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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
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(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
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Chapter 19, Slide 7
Fig. 19-2
Potential GDP and the Output Gap, 1985–2011
(i) Potential and actual GDP
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(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
LO1
Self-Test 1
Suppose the population of Etrusca is 20 million, the working age
population is 15 million, the number of employed is 9 million and the
number unemployed is 1 million, answer the following questions:
a) What is the size of the labour force?
b) What is the unemployment rate?
4-11
© 2012 McGraw-Hill Ryerson Limited
Calculating Nominal and Real GDP
Year 1 (base year)
Item
Qty of
Output
Prices
Year 1
Machines
100
$100
Km of Road
Bread
Cars
Totals
Nominal
GDP
Year 2
Qty of
Output
Prices
Year 2
Nominal
GDP
120
$120 $
50
300 $
40
320 $
500
2
600
2.50 $
20
800 $
25
820 $
$42 000
$49 200
Real
GDP
Calculating Nominal and Real GDP
Year 1 (base year)
Item
Machines
100
$100 $10 000
120
$120 $14 400
$100 $12 000
50
300 $15 000
40
320 $12 800
300 $12 000
500
2 $ 1 000
600
2.50 $ 1 500
2 $ 1 200
20
800 $16 000
25
820 $20 500
800 $20 000
$49 200
$45 200
Bread
Cars
Totals
Nominal
GDP
Qty of
Output
$42 000
Prices
Year 2
Nominal
GDP
Prices
Year 1
Real
GDP
Qty of
Output
Km of Road
Prices
Year 1
Year 2
Types of Unemployment
LO2
Frictional Unemployment
unemployment caused by the fact that it takes time for
people to find their first job or to move between jobs
Structural Unemployment
unemployment that results from a mismatch in the
skills or location between jobs available and people
looking for work.
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© 2012 McGraw-Hill Ryerson Limited
Types of Unemployment
LO2
Cyclical Unemployment
occurs as a result of the recessionary phase of the
business cycle
Discouraged Worker
an individual who wants work but is no longer actively
seeking it because of the belief that no opportunities
exist
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© 2012 McGraw-Hill Ryerson Limited
Types of Unemployment
LO2
Full Employment
situation in which there is only frictional and structural
unemployment
cyclical unemployment is zero
Natural Rate of Unemployment
the unemployment rate at full employment
4- 16
© 2012 McGraw-Hill Ryerson Limited
Fig. 19-3
Labour Force, Employment,
and Unemployment, 1960–2011
(i) Labour force and employment
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(ii)Unemployment rate
Chapter 19, Slide 17
• 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 18
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 19
Fig. 19-4
Canadian Labour Productivity, 1976–2011
Real GDP per worker
is measured in
thousands of
dollars!
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Chapter 19, Slide 20
Inflation
LO3
A persistent rise in the general level of prices
Measured using a price index
Most widely used:
• Consumer Price Index (CPI)
• GDP Deflator
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© 2012 McGraw-Hill Ryerson Limited
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 22
Measuring Inflation
LO3
Consumer Price Index (CPI)
a measurement of the average level of prices of the
goods and services that a typical Canadian family
consumes
CPI = cost of basket in a given year x 100
cost of basket in a base year
Inflation rate = index Year 2 – index Year 1 x 100
index Year 1
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© 2012 McGraw-Hill Ryerson Limited
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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Chapter 19, Slide 24
Fig. 19-5
The Price Level and
the Inflation Rate,
1960–2012
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Chapter 19, Slide 25
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 26
LO4
Self-Test
If you borrowed a sum of money for one year at a nominal
rate of interest of 11 percent and during that same year the
inflation rate was 4 percent, what real rate of interest did
you pay?
4-27
© 2012 McGraw-Hill Ryerson Limited
Fig. 19-6
Real and Nominal Interest Rates, 1965–2012
Copyright © 2014 Pearson Canada Inc.
Chapter 19, Slide 28
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 29
Fig. 19-7
Canadian–U.S. Dollar Exchange Rate, 1970–2012
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Chapter 19, Slide 30
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 31
Fig. 19-8
Canadian Imports, Exports, and Net Exports, 1970–2011
Copyright © 2014 Pearson Canada Inc.
Chapter 19, Slide 32
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 33
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 34
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 35
Review
1. Consider an economy in which existing capital is being used at a
high degree, shortages in labour and goods markets are developing,
and costs are rising. Which of the following terms best describes this
stage of the business cycle?
A) peak
B) trough
C) slump
D) recession
E) recovery
© 2014 Pearson Education Canada Inc.
36
Review
2. If a country's labour force is 15 million people, and 0.5 million are
unemployed, the country's unemployment rate is
A) 2.5 percent.
B) 3.3 percent.
C) 4.5 percent.
D) 6.7 percent.
E) 9.0 percent.
© 2014 Pearson Education Canada Inc.
37
Review
If the Consumer Price Index changes from 120 in year one to 150 in
year two, the rate of inflation in the intervening year is
A) 10 percent.
B) 12.5 percent.
C) 20 percent.
D) 25 percent.
E) 30 percent.
© 2014 Pearson Education Canada Inc.
38
Review
An output gap, where Y < Y*,
A) tends to force prices up.
B) is desirable because it keeps wage costs low.
C) is known as an inflationary boom.
D) results in a dead-weight loss of unemployed resources that cannot
be recovered.
E) occurs when there is excess demand.
© 2014 Pearson Education Canada Inc.
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