
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11.1.7 Preview
Same approach as before
Defining terms
Assembling a model
Applying the model to historical and current cases
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11.2.1
Defining terms
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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
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Actual GDP – how much the nation is currently producing
Can be near full GDP (healthy)
Or fall far short of full GDP (not healthy)
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Recession-
2 quarters (6 months) of falling actual GDP
Depression –
Prolonged period of declining GDP
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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
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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
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Labor force has two parts
Employed – have a job
Unemployed – don’t have a job but want one
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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
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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
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Job search process
$
Figure 11.2.1 - Marginal Benefits/Marginal Costs of Search and Stop Point
Search
MC
MB
Stop
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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
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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%
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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
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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
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It is important to distinguish
between relative price changes (one market)
and inflation (overall level of prices)
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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
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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
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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
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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
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Knowing the difference between
real and nominal values will help us compare things over time more accurately
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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
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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
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11.2.15
Two methods to measure the price level
Price index
Price deflator
We’ll start with a price index
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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
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Target year
the year whose price level you are trying to determine
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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
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The GDP deflator
Measures prices for all the items in the GDP, not just consumer goods
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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
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11.2.16
Nominal value = (Real value) X (Price level)
Or
(Nominal value) / (Price level) = Real value
When comparing over time,
Keep it real