Unit 2

Macroeconomics and the Circular Flow

MacroeconomicsThe part of economics concerned with the economy as a whole; with such aggregates as the household, business, and government sectors; and measures of the total economy

Why does output fluctuate?

As output rises and falls, it can affect;# of goods and services people haveStandard of living# of people employed

Macroeconomics looks at the determinants of output fluctuation and how these factors can be controlled

What determines economic growth?

Growth (long-run) in the economy depends on:

Number of workersEducation and training of workersTechnological advancesAmount of machinery and technology labor has to work withBasic material resources

Macroeconomics addresses how society can encourage the development of these factors, which determine economic growth

Why do we have unemployment,and why is unemployment a problem?

The unemployed are people who are actively seeking jobs or are temporarily laid offUnemployment means that society has fewer products because workers are not workingUnemployment also imposes social and psychological costs on society

Why do we have inflation, and why is inflation a

problem?Inflation

An increase in the average price level over time (price level –weighted avg. of the prices of all final goods & services)

UnpredictableMacroeconomics studies the causes of inflation, the misallocation of resources that result from inflation, and methods for controlling inflation.

Which government policy affects output, growth, unemployment and

inflation?

Fiscal policySummary of the government’s decisions about expenditures and taxation

Government decisions on taxes and spending will affect the level of output, growth, unemployment and inflation.

How do changes in the amount of money in the economy affect output, growth,

unemployment and inflation?

Decisions of the central bank – the Federal Reserve in the United States – determine the amount of money (money supply) in the economy Monetary policy

Summary of the Federal Reserve’s decisions about money and interest rates

How do domestic economic activities affect other

countries?A nation’s economy does not operate independent of other countries’ economiesTrade, Monetary, and Fiscal policies all affect the impact of the domestic economies of other nations

Activities 9 and 10

Economic goals of U.S. society

Full EmploymentPrice StabilityEconomic Growth

Goals may conflictTrade-offs

Activity 11

Unemployment RateBroad measure of economic activityHowever, if policy makers are going to create and implement programs to help the unemployed, they need to know more about the unemployed:

Skill levelEthnic and racial groupsAge groups

Measuring Price ChangesCritical Issues

The CPI (Consumer Price Index)measures the price level; and from this the inflation rate can be calculatedThe CPI is only one of several price level measuresThe CPI may overstate the actual change in the cost of livingThe growth rate in real GDP is a better measure of the change in macroeconomic conditions than the growth rate of nominal GDP because real GDP includes the effects of inflationThe growth rate in real GDP per capita captures a measure of changes in the standard of living

Fluctuations in output and long-run economic growth

Fluctuations in output (short-run economic growth)

Measured by the changes on real GDP from quarter to quarter or year to yearIn general, caused by greater or lesser utilization of existing capital stock and technology

Fluctuations in long-run economic growthLong-run economic growth refers to changes in the productive capability of the economy through changes in the amount of plant, equipment, and technology

GDP and national income accounting

Only final goods and services are included in GDPMarket activities are included, but financial transactions are notGDP = C+Ig+G+Xn

C= consumption spendingIg= investment spendingG= government spendingXn= net exports (exports-imports)

GDPConsumption (C)

All expenditures by households on final goods and services

Investment Spending (Ig)All final purchases of capital by businessesAll construction All changes in inventories

Government Spending (G)Expenditures for goods and servicesExpenditures for social capital (schools, highways)

Net Exports (Xn)(Exports – Imports)

GDPINCLUDED

All final goods & services produced with-in the country for a given year

NOT INCLUDEDPurely financial transactions

Public transfer paymentsPrivate transfer paymentsStock market transactions

Secondhand sales

Two approaches to calculate GDP

Expenditures Approach (C+Ig+G+Xn)All the spending on final goods and services throughout the year

Income ApproachSums employee compensation, rent, interest, proprietor's income, & corporate profits to obtain national income. Then add indirect business taxes, depreciation, and net foreign factor income to measure GDP

Shortcomings of GDPNonmarket transactionsLeisureImproved Product QualityUnderground EconomyEnvironment

Activity 12

Price Indexes and InflationPrice index

An index number that shows how the weighted-average of a “market basket”of goods changes over time

Activity 13

InflationInflation

Increase in the overall level of pricesAnticipated inflation

The level of inflation people expect to occur and have built into their economic decisions

Unanticipated inflationLevel of inflation that is not expected or is unforeseen

Who is hurt or helped by unanticipated inflation?

HurtFixed-income receivers, savers, creditors

Why? Redistributes real income away from them and toward others

HelpedFlexible-income receivers, debtors (borrowers)

Why? Redistributes real income toward them and away from others

Activity 15

UnemploymentEmployed

Everyone currently working, including part-time workers

UnemployedPeople looking for work or temporarily laid off from work

Labor forceEmployed + unemployed

Unemployment rateUnemployed / labor force

Labor force participation rateLabor force / population aged 16 and older

Issues with UnemploymentDiscouraged workers

People who were looking for work but gave up because they didn’t succeed in finding a job

Underemployed workersPeople who are working part time but would like to work full time, or who hold a job that requires a lower skill than they possess

Unequal burdens of unemploymentOccupation, age, race & ethnicity, gender, education

Types of UnemploymentFrictional

People who are temporarily between jobs

CyclicalPeople who are not working because firms do not need their labor due to lack of demand or a downturn in the business cycle

Structural Mismatches between job seekers and job openings

Other termsNatural rate of unemployment

There is no cyclical unemploymentFrictional and structural unemployment may exist

“Full employment”Occurs when the economy is at the natural rate of unemployment

Activity 16

The Business CycleWhat causes output to rise and fall?What causes unemployment to rise and fall?The Business Cycle describes economic fluctuations

the rising and falling of output in relation to potential output

Phases of the Business Cycle

Recession/ContractionaryTwo consecutive quarters (six months) of negative growth in real GDP

PeakThe point at which output starts to decline; beginning of recession

TroughThe point at which output starts to increase; end of recession

Recovery or expansionThe economy begins to move forward; period between the trough and the next peak

Business Cycle’s affect on Output, Employment & the Price

LevelRecession

Period of decline in output and employment. Price level will fall only if a depression occurs

PeakEconomy is at full employment, level of real output is at or close to capacity, & the price level is likely to rise

TroughOutput and employment “bottom out”, they are at there lowest levels. Price level may fall

Recovery or ExpansionOutput and employment rise toward full employment. As recovery intensifies the price level may begin to rise

Key PointsThere is no consistent length of time for each phaseBusiness cycles are unpredictable

After the fact, economists can identify some causes but predicting the actual downturn is hard

Countercyclical and Procyclical variablesCountercyclical – move in opposite direction from real GDPProcyclical – move in same direction as real GDP

Activity 17 and 18