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Unit 3: Macroeconomic Concepts The Impact of Economics on the American Economy Micro vs. Macro What’s the difference? Micro – studying economic behavior and decisions in small units individuals, households, etc. Macro – studying economic behavior and decision making in an entire economy ex. Nation, state, etc. Measuring the Economy We look at… ◦ Overall levels of income ◦ Employment ◦ Prices These data sources can provide a picture of the overall economy… Why do you think this is? What Impacts our Measurements? Spending and production decisions made in the Resource (Factor) and Product Markets ◦ Driven by households, business, and government Remember Circular Flow???? Gross Domestic Product (GDP) The primary tool to measure the size of an economy GDP is the total market value of all goods and services produced within a country in a given time period. Let’s break down its components… Parts of GDP “Market Value” – GDP uses market prices for goods and services – discounted prices are not considered “Final Goods” – only final goods are used in calculations (not intermediate goods). the value of a loaf of bread would be counted while the flour to make the bread would not this avoids “double counting” Parts of GDP (continued) “Produced within a country” – means ALL goods produced within U.S. borders are counted – even those by foreign companies. ◦ goods produced by American companies outside U.S. borders are NOT counted ex. Kia’s produced in Georgia are counted, but iPhones produced in China are not Parts of GDP (continued) “in given time period” – can be quarterly or yearly, but exact beginning dates are used from year to year. ◦ ex. GDP for 2013 began at 12:00 am on January 1 and ended at 11:59 on December 31 GDP Measures Economic Growth “Real” GDP is used to measure growth from one time period to the next Nominal GDP uses current prices to determine market value Real GDP adjusts prices for inflation to determine market value Why is adjusting for inflation necessary for comparison? Calculating GDP – Using the Expenditure Approach Expenditure Approach – calculated by totaling transactions in the… ◦ Product Market where goods and services are purchased GDP = C + I + G + Net Exports (X-M) GDP = C + I + G + (X-M) C = Consumer Spending on Goods (durable and non-durable) & services I = Business Investment in capital goods G = Government Spending (X-M) = Total Exports – Total Imports give you net exports Calculating GDP – Using the Income Approach Calculated by totaling all transactions in the Factor Market ◦ Income payments for land, labor, and capital acquired in the market (ex. Rent, wages, interest on loans, etc.) Economic Growth GDP Growth = Outward shift of Production Possibilities Curve Economic Growth Occurs when there is an increase in Real GDP compared to a previous time period. (𝑅𝑒𝑎𝑙 𝐺𝐷𝑃 𝑌𝑒𝑎𝑟 2 − 𝑅𝑒𝑎𝑙 𝐺𝐷𝑃 𝑌𝑒𝑎𝑟 1) 𝑋 100 (𝑅𝑒𝑎𝑙 𝐺𝐷𝑃 𝑌𝑒𝑎𝑟 1) Influences on GDP Aggregate Supply- the total amount of goods and services in the entire economy available at all possible price levels. ◦ Simply add them all up for a total (aggregate) and calculate an average price (called price level) ◦ Tells us all the goods available at various price levels Aggregate Supply Curve AS curve illustrates relationship between prices and output supplied (seen in GDP) Influences on GDP (cont.) Aggregate Demand- the amount of goods purchased at all possible price levels ◦ This is driven by the collective behavior of consumers in an economy… Aggregate Demand Curve As Price Levels increase, demand for goods and services decreases (change in quantity impacts GDP) Equilibrium in the Macro Intersection of AS & AD is an “ideal” economy… What effect would shifting Demand or Supply have on GDP? Causes of Shifts in AS and AD Business Investment ◦ Increases lead to more jobs – AD GDP increases (economy grows) & the Causes of Shifts in AS and AD Consumer Expectations ◦ Consumer confidence effects the economy ◦ When good things are expected to happen, consumer confidence grows spending increases, AD (GDP) grows & economy Causes of Shifts Interest Rates (the cost of borrowing money) ◦ Low rates = business investment grows and creates jobs & people borrow more $ to buy and do AD and economy (GDP) grows Causes of Shifts External Shocks impact AS ◦ Negative – wars, droughts, trade disputes, natural disasters cause AS & economy (GDP) shrinks ◦ Positive – new discoveries of resources, record crop production due to perfect weather conditions cause AS & economy (GDP) grows Factors Impacting GDP & Economic Growth Inflation – Increase in average Price Level of all goods and services ◦ AD is increasing faster than AS ◦ Effects: Decline in Purchasing Power of the dollar Real Wages Decline because they grow slower than the Inflation Rate (IR) Interest Rates Increase Loss of $ in Savings Investments Increased