Macro – Chapter 5

Macroeconomics concerns…
… the overall performance of the national economy including how the national economy interacts with other national economies around the world.

Economy
The structure of economic activity in a community, a region, a country, a group of countries, or the world

Gross Domestic Product (GDP)
The market value of all final goods and services produced in the nation during a particular period, usually a year

The most common economic performance is:
Gross product

Gross World Product
The market value of all final goods and services produced in the world during a given period, usually a year

Flow variable
A measure of something over an interval of time, such as your spending per week

Stock variable
A measure of something at a particular point in time, such as the amount of money you have with you right now

Mercantilism
– The incorrect theory that a nation’s economic objective should be to accumulate precious metals in the public treasury and export more than they import.
– To achieve this, nations restricted imports by such barriers as tariffs and quotas but these restrictions led to retaliations by other countries, reducing international trade and the gains from specialization.

Economic Fluctuations
– The rise/fall of economic activity relative to the long-term growth trend of the economy.
– When output increases, unemployment decreases

Expansion
– A period during which the economy grows as reflected by rising output, employment, income, and other aggregate measures
– The period between the trough and the subsequent peak
– Last longer than contractions

Contraction
– A period during which the economy declines as reflected by falling output, employment, income, and other aggregate measures
– Begins after the previous expansion has reached a peak and continues until the economy reaches a trough
– The period between the peak and trough

Depression
– A severe and prolonged reduction in the economic activity
– The Great Depression
– Decrease in output (GDP)
– Unemployment increases

Recession
– Milder form of a depression
– GDP has fallen for a few (6-8) months
– Hits hardest those regions that produce more capital goods, such as heavy machinery, and durable goods, such as appliances, furniture, and automobiles.
– The demand for these goods falls more during hard times than does the demand for other gods and services, such as breakfast cereal, gasoline, and haircuts
– Also hit hardest those states that rely on housing construction

Inflation
– An increase in the economy’s average price level

Production level can increase through:
– Increases in the amount and quality of resources, especially labor and capital
– Better technology
– Improvements in the rules of the game that facilitate production and exchange, such as property rights, patent laws, the legal system and market practices

Leading economic indicators
– Variables that predict, or lead to, a recession or recovery
– Examples: Consumer confidence, stock market prices, business investment, and big-ticket purchases, such as automobiles and homes

Coincident economic indicators
– Variables that reflect peaks and troughs in economic activity as they occur
– Examples: employment, personal income, and industrial production

Lagging economic indicators
– Variables that follow, or trail, changes in overall economic activity
– Examples: the interest rate and the average duration of unemployment

Aggregate Output (aggregate supply)
– Total quantity of all final goods/services produced in the economy during a year
– Because output is measured per period, it’s a flow of measure

Nominal GDP
– Measures current production using current-year prices

Real GDP
– The economy’s aggregate output measured in dollars of constant purchasing power
– GDP measured in the prices prevailing in the base years
– Best measure of current aggregate output
– Real GDP demanded depends in part on household wealth
– Measures current production using base-year prices

Aggregate demand
– Total quantity of all final goods/services demanded from the economy in a year
– Relationship between the average price of aggregate output in the economy and the quantity of aggregate output demanded
– Sums demands of the four economic decision makers (households, firms, governments, and the rest of the world)

Price level
– The average price of aggregate output
– PL in any year is an index number comparing average prices that year with average price in some base year.
– PL in the base year is standardized to a benchmark value of 100

Aggregate Demand Curve
– A curve representing the relationship between the economy’s price level and real GDP demanded per period with other things constant
– Reflects an inverse relationship between the price level in the economy and real GDP demanded
– As the price level increases, households demand less housing and furniture, firms demand fewer trucks and tools, governments demand less computer software and military hardware, and the rest of the world demands less U.S. grain and U.S. aircraft
– Since wealth is usually held in bank accounts and in currency, an increase in the price level decreases the purchasing power of bank accounts and currency

Aggregate Supply Curve
– Curve shows relationship between price level and quantity of output supplied per period
– Positive relationship between the price level and the quantity of real GDP supplied.
– As long as the prices firms receive for their products rise faster than their cost of production, firms find it profitable to expand output, so real GDP supplied varies directly with the economy’s price level.

