Download Unit 3 Macroeconomics-pp_UPDATED 2013

Unit 3
Macroeconomics
Macroeconomics: the branch
of economics that deals with
the economy as a whole,
including employment, gross
domestic product, inflation,
economic growth and the
distribution of income.
Gross Domestic Product: The
dollar value of all final goods
and services produced within
a nation’s borders in one
year.
GDP excludes certain items:
1. Intermediate goods: products
used to make other products. These
require further processing before
being sold to the final consumer.
2. Secondhand Sales: Sales of
used goods.
3. Nonmarket Transactions: work
done for which no money is paid
such as mowing your own yard,
house cleaning or other home
improvements.
4. Underground Economy:
unreported legal and illegal
activities.
5. Financial Transactions: money
paid for stocks, bonds and other
financial assets.
Gross National Product: The dollar value
of all final goods and services, and
structures produced in one year with
labor and property supplied by a nation’s
residents.
To go from GDP to GNP it is necessary
to add all payments that Americans
receive from outside the U.S., and then
subtract all payments made to foreign
owned resources in the U.S.
Output-Expenditure Model: a macro model
used to show aggregate demand by consumers,
businesses, government, and foreign sector.
Aggregate demand= total spending.
C = Consumer spending by households.
I = Investment spending by businesses.
G= Government spending, federal, state, and
local.
X= Exports or goods sold abroad.
M= Imports or goods purchased from abroad.
(X-M) = Net Exports can also be
denoted using an (F).
If (X-M) is positive, we have a trade
surplus meaning we export more than
we import.
If (X-M) is negative, we have a trade
deficit meaning we import more than
we export.
GDP = C + I + G + (X-M)
or
GDP = C + I + G + F
http://www.econedlink.org/interactives/Eco
nEdLink-interactive-toolplayer.php?iid=204&full
GDP= C+I+G+NX
Which category from the above equation
accounts for the greatest percentage of
GDP in our country?
A. C
B. I
C. G
D. NX
Inflation: a rise in the
general/average price level.
To remove distortions of
inflation on GDP economists
must construct a price index.
Price Index: a statistical series used to
measure changes in prices over time, or
more simply, it is a ratio of 2 prices.
Base Year: a year that serves as the
basis of comparison for all other years.
Market Basket: a representative selection
of commonly purchased goods and services
by urban consumers.
Major Price Indexes
1. Consumer Price Index (CPI):
reports on price changes for
about 80,000 items in 364
categories used by a typical
household.
It is used to calculate the rate of
inflation in the economy.
2. Producer Price Index (PPI):
measures price changes paid by
domestic firms for their inputs.
It can be a good indicator of
inflation at the consumer level
down the road.
3. Implicit GDP Price Deflator:
an index of the average levels
of prices for all goods/services
in the economy.
This is the most complete
measure of inflation in the
economy.
Current/Nominal GDP: is GDP that has
not been adjusted for inflation.
Real/Constant GDP: GDP that has been
adjusted for inflation.
Real GDP = Current GDP ÷ Price Index × 100
There are 2 ways to measure economic
growth. Remember economic growth is the
ability to produce more goods and services
over time.
1.Changes in real GDP from 1 year to
another.
2.Changes in real GDP per capita which is
real GDP divided by population.
Improvements in real GDP per capita
indicate an improved standard of
living and can be easily compared
from 1 nation to another.
Economic growth is the result of more
resources and/or better quality
resources such as improvements in
education and labor productivity.
Per Capita GDP
Luxembourg
United States
Switzerland
Japan
Iceland
$33,609
$33,586
$27,126
$23,311
$23,230
Economists use numbers such as those in the table
as a measure of
A. Standard of living
B. Total dollar value of all final goods and services
C. Net Exports
D. Net Imports
Business Cycle: the systematic ups
and downs in real GDP.
Phases
1.Recession: a period during
which real GDP declines for a
minimum of 6 months.
2.Trough: the turnaround point
where real GDP stops going
down.
3. Expansion: a period of
recovery from recession
where real GDP is rising.
4. Peak: the point where real
GDP stops going up.
Trend Line: shows the long run
growth in real GDP. It’s a process
of two steps forward and one step
back.
Depression: a state of the economy
with large numbers of people out of
work, acute shortages, and excess
capacity in manufacturing plants.
Index of Leading Indicators: a
monthly statistical series that usually
turns down before real GDP turns
down, and turns up before real GDP
turns up.
It’s like trying to forecast where
the economy is headed in the future.
Unemployment Rate: the number
of unemployed people looking for
work divided by the total number
of persons in the civilian labor
force.
UR = # unemployed but looking ÷
civilian labor force × 100 = %
Civilian Labor Force: those
16 years and older who are
currently working or looking
for work.
Criticisms of UR:
1.Discouraged workers: People
who have become frustrated
with looking for a job and
quit looking. This tends to
understate the actual rate
of unemployment.
