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What is Macroeconomics?
Macroeconomics is the study of the structure and
performance of national economies and of the
policies that governments use to try to affect
economic performance
1.
2.
3.
4.
5.
What determines a nation’s long run economic growth?
What causes a nation's economic activity to fluctuate?
What causes unemployment?
What causes prices to rise?
Can government policies be used to improve a nation’s
economic performance?
7
Introduction to
Economic Growth
and Instability
Chapter Objectives
• The Business Cycle and its Primary Phases
• How Economic Growth is Measured and
Why is it Important
• How Unemployment and Inflation are
Measured
• The Types of Unemployment and
Inflation and their Various Economic
Impacts
Economic Growth
•
Economic growth is calculated as a
percentage rate of growth per time
period
1. Increase in Real GDP
Example: Real GDP in the US was $10,755.7 billion in
2004 and $11,134.8 billion in 2005. Rate of
economic growth in US for 2005 was?
[(11,134.8- 10,755.7 )/ 10,755.7 ] = 3.5%
Economic Growth
2. Increase in Real GDP Per Capita
• Takes into consideration the size of the
population.
• Found by dividing real GDP by the size of the
population
Example:
• Real GDP in the US was $10,755.7 billion in 2004 and population
was 293.9 million
• GDP per capita = $36,596
• In 2005 GDP per capita rose to $37,536. Rate of growth of GDP
per capita?
• 2.6%
Economic Growth
• Growth as a Goal
• Arithmetic of Growth
– Rule of 70
Approximate number of
years required to double
real GDP
70
=
annual percentage rate
of growth
Main Sources of Growth
1. Increases in Inputs
2. Increases in Resource Productivity
• Productivity: measured as real output per unit
of input
• Productivity in the United States
– Improved Products and Services
– Understating the actual growth of economic well being
– Added Leisure
– Increases achieved despite increases in leisure
– Other Impacts
– Environment and quality of life
The Business Cycle
• Business cycles are alternating rises and
declines in the level of economic activity
• Phases:
– Peak: business activity reaches a temporary
maximum
– Recession: period of decline in total output,
income and employment
– Trough: output and employment at the lowest
levels
The Business Cycle
Phases of the Business Cycle
Peak
Level of Real Output
Peak
Peak
Trough
Trough
Time
Cyclical Impact
• The business cycle is felt everywhere but affects differs
across sectors of the economy:
1. Durables:
• Industries producing capital goods (eg. Heavy equipment
etc) and consumer durables (eg. Household electronics)
1. Nondurables:
• Service industries such as medical and legal services and
nondurable consumer goods such as bread, milk etc
• Relatively insulated from the most severe effects of
recession
• Twin Problems of the Business Cycle
– Unemployment
– Inflation
Unemployment
• Measurement of Unemployment
1. People under 16 years of age and people who are
institutionalized
2. Not in Labour Force
3. Labour Force
• Unemployment Rate
Unemployment Rate
=
Unemployed
Labor Force
x 100
Unemployment Rate
Criticisms:
– Part-Time Employment
• Want to work full time or are working fewer hours than
they want
– Discouraged Workers
• After unsuccessfully seeking employment for a time,
become discouraged and drop out of the labour force
Unemployment
Labor Force, Employment, and Unemployment, 2005
Under 16
And/or
Institutionalized
(70.5 Million)
Not in
Labor Force
(76.8 Million)
Total
Population
(296.6 Million)
Employed
(141.7 Million)
Unemployed
(7.6 Million)
Labor
Force
(149.3 Million)
Types of Unemployment
1. Frictional Unemployment
–
‘Frictional’ implies that the labour market does not
operate perfectly and instantaneously in matching
workers and jobs
1.
Search unemployment
2.
Wait unemployment
Types of Unemployment
2. Structural Unemployment
- Changes over time in consumer demand and in
technology alter the ‘structure’ of the total demand
- Composition of the labour force does not respond
immediately or complete to the new structure of ob
opportunities
- Geographically
Types of Unemployment
• Distinction between frictional and
structural is hazy
- Frictional is short term because the
unemployed have salable skills
- Structural is longer term and unemployed
workers find it hard to obtain new jobs
without retraining, gaining additional
education or relocating
Types of Unemployment
3. Cyclical Unemployment
• Caused by decline in total spending
• Typically in the recession phase
• Insufficient demand for goods and services
Full Employment
• Because frictional and structural unemployment is
largely unavoidable, ‘full employment’ is something
less than 100% employment of labour force
• Full-Employment Rate of Unemployment or the
Natural Rate of Unemployment (NRU)
• At NRU, economy is producing its potential output
• The economy will not always operate at this rate – due
to cyclical unemplpyment
Economic Cost of Unemployment
• Basic cost is forgone output resulting in a GDP GAP
GDP gap = Actual GDP – Potential GDP
• Okun’s Law - quantify the relationship between
unemployment rate and the GDP gap
• For every 1 percentage point by which the actual
unemployment rate exceeds the natural rate, a negative GDP
gap of about 2 % occurs
• Eg: if unemployment rate was 7.4% and natural rate of
unemployment 6%, what will be the GDP gap?
