ECON 3560/5040 INTRODUCTION TO MACROECONOMICS 1. What Macroeconomists Study - Macroeconomics, the study of the economy as a whole, attempts to answer the following issues. (1) Economic growth (2) Inflation (3) Unemployment cf) Microeconomics: the study of the economy in the small (individual firm, industry, or consumer) 2. The Data of Macroeconomic (1) Measuring the Value of Economic Activity (chapter 3) - Gross Domestic Product (GDP): Sum of money values of all final goods and services produced in the domestic economy within the year - What gets counted in GDP? 1) For the most part, only goods and services that pass through organized markets count in the GDP illegal activities, housework, do-it-yourself repairs, and leisure will be excluded 2) Only final goods and services count in the GDP intermediate goods will be excluded
3) Production within the geographic boundary of the U.S. 4) The GDP for a particular year includes only goods and services produced within the year. Sales of items produced in previous years are excluded - The Bureau of Economic Analysis (http://www.bea.doc.gov) - GDP = total income of everyone in the economy (= Y ) = total expenditure on the economy s output of goods and service ( = C + I + G + NX ) cf) GDP and the components of Expenditure (fig. 2-1, p. 17; table 2-1, p. 26) - Nominal GDP: the value of goods and services measured at current prices not a good measure of economic well-being - Real GDP: the value of goods and services measured at constant prices RGDP is not influenced by changes in prices - Real GDP per person: income of the average person in the economy (fig. 1-1, p. 4) Boom vs. Recession (Depression) - Other measures of income (pp. 27-29)
(2) Measuring the Cost of Living (chapter 4) - Inflation: sustained increase in general price level cf) Stagflation: inflation occurring while the economy is growing slowly or in a recession - Inflation rate: the percentage change in the average level of prices from the year before (fig. 1-2, p.5) - Deflation: sustained decrease in general price level 1) The Consumer Price Index (CPI) - The CPI is measured by pricing the items on a list representative of a typical urban household budget - CPI is calculated and announced each month by the Bureau of Labor Statistics (BLS, http://www.bls.gov) - CPI in given year = Cost of market basket in given year ------------------------------------------ x 100 Cost of market basket in base year most price indexes, like CPI, are computed by pricing a standard market basket of goods in subsequent periods
cf) Deflating - Deflating is the process of finding the real value of some monetary magnitude by dividing by some appropriate price index money wage in 2000 - Real wage in 2000 = --------------------------- x 100 CPI of 2000 A price index can be used to measure inflation and to deflate nominal values to adjust for inflation 2) The GDP Deflator - Definition: The price index used to deflate GDP Nominal GDP - Real GDP = ------------------- x 100 GDP Deflator Different price indexes, such as the CPI and the GDP deflator, will show slightly different measures of inflation because they use different market basket i.e., The GDP deflator includes the price of Airplanes, government service, other goods purchased by business. However, the discrepancy is usually minor (fig. 2-3, p.32)
(3) Measuring Joblessness (chapter 6) - How well an economy uses its resources (fig. 1-3, p.6) - Unemployment rate is calculated and announced each month by the BLS (http://www.bls.gov) - Labor force = Number of employed + Number of unemployed (fig. 2-4, p.35) # of Unemployed - Unemployment rate = ---------------------- x 100 Labor force - Okun s Law: the negative relationship between unemployment and GDP (fig. 2-5, p.36) 3. How Economists Think - Economists use model to illustrates the essence of the real economy and to help explain economic variables - Endogenous variables: those that the model explains Exogenous variables: those that come from outside the model - An economic model can show how the exogenous variables affect the endogenous variables. Ex) the model of supply and demand (pp. 7-10)
4. The Circular Flow of Dollars through the Economy - The linkages among the economic actors - households, firms, and the government - and how dollars flow among them through the various markets in the economy (fig. 3-1, p.43)
NATIONAL INCOME 1. What Determines the Total Production of Goods and Services - Factors of production: the inputs used to produce goods and services (1) Capital (K) (2) Labor (L) - Production function expresses mathematically how the factors of production determine the amount of output produced Y = F( K, L) cf) Constant Returns to Scale (CRS): zy = F( zk, zl) - Supply of goods and services ex) If the factors of production are fully utilized, Y = F( K, L) = Y
2. How is National Income Distributed to the Factors of Production Neoclassical theory of distribution - Factor price: the amounts paid to the factors of production (wage, rent) determined by the supply and demand for that factor (fig. 3-2, p.47) (1) The competitive firm s demand for factors - Marginal Product of Labor (MPL): the extra amount of output the firm gets from one extra unit of labor MPL = F( K, L + 1) F( K, L), ΔY ΔF( K, L) In general, MPL = = ΔL ΔL Diminishing marginal product (fig. 3-3, p.49) - Profit maximization 1) Profit = TR TC = PY WL - RK = PF(K, L) WL - RK 2) Profit from hiring an additional unit of labor Δ profit = Δ TR - Δ TC = ( P MPL) W if ( P MPL) > W, continue to hire until the next unit would no longer be profitable
