Download How Macroeconomics Affects our Everyday Lives Productivity growth

Robert J. Gordon, Macroeconomics, 10th
edition, 2006, Addison-Wesley
Chapter 1
What Is Macroeconomics?
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
How Macroeconomics Affects our Everyday Lives

Macroeconomics is concerned with the big economic issues that
determine our economic well-being.

Macroeconomic issues involves the overall economic performance
of the nation.

There are three central concepts in macroeconomics; the
unemployment rate, the inflation rate and productivity growth.

The basic task of macroeconomics is to study the behavior of each
of these concepts, why they matter to individuals and what the
government can do improve macroeconomic performance.
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
How Macroeconomics Affects our Everyday Lives
The unemployment rate
When unemployment rate is high, it is going to be harder for
individuals who want to work to find a job.
 Unemployed people will not be able to pay their bills. Crime,
mental illness and suicide will increase.
 Many economists consider unemployment as the single most
important macroeconomic issue.
 “Indolence is justly considered the mother of misery”, Robert
Burton said (1621).
1.

The Inflation Rate
A high inflation means that prices, on average are rising.
In inflationary periods, retired people lose the most, as their savings
buy less as prices go up. While inflation harms savers, it helps
borrowers, i.e inflation redistributes income.
 Inflation increases uncertainty about the future
2.


Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
How Macroeconomics Affects our Everyday Lives
Productivity growth
 Productivity is the average output per hour of work that a nation
produces in total goods and services.
 The faster average productivity grows, the easier is for individuals
to raise their standards of living, i.e., there will be more houses,
roads, cars, hospitals, schools ..etc.
 An economy with no productivity growth is called the “zero sum
society” (the rate of growth is zero), any extra good or service
enjoyed by one person requires that something else is taken from
another. For example in order to build more houses, the economy
has to sacrifice building fewer hospitals.
3.
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Real GDP: Actual and Natural
 The official measure of the economy is “the real GDP” includes
all currently produced goods and services sold on the market
within a given time period, i.e., reflects the quantity produced
corrected for any changes in prices.
 Actual real GDP is the amount an economy actually produces at
any given time. Too much production of real GDP causes
inflation, while too little causes a waste of resources. Neither are
desirable.
 Natural real GDP is the actual real GDP when inflation rate is
constant with no tendency to accelerate or decelerate.
(Figure 1-1)
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Figure 1-1 : The Relation Between Actual and Natural
Real GDP and the Inflation Rate
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Real GDP: Actual and Natural
 Note:
 When real GDP equals natural GDP the inflation rate will be
constant.
 During periods of low actual real GDP, inflation slows down.
 During periods of high actual real GDP, inflation accelerates
(excessive actual real GDP is called overheating the economy).
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Unemployment: Actual and Natural
 When actual real GDP is low, actual unemployment rate rises
above its natural level (note that inflation slows down here).
 When actual real GDP is high, actual unemployment rate falls
below its natural level (inflation accelerates).
 Whenever actual real GDP equals natural real GDP actual
unemployment equals natural rate of unemployment NRU.
(Figure 1-2)
 NRU corresponds exactly to natural real GDP. A situation in
which there is no tendency for inflation to change.
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Figure 1-2 The Behavior over Time of Actual and Natural Real GDP and the
Actual and Natural Rates of Unemployment
Inflation speeds up
Macroeconomic Theory
Inflation slows down
Prof. M. El-Sakka
CBA. Kuwait University
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
 Note:
 The NRU is not necessarily constant
 The NRU is neither optimal nor immutable, and it can be
reduced by the government policies that help the economy to
function better.
 To achieve a low inflation and unemployment at the same time is
a dilemma. To lower inflation real GDP must be reduced which
in turn increases actual unemployment and vice versa.
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
GDP and the three macro concepts
 When actual real GDP is higher than its natural level,
unemployment is low and vice versa
 When actual GDP is higher than its natural level, inflation
speeds up and vice versa
 When actual real GDP is higher than its natural level,
productivity is most likely to grow up.
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Macroeconomics in the short run and in the long run
 Macroeconomic theories can be divided into 2 main groups
 the short run (concern) stability of the economy
 the long run (concern) growth of the economy
 In the short run we focus on two main concepts unemployment and
inflation. Ups an downs in economic fluctuations are called the
business cycles.
 In the long run we focus on productivity growth, or economic growth.
 Short run business cycles
 The main concern of macroeconomists is to minimize fluctuations in
unemployment and inflation rates. Fluctuations can be wide or small
Figure 1-3
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Figure 1-3 Business Cycles in Volatilia and Stabilia
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
 Business cycle concepts




Peak: the highest point reached by real output in each cycle
Trough: the lowest point reached by real output in each cycle
Recession: the interval in the business cycle between the peak
and the trough
Expansion: the period in the business cycle between the
trough and the peak
Figure 1-4
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Figure 1-4 Basic Business-Cycle Concepts
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
 The long run: Economic growth
 To achieve an increasing standard of living, output per person
must grow.
 Look at Figure 1-5 of two hypothetical nations, stag nation and
speed nation.
 If population growth is the same in the two countries, GDP per
capita in the speed nation is faster. i.e., people there can
purchase more goods, have better schools, hospitals and other
public services compared to the people of the stag nation.
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Figure 1-5 Economic Growth in Stag-Nation and Speed-Nation
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
 Taming the business cycles: Stabilization policy
 In policy discussions the target variables are inflation,
unemployment and long term productivity growth.
 Alternative policy instruments are used when these targets are
different from their desired values.
 policy instruments are:



Monetary policies (money supply and interest rates)
Fiscal policies (changes in G and T)
Miscellaneous group, to equip workers with skills they need to qualify
for jobs
 The goal of productivity growth is simple; just make
productivity growth as fast as possible.
 The goal of unemployment is not simple. If unemployment is set
to be low, inflation accelerates. A compromise is to set it at its
natural level (constant inflation)
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
 The role of stabilization policy
 They are used to offset undesired changes in private spending.
 But sometimes it may not be possible to control aggregate
demand instantly and precisely.
 The impact of different policies may also be highly uncertain.
 Macroeconomic goals are incompatible, we cant have low
unemployment rate and a stable price level.
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
 The internationalization of macroeconomics
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University