Macroeconomics Broad Social Goals Economic Freedom Freedom Index

Macroeconomics

Broad Social Goals • Economic Freedom- Freedom Index • Economic Growth-GDP • Economic Stability-CPI • Economic Equity- Gini Index • Economic Efficiency - Hard to measure MSB=MSC

Macroeconomic Goals • Full Employment • Price Stability • Economic Growth

Phases of the Business Cycle

What causes fluctuations in output? • Irregular innovation that sparks investment i. e. microchip, internet & railroad • Productivity changes-result in unexpected changes in resource availability. • Monetary factors – too much money and to too little • Political events- 9/11, war, peace • Financial Instability- financial bubbles and bursts • Short run stickiness in prices prevent the economy from adjusting rapidly to shocks. • Most effected by business cycles: consumer durable goods and capital goods. Nondurable consumers goods are somewhat insulated from the cycles.

Economic Indicators Leading Indicators v Avg wkly hrs, manufacturing v Avg wkly initial claims for unemployment v Building permits v Stock prices, S& P 500 v Money Supply, MM 2 v Interest rate spread, 10 -yr Treasury bonds less federal funds v Index of consumer expectation Lagging Indicators v Avg duration of unemployment v Manufacturing and trade inventories v Commercial loans v Ratio of consumer debt to personal income v Change in labor cost per unit of output, manufacturing v Short term Interest rates

The Circular Flow of Resources, Goods, Services and Money Payments

Circular Flow with Government

GDP Gross Domestic Product, is the market value of all final goods and services produced in a country in a given time period 30% Goods 70% Services

Consumer Spending (C) • Spending by households on goods and services such as food, rent, medical expenses and so on but does not include new housing. 2/3 of GDP 10% durable goods 30% nondurable goods 60% services

Gross Investment (I) Spending by business on machinery, factories, equipment, tools. All construction-includes residential construction b/c they earn income if they are rented. Changes in inventory

Gross Investment – (all investment-even replacement of broken equipment) Net investment plus depreciation Net investment is the added capital If gross is less than depreciation net investment is negative ex. Great Depression. Depreciation- capital used up in a year

Gross Investment • Changes in inventory- count all goods that were produced even though it might not have been sold. • Inventories can increase, or decrease – increase in inventory producing more than it sold but counted. – “draw down inventories” means sold more output than it produced (sold stuff from last year already counted)

Net Exports (Nx or X-M) • Spending by people abroad on US goods and services (exports) minus spending by people in the US on foreign goods and services (imports)

Government Spending (G) • Spending by all levels of government on goods and services. Includes spending on the military, schools, and highways.

Not included in GDP • • • Secondhand Sales Illegal activities Transfer payment Financial transactions Intermediate Goods Intermediate good: meat, bun, lettuce, tomato

GLOBAL PERSPECTIVE The Underground Economy as a Percent of GDP 0 5 10 15 20 25 30 Greece Italy Spain Portugal Belgium Sweden Germany France Holland United Kingdom Japan United States Switzerland Source: The Journal of Economic Literature, 2000

Two ways of computing GDP Product Market • Aggregate expenditures approach AE=GDP=C+I+G+(X-M) Resources Market • Factor income approach GDP=Y=wages +interest +rent + profits Y=C+S+T

Why do we have inflation, and why is inflation a problem? • Increase in the average price level over time. • Mostly a monetary problem but other reasons exist.

Price Stability Inflation Deflation • A rise in the general level of • A decline in the general prices (1970 s) level of prices (Great Depression)

Worst Inflation on Record Germany Aug. 1922 -Nov. 1923 �Inflation Rate 1, 020, 000, 000% �Before 1920, one mark would buy a full meal for 2 �By Nov. 1923, a foot high stack of 50 M mark notes to feed one couple. �German prices rose at the rate of 41 percent per day Hungary Aug. 1945 - 1946 � 381, 000, 000, 000% �Octillions x-mas price index

Measurements of inflation Two ways to estimate prices • Directly by constructing price indexes – Consumer Price Index (CPI) – Producer Price Index (PPI) • Indirectly by computing the implicit price deflator (the most inclusive index). – GDP Price Deflator •

Price index for groceries • Market basket (in base year of 1960) – 1 dozen eggs – 2 chickens – 3 pounds hamburger – Other things a typical family might buy Price of basket =$100 in 1960 Price of basket = $200 in 1970

Calculations of Price changes • CPI= cost of market basket current-year cost of same market basket in base-year X 100 • Price Change = Change in CPI X 100 Beginning CPI overstates or understates real GDP?

Price index • The market basket does not change so any difference must be due to prices. • Price indexes however miss – Substitution effect – New goods – Quality changes – Discount stores – Changes in products over time

Measuring Short-Run Economic Growth • is to measure fluctuation in output • We measure increases in the quantity of goods and services produced in the economy. • Fluctuations in output are caused by greater or lesser utilization of the existing capital stock. • We are actually measuring changes in real output because of more or less labor applied to the existing level of technology and plant equipment.

