Economics BASIS 8 Unit 6 : Macroeconomics

Intro to Macroeconomics

Goals:

• Economic Growth: producing more and better goods and services to develop a higher standard of living

• Stable Prices: reduce/avoid large price fluctuations (inflation/deflation)

• Limit Unemployment: maintain a 4-5% unemployment rate

• Sustainability of Productive Resources

• Balance of Trade: seek an efficient level of trade with international markets

• Income Equity

Economic Growth can be measured as either:

• An increase in real GDP occurring over some time period

• An increase in real GDP per capita over some time period

Economic Growth is important because it lessens the burden of scarcity and provides a way to obtain people’s wants.

Two Major Sources of Economic Growth:

1. Increasing availability of input resources

2. Increasing productivity of existing input resources

The Business Cycle Model shows how a nation’s real GDP [a measure of the economy’s output] fluctuates over time. It has 4 parts/phases:

1. peak/boom—the point at which business activity has reached its temporary maximum

2. recessions/contractions—periods of decline in total output, income, employment and trade

3. troughs/bust—the bottoming out of output and employment loss and can either be for a short or long period of time

4. expansion/recovery—a period where output and employment are rising

On an international scale economists adopt the rule that two consecutive quarters during which aggregate output falls is considered to be a recession.

A depression is a very deep and prolonged downturn.

The circular flow of goods and services is a model of an economy showing the interactions among households, firms, and governments as they exchange goods, services, and resources in markets.

3 Sectors Within an Economy:

1. Consumer (Household): consist of either an individual or a group of people who share their income

2. Investment (Business/Firms): an organization that produces goods and services for sale and employs members of households

3. Government: a body of people that sets and administers public policy and purchases goods within an economy

   • [Product Markets]: where goods and services are bought and sold

   • [Factor Markets]: where resources like capital and labor are bought and sold

GDP

GDP (gross domestic product) is the dollar value of the final goods and services produced within a nation in a year

Final Goods are those ready for consumption

• Avoids double counting

Intermediate goods are goods bought from one firm by another firm to be used as inputs into the production of final goods and services.

GDP Exclusions

• Second-hand Sales

• Nonmarket Transactions

• Underground Economy

• Financial Assets

• Foreign Produced

• Intermediate Goods & Services

Measuring GDP

• Output Expenditure Model: Y = C + I + G + (X - IM)

  • [C] Consumption—private consumption is the largest portion of GDP; focuses on the spending that is done by the average consumer

  • [I] Investment—any current spending in order to improve output/efficiency for businesses and workers; includes spending on new productive physical capital new construction, and the market value of unsold inventory

  • [G] Government Spending—the gov. at all levels purchases final goods, services, and investments in infrastructure; DOES NOT INCLUDE GOV. TRANSFERS

  • [X] Exports—domestically produced goods/services bought by foreign consumers

  • [IM] Imports—consumption of goods/services produced within other nations

Real vs. Nominal GDP

• Real GDP is the value of all final goods and services but using prices from a base year (adjusted for inflation)

  • Real GDP = (Nom./Price Index) x 100

• Nominal GDP is the value of all final goods and services at current prices of that year

The most important use of GDP is as a measure of the size of the economy.

GDP is an imperfect measure of economic prosperity and growth.

• Nation Size

• Leisure Time

• Improved Product Quality

• Increases in disease, divorce, crime, & natural disaster

• Inability to measure sustainability & environmental impacts

Unemployment

Employed are people currently holding a job within the economy.

Unemployed are people actively looking for work but are not currently employed.

• The labor force is the sum of employed and unemployed individuals.

• The working age population is the portion of the population age 16 and older.

labor force (LF) = unemployed + employed

unemployment rate (UR) = unemployed/labor force x 100

labor force participation rate (LFPR) = labor force/working age population x 100

The unemployment rate is usually understated. Reasons may include:

• Discouraged Workers are non-working people who are capable of working but have given up looking for a job due to the state of the economy.

• The underemployed are people who work part time jobs because they cannot find a full-time job.

Overemployed individuals have a full-time job and work additional hours for another employer.

Types of Employment

• Frictional Unemployment is due to workers voluntarily searching for jobs

• Structural Unemployment is when the skills of workers are not demanded by employers.

The natural rate of unemployment (NRU) is the unemployment rate that arises from the effects of frictional & structural unemployment.

• natural unemployment = frictional un. + structural un.

• today it is around 4%

Cyclical unemployment is the deviation of the actual rate of unemployment from the natural rate.

Prices Indices & Inflation

A price index is a ratio that shows the extent to which a price has changed over a period—such as a month, quarter, or year— by comparing current prices with the price in a certain year taken as a standard, known as the base year.

A market basket is a fixed list of items used specifically to track the progress of inflation in a economy or specific market

The consumer price index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services.

• Prices are collected monthly in 75 urban areas across the country from approximately 23k firms. Rent is collected separately from 50k landlords or tenants.

• The goods and services are weighted according to their importance.

  • consumer price index (CPI) = value of market basket in given year/value in base yr. x 100

The method for determining CPI does not account for:

1. Consumers can substitute for goods that are in the market basket if their price rises too high.

2. The products we buy tend to change over time making the market basket inaccurate.

3. Quality Differences are not always taken into account with a price change.

The producer price index (PPI) measures changes in the prices of goods and services purchased by producers.

• usually contains raw commodities like steel, electricity, and coal.

The two problems that appear from instability are unemployment and inflation.

• Unemployment is the number of people who are actively looking for work but aren’t currently employed.

• Inflation is a rise in overall price level.

  • inflation rate = CPI_yr2 - CPI_yr1/CPI_yr1 × 100

Hyperinflation is a very high rate of inflation that is typically accelerating out of control. It erodes the value of currency because prices of all goods increase rapidly, making currency—especially cash—less valuable.

Stagflation is a period of slow economic growth and relatively high inflation, so the economy isn’t growing but price are.

The nominal interest rate is the interest rate appearing on the documentation for a loan.

The real interest rate is the nominal interest rate minus the rate of inflation.

• R = N - I

The nominal income income is an increase in the amount of money a person receives without adjusting for inflation. Nominal income can come from wages, rent, interest, or profit.

The real income interest is the nominal income increase minus the rate of inflation.

• R = N - I

Unexpected inflation can disrupt economic activity, causing the circular flow of resources and goods/services to slow down.

Who is hurt?

• Fixed income receivers

• Savers

• Creditors (lenders)

Who benefits?

• Debtors (borrowers)

Equations

GDP = C + I + G + (X-IM)

Real GDP = Nominal GDP/Deflator x 100

GDP Deflator = Nominal GDP/Real GDP x 100

Inflation Rate = CPI₂ - CPI₁/CPI₁ × 100

Nominal GDP = (Deflator x Real GDP)/100

Real Interest Rate = Nominal Interest Rate - Inflation

Unemployment Rate = Unemployed People/Labor Force x 100

Labor Force = Employed + Unemployed

CPI Formula = Value in Given Year/Value in Base Year x 100

Real Income Increase = Nominal Increase in Income - Inflation

Per Capita RGDP = RGDP/Population

Real Wage = Nominal Wage/CPI x 100

LFPR = Labor Force/Working Age Non-Institutionalized Pop x 100

Natural Rate of Unemployment = Frictional + Structural Employment