2. Part time workers:
These workers are counted
the same as full time
workers. Again, this tends
to understate the true rate
of unemployment.
Kinds of Unemployment
Frictional Unemployment: workers who
are between jobs for one reason or
another. Also called search and wait
unemployment.
Structural Unemployment: this is
unemployment caused when a
fundamental change in the economy
reduces the demand for workers and
their skills. This if often caused by
changes in technology, called
automation.
Cyclical Unemployment: this is
unemployment related to swings in
the business cycle, caused by a
recession.
Seasonal Unemployment:
unemployment resulting from
changes in the weather or changes
in the demand for certain products
at regular intervals each year.
Full Employment: the lowest possible
unemployment rate with the economy
growing and all factors of production
being used as efficiently as possible.
Our estimate is 4.5% in the United
States.
The first 4.5% represents frictional and
structural unemployment. Anything over
and above that is cyclical.
Price Level: measures the relative
magnitude of prices at a point in
time using the Consumer Price
Index (CPI).
The inflation rate can be measured
using the following formula.
Inflation Rate = ∆ in price index ÷
beginning price index × 100 = %
Deflation: a decrease in
the general/average price
level as measured by an
index number.
The effects of deflation
are the opposite of
inflation.
When the economy is working
normally in the United
States, what is the inflation
rate?
A. 1 to 3 percent
B. 4 to 7 percent
C. 8 to 11 percent
D. 12 to 15 percent
The immediate result of
inflation is a decrease
in the purchasing power
of the dollar.
2 types of inflation include:
1.Demand-pull inflation: when
different groups such as
consumers, businesses or the
government attempt to spend
beyond what the economy can
produce. “Too many dollars
chasing too few goods.”
2. Cost-push inflation: when
costs for producers rise they
will raise prices to compensate
for higher costs. This could
come primarily from wages or
energy/oil prices.
Inflation also causes a redistribution
of income from some people to
others. Some will benefit from
inflation while others will be hurt.
Winners
Flexible incomes
Borrowers
Losers
Fixed incomes
Savers
Lenders
In 1913 Congress created the Federal
Reserve System or the “Fed” as our
nation’s central bank. Because everyone
uses money, and because interest rates
affect the overall level of economic
activity, the Fed’s activities affect us
all.
Figure 15.1
Board of Governors
7 members
Appointed by the president and
confirmed by the Senate
Serve 14 year terms
Sets the general policies for Fed and
banks to follow
Federal Open Market Committee
12 members
Meets 8 times a year
Makes decisions about the growth
of money supply and interest rates
Is the Fed’s primary policymaking
body
District Banks
 12 districts and 25 branches
District banks accept deposits from and make loans
to banks and Thrift institutions
Member Banks
Commercial banks that are
members of and hold stock in the
Fed bank in their district.
These are the banks we use.
This man is
considered the
2nd most
powerful person
in the U.S.
Who is he?
Monetary Policy: the
expansion or contraction of
the money supply in order to
influence the cost and
availability of credit which
is the interest rate.
(Federal Reserve controls
this)
The Fed controls the
money supply to create
greater stability within the
economy. It’s goal is to
promote economic growth,
full employment and price
level stability.
Our definition of money
will include 3 things, all
of which are
immediately usable to
buy goods and services.
M1 includes:
1.Paper money
2.Coins
3.Checking accounts
Fractional Reserve System: a
system that requires banks and
other depository institutions to
keep a fraction of their
deposits in the form of legal
reserves.
Let’s look at a bank’s balance
sheet.
Reserve Requirement: a rule stating that a
percentage of every deposit be set aside as
legal reserves.
Ex. Deposit $100 with a reserve requirement
of 10%. The bank must set side $10 as
a required reserve and may loan the
rest, $90.The $90 is called excess
reserves. It is logical to assume the
bank will want to loan that money
because banks will earn interest on those
loans.
The fractional reserve system
will allow the money supply to
grow to several times the size
of the excess reserves the
banking system keeps.
Ex. Fred deposits $1,000 in a bank
with a reserve requirement of 20%.
By how much will the money supply
expand?
$1,000 ÷.20 = $5,000 (money supply)
or
1 ÷ RR × ∆ in reserves.
1 ÷ .20 = 5 × $1,000 = $5,000
The Fed has 3 main tools it uses
to conduct monetary policy. Each
tool affects the amount of
excess reserves in the banking
system.
The tools are used within 2
broad policies.
Easy Money Policy: the Fed
allows the money supply to
expand and interest rates
to fall which normally
stimulates the economy.
This policy is used when
the economy is in a
recession.
Tight Money Policy: the Fed
restricts the money supply
which increases interest
rates and slows the economy
down. This is used when the
economy is experiencing
inflation.
Tools
1.Reserve Requirement: the amount
that banks must set aside for
every dollar deposited.