Production Costs Factors Impacting GDP & Economic Growth Types of Inflation ◦ Demand-Pull – occurs when increased AD “pulls” prices higher ◦ Cost-Push – occurs when costs for factors of production increase and “pushes” prices higher Factors Impacting GDP & Economic Growth Deflation – decrease in overall Price Levels Hyperinflation – Inflation Rate (IR) is several hundred % vs. normal rate that is (1% to 3%) Stagflation – occurs when there is both a RISING Price Level and a DECREASE in Real GDP ◦ Typically comes with rising unemployment How We Measure These Consumer Price Index (CPI) – measurement of inflation using prices for a fixed group of products (called the “Market Basket”). The “Base Year” (comparison year) is given a standard value or “index” of 100 ◦ 1982-84 is the current Base Year time period CPI Calculation Calculating inflation using a standard “market basket”… 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑀𝑎𝑟𝑘𝑒𝑡 𝐵𝑎𝑠𝑘𝑒𝑡 𝑌𝑒𝑎𝑟 2 𝐶𝑃𝐼 = × 100 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑀𝑎𝑟𝑘𝑒𝑡 𝐵𝑎𝑠𝑘𝑒𝑡 𝑌𝑒𝑎𝑟 1 Calculating Inflation Rate Inflation (IR) is calculated by using the prices from one year to the next… ( 𝑌𝑒𝑎𝑟 2 𝑃𝑟𝑖𝑐𝑒 − 𝑌𝑒𝑎𝑟 1 𝑃𝑟𝑖𝑐𝑒) 𝐼𝑅 = 𝑋 100 (𝑌𝑒𝑎𝑟 1 𝑃𝑟𝑖𝑐𝑒) Factors Impacting GDP & Economic Growth Unemployment – refers to people who do not currently hold a job, but are actively seeking one. ◦ Means we are inefficient using one of our major factors of production ◦ Point of Underutilization in Production Possibilities Unemployment Unemployed are those without a job, but actively seeking one Another measure of our economy ◦ (4-6% is “normal”) Calculated by simple division: 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑 (Total Labor Force) x 100 Unemployment Three (Four) Types ◦ ◦ ◦ ◦ Structural Cyclical Frictional (Seasonal) See Graphic Organizer & Article The Business Cycle The Business Cycle A graph that illustrates the relationship between real GDP and time. ◦ Y-axis – Real GDP ◦ X-axis – time Four Parts of the Cycle Peak – the highest point of real GDP between the end of an economic expansion and beginning of an economic contraction Contraction – phase in cycle when real GDP is declining ◦ > 6 months (two quarters) is recession ◦ If long/sustained, it is depression Four Parts of the Cycle Trough – the lowest point of real GDP between the end of a contraction and beginning of a recovery Recovery - when real GDP becomes positive after a period of negative real GDP ◦ Recovery lasts until real GDP reaches the previous level at peak ◦ Period of expansion ◦ Called prosperity after the previous level is achieved The Federal Reserve Bank and Monetary Policy Called the FED for short ◦ In charge of MONETARY POLICY Notice “monetary” looks like “money” ◦ Created in 1913 to instill trust in the nation’s banks ◦ Regulates how much $ is in the economy Called the MONEY SUPPLY Our $ is called a FEDERAL RESERVE NOTE The FED (cont.) Our Government’s Bank ◦ Holds its assets (Bonds, etc.) ◦ Regulates how much $ is circulating through the economy Called MONEY SUPPLY ◦ Our currency is called a FEDERAL RESERVE NOTE Backed by FED’s assets – give $ value ◦ It’s profits go to the government – OVER $75 BILLION a year THE FED (cont.) It’s the “BANKER’S BANK” ◦ It helps struggling banks ◦ It backs our deposits ◦ It is a “lender of last resort” to banks They usually borrow from other banks FED helps when needed Primary Goals of the FED Goals to support economic growth of our economy ◦ Goal 1: Promote Price Stability ◦ Goal 2: Promote Full Employment (Job Growth) Help prevent cyclical unemployment Structure of the FED Public features ◦ Created by Congress and can be dissolved by Congress ◦ Led by Chairman and Vice-Chairman – serve four year term ◦ Has a Seven Member Board of Governors that includes Chairman and Vice-Chairman Nominated by the President and confirmed by the Senate Serve 14 year terms Members are part of the Federal Open Market Committee (FOMC) Structure of the FED (cont.) Private Features ◦ It is decentralized with 12 district banks serving different regions of the country Each of the 12 is organized as a private corporation and is self-financed Makes money through interest on securities it holds Gets payments for check clearing services Board of Directors for each of the 12 banks has 2/3 of its members by privately controlled member banks Structure of the FED (Cont.) NY Federal Reserve Bank President is always a member of the FOMC 4 of the other Presidents serve as voting members These 4 serve on a rotating basis Five of the 12 district bank presidents serve as voting members of the Federal Open Market Committee FED District Banks How does the FED Meet these Goals? MONETARY POLICY ◦ Refers to “money” tools of the Federal Reserve to meet these goals ◦ These tools impact the FED Funds Rate: the % rate banks charge one another 3 Tools of Monetary Policy – Tool #1 Open Market Operations – Most Common Tool ◦ Buying and selling bonds/securities ◦ Selling bonds reduces money supply ◦ Buying bonds increases money supply Tool #1 (cont.) Contractionary Policy ◦ Individuals & banks use $ to buy bonds ◦ Increases the FED Funds Rate - Less $ is available for spending and/or lending Expansionary Policy ◦ Selling bonds increases the $ supply ◦ Decreases the FED Funds Rate Tool #2 Change the DISCOUNT RATE ◦ Second most common ◦ It’s the interest rate that the FED charges banks on the money that they borrow ◦ Contractionary: Raising the rate makes it more expensive to borrow money less $ in economy & increases FED funds rate ◦ Expansionary: Lowering more $ (opposite effect) Tool #3 Change the RESERVE REQUIREMENT ◦ Least Common Tool ◦ % of deposits banks must keep on hand (in reserve) & can’t loan out ◦ Contractionary: Raising % allows banks to lend less $ & increases FED funds rate Ex. If bank has $10,000 & a reserve requirement of 10% -- it can only lend out $9,000 ◦ Expansionary: Lowers % allowing banks to lend more What if the requirement was changed to 20% - how much of the $10,000 could the bank lend? Summary of Monetary Policy “Tight” Money – Contractionary ◦ uses tools to decrease money supply fights inflation “Loose” Money – Expansionary ◦ uses tools to increase money supply fights deflation or contraction in the economy Government and Fiscal Policy Fiscal Policy ◦ Government spending and taxation policies to influence economic activity ◦ Influences business investment and consumer spending Fiscal Policy Goals Growing the economy through: ◦ Price Stability ◦ Full Employment Fiscal Policy Tools Taxation & Government Spending ◦ Occurs at federal, state, and local levels ◦ Typically proposed by the executive branch (ex. President) and legislature (ex. Congress) writes a bill to address the action ◦ Bills often have many projects added on to them in order to get it passed & become a law ◦ Many laws have clauses that allow additional taxes/spending without adding new laws Tool #1: Taxation Tax increases ◦ less consumer net income & spending declines ◦ Contractionary Tool Tax decreases ◦ more consumer net income & spending increases ◦ Expansionary Tool Tool #1: Taxation Many taxes grow with the economycalled “automatic stabilizers” because they follow the economy Tax collection increases with inflation in salaries Tax collection decreases with deflation in salaries ◦ Income Tax is the largest source of tax revenue Called a Progressive Tax because tax dollars paid increase as salary increases Tool #2: Government Spending Governments can increase or decrease spending to influence the economy ◦ More spending increases government investment more workers & businesses ◦ Less spending decreases government investment less workers & businesses ◦ Spending can also increase/decrease transfer payments (welfare, social security, etc.) Fiscal Policy What kind of fiscal tool was the New Deal supposed to be? Why (in theory) can’t the government keep spending more to keep the economy growing? Debt vs. Deficit What is the difference between a government budget deficit and government debt? Debt vs. Deficit Deficits – occur when government spending exceeds its revenue in their annual budget…occurs in one year ◦ Opposite would be a Surplus ◦ Balanced budget occurs when expenses = income Debt – the compilation of all deficits plus interest owed…grows over many years Government Debt Why doesn’t the government cut back all its spending so we can get out of debt? United States Debt Business Cycle Graph 6. Label the following economic indicators on your graph: CPI CPI Unemployment Unemployment Real GDP Real GDP Business Cycle Graph Activity On your provided paper 1. Label Y-Axis as “Real GDP” 2. Label X-Axis as “Time” 3. Draw the Business Cycle on your graph as big as possible, but leave room for labels 4. On the back of the paper write the definitions for peak, trough, contraction, expansion, and recovery Business Cycle Graph Closing discussion questions: 7. ◦ Monetary Policy is the Federal Reserve Bank’s power to increase or decrease the supply of money in the economy. They can do this by increasing or decreasing interest rates. If the FED is worried about inflation, what would they want to do about the supply of money in the economy? Would they raise or lower interest rates to do this? Business Cycle Graph Answer these questions: 5. ◦ ◦ Why do you think the expansion on your chart is divided between a recovery and prosperity? How do you find the start of prosperity? How long must a contraction last before it can be considered a recession? Business Cycle Graph ◦ Fiscal Policy is the power of Congress to increase or decrease taxes and increase or decrease government spending. When the government is worried about inflation should they increase or decrease government spending? Should they increase or decrease taxation?
