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Chapter 19
What
Macroeconomics
Is All About
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
In this chapter you will learn to
1. Describe the meaning and importance of the key
macroeconomic variables, including national income,
unemployment, inflation, interest rates, exchange rates,
and trade flows.
2. Explain that most macroeconomic issues are about longrun trends or short-run fluctuations, and that government
policy is relevant for both.
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Key Macroeconomic Variables
Output and Income
The production of output generates income.
To measure total output in dollars, we add up the values of the
many different goods produced.
This gives nominal national income (in current dollars).
Using base-period prices, we get real national income (in
constant dollars).
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Figure 19.1 Growth and Fluctuations
in Real GDP, 1962–2005
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Movements in Real GDP
Real GDP fluctuates around a rising trend:
- the trend shows long-run economic growth
- the short-run fluctuations show the business cycle
APPLYING ECONOMIC CONCEPTS 19.1
The Terminology of Business Cycles
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Potential Output and the Output
Gap
Potential output is what the economy could produce if all
resources were employed at their normal levels of utilization
- often called full-employment output
The output gap measures the difference between potential
output and actual output.
Output Gap = Y-Y*
When Y < Y* , there is a recessionary gap.
When Y > Y*, there is an inflationary gap.
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Figure 19.2 Potential GDP and
the Output Gap, 1971–2005
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Employment, Unemployment, and
the Labor Force
Employment: the number of workers (16+) who hold jobs.
Unemployment: the number who are not employed but are
actively looking for a job.
Labor force: the total number of employed + unemployed.
The unemployment rate is the number of unemployed
expressed as a percentage of the labour force.
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Unemployment Rate
Unemployment =
Rate
Number of people unemployed
Number of people in the labor
force
X 100
Even when Y = Y*, some unemployment exists:
• frictional unemployment
• structural unemployment
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Full and Cyclical Unemployment
The unemployment rate when Y=Y* is called full employment.
Cyclical unemployment is neither structural or frictional
- changes with the ebb and flow of the business cycle
Why Does Unemployment Matter?
Some unemployment is desirable, as it reflects the time required for
workers and firms to “find” each other so that good matches are made.
But some unemployment is associated with human hardship, especially
for those individuals with skills that are not in high demand by firms.
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
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Figure 19.3 Labor Force, Employment,
and Unemployment, 1960–2006
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Productivity
Productivity: a measure of output per unit of input
- often measured as GDP per worker (labor
productivity)
- or GDP per hour of work
Increases in productivity are probably the single largest
determinant of long-run increases in material living standards.
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Figure 19.4 Labor
Productivity, 1960–2006
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Inflation and the Price Level
The price level: the average level of all prices in the economy.
Inflation: the rate at which the price level is changing.
The CPI is based on the price of a typical “consumption
basket,” relative to the price in some base year:
CPIt
PQ


P Q
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t
0
0
0
 100
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Inflation Matters
APPLYING ECONOMIC CONCEPTS 19.2
How the CPI Is Constructed
Why Inflation Matters
The purchasing power of money is negatively related to the
price level.
Also, because it is hard to forecast accurately, inflation adds
to the uncertainties of economic life.
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Table 19.1 Expenditure
Behavior in 1997
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Table 19.2 1997 Expenditure
Behavior at 2007 Prices
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Figure 19.5 The Price Level and the
Inflation Rate,1960–2006
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Interest Rates
The interest rate is the price of borrowing funds — the
percentage amount per period.
Nominal interest rate: the rate expressed in money terms.
Real interest rate: the rate expressed in terms of purchasing
power.
The burden of borrowing depends on the real interest rate.
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Figure 19.6 Real and Nominal
Interest Rates, 1960–2006
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The International Economy
Foreign exchange: foreign currencies or claims on foreign
currencies.
Exchange rate: the number of U.S. dollars required to
purchase one unit of foreign currency.
An appreciation of the U.S. dollar means that a U.S. dollar buys
more foreign currency
- a rise in the exchange rate
A depreciation of the U.S. dollar means that a U.S. dollar buys less
foreign currency
- a fall in the exchange rate
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Figure 19.7 U.S. Dollars Needed
to Purchase A Euro, 1999–2007
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Exports and Imports
The balance of payments accounts record all payments
made in international transactions — goods, services, and
assets:
- trade balance (exports – imports)
- current account balance
- capital account balance
For the U.S., the increasing role of international trade is an
important aspect of globalization.
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Figure 19.8 Imports, Exports,
and Net Exports, 1960–2006
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Growth Versus Fluctuations
Long-Term Economic Growth
Long-term growth is considerably more important for a
society’s living standards from decade to decade than shortterm fluctuations.
There is considerable debate regarding the ability of
government to influence the economy’s long-run growth rate.
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Short-Term Fluctuations
Short-term fluctuations are often called business cycles.
Economists debate the effectiveness of monetary and fiscal
policy in influencing these fluctuations.
Some economists argue that despite the power of policy to
affect the economy, governments should not attempt “finetuning.”
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What Lies Ahead?
To organize our thinking about macroeconomics, we must
develop some tools. These will include:
• discussing the measurement of national income
• building a simple model of the economy
• modifying the model to make it more realistic
• using our model to analyze some pertinent economic
issues
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