• 2.8% of potential GDP
Unemployment
GDP (billions of 1996 dollars)
Actual and Potential GDP and the Unemployment Rate
12,000
12,000
The GDP Gap
11,000
11,000
GDP gap
(positive)
10,000
10,000
9,000
9,000
Potential GDP
8,000
8,000
GDP gap
(negative)
7,000
7,000
6,000
6,000
Actual GDP
5,000
5,000
1985
1987
Unemployment
(percent of civilian
Labor force)
1985
1987
1989
1989
1991
1991
1993
1993
1995
1995
1997
1997
1999
1999
2001
2001
2003
2003
2005
2005
10 10
8
8
6
6
4
4
2
2
0
0
1985
The Unemployment Rate
1985 1987 1987
1989
1989
1991 1991
19931993
1995
1995
1997
1997
1999
1999
2001
2001
2003
2003
2005
2005
Source: Congressional Budget Office & Bureau of Economic Analysis
Economic Cost of Unemployment
• Unequal Burdens
– Occupation
– Age
– Race and Ethnicity
– Gender
– Education
– Duration
• Noneconomic Costs
- Depression
Inflation
• Inflation is a rise in the general
level of prices
• Reduces the purchasing power
of money
Measurement of Inflation
Consumer Price Index:
– CPI report the price of a ‘market basket’ that
are purchased by a typical urban consumer
– Set CPI equal to 100 for the base year
Price of the Most Recent Market
Basket in the Particular Year
CPI =
Price of the Same Market
Basket in base year
x
100
– Inflation is found for a year by comparing
the year’s index with the index in previous
year
– Example: CPI was 195.3 in 2007, up from 188.9 in
2006. So the rate of inflation for 2007 is:
Rate of inflation =
[( 195.3 – 188.9)/ 188.9 ]* 100 = 3.4%
– Can apply the rule of 70 to estimate how
long will it take for the price level to double
Types of Inflation
1.
Demand Pull Inflation
-
Changes in the prices level caused by an excess of total
spending beyond the economy’s capacity to produce
-
Excess demand pushes up the price of the limited output
-
‘too much spending chasing too few goods’
2.
Cost-Push Inflation
-
Inflation arising on the supply or cost side of the economy
-
Rising prices explained by rises in per unit production costs:
(total input cost/ unit of output)
-
Caused by supply shocks such as abrupt increases in the cost of
raw materials or energy inputs
Redistributive Effects of inflation
–Nominal income
–Number of dollars received
–Real Income
–Measure of the amount of goods and
services nominal income can buy
–Purchasing power of nominal income
Real income = nominal income / price index
Redistributive Effects of inflation
– Percentage change in real income is
approximately given by:
Percentage change in nominal income – percentage change in price level
- If nominal income and price level rises by
same percentage points then real income
remains unchanged
Who is Hurt by Inflation?
• Fixed-Income Receivers
• Savers - Real value of accumulated value
decreases
• Creditors (lenders)
Who is unaffected or helped by Inflation?
– Flexible-Income Receivers
• Indexed to the CPI
• Cost-of-Living Adjustments
• Businesses whose resource costs rise less than
rise in product price
– Debtors (borrowers)
• When borrowed was worth more, will now return
the principal and interest with dollars whose
purchasing power has decreased
Anticipated Inflation
– Redistribution effects of inflation are less severe
or are eliminated altogether if people anticipate
inflation
– Nominal Interest Rate
– Real Interest Rate
– Inflation Premium
11%
=
5%
Nominal
Interest
Rate
Real
Interest
Rate
+
6%
Inflation
Premium
Does inflation affect output?
• Cost-Push Inflation and Real Output
- As prices rise, the quantity of goods and services
demanded falls so firms respond by producing
less
• Demand-Pull Inflation and Real Output
- Even low levels of inflation diverts time and effort
towards activities such as cost of changing prices
on shelves
Hyperinflation
• Extraordinarily rapid inflation
• As prices shoot up sharply and
unevenly during hyperinflation,
people begin to anticipate even more
rapid inflation