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Where You Are!
Economics 201 – Principles of Macroeconomics
Tuesday and Thursday from 2:00 to 3:15pm
1. Principles of Macroeconomics by Parkin, 12th edition,
Pearson.
2. MyEconLab for Parkin for graded homework
assignments and practice.
Course website:
http://www.terpconnect.umd.edu/~jneri/Econ201
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Dr. John Neri
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Advice!!!
• Course is cumulative.
• Important to keep up with the lectures, and
readings each week.
Introduction to Macroeconomics
Microeconomics Examines the functioning of individual
industries and the behavior of individual decision-making
units - firms and households.
Macroeconomics Deals with the economy as a whole.
Focuses on the determinants of total national income,
deals with aggregates such as aggregate consumption and
investment, and looks at the overall level of prices instead
of individual prices.
aggregate behavior The behavior of all households and
firms together.
sticky prices Prices that do not always adjust rapidly to
maintain equality between quantity supplied and quantity
demanded.
Examples of Macroeconomic Questions
• What causes inflation?
• Why is the unemployment rate sometimes high and
sometimes low?
• What might cause interest rates to be low one year
and high the next?
• How do changes in the money supply affect the
economy?
• How do changes in government spending and tax
policy affect the economy?
A couple of questions for you:
What is the current unemployment rate in the US?
What is fiscal policy?
What is the federal government budget deficit?
What is the Federal Reserve System?
Who is the head of the Federal Reserve System?
What is monetary policy?
Three Major Macroeconomic Concerns
•
Economic growth in production
•
•
how much we produce and can we keep it
growing
Unemployment
•
•
High employment - Low unemployment
Inflation and deflation
•
Low stable inflation
Economic Growth
• Defined as the increase in total production of
goods and services in an economy that
occurs over long periods of time
• Real Gross Domestic Product (real GDP)
– The measure of total production. Total
quantity of goods and services produced in
a country over a year
– Also called “total output”
Output and Growth – Important Concepts
aggregate output The total quantity of goods and services
produced in an economy in a given period – called GDP
business cycle The cycle of short-term ups and downs in
the economy.
recession A period during which aggregate output
declines. Conventionally, a period in which aggregate
output declines for two consecutive quarters.
depression A prolonged and deep recession.
expansion or boom The period in the business cycle from
a trough up to a peak during which output and employment
grow.
contraction, recession, or slump The period in the
business cycle from a peak down to a trough during which
output and employment fall.
A Typical Business Cycle
The overall trend
growth in output is
upward – black line
The blue line
represents a business
cycle. The economy is
expanding as it
moves through point
A from the trough to
the peak.
The economy is in
recession when it
moves through point
B from a peak down
to a trough.
The Business Cycle
+3%
peak
-2%
+4%
trough
Three growth rates presented:
(1) the long-run upward trend is 3%;
(2) in a recession, output falls (growth is negative);
(3) in the expansion phase of the cycle, growth rate is higher than the
trend.
U.S. Aggregate Output (Real GDP) back to 1900
The periods of the Great Depression and World War I and
World War II show the largest fluctuations in aggregate
output.
Graphs:
The Graph on the Previous Slide is a Time-Series Graph
A time-series graph
measures
 Time on the x-axis
 The variable in which
we are interested on
the y-axis.
Time-Series Graph
Reading a Time-Series
Graph
A time-series graph
shows the
 Level of the variable
 Change in the variable
 The speed of change in
the variable
Time-Series Graph – Ratio Scale
Figure A21.2(a) in the
appendix shows the average
prices paid by consumers
1974 to 2014.
In 1974, the price is set at
100.
The price in other years is
measured as a percentage
of the 1974 level.
Prices look as if they rose at
a fairly constant rate.
Time-Series Graph - Using a Ratio Scale
On the y-axis of a normal
graph, the gap between 100
and 200 is the same as that
between 300 and 400.
On a graph with a ratio
scale, the gap between 100
and 200 is same as that
between 200 and 400.
The ratio of 200 to 100
equals the ratio of 400 to
200—a constant ratio gap.
Time-Series Graph - Using a Ratio Scale
Graphing data on a ratio
scale reveals the trend.
The steeper the line, the
faster is the growth rate of
prices.
Prices rose rapidly in the
1970s and early 1980s
and more slowly in the
later 1980s, 1990s, and
2000s.
Economic Growth Questions
• What drives trend growth?
• What causes expansions and recessions?
• What macroeconomic policies can be used to
offset recessions or to sustain expansions?
• What has caused the recent/current
recession - often referred to as the “Great
Recession”?
Unemployment
unemployment rate The percentage of the labor
force that is unemployed.
