Professor Christina Romer. LECTURE 17 MACROECONOMIC VARIABLES AND ISSUES March 17, 2016

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1 Economics 2 Spring 2016 Professor Christina Romer Professor David Romer LECTURE 17 MACROECONOMIC VARIABLES AND ISSUES March 17, 2016 I. MACROECONOMICS VERSUS MICROECONOMICS II. REAL GDP A. Definition B. Nominal GDP and real GDP C. A little about measuring GDP D. Facts 1. Strong upward trend 2. Huge differences across countries 3. Short-run fluctuations III. UNEMPLOYMENT A. Measurement B. Facts 1. The normal unemployment rate is not zero 2. Fluctuations in unemployment are negatively correlated with real GDP growth IV. INFLATION A. Measurement B. Facts C. Why do we care about inflation? D. Adjusting for price changes E. Unmeasured quality changes V. OVERVIEW OF MACRO FRAMEWORK

2 Economics 2 Spring 2016 Christina Romer David Romer LECTURE 17 Macroeconomic Variables and Issues March 17, 2016

3 Announcements Problem Set 4 is being distributed: Due Thursday, March 31 st. Same ground rules apply. There will be a problem set work session on Tuesday, March 29 th, 5 7 p.m. in 648 Evans Hall.

4 Announcements (continued) Research reading for Tuesday, March 29 (by William Nordhaus): Read only the assigned pages. Read for approach and findings; think about relevance for the measurement of inflation and growth in standards of living.

5 I. MACROECONOMICS VERSUS MICROECONOMICS

6 Macroeconomics Definition: The study of the aggregate economy. Concerned with: Total output. Aggregate price level and inflation. The unemployment rate. The overall level of interest rates; the exchange rate; overall exports and imports.

7 II. REAL GDP

8 Real Gross Domestic Product (Real GDP) The market value of the final goods and services newly produced in a country during some period of time, adjusted for price changes.

9 Nominal GDP Nominal GDP: The market value of the final goods and services newly produced in a country during some period of time, not adjusted for price changes. Thus, for the United States, it is measured in dollars. Example: Nominal GDP in 2015 = P i,2015 Q i,2015, i where i represents each possible good in the economy (and is the symbol for a sum). Note that we use 2015 prices in computing 2015 nominal GDP, 2014 prices in computing 2014 nominal GDP,.

10 Calculating Real GDP Choose a base year (for example, 2009), and always use prices from the base year to multiply the quantities. Example: If 2009 is the base year: 2015 real GDP = P i,2009 Q i,2015. i That is, if 2009 is the base year, 2015 real GDP is the answer to the question, How much would all the final goods and services newly produced in the United States in 2015 have been worth at 2009 prices?

11 Growth Rate of Real GDP The percentage change in real GDP from one year to the next.

12 A Little about Measuring GDP Key points: Final goods and services. Newly produced. Within the country.

13 3 Approaches to Measuring GDP Expenditure: Use market prices and the quantities of final goods. Can divide into consumption (C), investment (I), government purchases (G), and net exports (NX). Production (value added): follow goods through each stage of production. Income: Income from producing new goods and services within the country. Can divide into labor income and capital income.

14 Real GDP in the United States, Source: FRED (Federal Reserve Economic Data); data from Bureau of Economic Analysis.

15 Real GDP per Capita in the U.S., Source: FRED; data from Bureau of Economic Analysis.

16 GDP per Capita over Time and Regions Source: Bloom and Sachs, Geography, Demography, and Economic Growth in Africa.

17 U.S. Real GDP, Source: FRED; data from Bureau of Economic Analysis.

18 U.S. Real GDP, Source: FRED; data from Bureau of Economic Analysis.

19 U.S. Real GDP, Source: FRED; data from Bureau of Economic Analysis.

20 III. UNEMPLOYMENT

21 Definitions Employed: The number of people who are working. Unemployed: The number of people who are not working and who are actively looking for work. Labor force: Employed + unemployed. Unemployment rate: u = Unemployed Labor force 100.

22 The U.S. Unemployment Rate, Source: FRED; data from Bureau of Labor Statistics.

23 The Natural Rate of Unemployment The economy s normal or usual unemployment rate. The natural rate of unemployment is more than zero.

24 Real GDP Growth (Percent, Red) and Change in the Unemp. Rate (Percentage Points, Blue), Source: FRED; data from Bureau of Economic Analysis and Bureau of Labor Statistics.

25 IV. INFLATION

26 Consumer price index: CPI t = Definitions Price of market basket in year t Price of market basket in base year 100. Inflation: The percent change in a price index. Example: the inflation rate from 2014 to 2015 is: π 2015 = P 2015 P 2014 P Deflation: A negative rate of inflation.

27 U.S. Inflation (Percent Change in the Price Index for Personal Consumption Expenditures), Source: FRED; data from Bureau of Economic Analysis.

28 Price Index for Personal Consumption Expenditures, Source: FRED; data from Bureau of Economic Analysis. Note: The graph shows a measure of prices, not inflation. Thus, a decline corresponds to deflation.

29 Adjusting Variables for Price Changes What would $X in Year A be equivalent to in terms of Year B dollars? $X P B P A, where P A and P B are the price index in year A and year B. Example: What was Richard Nixon s final salary equivalent to in today s dollars? His salary was $200,000; the CPI in August 1974 was 45; the CPI now is Thus: $200, = $1,056,000.

30 V. OVERVIEW OF MACRO FRAMEWORK

31 Determinants of the Long-Run Trend Potential Output: The amount of output (real GDP) that the economy can produce when using its resources at normal rates. Key resources: Labor Capital Technology

32 Determinants of Short-Run Fluctuations Aggregate demand: The total demand for final goods and services. Key features of the short-run model: In the short run, output depends on aggregate demand. Developments in the private sector, monetary policy, and fiscal policy all affect aggregate demand. The level of output relative to potential affects inflation, which in turn affects aggregate demand through monetary policy.

33 International Macroeconomics Interactions between aggregate economies. Key issues: Exchange rates The trade deficit or surplus

34 Real Broad Effective Exchange Rate for the U.S., Source: FRED; data from Bank of International Settlements.

35 Net Exports as a Share of GDP, Source: FRED; data from Bureau of Economic Analysis.

36 The Federal Funds Rate, Source: FRED; data from Board of Governors of the Federal Reserve System.

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