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Macroeconomics Unit 3: Chapters 12-16 Essential Questions 1) Why & how is economic activity measured? 2) How do fiscal policy decisions affect the nation’s economy? 3) How can monetary policy through interest rates contribute to price stability, employment and economic growth? Macroeconomics Study of the economics of a nation as a whole The big picture Measuring the “health” of a nation’s economy Key economic indicators are used Gross Domestic Product (GDP) Consumer Price Index (CPI) Unemployment Rate Practice EOCT Q: Which choice describes a macroeconomic calculation? a. b. c. d. Calculating Calculating Calculating Calculating a family’s monthly budget a firm’s annual profits the unemployment rate the interest on a personal loan Gross Domestic Product Expressed in $$ terms instead of # of products Only value of final goods is used, not value of inputs Count 15 shirts? Or count 15 shirts x $20 each? Count bread, but not wheat and flour Don’t count resales, except in housing market Only goods/services produced within borders American or Foreign companies, but not American co overseas Illegal activities are NOT included Non-market activities are NOT included ie:stock market, doing things yourself GDP, Cont’d Nominal GDP is NOT adjusted for increased prices (inflation) Real GDP is adjusted for changing prices Increase in GDP=good economic performance Decrease in GDP=poor economic performance Economic Growth=% change in real GDP from one year to the next GDP, Cont’d Calculating GDP GDP = C + I + G + Xn C = consumer spending Most common way is to use the expenditure approach vs income approach Durable (last long time) + nondurable (short life) I = investment spending (business spending) G = government spending Xn = exports – imports (net exports) Cont’d Durable goods vs. Nondurable goods Durable goods are goods that have a reasonable expectation of lasting more than 2 years Automobiles, Tv’s Nondurable goods are goods that have a relatively short life span Food, pencils How these factors affect GDP Practice EOCT Questions: a. b. c. d. Which of the following is not included when calculating GDP? A refrigerator sold at Best Buy Nails purchased for construction of a home Toyotas made in TE and sold in Mexico Pappa John’s pizza I ate last night Practice EOCT Q: Calculate a country’s GDP using the following statistics: Calculate the % the governments portion Net exports = -$1.5 billion Gov Expenditures = $ 3.2 billion Investment Expenditures = $6.4 billion Consumer Expenditures = $10.8 billion Inflation and CPI Inflation rate is needed to find Real GDP Inflation = average prices are increasing Deflation = average prices are decreasing Hyperinflation = extreme increase in prices Inflation affects people’s purchasing power People on fixed income are hurt most Workers who receive cost-of-living increases aren’t Measure Inflation rate using the Consumer Price Index CPI CPI is calculated by looking at a base year’s prices and comparing to current year’s prices CPI = cost of today’s market basket x100 cost of market basket from base year CPI = 1000 = 1.04 x 100 = 104 960 100 To 104 = %4 increase What is inflation? EOCT Practice Q: The consumer price index is a measure of a. Gross domestic product b. Aggregate supply c. Aggregate demand d. Inflation Practice EOCT Q: a. b. c. d. When is the benefit for workers to have a contract with a cost of living adjustment? During a recession During a depression During an inflationary period During a strike, or work stoppage Unemployment Rate of unemployment = # of people looking for work / number of people in workforce Workforce = Over age 16 Not employed Actively looking for job within last 30 days Some people CHOOSE not to work household production, age, illness, Frustration Unemployment, cont’d 4 types of unemployment Frictional Seasonal Unemployed due to seasons, agricultural workers, construction workers Structural Left one job and looking for another, changing careers, Skills don’t match employers needs, computer skills Cyclical Due to a business cycle contraction, less spending results in less production resulting in layoffs and closings EOCT Practice Q: The government begins funding training programs to teach computer repair to unemployed adults. Which kind of unemployment would this help the MOST? a. Frictional b. Seasonal c. Structural d. Cyclical 700,000 are working 35,000 have given up looking for work 22,800 are still looking for work How many people are in the Labor Force? What is the unemployment rate? 1,800,000 are working 49,000 are looking for work Calculate the unemployment rate EOCT Practice Q: Sam is a 14 year old looking for a weekend babysitting job. Is he calculated in the unemployment rate? Aggregate Demand and Supply AD and AS affect GDP, Inflation and Unemployment rates!! AD = Total amount of goods and services people in an economy are willing to buy. AS = Total amount of goods and services that all producers in an economy are willing to provide Usually when consumer demand changes, causing prices to change, producers can respond relatively quickly to changing prices. Not so easy for an entire economy. AD shifts to the left (decrease), results in less being bought, wide spread price changes take time, products don’t get sold, producers need to cut production, people get laid off (bad). AD/AS Cont’d Production cuts resulting in layoffs leads to decrease in GDP. Decreasing GDP for 6 months or more is a Recession. When prices drop to meet equilibrium again, the economy enters a recovery. Recession lasting long time and GDP decrease is severe, economy has entered Depression. Business Cycle Expansion – time of increasing employment, income and general prosperity Peak – moment before contraction Contraction – dwindling business activity; unemployment Trough – lowest point of contraction, economy has “bottomed out” Practice EOCT Q: If