Download S U M M A R Y The Economy and the Election in 2008

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CHAPTER 20 Introduction to Macroeconomics
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ECONOMICS IN PRACTICE
The Economy and the Election in 2008
On November 4, 2008, Democrat Barak Obama
was victorous over Republican John McCain in the
U.S. presidential election, winning over 53 percent
of the popular vote.
At the time of the 2008 election, the economy
was not doing well. Output was falling and unemployment was rising. Indeed, in the fall of 2008, the
United States was in the midst of a worldwide
financial crisis in which large financial institutions
around the globe were faltering. In the United
States, fiscal policy and monetary policy were
expansive in 2008 as policy makers tried to help the economy. These policies are discussed in future
Economics in Practice boxes. The policies were not enough, however, to prevent a contraction.
The economy and election outcomes are closely linked. The state of the economy is almost
always an important issue in U.S. presidential elections. Voters appear to hold the party that is
in power in the White House accountable for the economy. Voters tend to favor the incumbentparty candidate if the economy is good (high output and low inflation) and vote against the
incumbent-party candidate if the economy is bad (low output and high inflation). In fact, it is
possible to quantify the relationship between the economy and election outcomes using the
tools of econometrics, one of the fields listed in Table 1.2 on p. 9. One of the authors of this text
(Fair, Predicting Presidential Elections and Other Things, Stanford University Press, 2002) has an
equation that explains the incumbent-party vote share for president based on output and inflation (and some non-economic incumbency information). Economic performances and election outcomes back to the 1916 election are used for the analysis. Given predictions of output
and inflation before an election, this equation can be used to predict each party’s vote share.
Two years ahead of the 2008 election, on November 1, 2006, the equation was predicting, given
economic forecasts that were available at the time, that the Democratic challenger, whoever he or
she might be, would get 53.5 percent of the vote. During the next two years the economic forecasts changed as new economic information became available, which allowed a new vote prediction to be made. The final vote prediction before the election, on October 30, 2008, was
51.9 percent for the Democratic challenger (Obama). In fact, Obama got 53.3 percent of the vote,
so the predictions from the vote equation were quite close to what actually occurred. Two years
ahead the equation was predicting that the Democrats would win and by roughly the amount by
which they did! Not all economic and political predictions are this accurate, but it is important to
realize that the economy is generally very important in influencing elections. The economy was
struggling at the time of the 2008 election, and the incumbent-party candidate lost.
S U M M A R Y
1. Microeconomics examines the functioning of individual
industries and the behavior of individual decision-making
units. Macroeconomics is concerned with the sum, or aggregate, of these individual decisions—the consumption of all
households in the economy, the amount of labor supplied
and demanded by all individuals and firms, and the total
amount of all goods and services produced.
MACROECONOMIC CONCERNS p. 402
2. The three topics of primary concern to macroeconomists are
the growth rate of aggregate output; the level of unemployment; and increases in the overall price level, or inflation.
THE COMPONENTS OF THE MACROECONOMY p. 404
3. The circular flow diagram shows the flow of income received
and payments made by the four groups in the economy—
households, firms, the government, and the rest of the
world. Everybody’s expenditure is someone else’s receipt—
every transaction must have two sides.
4. Another way of looking at how households, firms, the government, and the rest of the world relate is to consider the
markets in which they interact: the goods-and-services market, labor market, and money (financial) market.
5. Among the tools that the government has available for influencing the macroeconomy are fiscal policy (decisions on
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PART IV Concepts and Problems in Macroeconomics
taxes and government spending) and monetary policy (control of the money supply, which affects interest rates).
1960s, it was believed that the government could “fine-tune”
the economy to keep it running on an even keel at all times.
The poor economic performance of the 1970s, however,
showed that fine-tuning does not always work.
A BRIEF HISTORY OF MACROECONOMICS p. 407
6. Macroeconomics was born out of the effort to explain the
Great Depression of the 1930s. Since that time, the discipline
has evolved, concerning itself with new issues as the problems facing the economy have changed. Through the late
THE U.S. ECONOMY SINCE 1970 p. 410
7. Since 1970, the U.S. economy has seen four recessions and
two periods of high inflation.
REVIEW TERMS AND CONCEPTS
aggregate behavior, p. 401
aggregate output, p. 402
business cycle, p. 402
circular flow, p. 405
contraction, recession, or slump, p. 402
corporate bonds, p. 407
deflation, p. 404
depression, p. 402
dividends, p. 407
monetary policy, p. 407
recession, p. 402
shares of stock, p. 407
stagflation, p. 408
sticky prices, p. 401
transfer payments, p. 405
Treasury bonds, notes, and bills, p. 407
unemployment rate, p. 403
expansion or boom, p. 402
fine-tuning, p. 408
fiscal policy, p. 407
Great Depression, p. 407
hyperinflation, p. 404
inflation, p. 404
macroeconomics, p. 401
microeconomics, p. 401
PROBLEMS
Visit www.myeconlab.com to complete the problems marked in orange online. You will receive
instant feedback on your answers, tutorial help, and access to additional practice problems.
1. Define inflation. Assume that you live in a simple economy in
which only three goods are produced and traded: fish, fruit, and
meat. Suppose that on January 1, 2007, fish sold for $2.50 per
pound, meat was $3.00 per pound, and fruit was $1.50 per
pound. At the end of the year, you discover that the catch was
low and that fish prices had increased to $5.00 per pound, but
fruit prices stayed at $1.50 and meat prices had actually fallen to
$2.00. Can you say what happened to the overall “price level”?
How might you construct a measure of the “change in the price
level”? What additional information might you need to construct your measure?
2. Define unemployment. Should everyone who does not hold a
job be considered “unemployed”? To help with your answer,
draw a supply and demand diagram depicting the labor market.
What is measured along the demand curve? What factors determine the quantity of labor demanded during a given period?
What is measured along the labor supply curve? What factors
determine the quantity of labor supplied by households during
a given period? What is the opportunity cost of holding a job?
3. [Related to the Economics in Practice on p. 409] The
Economics in Practice describes prosperity and recession as they
are depicted in literature. At the beginning of 2008, there was a
debate about whether the U.S. economy was in recession. Look
at the data on real GDP growth and unemployment and
describe the pattern since 2007. You can find raw data on
employment and unemployment at www.bls.gov, and you can
find raw data on real GDP growth at www.bea.gov. (In both
cases, use the data described in “Current Releases.”) Summarize
what happened during 2008. Did we have a recession? Explain.
4. A recession occurred in the U.S. economy during the first three
quarters of 2001. National output of goods and services fell during this period. But during the fourth quarter of 2001, output
began to increase and it increased at a slow rate through the first
quarter of 2003. At the same time, between March 2001 and
April 2003, employment declined almost continuously with a
loss of over 2 million jobs. How is it possible that output rises
while at the same time employment is falling?
5. Describe the economy of your state. What is the most recently
reported unemployment rate? How has the number of payroll
jobs changed over the last 3 months and over the last year? How
does your state’s performance compare to the U.S. economy’s
performance over the last year? What explanations have been
offered in the press? How accurate are they?
6. Explain briefly how macroeconomics is different from microeconomics. How can macroeconomists use microeconomic theory
to guide them in their work, and why might they want to do so?
7. During 1993 when the economy was growing very slowly,
President Clinton recommended a series of spending cuts and
tax increases designed to reduce the deficit. These were passed
by Congress in the Omnibus Budget Reconciliation Act of 1993.
Some who opposed the bill argue that the United States was
pursuing a “contractionary fiscal policy” at precisely the wrong
time. Explain their logic.
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8. Many of the expansionary periods during the twentieth century
occurred during wars. Why do you think this is true?
9. In the 1940s, you could buy a soda for 5 cents, eat dinner at a
restaurant for less than $1, and purchase a house for $10,000.
From this statement, it follows that consumers today are worse
off than consumers in the 1940s. Comment.
10. [Related to Economics in Practice on p. 411] John Maynard
Keynes was the first to show that government policy could be
used to change aggregate output and prevent recessions by stabilizing the economy. Describe the economy of the world at the
time Keynes was writing. Describe the economy of the United
States today. What measures were being proposed by the
Presidential candidates in the election of 2008 to prevent or end
a recession in 2008-2009? Where the actions taken appropriate
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from the standpoint of John Maynard Keynes? Did they have
the desired effect?
11. [Related to Economics in Practice on p. 413] Presidential elections are often influenced by the current state of the economy.
The state of the U.S economy was a major campaign issue in the
2008 presidential election. Go to www.bls.gov to find the quarterly data on the unemployment rate in 2008, and www.bea.gov
to find the quarterly GDP data for 2008. Based on this data, was
the economy in a recession prior to the 2008 presidential election? Does there appear to be any link between the election
results and the state of the economy? Briefly explain how the
election results may or may not have been influenced by the
state of the economy in 2008. For more information, see
fairmodel.econ.yale.edu/vote2008/index2.htm.