Macroeconomics: Study of the determinants of Output, Employment and the Price Level Put less formally, macroeconomics is about understanding the causes of prosperity and poverty.

Two Frameworks  Long run: concerned with growth – most obvious feature of capitalism: affluence – Benefits and Costs of Growth  Short run: business cycle

Percentage Change in GDP: The Business Cycle

20% 10% 0% -10% -20% -30% 1930 35 40 45 50 55 60 65 70 75 80 85 90 Years

Relation Between Unemployment and the Business Cylce  Okun’s law: for every 3 percent increase in GDP, unemployment falls by 1 percent

Unemployment  Social problem – Cyclical unemployment: unemployment associated with the business cycle – Family or social problem?

 Government’s problem – Frictional unemployment: unemployment associated with changing jobs  Who is responsible?

Employment  Unemployment rate--unemployed/labor force  unemployed – between 16 and 65 – involuntarily unemployed – noninstitutionalized  labor force--employed + unemployed

Unemployment Rate

30% 20% 10% 0% 1930 35 40 45 50 55 60 65 70 75 80 85 90 95

Great WWII Korean Vietnam Oil Fed Depression War Embargo Induced Recession

Labor Force Participation Rate Number employed/working age population 68.0

66.0

64.0

62.0

60.0

58.0

56.0

54.0

1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996

Types of Unemployment  Frictional unemployment  structural unemployment  seasonal unemployment  cyclical unemployment

Costs and Benefits of Unemployment  Costs – Costs of supporting the unemployed – loss of output – crime, suicide, etc.

– psychological costs  Benefits (dubious) – disciplines the labor force – checks wage increases (Marx’s point) – reduces inflationary pressures

Inflation  Percentage change in the price level  Price level--average level of prices of a market basket of goods

Price Level

120 100 80 60 40 20 0 1930 40 50 60 70 80 90

Inflation Rate: Percentage change 20 Sum of CPI Year to Year 15 10 5 0 1929 1942 1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 -5 Total -10 Year

Measures of inflation  Index—ratio, prices in one year over prices in the base year  CPI--measures changes in prices of consumer goods  PPI-- measures changes in prices of producer goods  GDP Price Deflator--measures changes in prices of goods making up GDP

Costs and Benefits of Inflation  Costs – hurts creditors – hurts those on fixed incomes – increases uncertainty – costs of marking up prices, updating contracts (transactions costs) etc.

 Benefits – alleviates the burden of debt – raises profits, and therefore may help the economy

Inflation and interest rates  Interest—this the price paid to induce people to forgo liquidity  Interest rate—ratio of interest per year/loan  Nominal interest rate—interest measured in terms of current dollars (market interest rate  Real interest rate = nominal interest rate – inflation rate

Chapter 7 National Income Accounting  Purpose: measure the performance of the economy for purposes of public policy  Created in the aftermath of the Great Depression  GDP: most important measure of the economy’s performance

Gross Domestic Product  GDP is the most important measure of economic output  GDP is defined as the total value of all final goods and services produced by the domestic economy in one year

Other Measures of Economic Output  GNP=total value of all goods and services produced by the nation’s citizens  GNP = GDP + net foreign factor income  Net national product (NNP) = GNP depreciation  National Income (NI) = NNP - indirect taxes + business transfer payments (gifts, etc)

 Personal Income (PI) = NI - contributions to social insurance (FICA) - corporate profits minus dividends + personal interest income from the government and consumers + government transfer payments (e.g., unemployment insurance, relief, benefits to veterans)  Disposable Income (Y d ) = NI - personal taxes

Measuring GDP Expenditure Approach: GDP = C + I + G + X M Income Approach: GDP = Wages + Profits + Rents + Interest + Indirect Business Taxes

Types of Expenditures   Consumption: – durable goods – nondurable goods – services Investment – inventories – producer goods – new construction  Government  Net Exports – exports – imports

90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1930

Consumption as a Percentage of GDP

35 40 45 50 55 60 65 70 75 80 85 90

0.65

0.6

0.55

0.5

0.7

Sum of C/Y

Consumption as a Percentage of GDP

Total Total Year or quarter

Investment as a Percentage of GDP

20% 15% 10% 5% 0% 1930 35 40 45 50 55 60 65 70 75 80 85 90 95

Investment as a

Total

Percentage of GDP

Sum of I/Y 0.25

0.2

0.15

0.1

0.05

0 Total Year or quarter

Government Spending as a Percentage of GDP

50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 1930 35 40 45 50 55 60 65 70 75 80 85 90 95

Government Spending as

50 Sum of Outlays 45 40 35 30 25 20 15 10 5 0 1934 1939 1944 1949 1954 1959 1964 1969 1974 Fiscal year or period 1979 1984 1989 1994 1999 2004 1 Total

100% 80% 60% 40% 20% 0% Government expenditures

Government Expenditures as a Portion of the Budget Other International Affiars Social Security Income Security Medicare Health Defense Net Interest

Exports and Imports as a Percentage of GDP

14% 12% 10% 8% 6% 4% 2% 0% 1930 35 40 45 50 55 60 Years 65 Imports 70 Exports 75 80 85 90 95

GDP based on the Income Approach:  Aggregatre expenditure = GDP = Aggregate Income  Value added – look at the value that is added by each firm in the production process

Types of Income  Compensation  Corporate Profits  Proprietor Profits  Interest  Rents

Employee Compensation as a Percentage of National Income

1 0.9

0.8

0.7

0.6

0.5

0.4

0.3

0.2

0.1

0 30 35 40 45 50 55 60 65 Years 70 75 80 85 90 95

Corporate Profits, Proprietorships, and Interest as a Percentage of National Income

25% 20% 15%

Proprietorships

10%

Coporate Profits

5%

Interest

0% -5% 30 35 40 45 50 55 60 65 70 75 80 85 90 95

Circular Flow

GDP over time

Real versus nominal variables  Nominal—expressed in current dollars (unadjusted for inflation)  Real—expressed in constant dollars (adjusted for inflation)

Nominal and Real GDP

8,000.0

7,000.0

6,000.0

5,000.0

4,000.0

3,000.0

2,000.0

1,000.0

0.0

Nominal GDP Real GDP

Converting Real to Nominal GDP  Nominal GDP: expressed in current dollars  Real GDP: GDP produced in one year expressed in some base year prices  Real GDP= nominal GDP/GDP deflator  Nominal GDP=PcQc  GDP deflator=Pc/Pb – where c stands for the current year, b the base year – Pb is always set to 100