aggregate demand and real GDP are beginning to fall and the unemployment rate is beginning to rise, what conclusion can you draw? a. The economy is in an expansion phase b. The economy is facing a slowdown c. The economy is in recovery d. Aggregate supply is increasing Fiscal Policy Government decided to tax/spend Increase taxes=less consumer disposable income…less spending…AD decreases…prices come down…economy contracts Decrease taxes=more consumer disposable income…more spending…AD increases…economy expands Fiscal policy Governments policies of tax and spend Raise taxes/lower taxes Increase gov. spending/decrease gov. spending Fiscal Conservatives; ie Ronald Reagan, Newt Gingrich: lower taxes, less spending, “social needs met by individuals, organizations, businesses” Fiscal Liberals; ie Ted Kennedy, FDR: more active and involved government and willing to pay higher taxes for it Taxes Congress (legislative branch) passes tax laws, signed or vetoed by President (executive branch) Tax structure: progressive (gets higher as higher income), regressive (sales tax… higher % of income the lower the income), proportional Tax Base: Individual income, corporate income, ss, estate, gift, etc Deficit vs. Debt Budget deficit vs. National debt Taxes = revenue Gov must plan a budget, decide what to spend with taxes collected When the government spends more than budget allows, it is running a deficit That deficit gets added to the national debt National debt continues to grow until gov begins paying it off (and accrues interest) Debt Clock Monetary Policy Federal Reserve Goal is to help maintain economic stability Established in 1913 after the panic of 1909 Federal Open Market Committee makes important decisions Federal Reserve System The System Provides financial services to the government, regulates financial institutions, maintains the payments system, conducts monetary policy 12 Districts Limits power by decentralizing system More responsive to local needs Owned by banks that belong to the system NOT OWNED BY THE GOVERNMENT!!! Receives no federal funding Federal Reserve System Structure Board of Governors 7 members appointed by president for 14 year terms One member serves as chairperson Confirmed by the Senate to staggered terms 1 new member every 2 years Currently Ben Bernanke Board sets policies for the Fed and the member banks Federal Reserve System Structure cont. Federal Open Market Committee (FOMC) 7 members of the board and 5 districts presidents who serve 1 year rotating terms Meets about 8 times a year Make decisions about growth of money supply and interest rates. Federal Advisory Council 12 members appointed by the 12 regional banks Offer advise on the overall health of the economy Federal Reserve System Responsibilities of the Fed Mergers Clears Checks Regulates bank mergers You write a check to Publix Publix deposits the check in Publix’s bank Publix’s bank then place money in Publix’s account Publix’s bank deposits the check at the Fed Fed then places money in Publix’s bank Fed deposits check in your bank Your bank takes money out of your account and gives it to the Fed Your bank then gives you the cancelled check Currency Replaces old currency and stores currency Challenges Fighting unemployment and declining GDP Fighting inflation Tools Open Market Operations/Often…like breathing Discount rates/Occasionally…like getting the flu Bonds/securities Buys and sells Rate of interest charged on loans to banks Raises and lowers Reserve Requirements/Rarely…like open-heart surgery Amount banks are required to keep on hand changes the minimum reserves Higher=tighter money policy Lower=easier money policy Bonds Buy bonds=puts money in the system, increases money supply, consumers have more cash, spend more, helps to raise GDP Sell bonds=takes money out of the system, decreases money supply, consumers have less cash, helps slow GDP Discount Rate Raise interest rates=less consumer spending Lower interest rates=more consumer spending Required Reserve Ratio Raise reserves=less money for banks to loan out, interest rates go up, less consumer spending Lower reserves=more money banks can loan out, interest rates go down, more consumer spending Money Creation Money Multiplier Effect = money being created in the economic system Money is not created by printing, but by banks doing their business…lending Money Multiplier Formula = Deposit x 1/RRR(Required Reserve Ratio) Suzy deposits $1000 in her checking acct. RRR = 10% $900 is loaned to Julie who gives it to John for a car John deposits $900 10% RRR $810 is loaned to Sam Total money supply is: $1000+$900+$810=$2710 (MME!) Calculate the MME: You deposit $500 and the RRR is 10% If the bank loans out all the money, how much money is put into the money supply? Answer: $500 x 1/.10= $5000 Monetary Policy cont. Summary Easy Money Policy (Increasing the Money Supply and Inflation) Buy Bonds Lower Discount Rate Lower Reserve Requirement Tight Money Policy (Decreasing the Money Supply and Inflation) Sell Bonds Raise Discount Rate Raise Reserve Requirement EOCT Practice Q’s 1. Which of the following is responsible for the monetary policy of the U.S.? A. Congress B. The President C. The Senate D. The Federal Reserve System 2. When the Fed sells government securities, or bonds, on the open market, what effect does this action have on the economy? A. increases money supply; increases consumer demand Increases money supply; reduces inflation risk Decreases money supply; increases consumer demand Decreases money supply; reduces inflation risk 3. a. b. c. d. If GDP is decreasing and the unemployment rate is increasing, which fiscal policy would the government MOST likely use? Increase taxes Decrease taxes Increase bank reserves Decrease spending 4. If the inflation rate is rising too fast, which fiscal policy would make the MOST sense? a. Increase taxes b. Decrease taxes c. Increase spending d. Decrease bank reserves