Macro - (Unit 2 Test)

Macroeconomics

Macroeconomics

 The study of the large economy as a whole.  It is the study of the big picture.

Macro was created to…

1. Measure the health of the whole economy.

2. Guide government policies to fix problems (The field of macroeconomics was born during the Great Depression, the government didn’t understand how to fix a depressed economy with 25% unemployment.)

Gross Domestic Product (GDP)

the dollar value of all final goods and services produced within a country’s borders in one year.

What is NOT included in GDP?

1. Intermediate Goods 

   • Goods inside the final goods don’t count. 

   • EX: Price of finished car, not the stock radio or tires. 

2. Non Production Transactions

• Financial Transactions (nothing produced)

  • Ex: Stocks, bonds, Real estate

• Used Goods

  • Ex: Old cars, used clothes  

3. Non-Market and Illegal Activities 

• Things made at home- household production

  • Ex: Unpaid work, black markets, drugs  

Expenditures Approach

Add up all the spending on final goods and services produced in a given year. 

Calculates GDP

*WE USE MOST

Income Approach

Add up all the income that resulted from selling all final goods and services produced in a given year. 

Calculates GDP

*WE USE LESS

Adding up how much was spent on goods and services and how much income was earned should generate the same number..

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Four components of GDP:

Expenditures Approach

Four components of GDP:

1. Consumer Spending- 68% of U.S. GDP Purchases of final goods by private individuals. Ex: $5 Sandwich at Subway

2. Investment- Businesses spending on tools and equipment.  

      Ex: Walmart buys self checkout machines

3.  Government Spending-

Ex: School, tanks, but NOT transfer payments

4.  Net Exports- Exports (X) – Imports (M)

Ex: Value of 3 Ford Focuses minus 2 Hondas

What does GDP tell us

Just like calculating your own income, GDP measures how well the U.S. is doing financially. 

How do you use GDP? 

1. Compare to previous years (Is there growth?)

2. Compare policy changes (Did a new policy work?)

3. Compare to other countries (Are we better off?)

GDP Per Capita (per person)

GDP divided by the population. It identifies on average how many products each person makes. 

GDP per capita is the best measure of a nation’s standard of living.

GDP per capita is the best measure of a nation’s standard of living.

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Does GDP accurately measure standard of living?

Standard of living can be measured, in part, by how well the economy is doing…

But it needs to be adjusted to reflect the size of the nation’s population.

How can you measure growth from year to year?

% Change in GDP = (Year 2 - Year 1)/Year 1 × 100

What is Inflation?

A rise in the general level of prices.

Nominal GDP

is GDP measured in current prices.  It does not account for inflation from year to year.

(Current Year Price * Current Year Qty)

How do you find Nominal GDP?

(Current Year Price * Current Year Qty)

Real GDP

Is GDP expressed in constant, or unchanging, dollars.

(Base Year Price*Current year Qty)

 Real GDP adjusts for inflation.

What is the best measure of economic growth, and why?

REAL GDP IS THE BEST MEASURE OF ECONOMIC GROWTH! 

 Real GDP adjusts for inflation.

How do you find real GDP?

(Base Year Price*Current year Qty)

Real GDP “deflates” nominal GDP by adjusting for inflation in terms of a base year prices.

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GDP Deflator = (Nominal GDP/Real GDP) x 100

How do you find the GDP Deflator

GDP Deflator = (Nominal GDP/Real GDP) x 100

Five Ways to Measure the U.S. Economy

1. U.S. Nominal GDP

2. GDP Growth Rate

3. GDP Per Capita

4. Real GDP

5. Debt to GDP Ratio

Unemployment

Workers that are actively looking for a job but aren’t working

The Unemployment Rate

The percent of people in the labor force who want a job but are not working.

Who is in the Labor Force?

• 16 years old and older

• Able and willing to work

• Not institutionalized (in jails or hospitals)

• Not in military, in school full time, or retired

Why is a stay at home mom/dad not unemployed?

They are not actively job-searching.