Price Index Current year cost X 100= Base year cost Base year always indexed at 100 CPI and GDP Price deflator are both examples of a price index • Nominal – values that increase or decrease with price level • Real – adjust for price changes

Implicit price deflator • Estimate real GDP by determining what people buy now using base year prices • Changes in consumption patterns or new goods are reflected in the deflator unlike the CPI.

Implicit price deflator GDP deflator = Nominal GDP X 100 Real GDP Ratio of current year prices to some base year P deflator of 200 means that a current year price is twice its base year.

Converting nominal GDP to real GDP using a price index (In year 1) index X 100

Have cars gotten cheaper? Real Output Growth Real GDP growth = (real GDP yr 2 - real GDP yr 1) x 100 (Output) real GDP yr 1 Elwood Haynes in his first car in 1894 - $2, 000 REVAi/G-Wiz i electric car - £ 9, 995

Real GDP per Capita = year 1 real GDP population in Yr 1

GDP and economic welfare • GDP ignores: – changes in heath and life expectancy – leisure time (early retirement) – environmental quality – political freedom and social justice

Why do we have unemployment, and why is unemployment a problem? • Many reason for unemployment • Unemployment means that society has fewer products because workers are not working. • Imposes social and psychological costs on society

Types of Unemployment Frictional Unemployment Structural Unemployment Cyclical Unemployment Seasonal Unemployment Other Employment Concepts Natural Rate of Unemployment Full Employment

Frictional Unemployment • Workers voluntarily changing jobs; and by temporary layoffs. • Example: quit your job to look for a better one because you hate your boss.

Structural Unemployment • Workers whose skills are not in demand by employers. • Example: typists that lack computer skills

Cyclical Unemployment • Unemployment caused by an insufficient aggregate demand; recession.

Full Employment • When the economy experiences only frictional and structural unemployment. Or • Full employment occurs only when there is no cyclical unemployment. • Full employment is less than 100%. • Unemployment Map

Definitions of Employed, Unemployed and Unemployment Rate Employed = everyone currently working, including part-time workers Unemployed = people looking for work or temporarily laid off from work Unemployment Rate(UR) = # of unemployed X 100 labor force Labor force(LF) = employed + unemployed Labor force participation rate (LFPR) = # in labor force X 100 adult population

Employed, Unemployed, Not in labor force Unemployed includes people who are actively looking for work. People who have stopped looking are not counted as unemployed. People are not consider part of the labor force if under the age of 16, not looking for work (house wife or retired) or institutionalized.

Problems with the measurement • Discouraged workers –persons who have given up looking are no longer counted as unemployed. • Underemployed workers- people who are working part time but would like full time or who holds a job that requires a lower skill level than they possess. • Different groups experience different levels of unemployment rates

Programs to Reduce Unemployment • Frictional – Job information – Employment services • Structural – – Educational subsidies Job training/ Retraining Wage Subsidies/ Employment Tax Credits Public Services Employment • Cyclical – – Fiscal Policy Monetary Policy Public Service Employment Wage Subsidies/ Employment Tax Credit

What determines economic growth? • Growth depends on: o Number of workers o The education and training of workers o The technological advances o The amount of machinery &technology labor has to work with o The basic material resources o Trade

Long Run Economic Growth • refers to changes in the productive capabilities of the economy through changes in amount of plant and equipment and technology

How do changes in the amount of money in the economy affect output, growth, unemployment and inflation? • Decisions of the Federal Reserve Bank determine the amount of money in the economy. • The amount of money in the economy determines the level of economic activity. • Monetary policy

Which government policy affects output, growth, unemployment and inflation? • Government policy decisions on taxes and spending affects the level of economic activity. • Fiscal policy

Deficit/Surplus/Debt • Tax Revenue – Government Spending= Deficit – negative balance government must borrow. Or Surplus – positive balance Debt- The total accumulation of the deficits the Federal government has incurred through time. Total amount owed. US securities: Treasury bills, Treasury Notes, Treasury Bonds and US Saving Bonds $10, 852, 628, 401, 130. 22 2008 $15, 574, 428, 564, 198. 34 2012

A Trillion Dollar 1 Million Dollars $10, 00 0

100 Million Dollars 1 Trillion Dollars 1 Billion Dollars

US Debt National debt is the sum of all securities issued by the US Treasury

US Deficit / Surplus

US Deficit / Surplus

SS 24% Unempl oyment Medicare 17% Medicaid 9% ACA Subsidies 1%

Special Interest • Pork Barrel Spending the politicians win political favor with a small group of highly valued local constituents by spending on projects that cannot others wise be economically justified. • Logrolling trading votes to secure favorable outcomes can either diminish or increase in economic efficiency.