Macroeconomics Economics

Chapter 23 Chapter 6

Macroeconomics: The Big Picture - in references to figures, X refers to the relevant chapter - either 6 or 23

Chapter Objectives: In this chapter, students will learn: - the definition of macroeconomics and how macroeconomics differs from microeconomics - how what is good for a part is not necessarily good for the whole - the importance of the business cycle and why policy makers seek to diminish the severity of business cycles - the meaning of long-term (L-T) growth and how it affects a country's standard of living - the difference between nominal and real variables - how unemployment rates are calculated - the definitions inflation and deflation - why policy makers and economists prefer price stability in the macro-economy - the meaning of an open economy vs. a closed economy

Chapter Outline Opening Ex: A comparison of starting salaries of new MBA graduates from top schools in 2000, 2002 & 2004 A. Macroeconomics vs. Microeconomics - macroeconomics: - the area of economics that focuses on the behavior of the economy as a whole - microeconomics: - the area of economics concerned with the production & consumption decisions of producers & consumers and with the allocation of scarce resources among industries - short term (S-T): a period consisting of several years, but typically less than a decade - combined effect of individual (microeconomic) decisions on macro-economy may differ alot from what individuals intend Thus, macroeconomics is not simply the aggregate outcome of all microeconomic choices - most economists agree that, with limited exceptions, govt intervention in markets at the micro-level leaves society worse off - most economists agree that there is a broader role for govt in the macro-economy, especially in managing S-T fluctuations and the effect of adverse events (shocks) on the economy. This view dates back to the Great Depression in the 1930s - macroeconomics focuses, in part, on L-T growth, or on how society can increase the total supply of productive resources so that higher rates of economic growth and a higher standard-of-living can be achieved - economic aggregates: economic measures that summarize data across different markets

B. The Business Cycle - is the S-T alternation of economy between recessions (economic downturns) and expansions (economic upturns) - length of the business cycle is the period from start of one recession to the start of the next recession - so a business cycle includes one full period of expansion and one full period of contraction - average length of a business cycle in US post WWII has been 5 to 7 years - post WW II, US has had 10 recessions => with average recession lasting 10 months & average expansion 57 months - graph on left indicates the change in Real GDP vs. time for a period including the recession of 1990. Note that the overall trend, however, is toward higher levels of output recession: an economic downturn where output and employment decline depression: a very deep and prolonged economic downturn expansion: economic upturns where output and employment rise (also called recoveries) aggregate output: economy's total production of final goods & services for a given period

- stabilization policy: policy whose goal is to reduce the severity of recessions and rein in excessively strong expansions - monetary policy: type of stabilization policy that involves - changes in the quantity of money in circulation, and/or - changes in interest rates - fiscal policy: type of stabilization policy that involves changes in taxation or govt. spending or both

- in the short-run, the combined effect of individual decisions can be very different from that intended by any one individual - paradox of thrift: increased savings (reduced spending) by individuals may increase their chance of becoming unemployed

Other economic changes: - not related to business cycle; these changes occur w/o regard to the phase of the business cycle in which we find ourselves 1) seasonal variation: changes that occur on annual basis with the change in seasons e.g., we expect that construction activity in the northeast will be higher during summer months than during the winter 2) secular (i.e., long-term) trends - ongoing change related to an industry e.g., U.S. textile industry is in L-T decline while the computer industry has experienced L-T growth

C. Recession & Unemployment - we worry about recessions because of the pain unemployment causes for those effected Types of unemployment (3 types) 1) frictional unemployment - unemployment resulting when workers voluntarily change jobs or when graduating students experience a period of unemployment before finding work - frictional unemployment is generally considered to be advantageous for the economy because: - the unemployed have the skills required by the available jobs - the workers are presumably moving to jobs that represent a better use of their skills - it illustrates that the workforce is flexible and willing to accept new challenges 2) structural unemployment - results from mismatch between workers skills & skills that market is looking for. May occur when: - an industry is in economic decline (e.g., textiles today) - the geographic distribution of jobs changes (e.g., between 1880s & 1920s, textile mills moved from N.E. to South) - there is consolidation within an industry (an industry may shed jobs even if not in L-R decline) -e.g., defense industry in 1990s; oil industry in 1980s; banking industry in 1980s & 1990s - with structural unemployment: - unemployed dont have the skills demanded by the jobs available (i.e., training required) - there is no expectation that the jobs that are lost will be replaced within that industry 3) cyclical unemployment - unemployment that is directly related to a downturn in the business cycle - i.e., a low level of aggregate spending within the economy