The following chart shows how a
change in the reserve requirement
will change the money supply.
Figure 15.5
2. Open Market Operations:
this is the most popular tool of
monetary policy. It involves the
buying and selling of
government securities/bonds.
3. Discount Rate: this is the
interest rate the Fed
charges on loans to other
banks.
Monetary Policy Review
http://www.econedlink.org/interactives/Eco
nEdLink-interactive-toolplayer.php?iid=206
Misery Index: sometimes called the
discomfort index, is the sum of the
monthly inflation and unemployment
rates.
When we studied markets in unit
2 we used the tools of supply
and demand to show how the
equilibrium price and quantity of
output were determined. When
we study the economy as a
whole, we can use the concepts
of supply and demand in much
the same way.
Aggregate Supply: the total value
of goods and services that all
firms would produce in a specific
period of time at various price
levels.
The AS curve is up-sloping and can
also increase or decrease. When
costs go down producers are willing
to increase output so AS shifts
right. When costs rise the AS
curve shifts left.
The factors that shift the AS curve
include the following:
Ex. Costs of inputs
Productivity
Technology
Taxes
Subsidies
Government regulations
Number of sellers
Which one of the following is a
determinant of aggregate
supply?
A. input costs
B. substitute goods
C. consumer expectations
D. tastes or preferences
How do subsidies given to a business
affect aggregate supply?
A They can make it cheaper for firms to
produce their products, thereby
allowing them to increase supply.
B They can make it more expensive for
firms to produce their products,
thereby forcing them to decrease
supply.
C No impact on Aggregate Supply
D All of the above
Stagflation: a period of
stagnant growth combined with
inflation. This is caused by a
leftward shift in the AS curve
due to say rising oil prices or
wages.
AGGREGATE SUPPLY REVIEW
http://www.econedlink.org/interactives/Eco
nEdLink-interactive-toolplayer.php?iid=198
Aggregate Demand: the total
quantity of goods and services
demanded at different price
levels. Figure 16.4a
The AD curve is downsloping and
can also increase or decrease. It
consists of the following
components; consumption,
investment, government, and
foreign spending.
AD = C + I + G + (X-M)
Factors that shift the AD curve include
the following.
Ex. Consumer wealth
Taxes
Expectations
Interest Rates
Exchange Rates
Incomes
Figure 16.4b
Which one of the following would
cause aggregate demand
to shift?
A. substitution
B. complementary good prices
C. an increase in resources
D. a change in consumer spending
Which of the following factors would
cause a shift in the aggregate
demand curve?
A. changes in input prices
B. changes in productivity
C. changes in the supply of labor
D. changes in government spending
AGGREGATE DEMAND REVIEW
http://www.econedlink.org/interactives/Eco
nEdLink-interactive-toolplayer.php?iid=197
Macroeconomic Equilibrium: this
represents the level of real GDP
consistent with a given price level, as
determined by the intersection of the
AS and AD curves.
Fiscal Policy: the federal
government attempts to stabilize
the economy by taxing and spending
decisions. (Congress)
The stimulus package passed in
February of 2009 by Congress is a
good example.
Here are the governments
options.
Recession ( increase AD)
Lower taxes
Increase spending
Inflation ( decrease AD)
Raise taxes
Lower spending
When (AD) shifts to the right real
GDP increases, employment increases,
but we may see some inflation too.
A second part of fiscal policy uses
automatic stabilizers which are
programs that trigger benefits if
changes in the economy threaten
income.
Ex. Unemployment Compensation
Entitlement Programs
Progressive Income Taxes
Supply-Side
Economics/Reaganomics
Supply-Side Economics
attempts to create greater
stability in the economy by
shifting the (AS) curve rather
than the (AD) curve.
It does this by:
1.Reducing marginal tax brackets
to give people the incentive to
work longer and harder which in
turn increases our productive
capacity.
2.Reducing government regulations
on businesses so they can
produce output more efficiently.
The goal of Supply-Side policies is to
shift the (AS) curve to the right.
This increases real GDP and
employment and also creates stable
prices.
The government’s budget has 3 possible
outcomes.
Balanced budget: Tax revenues exactly
equal spending for a given year.
Budget surplus: Tax revenues are
greater than spending for a given year.
Budget deficit: Tax revenues are less
than spending for a given year.
The main problem with fiscal
policy when fighting a recession
is that the increase in
government spending and
reduction in taxes will push the
government’s budget toward
deficit.
In essence we are spending
money we don’t have and we must
borrow.
Deficit Spending: when
government spending is in excess
of revenues collected for a given
year.
Federal Debt: the total amount
borrowed from investors to
finance the government’s deficit
spending.
Let’s put the federal debt into
perspective.
Add up all past Federal
government ___________’s
and you get the Federal
___________.
A. debt, deficit
B. deficit, debt
Federal Debt as of March
13, 2013 is
$16,750,130,322,121.01