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Chapter 5 – Macroeconomy Foundations
ECONOMICS
THEORY AND PRACTICE
Seventh Edition
Patrick J. Welch
&
St. Louis University
Gerry F. Welch
St. Louis Community College
at Meramec
PowerPoint Presentation by:
Dr. Ray Everett
Pima Community College
Copyright © 2004 John Wiley & Sons, Inc. All rights reserved.
Foundations of the Macroeconomy
Contents
Macroeconomic Activity Changes
Total Spending & Activity
Household Sector
Business Sector
Government Sector
Foreign Sector
Summary of Total Spending & Activity
Multiplier Effect
Macroeconomic Policies
Foundations of the Macroeconomy
Chapter Objectives
• To define and explain business cycles.
• To understand how total spending drives the economy’s levels of
employment and production, and influences prices.
• To examine the spending behavior of households, businesses, government
units, and the foreign sector.
• To identify the macroeconomy’s “leakages” and “injections” and show how
they affect economic activity.
• To introduce the multiplier effect.
• To discuss how expectations affect the economy’s output and price levels.
• To identify the role of total spending in macroeconomic policies.
Changes in Macroeconomic Activity
• Overview of Activity
FIGURE 5-1
Real Gross Domestic Product and the Unemployment Rate for 1985 through 2001
5-1a
Changes in Macroeconomic Activity
• Business Cycles
 Recurring periods of growth and decline in an
economy’s real output, or real GDP.
 Composed of four phases:
• Recovery
– Expansionary phase during which real GDP increases.
• Peak
– Where maximum output occurs.
• Recession
– Phase during which GDP falls.
• Trough
– Where GDP reaches its minimum.
5-1b
Changes in Macroeconomic Activity
• Business Cycles (cont.)
5-1c
Changes in Macroeconomic Activity
• Cyclical Behavior of the U.S. Economy
FIGURE 5-3
Economic Activity (1900–1984)
5-1d
Changes in Macroeconomic Activity
• Cyclical Behavior of the U.S. Economy (cont.)
FIGURE 5-3
(continued)
5-1e
Spending & Macroeconomic Activity
• Total Spending
 Also called aggregate spending.
 Total combined spending of all units in the economy for
new goods and services.
• Includes households, businesses, government, and foreign.
FIGURE 5-4
Total Spending and the Level of Economic Activity
5-2
Household Sector
• Personal Consumption Expenditures
 Household spending on new goods and services.
FIGURE 5-5
Real Personal Consumption Expenditures for 1970–2001
5-3a
Household Sector
• Household Sector & the Circular Flow
 Income-Determined Spending
• Household spending on new goods and services that
comes from income earned from providing resources to
producers.
FIGURE 5-6
Household Spending, Borrowing, Transfers, Saving, and Taxes
5-3b
Household Sector
• Household Sector & the Circular Flow (cont.)
 Transfer Payments
• Money from the government for which no direct work is
performed in return.
 Nonincome-Determined Spending
• Spending that is not generated from household earned
income.
 Injections into the Spending Stream
• Spending that comes from a source other than household
earned income.
 Leakages from the Spending Stream
• Uses for earned income other than spending, such as taxes
and saving.
5-3c
Business Sector
• Investment Spending
 Also considered nonincome-determined spending.
 Business spending on new goods, such as machinery,
equipment, buildings, and inventories.
FIGURE 5-7
Real Gross Investment for 1970–2001
5-4a
Business Sector
• Business Sector & the Circular Flow
 Retained Earnings
• Portion of a business’s accumulated profits that has been
retained for investment or other purposes.
FIGURE 5-8
Business Investment Spending, Saving, and Taxes
5-4b
Business Sector
• Saving-Borrowing Relationship
 Relationship between the amount saved by households
and businesses and the amount returned to the spending
stream through business and household borrowing.
FIGURE 5-9
Saving, Investing, and Borrowing by Households and Businesses
5-4c
Government Sector
• Government Purchases of Goods & Services
 Also considered nonincome-determined spending.
 Government spending on new goods and services.
FIGURE 5-10
Real Government Purchases of Goods and Services for 1970–2001
5-5a
Government Sector
• Government Sector & the Circular Flow
FIGURE 5-11
The Government Sector and the Circular Flow
5-5b
Foreign Sector
• Exports
 Goods and services that are sold abroad.
• Imports
 Goods and services purchased from abroad.
• Net Exports
 Exports minus imports.
FIGURE 5-12
Real U.S. Exports, Imports, and Net Exports of Goods and Services for 1970–2001
5-6a
Foreign Sector
5-6b
• Exports, Imports, & Net Exports (cont.)
FIGURE 5-12
(continued)
Foreign Sector
• Foreign Sector & the Circular Flow
FIGURE 5-13
The Foreign Sector and the Circular flow
5-6c
Summary of Total Spending & Activity
• Total Spending
 Drives the economy’s production, employment, and
income levels.
5-7
Multiplier Effect
• Multiplier Effect
 Change in total output and income generated by a
change in nonincome-determined spending is larger
than, or a multiple of, the spending change itself.
TABLE 5-2
Effect on Total Output and Income from a
Nonincome-Determined Spending Injection of $10,000,000
5-8a
Multiplier Effect
• Calculating the Multiplier Effect
 Initial change in nonincome-determined spending divided
by the percentage of additional income not spent will
yield the total change in output and income.
• $2,000,000 (what was not spent) / $10,000,000 = 0.20
• $10,000,000 / 0.20 = $50,000,000
5-8b
Macroeconomic Policies
• Fiscal Policy
 Influencing the levels of aggregate output and
employment or prices through changes in federal
government purchases, transfer payments, and/or taxes.
• Monetary Policy
 Influencing levels of aggregate output and employment
or prices through changes in interest rates and the
money supply.
5-9
Chapter 5 – Macroeconomy Foundations
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Seventh Edition
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