How do you calculate the Unemployment rate

(# Unemployed)/(# in labor force) x 100 = Unemployment rate

How do you caluclate the Labor Force

Unemployed + Employed

How do you caluclate the Labor Force Participation Rate

(# in labor force)/(Adult Population) x 100 = Labor Force Participation Rate

The three types of Unemployment

#1. Frictional Unemployment

#2. Structural Unemployment

#3 Cyclical Unemployment

Frictional unemployment- DEF

• Temporary  unemployment or being between jobs 

#1. Frictional Unemployment

• Frictional unemployment- Temporary  unemployment or being between jobs 

• Individuals are qualified workers with transferable skills.

Examples: 

• High school or college graduates looking for jobs.

• Individuals that quit and are looking for a better job.

Seasonal Unemployment is a specific type of frictional unemployment which is due to time of year and the nature of the job.

Seasonal Unemployment

is a specific type of frictional unemployment which is due to time of year and the nature of the job.

Structural Unemployment DEF

Changes in the labor force make some skills obsolete.

#2. Structural Unemployment

• Structural Unemployment- Changes in the labor force make some skills obsolete.

• These workers DO NOT have transferable skills and these jobs will never come back. Workers must learn new skills to get a job.

• The permanent loss of these jobs is called “creative destruction” 

Examples: VCR repairman, Milkmen

Technological Unemployment- Type of structural unemployment where automation and machinery replace workers

Technological Unemployment

Type of structural unemployment where automation and machinery replace workers

• Cyclical Unemployment DEF

• Unemployment caused from a recession

#3 Cyclical Unemployment

• Cyclical Unemployment- Unemployment caused from a recession

• As demand for goods and services falls, demand for labor falls and workers are fired

• This is sometimes called “demand deficient unemployment”

Examples: 

• Steel workers laid off during recessions

• Restaurant owners fire waiters after

months of poor sales due to recession

• High unemployment during the 

Great Depression

Natural Rate of Unemployment (NRU)

Frictional plus structural unemployment. The amount of employment that exists when the economy is healthy and growing. 

Full Employment Output (Y)

The Real GDP created when there is no cyclical unemployment

When is the US at full employment?

The US is at full employment when there is 4-6% unemployment

• Frictional and structural unemployment are present at all times because people will always be between jobs or replaced by technology.

• So, the economy is doing great if there is only frictional and structural unemployment.

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The natural rate of unemployment is often greater in other countries than the USA. WHY?

• Some economists attribute the difference to more generous unemployment benefits in European countries

• In the U.S. unemployment benefits last for 6 months

• Unemployment benefits in some European countries are indefinite

• The generous benefits reduce incentives to search for a job

• Actual Unemployment (F+S+C) 12%

• NRU (F+S) 6%

• Cyclical Unemployment would be 6%.

Criticisms of the Unemployment Rate

The unemployment rate can misdiagnose the actual unemployment rate because of:

Discouraged Workers-

• Some people are no longer looking for a job because they have given up.

Labor Force Participation Rate

Percent of population in the labor force.

If people leave labor force the unemployment rate falls 

Underemployed Workers- 

• Someone who wants more hours but can’t get them is still considered employed.

Race/Age Inequalities-

• The overall unemployment rate doesn’t show disparity for minorities and teenagers

Discouraged Workers-

• Some people are no longer looking for a job because they have given up.

Labor Force Participation Rate

Percent of population in the labor force.

If people leave labor force the unemployment rate falls

Underemployed Workers- 

• Someone who wants more hours but can’t get them is still considered employed.

Race/Age Inequalities-

• The overall unemployment rate doesn’t show disparity for minorities and teenagers

Nominal Interest Rates- 

The percentage increase in money that the

borrower pays not adjusting for inflation.

Nominal = Real interest rate + inflation

Real Interest Rates-

The percentage increase in purchasing power

that a borrower pays. (adjusted for inflation)

Real = Nominal interest rate - (expected/actual) inflation

Base year gdp deflator will always be 100 unless there is inflation

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Nomnal is always bigger than real gdp because real gdp adjusts for inflation. Nominal GDP is current year price x current year quantity. Real GDP is base yaer price x current year quantity

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Inflation

Rising general level of prices and it reduces the “purchasing power” of money

When inflation occurs, each dollar of income will buy fewer goods than before

Nominal Interest Rates- 

The percentage increase in money that the

borrower pays not adjusting for inflation.

Nominal = Real interest rate + inflation

Real Interest Rates-

The percentage increase in purchasing power

that a borrower pays. (adjusted for inflation)

Real = Nominal interest rate - inflation

Is inflation good or bad

In general, ramped inflation is bad because banks don’t lend and people don’t save. 

This decreases investment and GDP.

Deflation

Decrease in general prices or a negative inflation rate.

🡪 Deflation is bad because people will hoard money (financial assets) and people will not borrow.

Disinflation

Prices increasing at slower rates  

People hurt by unanticipated inflation

• Lenders-People who lend money (at fixed interest rates)

• People with fixed incomes 

• Savers

People helped by unanticipated inflation

• Borrowers-People who borrow money

• A business where the price of the product increases faster than the price of resources

Nominal Wage

Wage measured by dollars rather than purchasing power

Real Wage

Wage adjusted for inflation

COLA

Cost of Living Adjustment

There are two ways to look at inflation over time:

The Inflation Rate

Price Indices

The Inflation Rate

The percent change in prices from year to year

Price Indices

Index numbers assigned to each year that show how prices have changed relative to a specific base year.

The most commonly used measurement of inflation for consumers is the _____

Consumer Price Index (CPI)

CPI formula

(Price of market basket in the year you are looking for)/(Price of market basket in base year) x 100

% Change In Prices

(Year 2 - Year 1)/Year 1 X 100

GDP Deflator vs. CPI

The GDP deflator measures the prices of all final goods produced domestically, whereas the CPI measures prices of only the goods and services bought by consumers, produced wherever.

An increase in the price of goods bought by firms or the government will show up in the GDP deflator but not in the CPI.

The GDP deflator includes only those goods and services produced domestically.  Imported goods are not a part of GDP and therefore don’t show up in the GDP deflator.

GDP Deflator Formula

Nominal GDP   / Real GDP x 100

Problems with the CPI

• Substitution Bias- As prices increase for the fixed market basket, consumers buy less of these products and more substitutes that may not be part of the market basket. (Result: CPI may be higher than what consumers are really paying)

• New Products- The CPI market basket may not include the newest consumer products. (Result: CPI measures prices but not the increase in choices)

• Product Quality- The CPI ignores both improvements and decline in product quality. 

(Result: CPI may suggest that prices stay the same though the economic well being has improved significantly)

• Substitution Bias-

• As prices increase for the fixed market basket, consumers buy less of these products and more substitutes that may not be part of the market basket. (Result: CPI may be higher than what consumers are really paying)

 3 Causes of Inflation

1. The Government Prints TOO MUCH Money (The Quantity Theory)

2. Demand- Pull Inflation

3. Cost-Push Inflation

1. The Government Prints TOO MUCH Money (The Quantity Theory)

• Governments that keep printing money to pay debts end up with hyperinflation.

  • Result: Banks refuse to lend so investment falls and people don’t save up to buy things. LESS CAPITAL GOODS PRODUCED.

The velocity of money

the average times a dollar is spent and re-spent in a year.

Quantity Theory of Money Equation: 

M x V = P x Y 

M = money supply P = price level 

V = velocityY = quantity of output

2. Demand- Pull Inflation

DEMAND PULLS UP PRICES!!!

“Too many dollars chasing too few goods”

An overheated economy with excessive

Spending but same amount of goods.

3. Cost-Push Inflation

Higher production costs increase prices

A negative supply shock increases the costs of production and forces producers to increase prices.

Rawr

• When tax revenue falls short of government spending, the government faces a choice.

  1. Borrow Money

  2. Taxing

  3. Print Money

• If the government prints money, inflation will be generated.

• In the long run, if 50% more money is printed, prices are going to go up by 50%

• For anyone who is holding wealth in its most liquid form or whose income is fixed, inflation is reducing the purchases power of your dollars

Expansionary Policy

Increased gov. spending

Circular flow diagram

The market for factors of production connects spending by firms to household income.

The most commonly used measurement of inflation for consumers is the

Consumer Price Index (CPI)

current

constant

nominal

real