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Chapter 1 -The Macro Goal Variables Measures of Economy’s “Health” Definitions, Realistic Goals, and Recent (US) Performance #1 -- Real Gross Domestic Product (Real GDP) Real GDP (Y) -- The total production of final goods and services over a period of time, expressed in constant prices of a base year. Why Real GDP (GDP in constant dollars), instead of Nominal GDP (GDP in current dollars)? Real GDP -- Realistic Goal Realistic Goal for Real GDP -- to be as high as possible without accelerating inflation (overstimulated economy). Can state this goal in a more formal way. The Natural Level of Real GDP (Potential Real GDP) The Natural Level of Real GDP (YN) -- that level of real GDP in which inflation has no tendency to accelerate or decelerate. Comparing Real GDP to the Natural Level of Real GDP Y < YN -- sluggish economy with decelerating inflation (inflation rate) Y > YN -- economy with accelerating inflation Y = YN -- economy with constant inflation rate Characteristics of YN Unobservable Grows at 2.5% per year for the US Affected by -- labor productivity -- the price of energy -- the capital stock -- the labor force Getting and Keeping Y at YN: The “Two Cars” If Y = YN, then seek annual real GDP growth = 2.5%. If Y < YN, then seek annual real GDP growth > 2.5%, for awhile. If Y > YN, then seek annual real GDP growth < 2.5%, for awhile. Special Case -- The Recession Goal Variable #2 -The Inflation Rate Inflation Rate -- the growth or percentage change in the overall price level. First, measure the price level (P). -- Consumer Price Index (CPI) -- GDP Deflator Inflation Rate = Percentage Change in P Realistic Goal -- Inflation Ideal Goal: Inflation Rate = 0%. Realistic Goal (US): |Inflation Rate| < 3%. An Inflation Problem Versus Accelerating Inflation Inflation Problem -|Inflation Rate| < 3%. Accelerating Inflation -Inflation Rate Consider -- Inflation Rates of 1981 versus 1985 (Y = YN) 1981 Inflation Rate = 9.0% 1985 Inflation Rate = 2.5% Goal Variable #3 -The Unemployment Rate (u) u = (# of people unemployed) (total labor force) Does not measure -- discouraged workers -- part-time versus full-time employment -- people with multiple jobs Types of Unemployment Frictional Unemployment -Unemployment due to normal labor market frictions. Structural Unemployment -Unemployment due to a mismatch of available workers and jobs. Cyclical Unemployment -Unemployment due to a generally slow economy. Realistic Goal -Unemployment Rate Realistic Goal -- zero cyclical unemployment Natural Rate of Unemployment (uN) -- The unemployment rate in which inflation has no tendency to accelerate or decelerate. Realistic Goal: u = uN Interpretation: u versus uN u = uN Inflation Rate Unchanged (Desired State of Economy) u > uN Inflation Rate (Sluggish Economy) u < uN Inflation Rate (Overstimulated Economy) Real GDP and the Unemployment Rate u = uN Y = YN, (Desired State of Economy) u > uN Y < YN, (Sluggish Economy) u < uN Y > YN, (Overstimulated Economy) Goal Variable #4 -The Federal Budget Budget = Tax Revenues Government Expenditure (over a given period) Budget = Tax Revenues (Government purchases of goods and services + Transfer Payments + Interest on the National Debt) Budget Definitions Budget < 0 -- Budget Deficit Budget > 0 -- Budget Surplus Budget = 0 -- Balanced Budget Realistic Goal -The Federal Budget Realistic Goal -- Balanced Budget when Y = YN. Sluggish economies tend toward deficits. Hierarchy of economic problems. Goal Variable #5 -The Balance of Trade Balance of Trade (BOT) -approximated by net exports. BOT = Exports - Imports BOT < 0 -- Balance of Trade Deficit BOT > 0 -- Balance of Trade Surplus BOT = 0 -- Balanced Trade Position Realistic Goal -Balance of Trade Realistic Goal -- BOT close to zero. Diagnosing the “Patient” -The Current US Economy and Prospects For the Near Future