Unemployment Questions
• What causes unemployment to rise and fall?
• Can monetary and fiscal policies be used to
keep the unemployment rate low?
• What are the obstacles?
Inflation and Deflation
inflation Percentage increase in the overall price
level.
hyperinflation A period of very rapid increases in
the overall price level.
deflation A decrease in the overall price level.
dis-inflation a decrease in the rate of increase in
the overall price level
U.S. Annual Inflation Rate, 1920–2015
• In most years, the inflation rate has been positive.
• During some periods (after World War II, and a few years in the 1970s and
early 1980s), the U.S. experienced double-digit inflation. For the last two
decades, however, the U.S. inflation rate has been very low - 1.70% in July
2016.
The Components of the Macroeconomy
Understanding how the macroeconomy works can be
challenging because a great deal is going on at one time.
Everything seems to affect everything else.
To see the big picture, it is helpful to divide the participants
in the economy into four broad groups:
(1) Households (C).
The Private Sector
(2) Firms (I).
(3) The government (G).
The Public Sector
(4) The rest of the world (X and M).
The Foreign Sector
Households and firms make up the private sector, the government is
the public sector, and the rest of the world is the foreign sector.
A Little Macroeconomic History:
• 19th and early 20th century, Classical
Theory/Classical Economist
• They focused on microeconomics
• They argued that market forces drive the
economy toward full employment, possibly quickly
– markets clear.
• In Macro Speak “The economy self-corrects”
• If unemployment exist, wages would fall to
move the economy back to full employment.
A Little Macroeconomic History:
• 1929 to 1933: The Great Depression
• Worldwide economic crisis.
• Total amount of goods and services
produced in the U.S. fell by more
than 25%.
• Unemployment up to 25%.
• A lot of unemployment for a long
period of time.
A Little Macroeconomic History:
• 1936: John Maynard Keynes, “The
General Theory of Employment, Interest,
and Money”
• Replaces classical theory with theory
based on:
– Aggregate (Total) Demand
– Wage and price rigidities
– Markets don’t clear and it may take a
long time for the economy to “self-correct”
• Birth of Macroeconomics as a field
separate from microeconomics
A Little Macroeconomic History:
• Keynes believed government should
intervene in the economy to stimulate the
level of output and employment
– During periods of low private demand, the
government should take action to stimulate
aggregate (total) demand to lift the economy to
full employment.
– Keynes was not a socialist. He was a capitalist.
He simply felt capitalism could be unstable.
A Little Macroeconomic History:
• Private demand and Public demand?
• What can the government do to stimulate
aggregate total demand (private and public) to
lift the economy out of recession?
• Big, Big Question – does this stuff work?
• Almost 80 years later still debating this!
Parkin -Chapter 4
MEASURING GDP AND
ECONOMIC GROWTH
In this chapter:
Define GDP (Gross Domestic Product)
Explain why GDP equals aggregate
expenditure and aggregate income
Explain how the Bureau of Economic
Analysis measures U.S. GDP and real GDP
Explain the uses and limitations of real GDP
as a measure of economic well-being
Gross Domestic Product(GDP)
GDP Defined
GDP or gross domestic product is the market
value of all final goods and services produced in a
country in a given time period.
This definition has four parts:
 Market value
 Final goods and services
 Produced within a country
 In a given time period
Gross Domestic Product
Market Value
GDP is a market value - goods and services
are valued at their market prices.
To add apples and oranges, computers and
automobiles, we add the market values so
we have a total value of output in dollars.
Gross Domestic Product
Final Goods and Services
GDP is the value of the final goods and services produced.
A final good (or service) is an item bought by its final user
during a specified time period.
A final good contrasts with an intermediate good, which
is an item that is produced by one firm, bought by another
firm, and used as a component of a final good or service.
Excluding the value of intermediate goods and services
avoids counting the same value more than once – double
counting.
Intermediate and Final Good
Tires taken from that pile and mounted on the wheels of
the new car before it is sold are considered intermediate
goods.
Tires taken from that pile to replace tires on your old car
are considered final goods.
If we included the value of the tires (an intermediate good)
on new cars and the value of new cars (including the tires),
we would be double counting.
Gross Domestic Product
Produced Within a Country
GDP measures production within a country—domestic
production.
In a Given Time Period
GDP measures production during a specific time period,
normally a year or a quarter of a year.
Gross Domestic Product
GDP and the Circular Flow of Expenditure and Income
• GDP measures the value of production, which
also equals total expenditure on final goods and
total income (Y).
• The circular flow diagram illustrates the equality
of income and expenditure.