Measuring unemployment - employment: the number of people currently employed in the economy - unemployment: the number of people who are not working , but are actively looking for work - the unemployment rate: is calculated as a percentage of the labor force - the average unemployment rate between 1948 and 2004 was 5.6%

see fig. X-2

- labor force: -sum of those working and those who, while not working, are actively looking for work -defined as those who are: - 16 years or older, - not in the military (since this is the civilian labor force), - not institutionalized (e.g., not in prison or a mental institution), and are - willing and able to work - unemployment rate can overstate the true level of unemployment -because it is common for workers to spend some time searching for a job even when jobs are plentiful - unemployment rate can understate the true level of unemployment -because it does not count discouraged workers and underemployed workers -discouraged workers: people capable of working, but not working =>gave up job search since they don't think job exists for them -discouraged workers are not working => are they counted as unemployed? NO -to be counted as unemployed, you must first be part of the labor force, BUT if you give up looking for work, THEN you will not be counted as part of the labor force -underemployed workers: -those that work part-time only because they are unable to find full-time employment -employment statistics count part-time workers as employed - Different groups have different unemployment rates (e.g., white collar vs. blue collar, black vs. white, teens vs. older workers) - Long-term unemployment rate is much lower than the overall rate of unemployment

Factors that may reduce the unemployment rate - there are two ways to reduce the unemployment rate: -good way: some of those who are unemployed find jobs # of unemployed: 100 100/1000 = 10% unemployment rate labor force: 1000

if 50 of unemployed become employed 50/1000 = 5% unemployment

-bad way: some of those who are unemployed become discouraged and drop out of labor force (nobody put to work) # of unemployed: 100 100/1000 = 10% unemployment rate if 50 of unemployed become discouraged labor force: 1000 50/950 = 5.3% unemployment U.S. needs to create about 150,000 jobs/month, just to keep up with growth of the labor force from 2000 - 2003, U.S. economy lost 2.3 million jobs from 2000 - 2003, U.S. economy failed to create 5.4 million jobs (150,000 per month for 36 months) from 2004 - 2006, U.S. economy gained 3 million jobs leaves us 4.7 million jobs in the hole Full employment level - full employment does not mean zero unemployment - we do not expect to ever drive frictional unemployment or structural unemployment to zero - at full employment, we will still have unemployment at a rate that is equal to the natural rate of unemployment - natural rate of unemployment is equal to the sum of frictional & structural unemployment (i.e.,types we wont get rid of) - at full employment, cyclical unemployment will be zero - so, effective governmental policy may eliminate cyclical unemployment (not the case w/ frictional & structural)

D. Long-Run Economic Growth - L-T growth (secular growth): sustained upward trend in aggregate output over several decades -from 1948 to 2004, the average annual rate of L-T economic growth of Real GDP in the US was 3.5% -over the same period, average annual rate of L-T growth of real per capita GDP in the US was 2.2% - the result was a doubling of the US standard of living every 32 years (Rule of 70; e.g., 70 / 2.2 = 31.81) - thus, in the 60 plus years since the end of WWII, the U.S. std of living double twice (4 times higher today than in 1945) - secular growth of this sort of growth did not really exist prior to the industrial revolution -the L-T impact of small changes in an economy's rate of growth => have big impacts on standard-of-living over time -impact of federal government borrowing can also be significant over time - National Savings is essentially the sum of all public & private savings - Govt debt is negative savings, so it reduces our total savings & our ability to make capital investments - reduced investment means that Americans will own fewer assets in the future - i.e., less physical & human capital - fewer productive assets mean lower productivity in the future and, thus, lower incomes - productive assets => single biggest factor influencing future productivity & production levels - Brookings Institute (William Gale) used models developed by George W. Bushs former C.E.A. Chairman, Greg Mankiw to estimate effect of $1.09 trillion in debt incurred by US from Jan 01 - July 03 - result is that in 2012, GDP will be 1% lower than it would have been absent this debt - translates into a reduction in National Income per household of about $2,300 per year - US debt added since this study was completed (i.e., from July 03 - Sept 06) is $1.6 trillion

E. Inflation and Deflation - inflation: a rising aggregate price level -increases the cost of making purchases & of holding cash for convenience, and can ead to unplanned transfers of wealth - deflation: a falling aggregate price level -encourages people to hold cash (because its value is rising) rather than invest in new factories and productive assets - price stability (a goal): a situation where the aggregate price level only changes slowing - aggregate price level: the overall price level for goods and services within the economy - inflation rate: the annual percent change in the aggregate price level see fig. X-7 - nominal measures: a measure that has not been adjusted for inflation (or deflation) over time - real measures: a measure that has been adjusted for inflation (deflation) over time

F. Open and Closed Economies - closed economy: an economy that does not trade goods, services and assets with other countries - open economy: an economy that does trade goods, services and assets with other countries -open economy economics: the study of those aspects of macroeconomics that are affected by the movement of goods, services and assets across national boundaries - exchange rate: the value of one nation's currency in terms of the another nation's currency - the exchange rate of the U.S. dollar against the Euro varied considerably from 1999-2005 see fig. X-8 - changes in exchange rates can alter the aggregate price level because it affects the prices of imported goods - exchange rate changes can also affect aggregate output through effects on the trade balance the difference between the value of goods & services that a nation sells to other countries and the value of goods & services that a nation buys from other countries - capital flows: international movements of financial assets - capital flows can affect aggregate output and raise a countries standard of living in the L-R -example discusses effect of changes in exchange rate between US & Canadian dollars on the US & Canadian economies - trade balance: