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Unit 4: Macroeconomic Statistics and Analysis M. Welch- CHS This is the first unit that deals with macroeconomic topics. Macroeconomics is the study of the economy as a whole, unlike microeconomics which is the study of individual businesses or industries. One of the major things to understand about macroeconomics is that in a market economy there seems to naturally be ups and downs in economic activity. Economists refer to this cycle of ups and downs as the business cycle. The business cycle includes 4 stages. Those stages include: Peak- Which is the highest point of economic activity during the cycle Recession- Which is characterized by a decline in economic activity Trough- Which is the lowest point of economic activity during the cycle Recovery- Which is characterized by an improvement in economic activity How can we tell where we are in a business cycle? There are several statistics that can be used to gauge how the economy is doing. The three most important statistics include: GDP- Gross Domestic Product Unemployment- The percentage of people who are considered to be unemployed Inflation-The percentage change in price level Usually (remember ceteris paribus) these statistics move in a predictable manner through the business cycle. During a recession: GDP declines, unemployment increases and price level declines.* During a recovery: GDP increases, unemployment declines and price level increases.* However, in the late 1970s, we experienced an economy where this relationship did not hold true. At that time there was an increase in prices combined with a decline in GDP and an increase in unemployment. This situation where the economy experienced stagnant growth combined with inflation became known as stagflation. We’ll learn more about this in a later unit. *Understanding these relationships is very important to having an understanding of macroeconomic trends. Now let’s learn more about each of these statistics: GDP GDP is probably the most important statistic used to determine the strength of an economy. It gives us the total amount of output in the economy. As a matter of fact, the technical definition for a recession is a decrease in GDP for two or more consecutive quarters. (A quarter is a quarter of a year- or 3 months) Let’s breakdown the definition of GDP. Gross means total Domestic refers to within a country Product refers to goods and services But, there is a little more to the definition. The official definition of GDP is: The total value of all final goods and services produced in a country during a given year. We need to make sure what this definition means: Total value refers to a dollar amount- So GDP is refers to an amount of money Final goods and services refers to finished products. This means that we do not count intermediate goods. Intermediate goods are purchased as a part of a particular item. For example, Ford Motor Company may buy tires from Goodyear. The purchase of the tires is not included in GDP because the price of the tires will be included in the final sale price of a car, which would be included in GDP. Basically we want to make sure that there is no double counting. Produced in a country refers to the fact that we count any good or service produced in a country regardless of where the ownership of the company is located. For example if a U.S. company like Apple manufactures an i-phone in China, the production of the i-phone is calculated in the GDP of China, not the GDP of the U.S. In a given year is self- explanatory. Technically this can be during a given period of time, but usually GDP calculates production for a period of one year. Also, growth rates are usually presented as a rate of yearly growth. So how is GDP actually added up? There are a few methods, but we will focus on the most common: The expenditure (spending) method- Here is the equation: Y=C+I+G+NX In this equation: Y= GDP C= Consumer Spending I= Business Investment (This refers to the products that businesses buy. This can also be thought of as economic capital) G= Government Spending NX= Net Exports or exports-imports Another method to determine GDP is known as the income method. The income method adds together total income in the economy including the following: Wages Interest earned Rents Profits Limits to using GDP as a statistic Using GDP to tell us a country’s standard of living can be limited. GDP only tells us the total value of production. It does not tell us the degree to which how the GDP is spread out. A country like China has a high level of GDP, but when that number is divided by the number of people in the country it is not quite so high. That is why economists often look at GDP per capita- GDP divided by the county’s population. GDP is also limited in that it does not tell us the distribution of wealth in an economy. The United States has a high GDP and many wealthy individuals; it also has a lot of poor people as well. Lastly, some economists believe that GDP tells us very little about quality of life. Living in a poorer country that might have beautiful views, no pollution, many required weeks of vacation, or a vibrant culture might be better than living in a country with a