A First Look at Macroeconomics

The Study of Economics

Economics -- The study of the production, allocation, and distribution of (limited) resources to most efficiently meet (unlimited) human wants and needs.

Microeconomics Versus Macroeconomics

Microeconomics -- The study of economic decisions of individuals and firms.

Macroeconomics -- The study of the economy as a whole (aggregates or totals).

The Macro Goal Variables

Measures of Economy’s “Health”Definitions, Realistic Goals, and

Recent (US) Performance

#1 -- Real Gross Domestic Product (Real GDP)

Real GDP (Y) -- The total production or output of final goods and services over a period of time, expressed in constant prices of a base year.

Real Versus Nominal GDP

Nominal GDP (unadjusted GDP) -- Total production at current prices.

Real GDP (GDP adjusted for changes in prices) -- Total production at constant prices of a base year.

Why is Production or Output Important?

The Macro Connection -- Firms produce goods and services in order to sell them. Because when they sell the newly produced goods and services, they generate income for the business.

Total Production or Output Total Sales Total Income

Real GDP -- Realistic Goal

Realistic Goal for Real GDP -- to be as high as possible without accelerating inflation (overstimulated economy).

The Full Sustainable Level of Real GDP (Potential GDP)

The Full Sustainable Level of Real GDP (Full GDP or YF) – the maximum level of real GDP the economy can produce without bringing on accelerating inflation.

Describing the Economy: Real GDP Versus Full GDP

Y < YF -- sluggish economy

Y > YF -- economy with

accelerating inflation

Y = YF -- economy with constant

inflation rate (desired

state)

Characteristics of YF

UnobservableGrows at 2.5% per year for the US

(historically)Primarily affected by:

-- labor productivity

-- the capital stock

-- the labor force

Recession -- A Special Case

Recession -- The situation where the level of real GDP decreases for at least two consecutive quarters.

Clearly, in a recession, Y < YF.

Goal Variable #2 -- Inflation

Measured by the Inflation Rate -- the growth or percentage change in the overall price level.

First, measure the price level (P).

-- Consumer Price Index (CPI)

-- GDP DeflatorInflation Rate = Percentage Change in

P.

Why is Inflation a Problem?

Inflation erodes the purchasing power of money.

-- Why hold money?

-- Why lend money?Inflation can erode people’s standard

of living

-- Fixed incomes.

-- Workers with insufficient raises.

Realistic Goal -- Inflation

Ideal Goal: Inflation Rate = 0%.

Realistic Goal (US):

|Inflation Rate| < 3%.

Goal Variable #3 -- Unemployment

Measured by the unemployment rate

u = (# of people unemployed)

(labor force)

Unemployed -- those people out of work and seeking work.

Labor Force -- people employed + people unemployed

Realistic Goal -- Unemployment Rate

Realistic Goal -- as low as possible without inflation accelerating (overstimulated economy).

Natural Rate of Unemployment (uN) -- The lowest unemployment rate the economy can achieve without accelerating inflation.

Realistic Goal: u = uN

Interpretation: u Versus uN

u = uN Desired State of

Economyu > uN Sluggish Economy

u < uN Accelerating Inflation

(Overstimulated Economy)

Where is uN for the US?

Historically -- uN = 5.5%

Is uN now maybe 5%?

Real GDP and the Unemployment Rate

u = uN Y = YF,

(Desired State of Economy)u > uN Y < YF,

(Sluggish Economy)u < uN Y > YF,

(Overstimulated Economy)

Unemployment -- Not an Independent Problem

Real GDP Growth Employment Growth u

Real GDP and unemployment -- not independent problems.

Focus on getting one of them to the desired goal, and the other one will automatically follow (although not a perfect correlation).

Goal Variable #4 -- The Federal Budget

Budget = Tax Revenues - Government Expenditure (over a given period)

Budget = Tax Revenues - (Government purchases of goods and services + Transfer Payments + Interest on the National Debt)

Federal Budget -- Notation

Let T = Net Taxes = Tax Revenues - (Transfer Payments + Interest on the National Debt).

Let G = Government purchases of goods and services.

Then The Federal Budget = (T - G).

Characterization of the Federal Budget

(T - G) < 0 -- Budget Deficit(T - G) > 0 -- Budget Surplus(T - G) = 0 -- Balanced Budget

Realistic Goal -- The Federal Budget

Realistic Goal -- Balanced Budget when Y = YF.

Sluggish economies tend to have deficits.

Hierarchy of economic problems: cure Real GDP and Inflation first, then look to the Budget.

Goal Variable #5 -- The Balance of Trade

Balance of Trade (BOT) -- approximated by net exports.

Net Exports (or the BOT) = Exports (X) - Imports (M)

(X - M) < 0 -- BOT Deficit(X - M) > 0 -- BOT Surplus(X - M) = 0 -- Balanced Trade

Position

Realistic Goal -- Balance of Trade

Realistic Goal -- Balance of Trade (X - M) close to zero.

Again, a hierarchy of economic problems