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Macroeconomics • Macro meaning Large • Micro looks at Individual choices – Indiv and Business – C + I = GDP • Macro looks at Big Picture” of how the whole economy functions – C+I+G+(X-M) = GDP • Consumers + Businesses + Gov’t + Foreign Trade • Aggregate – Total – combination of all individual choices • 3 BIG graphs to know • Aggregate Demand = Total of all individual choices • Aggregate Supply = Total of all individual business choices • Business Cycle shows when economy is growing and shrinking • Measures 2 BIG issues – – Level of Unemployment or Employment – Level of Inflation or prices Key Macro Tools • Aggregate Demand – Total Demand of entire economy • Combo of ALL indiv demand • Affected by same things as indiv Demand • Aggregate Supply • Total Choices of ALL business • Affected by costs This graph shows the Demand for ALL products Effects – Production has increased from Yn to some new amount..RESULT: Prices have risen – called Inflation This is tied to the Business cycle since these 2 effects ONLY happen if the economy is growing More Jobs => More Demand => increased production and Increased prices In this version, AS – AD causes a fall from AD1 to AD2 1.)Price and Productivity fall 2.)Unemployment increases and Demand falls This only happens in a Recession • Periods of growth called expansion – Bus expand – Hire new workers => workers spend wages => more expansion => Peaks – Aggregate D (AD) ↑ – As AD ↑ => ↑ P – due to more people want stuff – As AD ↑ => ↑ AS – Bus see larger profits as P ↑ – “Snowball effect” – economists call “the Multiplier Effect” – as AS ↑ => need for more workers => eventual ↓ availability of skilled workers => ↑ P of each new unit of “Skilled Worker” – ↑ D of goods and ↑ wages for new skilled labor => ↑ P -This causes Inflation – General rise in Prices • • • • Understanding the Business Cycle 2 main period expansion and recession A long period of Recession => Depression or “Panic” Key economic issues to examine; – – – – – – Yd – Disposable Income – Income after taxes AD – Aggregate Demand – C Consumption AS – Aggregate Supply – I - Investment Employment Prices i – Interest rates • Expansionary period and Multiplier Effect– • Economy is ↑ “Heating Up” – From the Business side (I) - I is ↑ - Expansion => ↑ Employment => AS ↑ (Curve Shift out) – From the Consumer side (C) – As Employment ↑, => ↑ Consumer Yd => AD ↑ => ↑ prices due to ↑AD (Curve shifts out) - From a Banking side (i) – since more people have jobs they tend to save more => banks have a lot of money to lend => i (The price of $ ↓) – This makes it cheaper to borrow => ↑ I => ↑ Employment => ↑Yd => both AD & AS ↑ But ↑ prices act like a “Brake” to the expansion- slowing the I as i slowly ↑ as more and more companies want to I and fewer and fewer people save as P ↑ => Inflation and an “overheated economy” Recessionary Period (opposite happens) • As Prices ↑ = ↓ YD = ↓ AD => Surpluses • As Business starts to ↓ production => ↑ unemployment => further ↓ AD which forces I to ↓ • On the good side in banks i is also ↓ • USD buys less in global markets => Imports become more expensive, but exports rise bc foreign currencies buy more USD As Bus ↑ => higher Demand for loans to expand => higher Price of loans => Interest (i) High rate of expansion => Higher i (interest) rates as Bus want more loans • i – The price of $ - how much it costs to borrow –Plans of a better future => more loans => increasing i • Stock Market increases as bus profits grow • People see a better future => ↑ willingness to consume –People want to buy profitable stocks as companies expand –Costs fall w/ Economies of Scale => ↑ ∏ • Peaks – Low Unemployment and increased inflation – High D b/c of high employment – “Too much money (high wages) chasing too few goods”(Excess Demand) • Bus. not able to keep up w/ Demand => Inflation – Inflation – General Rise in P – Measured against a “Base year” – This year vs some past years prices on a “Market-basket” of goods – Market Basket – sample of products usually bought by consumers • When economy slows called a Recession • Recession – 2 or more consecutive low growth periods • During Recession – bus. “Lay off workers” => ↓ Investment (I) due to ↓ AD • As wages ↓ => “Snowball Effect “ Multiplier” of slowing Consumption (C) • 2 main Types of Inflation • Demand Pull Inflation – increased Demand due to growing economy => rising prices – Increased D => increased P • Cost Push – Increased Prices due to increased costs of production – Usually CoP rise due to increasing costs of FoP – (Land, Labor, or taxes => costs are “Passed on” to consumers) – ↑CoP => ↑P – ↑ oil P => ↑CoP => ↓π and ↓Agg. D => ↓ economy • Special Types – – Administrative – usually assoc w/ oligopoly or Monopoly – Bus raises price to increase profits • Sectional inflation a special type of Cost Push – Costs rise in only one sector of the economy => affects other parts – Gas prices rise => increased transportation costs that increases costs in other areas not connected to gas like pizza – costs more to get supplies and deliver • Seasonal Inflation – P ↑ due to ↑ seasonal Demand – sandels in summer, Uggs in winter • Stagflation – special case of cost push – increased costs => rising unemployment, but Prices↑ – Economy is slowing, but Prices are rising – Real problem for gov’t • Increased Gov’t spending => more jobs but ↑P • Lowering inflation w ↑ Gov’t spending => ↑ unemployment • General rule on inflation – If economy is growing there will be inflation • Some level of inflation is acceptable • Usually 3-4% - shows 3-4% economic growth • ↑P can be met by current wages – If economy is declining there will not be inflation unless stagflation is happening • But there will be unemployment • Some level of unemployment is acceptable and unavoidable • Usually 3 – 5% - usually Structural & Frictional – To reduce inflation