higher level of GDP. Unemployment The unemployment rate tells us the percentage of people in the labor force who do not have a job. It is important to know the definition of the labor force. The labor force includes all people who are willing and able to work. So if a person is not seeking work (a stay at home parent, a retired person, a full time student, even a person who has given up looking for a job) that person would not be considered part of the labor force, and thus would not be considered unemployed. Because of the way that the unemployment rate is figured, some people criticize the statistic. Some people say the numbers are too low. They argue that discouraged workers who may have given up trying to find a job, part time workers who want a full time job, and people who have accepted jobs with lower wages out of necessity are not figured into the percentage and therefore undercount the actual rate of unemployed workers. Others argue that the numbers are too high. These people argue that many people work in what is known as the underground economy. Workers who work “under the table” may be counted as unemployed because they may want to hide their work situation from the government. Therefore there will be an over counting of unemployed workers. Types of Unemployment It is also important that we understand why people might be unemployed. Because of this, economists have created different classifications for the unemployed. They include: Cyclical Unemployment- This type of unemployment occurs when a person losses their job due to a recession. A person in this situation is considered to be a laid-off worker. A person who lost their job due to the recession of 2008 would be considered cyclically unemployed. The impact of this unemployment varies with the level of economic activity, and to a certain extent can be positively impacted by government actions. Structural Unemployment- This type of unemployment occurs because a job has become obsolete, or is no longer in demand in the nation’s economy. Structural unemployment occurred in the early 1980s when many U.S. steel plants closed due to international competition. This tends to be the most difficult type of unemployment to deal with. The most common approach to dealing with it is to educate and retrain workers. Frictional Unemployment- This is when a person is considered to be “between jobs” and it is temporary. A person who quits their job or is fired would be considered to be frictionally unemployed. Because this type of unemployment occurs due to choice and is temporary, the government does not tend to be concerned about this type of unemployment. Seasonal Unemployment- Some jobs do not provide year-round employment. A landscaper or a beach lifeguard in the winter would be examples of this type of unemployment. Because of the nature of this type of unemployment, it is not a concern for policy makers, and reported unemployment is usually “seasonally adjusted” to account for it. Full Employment It is also important that you know the definition of full employment: You might think that full employment would be when there is 0% unemployment, but economists believe that there will always be some level of unemployment. They believe that the “natural rate of unemployment” includes both structurally and frictionally unemployed workers. It is cyclically unemployed workers that bring the unemployment rate below the rate of full employment. Economists disagree over what the actual unemployment rate at full employment is, but most would agree that it is around 5% to 5.5%. Inflation In order to determine the rate of inflation- the percentage increase in price level, we need to understand how the price level is determined. It is also important to know that there can be a decrease in the price level. That would be called deflation. The most common method to determine the price level is by calculating the Consumer Price Index (CPI) The CPI is calculated by determining the changes in prices of selected consumer goods over time. These selected items make up what is known as the market basket. The market basket includes food, items of clothing, etc. that represent an average consumer. The percent changes in the overall price of the market basket from a selected base year to another year tell us the price level. Here is an example of how a chart including CPI might look: Year CPI 1 (base year) 100 2 105 3 120 First let’s go over how the CPI is calculated. Let’s assume the cost of the market basket in year one was $1000. We get the CPI by dividing the cost of the market basket by the base year, and multiplying that number by 100. In this case we divide 1000 (the cost of that year’s market basket) by 1000 (the cost of the base year’s market basket) Then multiply that number by 100. In this case we get (1000/1000)x 100 = 100. (By the way the base year is always 100.) To determine the CPI for year 2: Assume that the market basket costs $1050 We take the current year market basket of 1050 and divide it by the base year of 1000 then multiply it by 100 1050/1000= 1.05 1.05x 100 = 105 So the CPI for year 2 is 105 We could do the same for each year. The CPI numbers for year 2 and year 3 in the above chart represent