An Introduction

to
Macroeconomics
 Performance and Policy
• Real GDP
– Corrects for price changes
• Nominal GDP
– Uses current prices
– Expenditure Approach
– Income Approach
• Unemployment
• Inflation
– Increase in overall level of prices
 Performance and Policy
• Can governments:
– Promote economic growth?
– Reduce severity of recession?
• Is monetary or fiscal policy more
effective at mitigating recession?
• Is there a tradeoff between inflation
and unemployment?
 Economic Growth
• Standard of living measured by
output per person
• No growth in living standards prior to
Industrial Revolution
• Modern economic growth
– Output per person rises
– Not experienced by all countries
 Savings and Investment
• Saving
– Tradeoff current for future
consumption
• Investment
– Financial investment
– Economic investment
• Banks and financial institutions
 Gross Domestic Product
• Measure of aggregate output
• Monetary measure
• Avoid multiple counting
– Market value final goods
– Ignore intermediate goods
– Count value added

24-6
 Gross Domestic Product
• Exclude financial transactions
– Public transfer payments
– Private transfer payments
– Stock (and bond) market transactions
• Second hand sales
– Sell used car to a friend

24-7
 Two Approaches to GDP
• Income approach
– Count income derived from
production
– Wages, rental income, interest
income, profit
• Expenditure approach
– Count sum of money spent buying the
final goods
– Who buys the goods?
24-8
Two Approaches to GDP
Consumption by Wages

+
Households

+
Investment by Rents
Businesses G +
+ = D= Interest
Government
Purchases P +
Profits
+
Expenditures
+
Statistical
By Foreigners Adjustments
24-9
 Expenditure Approach
• Personal consumption
expenditures (C)
– Durable consumer goods
– Nondurable consumer goods
– Consumer expenditures for services
– Domestic plus foreign produced

24-10
 Expenditure Approach
• Gross private domestic investment
(I)
– Machinery, equipment, and tools
– All construction
– Changes in inventories
• Creation of new capital asset
• Noninvestment transactions
24-11
Expenditure Approach
Gross Investment
- Depreciation
= Net Investment
Net
Investment
Gross
Investment
Depreciation

Increase

Consumption
Stock of & Government Stock of
Capital Spending Capital
January 1 Year’s GDP December 31
24-12
 Expenditure Approach
• Government purchases (G)
– Expenditures for goods and services
– Expenditures for social capital
– Excludes transfer payments
• Net exports (Xn)
– Add exported goods
– Subtract imported goods
– NX = exports - imports
• GDP = C+Ig+G+Xn 24-13
Components of National Income
• Compensation of employees
• Rents
• Interest
• Proprietor’s income
• Corporate profits
– Corporate income taxes
– Dividends
– Undistributed corporate profits
• Taxes on production and imports
24-14
 Income Approach
• From national income to GDP
– Net foreign factor income
– Statistical discrepancy
– Consumption of fixed capital
• Other national accounts
– Net domestic product (NDP)
– National income (NI)
– Personal income (PI)
– Disposable income (DI)
– DI = C + S
24-15
U.S. Income Relationships 2007
Gross Domestic Product (GDP) P 13,841
Less: Consumption of Fixed Capital 1687
Equals: Net Domestic Product (NDP) P 12,154
Less: Statistical Discrepancy 29
Plus: Net Foreign Factor Income 96
Equals: National Income (NI) P 12,221
Less: Taxes on Production and Imports 1009
Less: Social Security Contributions 979
Less: Corporate Income Taxes 467
Less: Undistributed Corporate Profits 344
Plus: Transfer Payments 2237
Equals: Personal Income (PI) P 11,659
Less: Personal Taxes 1482
Equals: Disposable Income (DI) P 10,177
24-16
 Nominal vs. Real GDP
• GDP is a PESO measure of
production
• Using PESO values creates problems
• Nominal GDP
– Use prevailing price
• Real GDP
– Reflect changes in price
– Use base year price
24-17
 Shortcomings of GDP
• Nonmarket activities
• Leisure
• Improved product quality
• The underground economy
• GDP and the environment
• Composition and distribution of the output
• Noneconomic sources of well-being

24-18
 The Business Cycle
Peak

Peak
Level of Real Output

d
Tren

io n
Peak

ns
row th Re
ces

pa
G sio

Ex
n

on
si
Rec Trough

an
ess
io n

p
Ex
Trough

Time
Durable and nondurable industries
affected differently 26-19
 Unemployment
• Twin problems of the business cycle
– Unemployment
– Inflation
• Measurement of unemployment
– Who’s in the labor force
• Problems with the unemployment rate
– Part-time employment
– Discouraged workers