Equilibrium
– When the aggregate demand curve intersects the aggregate supply curve and determines the equilibrium levels of price and real GDP in the economy

Brief history of the U.S. economy
The history of the U.S. economy can be divided roughly into five economic eras:
1. Before and during the great depression –> suffered from recessions and depressions.
2. After the great depression to the early 1970’s –> One of generally strong economic growth, with only moderate increases in the price level.
3. From the early 1970’s to the early 1980’s –> Saw both high unemployment and high inflation at the same time.
4. From the early 1980’s to 2007 –> Good economic growth on average and only moderate increases in the price level
5. The Great Recession of 2007-2009 and beyond –> worst recession since the Great Depression

Before the Great Depression
– Macroeconomic policy was based primarily on the laissez-faire philosophy of Adam Smith.
– Referred to as classic economics
– Minimal government interference
– The economy will self-correct
– Operate with a balanced budget
– Government spending should match income

During the Great Depression
– Aggregate demand declined because the stock market crashed, banks failed, and high tariffs on trade
– Both price level and real GDP dropped
– Real GDP fell 27%
– Price level fell 26%
– Unemployment soared from 3% in 1929 to 25% in 1933.

John Maynard Keynes
– Argued that aggregate demand was inherently unstable, in part because investment decisions were often guided by the unpredictable “animal spirits” of business expectations.
– If businesses grew pessimistic about the economy, they would invest less, which would reduce aggregate demand, output, and employment
– Proposed that the government jolt the economy out of its depression by increasing aggregate demand
– The government could achieve this stimulus either directly by increasing its own spending, or indirectly by cutting taxes to stimulate consumption and investment.

Federal budget deficit
A flow variable that measures, for a particular period, the amount by which federal outlays exceed federal revenues.

Demand-side economics
– A macroeconomic policy that focuses on shifting the aggregate demand curve as a way of promoting full employment and price stability

Golden age of Keynesian economics
– 1960’s
– Nearly all advanced economies around the world enjoyed low unemployment and healthy growth with only modest inflation
– Increase government purchases and/or decrease taxes

Stagflation (1973-1975 & 1979-1980)
– A contraction, or stagnation, of a nation’s output accompanied by inflation in the price level
– During the late 1960’s government spending increased due to the Vietnam war and social programs at home which caused inflation to rise to double (4.4% rather than 2%) and went to 4.9% in 1969 and 5.3% in 1970. These were an increase in aggregate demand.
– Crop failures –> increase in price of grain
– OPEC cut oil production (1979) –> which increased the price of oil and caused the price level to increase by 9%
– Previous two bullets were decreases in aggregate supply
– Stagflation from 1973-1975 –> Real GDP decreased, unemployment rate practically doubled, price level jumped about 20%, and aggregate supply decreased

Why was demand side economics not effective in dealing with stagflation?
– Increasing aggregate demand might reduce unemployment but would worsen inflation
– Price level would fall and GDP would fall even worse making unemployment rise higher

Supply-Side economics
– The appropriate way to combat stagflation
– Both lower the price level and increase output and employment
– Rightward shift of the aggregate supply curve through tax cuts or other changes to increase production incentives

Major economic events and trends of the 1980’s through 2007
– Major recession occurred in 1981-1982. Unemployment rose to almost 10%
– After recession, economy grew throughout the 1980’s, RGDP rose, unemployment fell. However, government outlays grew faster than government revenues, causing big increase in federal budget deficit and national debt
– Mild recession in 1990-1991, followed by another decade of growth. This time, government revenues grew enough relative to government outlays to swing federal budget to surplus (1998-2001)
– Short recession in 2001, followed by slow recovery. Increases in government spending and cuts in taxes were used to get economy moving. Federal budget quickly swung back to deficits. Economy grew from late 2001 to late 2007.

Federal debt
A stock variable that measures the net accumulation of annual federal deficits

The Great Recession of 2007-2009 and beyond
– Home prices declined and foreclosures rose, as more borrowers failed to make their mortgage payments. With home prices falling, fewer were getting built, meaning fewer jobs in residential construction, furnishings, and other industries that rely on the housing sector.
– During the first 8 months of the recession, U.S. job losses averaged 151,000 a month, in line with monthly losses during the prior two recessions.
– Tax cuts tripled federal deficits
– In effect, the AD curve shifted leftward, leading to very large increases in unemployment although RGDP did not fall a lot
– Government responses to the great recession included tax rebates, efforts to stabilize financial institutions, and a major stimulus bill. As should be expected, this has resulted in huge budget deficits.
– The collapse of Lehman Brothers in September 2008 panicked financial markets around the world, cutting investment and consumption.
– Job losses were the highest since the great depression
– Massive federal programs aimed at stabilizing the economy and increasing aggregate demand resulted in gigantic federal deficits. (Troubled Asset Relief Program)
– Job losses continued afterwards
– Employment dropped 6%
– The recession lasted 18 months (from early 2008 through mid 2009). The economy is now growing, with real GDP rising approximately 2.7% in 2015, and the unemployment rate has fallen from a high of 10% in 2009 to about 5.0% at the end of 2015.

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