the percentage change from the base year. So: Year 2 (a CPI 0f 105) saw a 5% increase in the price level from the base year Year 3 (a CPI of 120) saw a 20%increase in the price level from the base year Determining the rate of Inflation To determine the inflation rate for a given year we calculate the percentage change in the CPI from one year to the next. To get the inflation rate for year 2 we would approach it this way: 105 is 5% greater than 100 So the inflation rate for year 2 is 5% To see a video showing how we calculate the CPI go this this link: video calculating CPI To see a video showing how we calculate the inflation rate go this this link: video: calculating inflation Just so you know there are other methods of determining the price level and inflation. Another common method is called the Producer Price Index or the PPI. This measures the change in wholesale prices. Types of Inflation Now that we know how to calculate inflation, it is important to understand the causes of inflation. Demand Pull Inflation Sometimes there is an increase in overall demand in the economy. When this occurs, price level increases. We call inflation caused by an increase in demand demand pull inflation. This type of inflation can be caused by things such as a rapidly growing economy, and by actions taken by the government. These government actions could include an in increase in government spending or an increase in the supply of money (we’ll learn about these in a later unit) Cost Push Inflation Sometimes the costs of inputs for businesses increase. When this occurs, producers produce less and price level increases. We call inflation causes by an increase in the price of inputs cost push inflation. This type of inflation can be caused by an increase in wages or when there is an increase in the price of an important natural resource like oil. Real GDP Now that we have learned about GDP and price level we can have a better understanding of real GDP. Many economists would consider Real GDP to be a good indicator of economic growth. Why? Because Real GDP removes the effects of inflation from GDP. How does this work? If we have a 5% increase in GDP, and the inflation rate is 2%; then we know the real GDP grew by 3%. Indicators There are other forms of data that can be collected by economists to either predict or tell economists what has happened in the economy. These indicators can be leading indicators, coincident indicators or lagging indicators. Leading indicators are statistics that help economists determine the direction an economy is heading in. An example of a leading indicator is the change in prices in the stock market. Coincident indicators tell economists where the economy is at a particular time. Personal income is an example of a coincident indicator. Lagging indicators indicate where the economy has been and they tend to trail the direction of the economy. The most common example of a lagging indicator is the unemployment rate. The ADAS Graph Now that we have covered Price Level and Real GDP, we can draw a graph that depicts the marcoeconomy. The graph below shows us the equilibrium level of the aggregate economy. Aggregate refers to the entire economy. So the graph below shows the total level of demand in the economy as AD or aggregate demand. The graph also shows the total level of supply in the economy as AS or aggregate supply. Price Level AS PL AD 0 Y Real GDP As you can seePrice level (usually CPI) is on the vertical axis. Real GDP (also referred to as output) is placed on the horizontal axis. The AD curve shows an inverse relationship between Price Level and real GDP. The AS curve shows a positive relationship between Price Level and Real GDP. The equilibrium price level is referred to as PL on the vertical axis. The equilibrium level of output is referred to as Y (remember the earlier symbol for GDP was Y) The ADAS Graph can show the relationship between Price level and GDP that we described earlier. Remember a decrease in GDP goes along with a decrease in price level during a recession. How can we show this on the graph? Price Level AS PL PL1 AD AD1 0 Y1 Y Real GDP Let’s assume that people believe that the economy is going to decline and consumer confidence decreases. (FYI- consumer confidence is a determinant of AD) When this happens, people get nervous about the future and start to buy less. This leads to a decline in aggregate demand We show this with a leftward shift of the AD curve (kind of like our earlier demand curves) - from AD1 to AD2 This leads to a decrease in Price Level from PL to PL1 and a decrease in GDP from Y to Y1. To recap: The decrease in consumer confidence leads to people buying less which leads to a decrease in prices and the amount produced. All of this can be described with the graph above. Big Things to Remember in This Unit: -What is a business cycle? -What is GDP and how is it calculated? -How is unemployment determined and what types of unemployment are there? -What is full employment? -What is the CPI and what types of inflation are there? -What is the relationship between the business cycle, GDP, unemployment and price level? -How can the relationship between GDP and price level be demonstrated graphically?