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Chapter 19: What Macroeconomics Is All About Copyright © 2014 Pearson Canada Inc. Chapter Outline/Learning Objectives Section Learning Objectives After studying this chapter, you will be able to 19.1 Key Macroeconomic Variables 1. define the key macroeconomic variables: national income, unemployment, inflation, interest rates, exchange rates, and net exports. 19.2 Growth Versus Fluctuations 2. understand that most macroeconomic issues are about either long-run trends or short-run fluctuations, and that government policy is relevant for both. Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 2 19.1 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. With base-period prices, we get real national income. Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 3 Fig. 19-1 Growth and Fluctuations in Real GDP, 1965–2011 (i) The level of real GDP Copyright © 2014 Pearson Canada Inc. (ii)Annual growth rate of real GDP Chapter 19, Slide 4 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 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 5 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. Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 6 The Terminology of Business Cycles Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 7 Fig. 19-2 Potential GDP and the Output Gap, 1985–2011 (i) Potential and actual GDP Copyright © 2014 Pearson Canada Inc. (ii)The output gap Chapter 19, Slide 8 Employment, Unemployment, and the Labour Force Employment: the number of workers (15+) who hold jobs. Unemployment: the number who are not employed but are actively looking for one. Labour force: the total number of employed + unemployed. Unemployment rate: the number of unemployed expressed as a percentage of the labour force. Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 9 Unemployment = Rate Number of people unemployed X 100 Number of people in the labour force Even when Y = Y*, some unemployment exists: • frictional unemployment (natural turnover) • structural unemployment (mismatch between jobs and workers) When Y < Y*, there is cyclical unemployment. Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 10 Fig. 19-3 Labour Force, Employment, and Unemployment, 1960–2011 (i) Labour force and employment Copyright © 2014 Pearson Canada Inc. (ii)Unemployment rate Chapter 19, Slide 11 • Long-term trend: employment has grown roughly in line with the growth in the labour force. • Short-term fluctuations have been substantial – from 3.4% in 1966 to 12% in 1982. 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 © 2014 Pearson Canada Inc. Chapter 19, Slide 12 Productivity Productivity: a measure of output per unit of input. • often measured as GDP per worker • or GDP per hour of work Increases in productivity are probably the single largest determinant of long-run increases in material living standards. Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 13 Fig. 19-4 Canadian Labour Productivity, 1976–2011 Real GDP per worker is measured in thousands of dollars! Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 14 Inflation and Price Level 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: Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 15 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. Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 16 Fig. 19-5 The Price Level and the Inflation Rate, 1960–2012 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 17 Interest Rates The interest rate is the price of "credit," and the flow of credit is crucial to firms and households in a modern economy. Nominal interest rate: the rate expressed in money terms. Real interest rate: the rate expressed in terms of purchasing power. Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 18 Fig. 19-6 Real and Nominal Interest Rates, 1965–2012 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 19 The International Economy Foreign exchange: foreign currencies or claims on foreign currencies. Exchange rate: the number of Canadian dollars required to purchase one unit of foreign currency. A depreciation of the Canadian dollar means that it is worth less on the foreign-exchange market. a rise in the exchange rate Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 20 Fig. 19-7 Canadian–U.S. Dollar Exchange Rate, 1970–2012 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 21 The balance of payments accounts record all payments made in international transactions—goods, services, and assets. • trade balance • current account balance • capital account balance For Canada, exports and imports are both very large—roughly 35% of GDP—but the trade balance is usually small. Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 22 Fig. 19-8 Canadian Imports, Exports, and Net Exports, 1970–2011 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 23 19.2 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 short-term fluctuations. There is considerable debate regarding the ability of government to influence the economy's long-run growth rate. Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 24 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 "fine-tuning." Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 25 What Lies Ahead? To organize our thinking about macroeconomics, we must develop some tools. These will include: • discussing 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 Copyright © 2014 Pearson Canada Inc. Chapter 19, Slide 26