Why does expenditure = income
In every transaction,
the buyer’s expenditure becomes the
seller’s income.
Thus, the sum of all expenditure equals
the sum of all income.
Simple Circular Flow
Income($)
Labor
Households
The circular flow diagram shows
the income received and
payments made by each
sector of the economy.
Goods(bread)
Expenditure($)
Firms
Gross Domestic Product
The circular flow shows two ways of measuring GDP.
GDP Equals Expenditure Equals Income
Total expenditure on final goods and services by
households (C), business firms (I), the government(G) and
the rest of the world (X-M) equals GDP.
GDP = C + I + G + X – M.
Aggregate income equals the total amount paid for the use
of factors of production: wages, interest, rent, and profit.
Firms pay out all their receipts from the sale of final goods,
so income equals expenditure,
Y = C + I + G + (X – M).
Value Added Approach to GDP
Important Concept - Not in the Book
• Value added
– Revenue a firm receives minus amount paid for
goods and services purchased from other firms
(intermediate goods)
• Value-added approach
– GDP = sum the values added by all firms in
the economy
– Value added = Wages + Interest + Rents + Profits
45
Value Added at Different Stages of Production
Notebook Example:
$5.00 is the value of the final expenditure
46
Value Added at Different Stages of Production
Notebook Example:
Intermediate
transactions
$5.00 is the value of the final expenditure
47
The Factor Payments Approach – Using the
Notebook Paper Example
Value Added goes to the factors of production
Exercise
A farmer grows a bushel of wheat and sells it to
a miller for $1.00.
The miller turns the wheat into flour and sells it
to a baker for $3.00.
The baker uses the flour to make a loaf of bread
and sells it to an engineer for $6.00.
The engineer eats the bread.
Compute:
• value added at each stage of production
• GDP
Exercise
Value added - farmer = ?
Value added - miller = ?
Value added - baker = ?
Total Value added
= ? = GDP
Gross Domestic Product (GDP)
Why “Domestic” and Why “Gross”?
Domestic
Domestic product is production within a country.
It contrasts with national product, which is the value of
goods and services produced anywhere in the world by
the residents of a nation.
Gross
Gross means before deducting the depreciation of capital.
The opposite of gross is net, which means after deducting
the depreciation of capital.
Gross National Product (GNP)
• GNP is the value of goods and services produced
anywhere in the world by the residents of a
nation.
• Nike’s income from shoe factories in Vietnam is part of
US GNP and Vietnam’s GDP.
• Toyota’s income from car plants in the US is part of
Japan’s GNP and US GDP.
• GNP = GDP plus payments received from the
rest of the world minus income paid to the rest of
the world
Gross Domestic Product
Depreciation is the decrease in the value of a firm’s
capital that results from wear and tear and
obsolescence.
Gross investment is the total amount spent on
purchases of new capital and on replacing
depreciated capital.
Net investment is the increase in the value of the
firm’s capital.
Net investment = Gross investment  Depreciation.
Measuring U.S. GDP
The Bureau of Economic Analysis uses
two approaches to measure GDP:
 The expenditure approach
 The income approach
Measuring U.S. GDP
The Expenditure Approach
The expenditure approach measures GDP as the
sum of consumption expenditure, investment,
government expenditure on goods and services,
and net exports.
GDP = C + I + G + (X  M)
Table 4.1 on the next slide shows the expenditure
approach with data (in billions) for 2014.
X = 2339 and M = 2877
Measuring U.S. GDP
The Income Approach
The income approach measures GDP by summing the
incomes that firms pay households for the factors of
production they hire—wages for labor, interest for capital,
rent for land, and profit for entrepreneurship.
Measuring U.S. GDP
The National Income and Expenditure Accounts divide
incomes into two broad categories:
Compensation of employees is the payments for labor
services. It is the sum of net wages plus taxes withheld
plus Social Security and pension fund contributions.
Net interest, rental income, corporate profits, and
proprietors' income earned by capital and land.
Measuring U.S. GDP
The sum of all factor incomes is net domestic income at
factor cost.
The expenditure on final goods is valued at market prices.
Two adjustments must be made to the net domestic
income get GDP:
1. Indirect taxes less subsidies are added to get from
factor cost to market prices.
2. Depreciation is added to get from net domestic income
to gross domestic income.
Table 4.2 on the next slide shows the income approach
with data for 2014.
Measuring U.S. GDP
GDP, is it Nominal or Real?
Real GDP is the value of final goods and services
produced in a given year when valued at the
prices of a reference base year.
- Currently, the reference base year is 2009 and
we describe real GDP as measured in 2009
dollars.
