Download Chapter 11

11.0 Introduction to
Macroeconomics
11.1.1
We will now shift perspectives
We will look at the economy as a whole
11.1.2
The difference between macro and micro
Macro perspective on war
Micro perspective on war
Life is lived at the micro level,
But the wholeness of the social experience
is aggregated into a macro picture
11.1.3
Macro : Micro :: Forest: Trees
However, just like
a forest is more than individual trees,
the macroeconomy is more than just all the
individual markets put together
the whole is greater than the sum of its parts
11.1.4
The micro system is the foundation for
macro events
For example – Pareto optimality in the micro
system means full employment and
maximum production at the national level
Market power and its resulting inefficiency
means unemployed resources in the
macroeconomy
11.1.5 Basic Macro questions
Why doesn’t the economy always produce
up to its full capacity?
Ex. Great Depression
Why are resources (like people)
unemployed? What causes this to
persist? Can high unemployment happen
again?
What causes the cost of living to go up?
Why does inflation occur, and can it occur
again?
Is it possible to live in an economy with
steady growth, full employment and stable
prices?
11.1.6 On policy
Most economists lie on a continuum
between
intervention and non-intervention
Therefore, there are differing opinions as to
what are appropriate policies
for macro problems
11.1.7 Preview
Same approach as before
Defining terms
Assembling a model
Applying the model to historical and current
cases
11.2.1
Defining terms
11.2.2
Gross Domestic Product (GDP) –
value of all new production in the nation in the year
Full, sustainable capacity GDP – greatest level of
production the economy can sustain over athe
long haul
We’ll call this full GDP
Actual GDP – how much the nation is
currently producing
Can be near full GDP (healthy)
Or fall far short of full GDP (not healthy)
Recession2 quarters (6 months) of falling actual GDP
Depression –
Prolonged period of declining GDP
11.2.3
GDP is a very important number,
but it doesn’t tell the whole story
Increased production may benefit only a few
More production may not always be good –
Ex. Harvesting all trees will definitely
increase GDP
What are you producing? Computer chips
vs. potato chips
11.2.4
Labor force – all those participating in or
making themselves available to participate
in productive activity
Voluntarily unemployed – not looking for
work, not counted in the labor force
Labor force has two parts
Employed – have a job
Unemployed – don’t have a job but want
one
Unemployment ratePercentage of the labor force that is
unemployed
Great Depression- 25%
WWII – 1%
Currently- 5%
There are different reasons why people are
unemployed
11.2.5
Frictional unemployment- people are
looking for work, and there are
appropriate jobs, they just haven’t
found it yet
Job search process takes time
Ex. Recent college graduate
Frictional unemployment exists even in
the best of economic times
Job search process
$
MC
MB
Stop
Search
Figure 11.2.1 - Marginal Benefits/Marginal Costs of Search and Stop Point
11.2.6
Structural unemployment – mismatch
between people and jobs
Can be caused by technological or
geographic changes
Always an issue in a dynamic,
changing economy
11.2.7
Economists expect to find both frictional and
structural unemployment
These two together are called the natural
rate of unemployment
Full employment means at the natural rate
Full employment does NOT mean zero
percent unemployment
Natural rate is generally believed to be
between 4 and 7%
11.2.8
Demand-deficient unemploymentNot enough jobs for those who want one
Loss of productive capacity, plus many other
social costs
1929 – 3.2%
1933 – 25%
Great Depression
11.2.9
Inflation – rise in the overall level of
prices, or a fall in the purchasing
power of money
Deflation – fall in the overall level of
prices, or a rise in the purchasing
power of money
It is important to distinguish
between relative price changes (one
market)
and inflation (overall level of prices)
11.2.10
Inflation imposes costs on an economy
Efficiency cost - money loses some of the
useful roles it usually plays
Hyperinflation – unbelievably high inflation –
Germany after WWI
Money ceases to become a store of value, a
medium of exchange, or a unit of account
Another cost of inflation
Equity cost- when inflation causes a
redistribution of wealth
People with a fixed wage lose value
because money is worth less and less
Those who can’t take steps to account for
inflation fall further and further behind
11.2.11
Indexing – automatically adjusting payments
for wages/loans to account for inflation
Ex. If Inflation goes up 10%, your paycheck
goes up 10%
COLA – cost of living adjustment
Social Security is indexed
11.2.12
Nominal value- the actual number, the face
value
Real value- the underlying true value
Ex. Earning $10,000 a year in 1963 vs.
Earning $10,000 a year in 2006
Nominally, they are the same
In real terms, 1963 was worth much more
because of inflation
Knowing the difference between
real and nominal values will help us
compare things over time more accurately
11.2.13
Charts page 170-171
Nominal GDP is rising
However, so is price level
Real GDP is falling, unemployment
skyrocketing
Severe recession
Real is a much better measure of what is
happening
11.2.14
Real values are immediately useful for
comparisons over time
Nominal values must also be accompanied
by data on price level that allow you to
convert to real to be useful over time
11.2.15
Two methods to measure the price level
Price index
Price deflator
We’ll start with a price index
Most common price indexCPI – Consumer Price Index
Government selects a “market basket” of
goods that a typical household consumes
Food, clothes, housing, transportation, etc.
As an orientation point, the government
chooses a base year
Everything gets measured against the base
year
Target year
the year whose price level you are trying to
determine
Calculating CPI
Pmb in target year / Pmb in base year X 100
Base year will always have a value of 100
If 5095/4450 X 100 = 114
Then 114 is the price index for that target
year
It takes 114 cents to buy what used to cost
100 cents in the base year
The GDP deflator
Measures prices for all the items in the GDP,
not just consumer goods
One can use these measures
to calculate the inflation rate
CPItarget /CPIbase year X 100%
114/100 X 100% = 14%
This tool allows use to transform nominal
values into real values
11.2.16
Nominal value = (Real value) X (Price level)
Or
(Nominal value) / (Price level) = Real value
When comparing over time,
Keep it real