3) Profit maximizing condition ( P MPL) = W MPL = W / P Marginal product of labor = real wage - Firm s labor demand curve = MPL schedule For any given real wage, the firm hires up to the point at which the MPL equals the real wage (fig. 3-4, p.50) - Marginal Product of Capital (MPK): the extra amount of output the firm gets from one extra unit of capital Firm s capital demand curve = MPK schedule (2) How the markets for the factors of production distribute the economy s total income - If all firms in the economy are competitive and profit-maximizing, Real economic profit = Y ( MPL L) ( MPK K) = 0 Y = F( K, L) = ( MPL L) + ( MPK K) The sum of factor payments equals total output - Total output is divided between the payments to capital and the payments to labor, depending on their marginal productivities
3. What determines the Demand for Goods and Services? - How the output from production is used Y=C + I + G + NX 1) Consumption (C) 2) Investment (I) 3) Government purchases (G) 4) Net exports (NX) (1) Consumption (chapter 16) - DI (Disposable Income) is the sum of the incomes of all the individuals in the economy after all taxes have been deducted and all transfer payment DI = GDP Taxes + Transfers = Y T = C + S - Transfer payments: Government grants to individuals (= negative taxes) 1) The Consumption Function Relationship between aggregate consumption expenditures and aggregate disposable income - Change in DI: movement along a consumption fn - Change in any other variable that affects C: shift in the entire consumption fn e.g., wealth, price level, expectation of future income
2) Marginal Propensity to Consume (MPC) MPC = change in C / change in DI the slope of consumption function cf) Marginal Propensity to Save (MPS) MPS = change in S / change in DI 3) Average Propensity to Consume (APC) APC = C / DI the slope of a ray from the origin to a point on the consumption function (2) Investment (chapter 17) - Gross Investment is the spending on new plant, new equipment, new houses, and additions to inventories Net investment = gross investment - depreciation - Investment decisions are influenced by the expected profit rate and the real interest rate The expected profit rate is affected by the phase of the business cycle, advances in technology, taxes The lower the real interest rate, the greater is the amount of investment
- Nominal interest rate vs. Real interest rate Nominal interest rate(i ): the rate of interest that investors pay to borrow money Real interest rate(r): the nominal interest rate corrected for the effects of inflation r = i π (inflation rate) (3) Government purchases exogenous (4) Net exports exogenous 4. What Brings the Supply and Demand for Goods and Services into Equilibrium Interest rate has the crucial role of equilibrating supply and demand (1) Equilibrium in the Market for Goods and Services - Demand for good and services Y = C + I + G, C = C( Y T ), I = I(r), G = G, T = T
- Supply of good and services Y = F( K, L) = Y - Equilibrium Y = C( Y T ) + I( r) + G - The role of interest rate r is the only variable not already determined r must adjust to ensure that demand equals supply e.g., if r is too high, excess supply of goods and services. (2) Equilibrium in the Financial Market - National Saving From Y = C + I + G, ( Y T C) + ( T G) = I. National Saving = Private Saving + Public Saving = Investment - Equilibrium Y C( Y T ) G = S = I( r)
- The role of interest rate (fig.3-7, p.60) At the equilibrium interest rate, households desire to save balances firms desire to invest, and the quantity of loans supplied equals the quantity demanded e.g., if r is too low, excess demand for loans. (3) Change in Savings - An increase in government purchase (fig.3-8, p.62) - A decrease in taxes (4) Change in Investment (fig.3-10, p. 65) - Technological innovation, change in tax laws etc.
UNEMPLOYMENT - The macroeconomic problem that affects people most directly and severely. - There is always some employment! - The rate of unemployment: the percentage of the labor force unemployed - The natural rate of unemployment: the average level around which the unemployment rate fluctuates The determinants of the natural rate of unemployment (not SR fluctuation) (1) Job Loss, Job Finding, and the Natural Rate of Unemployment - A model of labor-force dynamics that shows what determines the natural rate of unemployment - L=E+U, where L: labor force, E: the employed, U: the unemployed the unemployment rate (u) = U/L - L is assumed to be fixed the transition of individuals in the labor force between employment and unemployment Rate of job separation (s): fraction of unemployed individuals who lode their job Rate of job finding (f): fraction of unemployed individuals who find a job
- s and f determine the rate of unemployment - In a steady state, the number of people finding jobs (fu) = the number of people losing jobs (se) steady-state unemployment rate? Since E=L-U, fu=s(l-u) Solving for U/L gives U/L=s/(s+f) - The higher the rate of job separation, the higher the employment rate - The higher the rate of job finding, the lower the employment rate Any policy aimed at lowering the natural rate of unemployment must either reduce the rate of job separation or increase the rate of job finding (2) Job Search and Frictional Unemployment - Frictional unemployment: the unemployment caused by the time it takes workers to search for a job Sectoral shift Change in nature of economy e.g., when worker s characteristics do not fit with employers requirement - Public policy Government employment agency Unemployment insurance
(3) Real-Wage Rigidity and Wait Unemployment - Wage rigidity: the failure of wage to adjust until labor supply equals labor demand (fig. 6-3, p.162) reduces the rate of job finding and raises the level of unemployment (= Wait Unemployment ) - Minimum-Wage - Unions and Collective Bargaining - Efficiency Wages how wages affect productivity reduce labor turnover average quality of a firm s workforce increase a worker s effort level Therefore, a firm may find it profitable to keep wages above the equilibrium wage rate, b/c the firm operates more efficiently if it pays its workers a high wage.