Nominal GDP is the value of goods and services
produced during a given year valued at the prices
that prevailed in that same year.
Measuring U.S. GDP
Calculating Real GDP
This table shows the
quantities produced and
the prices in 2009 (the
base year).
Nominal GDP in 2009 is
$100 million.
Because 2009 is the base
year, real GDP equals
nominal GDP and is $100
million.
Measuring U.S. GDP
Table (b) shows the
quantities produced and
the prices in 2014.
Nominal GDP in 2014 is
$300 million.
Nominal GDP in 2014 is
three times its value in
2009.
Measuring U.S. GDP
In Table (c), we calculate
real GDP in 2014.
The quantities are those
of 2014, as in part (b).
The prices are those in
the base year (2009), as
in part (a).
The sum of these
expenditures is real GDP
in 2014, which is $160
million.
Now You Try It
2009
2010
2011
P
Q
P
Q
P
Q
good A
$30
900
$31
1,000
$36
1,050
good B
$100
192
$102
200
$100
205
Compute nominal GDP in each year
Compute real GDP in each year using 2009 as the
base year.
Example - Calculation of Real GDP
Nominal GDP multiply Ps & Qs from same year
2009:
2010:
2011:
Real GDP
2009:
2010:
2011:
multiply each year’s Qs by 2009 Ps
The Uses and Limitations of Real GDP
The Standard of Living Over Time
Real GDP per person is real GDP divided by the
population.
Real GDP per person tells us the value of goods
and services that the average person can enjoy.
By using real GDP, we remove any influence that
rising prices and rising cost of living might have
on our comparison.
The Uses and Limitations of Real GDP
The Uses and Limitations of Real GDP
Two features of expanding living standard are
 The growth of potential GDP per person
 Fluctuations of actual real GDP around potential GDP
Potential GDP - The value of real GDP when all the
economy’s labor, capital, land, and entrepreneurial ability
are fully employed. Its an estimate of the economy's
potential
Actual GDP – What actually happened.
The Uses and Limitations of Real GDP
This figure shows U.S.
real GDP per person.
Potential GDP grows at a
steady pace because the
quantities of the factors of
production and their
productivity grow at a
steady pace.
Real GDP fluctuates
around potential GDP.
The Uses and Limitations of Real GDP
Real GDP per person in
the United States:
Doubled between 1960
and 1987.
Was 3 times its 1960 level
in 2013.
The Uses and Limitations of Real GDP
Productivity Growth Slowdown
The growth rate of real GDP per person slowed after 1970.
How costly was that slowdown?
The answer is provided by a number that we’ll call the
Lucas wedge.
The Lucas wedge is the dollar value of the accumulated
gap between what real GDP per person would have been
if the 1960s growth rate had persisted and what real GDP
per person turned out to be.
The Uses and Limitations of Real GDP
Figure 21.3 illustrates the
Lucas wedge.
The red line is actual real
GDP per person.
The thin black line is the
trend that real GDP per
person would have followed
if the 1960s growth rate of
potential GDP had
persisted.
The shaded area is the
Lucas wedge.
The Uses and Limitations of Real GDP
Real GDP Fluctuations—The Business Cycle
A business cycle is a periodic but irregular up-and-down
movement of total production and other measures of
economic activity.
Every cycle has two phases:
1. Expansion
2. Recession
and two turning points:
1. Peak
2. Trough
The Uses and Limitations of Real GDP
Figure 21.4 illustrates the
business cycle.
An expansion is a period
during which real GDP
increases—from a trough
to a peak.
Recession is a period
during which real GDP
decreases—its growth
rate is negative for at least
two successive quarters.
http://cafehayek.com/2012/09/the-numbers-game.html
The Uses and Limitations of Real GDP
Limitations of Real GDP
Real GDP measures the value of goods and services that
are bought and sold in markets.
Some of the factors that influence the standard of living
and that are not part of GDP are




Household production
Underground economic activity
Leisure time
Environmental quality
The Uses and Limitations of Real GDP
The Bottom Line
• We may get the wrong message about the level and
growth of economic well-being and the standard of
living by looking at the growth of real GDP?
• The influences that are omitted from real GDP are probably
large.
• It is possible to construct broader measures that
combine the many influences that contribute to human
happiness.
• Despite all the alternatives, real GDP per person
remains the most widely used indicator of economic
well-being.
Mathematical Note: SKIP
Chained-Dollar Real GDP
The BLS uses a measure of real GDP called chaineddollar real GDP.
Three steps are needed to calculate this measure:
 Value production in the prices of adjacent years
 Find the average of two percentage changes
 Link (chain) back to the reference year