slow economy down – To reduce unemployment speed economy up – Both require some Gov’t involvement • Worst Case – Hyperinflation – Rates over 1,000% • Increases in wages can’t keep up w/ increased Prices • Money becomes worthless => People blame gov’t • Gov’t instability is typical in this situation • Deflation happens in the opposite direction • Prices fall => Bus less profitable => ↓ willingness to produce • Supply shifts in => Contraction • Bus Cycle show GDP growth (C+I) • Expansion => Inflation – both Demand Pull and Cost Push – Why? • Peak – Economy is “Overheating” => inflation • Cost Rises => ↓ ability to buy => excess inventory => layoffs and ↓ Prices (Sale) to “Clear” inventory => Economy ↓ (recession) • Trough – Economy “Bottoms Out” – Excess Inventory cleared => increased production => hiring => ↑ ability to consume => ↑ economy – Cycle starts over (recovery) • Unemployment • ∆ Employment caused by ∆ in Supply – If D > S => shortage => ↑ QD => ↑ D for labor => Employment ↑ – If D < S => Excess Inventories => ↓ QD => ↓ need for Labor => ↓ Employment • Unemployment - defined as those actively looking for work – Most economist agree - 4– 5% = full employment – Reasons • Job Skills don’t meet labor needs • Loss of market due to competition Types of Employment/Unemployment • Structural –due to ∆ in the market – ∆ in needs - education, tech, or skills – ∆ s in Taste => ∆ in D (↑ willingness) • Your company makes food– The Surgeon General announces that your food may cause cancer => ↓ D => ↓ Employment • Seasonal - Special kind due to seasonal needs – Summer or Holiday jobs • Frictional – People voluntarily unemployed – Changing jobs – Re-entering the workforce after school or child-rearing – Move to another city for personal reasons – Choose a new career • Cyclical – due to the cyclical nature of the economy – Being laid off during a recession with hopes of being called back – Recession => High Unemployment • Underemployment – Those who are working at jobs requiring less than their skill set – College Phd working at Macy’s • If you aren’t actively looking for a job the gov’t has no way of tracking your efforts • Special types of employment - not measured in national totals – – Black Market or “non taxable” (Working “under the table”) Federal Reserve System Structure • Board of Governors – heads of the FED • 12 Regional Reserve Banks • Most Important Committee - Federal Open Market Committee (FOMC) Board of Governors • Seven members – Appointed by president – Confirmed by Senate – Serve staggered 14-year terms • Work includes: – Analyze problems – Supervise and regulate the member Banks – Responsible for the nation’s payments system Where is my Fed? Federal Reserve Banks • Operate a national payments system • Distribute the currency and coin – Money is Printed by Treasury Dept, not the FED • Supervise and regulate member banks and bank holding companies • Central Bank - Serve as banker for the U.S. Treasury • Control Credit Card regulations Research • Gather and analyze regional, national and international economic data • Design and test econometric (Computer Regression) models used to produce data used in making monetary policy decisions Monetary Policy • Choices made by the Fed to increase or limit the money supply (MS) • affect money supply and credit. • Actions => short and long-term effects Federal Open Market Committee FOMC • Most Important power • Done by Seven governors + • Five FED presidents (New York and four others on a rotating basis) • Nonvoting presidents give opinions • Final interest rate decision is made by the 12-member Federal Open Market Committee (FOMC) Goals of Monetary Policy Full Employment Stable Prices Sustainable Economic Growth Federal Open Market Operations • • • • • • • • • • Fed’s Power to buy and sell US Bonds on the “Open Market” If the Fed sells Bonds – Promises to repay at a future time People buy bonds (Fed Sells bonds) Gov’t receives money Since Consumers choose Bonds, they can’t spend that $ on anything else => Takes away Disposable Income => Slows the economy If the Fed Buys Bonds – Consumers receive money from their bond – Consumers receive money => More disposable income Stimulates the economy Preferable to sell to your own people => Domestic Debt If Selling to foreign nations => Foreign Debt Today Quantative Easing – Fed is Selling Large amounts of Bonds (Mostly to foreign) receives money => Using that money to increase funds in banks => Keeps Interest rates low Very controversial b/c => ↑ Future Debt History of Econ Thought • called- “Supply Side” Economics • 1776 – 1930’s Adam Smith – “Wealth of Nations” – “Laissez-Faire”, “Says Law”, Ricardo – Called “Classical Economics” Goals • “Balanced Budget” - Taxes = spending • Little Deficit Spending • Allow Business to make ↑ profits • known as “Trickle Down” economics – Wealth “Trickles down” from business success • Recessions caused by Businesses expenses ↑ (Cost Push Inflation) during expansion => ↑P => Surplus Q • Surplus => Slowly ↓ P until all surplus is gone => new production, hiring and expansion cycle • Trickle Down was NOT working – Business failures => – 25% unemployment => loss of trust in gov’t Beginning of Keynesian Economics – Demand Side Economics •John Maynard Keynes – book “General Theory on Money and Interest” •Supported Gov’t involvement = G to replace C and I – use of Fiscal Policy – Called “Priming the Pump” • Keynes – • recessions can be due to ∆ Bus. cycle – – Small recessions fix themselves – Economy essentially re-primes itself • When inventories get too low (Stuff on the shelf) companies make more => re-hiring (↑ I) =>↑ C => ↑ GDP • Some Recessions are caused by ↓ (AD) • If AD ↓ => No one wants to buy =>↓C => ↓I => ↓GDP • Psychological effect – People fearful – Not spending – “pump doesn’t re-prime” – Key reason – Wages and Prices are “sticky downward” – Need ↑ G to replace ↓C &↓I => ↑ GDP