Unemployed
Unemployment Rate = x 100
Labor Force
26-20
 Unemployment
• Types of unemployment
– Frictional
– Structural
– Cyclical
• Full employment defined
– No cyclical unemployment
• Natural rate of unemployment
• Full employment rate
26-21
 Unemployment
• Natural rate of unemployment
– 1980’s 6%
– Today 4-5%
• Aging labor force
• Temp agencies and the internet
• New welfare laws and work
requirements
• Prison population has doubled
26-22
 Cost of Unemployment
• Foregone output
• Potential output
• GDP gap
– (Actual output – potential output)
• Okun’s Law
– Each 1% above NRU creates negative
2% output gap
26-23
 Unemployment
• Unequal burdens
– Occupation
– Age
– Race and ethnicity
– Gender
– Education
– Duration
• Noneconomic costs
26-24
 Inflation
• Rise in general level of prices
• Consumer price index (CPI)
– Market basket
– 300 goods and services
– Typical urban consumer
– 2 year updates
Price of the Most Recent Market
Basket in the Particular Year
CPI = Price estimate of the Market
x 100
Basket in 1982-1984 26-25
 Inflation
• Types of Inflation
– Demand pull
– Cost-push
• Redistributive Effects
– Nominal and real income
– Growth in nominal income vs.
inflation rate
– Anticipated vs. unanticipated
inflation
26-26
 Inflation
• Who is hurt by inflation?
– Fixed-income receivers
– Savers
– Creditors
• Who is unaffected or not hurt by
inflation?
– Flexible-income receivers
• Cost-of-living adjustments (COLAs)
– Debtors 26-27
 Other Inflation Issues
• Deflation
• Mixed effects
• Arbitrariness
• Cost-push inflation and real output
• Demand-pull inflation and real
output
• Hyperinflation
26-28
 Basic Relationships
• Income and consumption
• Income and saving
• Disposable income (DI)
• 45°line for reference
–C = DI on the Line
• S = DI - C
27-29
 Consumption and Saving
• Nonincome determinants of
consumption and saving
– Wealth
– Borrowing
– Expectations
– Real interest rates

27-30
 Consumption and Saving
• Other important considerations
– Changes along schedules
– Switch to real GDP
– Schedule shifts
– Stability
– Taxation
27-31
 Interest Rate and Investment

• Expected rate of return (r)

• The real interest rate (i)
– Nominal rate less rate of inflation
• Meaning of r = i
• Investment demand curve

27-32
 The Multiplier Effect
• More spending results in higher
GDP
• Initial change in spending changes
GDP by a multiple amount

Change in Real GDP

Multiplier =
Initial Change in Spending

27-33
 The Multiplier Effect
• Causes of the initial change in
spending
– Changes in investment
– Other changes
• Rationale
– Dollars spent are received as income
– Income received is spent (MPC)
– Initial changes in spending cause a
spending chain
27-34
 Squaring the Economic Circle

• Humorist Art Buchwald and the multiplier

• Suppose one person can’t buy a product
• Others subsequently impacted and cannot
buy other items
• Multiple effects impact psyche
• Ultimately causes multiple step impact
upon the economy as a whole

27-35
 Fiscal Policy
• Expansionary fiscal policy
– Increased spending and/or lower taxes
– Budget deficit
• Contractionary fiscal policy
– Lower spending and/or higher taxes
– Budget surplus
• Policy options?
30-36
 Built-In Stability
• Automatic stabilizers
– Taxes and transfers
• Economic importance
• Tax progressivity
– Progressive tax system
– Proportional tax system
– Regressive tax system
30-37
 Evaluating Fiscal Policy
• Standardized budget
– Full-employment budget
• Cyclical deficit
• Recent U.S. fiscal policy
• Budget deficits and projections
• Social security considerations
30-38
 FiscalCriticisms,
Problems, Policy Issues
and Complications
• Problems of timing
– Recognition lag
– Administrative lag
–Operational lag
• Political considerations
• Future policy reversals
• Offsetting state and local finance
• Crowding-out effect
• Current thinking on fiscal policy
30-39
 The Public Debt
• National or public debt $9.01
trillion
• Ownership
– U.S. securities
– 53% owned by federal government
and Federal Reserve
– 47% held outside the federal
government and Federal Reserve

30-40
 Debt and GDP
• Interest charges
– Primary burden
– 1.7% of GDP 2007
• False concerns
– Bankruptcy
– Refinancing
– Taxation
– Burdening future generations
30-41
 Debt and GDP
• Substantive issues
– Income distribution
– Incentives
– Foreign-owned public debt
• Crowding-out effect revisited
– Burden on future generations
– Public investment as an offset
– Graphically

30-42
 The Leading Indicators
1. Average workweek
2. Initial claims for unemployment
insurance
3. New orders for consumer goods
4. Vendor performance
5. New orders for capital goods
6. Building permits for houses
7. Stock prices
8. Money supply
9. Interest-rate spread
10. Consumer expectations

Source: The Conference Board

30-43
 Monetary Policy
• Expansionary monetary policy
– Economy faces a recession
– Lower target for federal funds rate
– Fed buys securities
– Expanded money supply
– Downward pressure on other interest
rates
• Contractionary monetary policy
33-44
 Monetary Policy
• Affect on real GDP and price level
• Cause-effect chain
– Market for money
– Investment and the interest rate
– Investment and aggregate demand
– Real GDP and prices
• Expansionary monetary policy
• Restrictive monetary policy 33-45
 The Mortgage Debt Crisis
• Home mortgage default 2007
• Banks write off bad loans
• Reserves reduced
• Fed as lender of last resort
• Term auction facility
• Fed lowered federal funds rate
• Mortgage backed securities as a new
innovation
– Bad incentives 33-46