ECON 2630 Principles of Macroeconomics

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ECON 2630Principles of Macroeconomics

• Instructor Dr. Ou Hu

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Principles of Macroeconomics

• Macroeconomics studies the behaviors of overall
  economy.
• Goals of Macroeconomics
• Sustainable economic growth
• Full employment
• Stable price

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Principles of Macroeconomics

• Spending, Income, and GDP

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Gross Domestic Product, GDP A
Definition

• A nations gross domestic product (GDP)
• Total value of all final goods and services
  produced for the marketplace during a given
  period within the nations borders

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Gross Domestic Product, GDP A
Definition

• The total value
• Approach of GDP is to add up dollar value of
  every good or servicethe number of dollars each
  product is sold for
• GDP must be adjusted to take away the effects of
  inflation
• Nominal GDP vs. Real GDP
• of all final
• When measuring production, we do not count every
  good or service produced in the economy
• Only those that are sold to their final users
• Avoids over-counting intermediate products when
  measuring GDP
• Value of all intermediate products is
  automatically included in value of final products
  they are used to create

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Gross Domestic Product, GDP A
Definition

• goods and services
• Goods cars, furniture, computers, beer, etc.
• Services medical, financial, educational, etc.
• produced
• In order to contribute to GDP, something must be
  produced.
• Q should stocks or bonds be included in the
  calculation
• of GDP?

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Gross Domestic Product, GDP
A Definition

• for the marketplace
• GDP does not include all final goods and services
  produced in the economy
• Includes only the ones produced for the
  marketplacethat is, with the intention of being
  sold
• during a given period
• GDP measures production during some specific
  period of time
• Only goods produced during that period are
  counted
• how about used goods?
• GDP is actually measured for each quarter, and
  then reported as an annual rate for the quarter
• Once fourth quarter figures are in, government
  also reports official GDP figure for entire year

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Gross Domestic Product, GDP A
Definition

• within the nations borders
• U.S. GDP measures output produced within U.S.
  borders
• Regardless of whether it was produced by
  Americans
• Americans abroad are not counted
• However, foreigners producing goods or services
  within the country are included
• Chinese Acrobat Team, Honda, Rolling Stones

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The Expenditure Approach to GDP

• Expenditure approach divides output into four
  categories according to which group in the
  economy purchases it as final users
• Consumption goods and services (C)purchased by
  households
• Private investment goods and services
  (I)purchased by businesses
• Government goods and services (G)purchased by
  government agencies
• Net exports (NX)purchased by foreigners

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The Expenditure Approach to GDP

• When we add up the purchases of all four groups
  we get GDP
• GDP C I G NX

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Consumption Spending

• Consumption is the part of GDP purchased by
  households as final users
• Almost everything households buy during the year
  is included as part of consumption spending when
  we calculate GDP
• One exception is construction of new homes
• Counted as private investment

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Private Investment

• Private investment has three components
• Business Purchases of Plant, Equipment, and
  Software
• A firms plant, equipment, and software are
  intended to last for many yearsonly a small part
  of them is used up to make the current years
  output
• Are regarded as final goods, and firms that buy
  them as final users of those goods
• New Home Construction
• Residential housing is an important part of
  nations capital stock
• House will continue to provide services into the
  future
• Changes in Inventories
• We count the change in firms inventories as part
  of investment in measuring GDP
• Why?
• When goods are produced but not sold during the
  year, they end up in some firms inventory stocks
• Part of the nations capital stock
• Will provide services in the future, when they
  are finally sold and used

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Government Purchases

• Purchases by state, local governments and federal
  government are included
• Government purchases include
• Goods
• Fighter jets, police cars, school buildings, spy
  satellites, etc.
• Services
• Such as those performed by police, legislators,
  and military personnel
• Government is considered to be a purchaser even
  if it actually produces the goods or services
  itself

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Government Purchases

• Exclude transfer payments
• Transfer payments represent money redistributed
  from one group of citizens (taxpayers) to another
  (poor, unemployed, elderly)
• While transfers are included in government
  budgets as outlays they are not purchases of
  currently produced goods and services
• Exclude interest paid on government debt

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Net Exports

• Once we recognize dealings with the rest of the
  world, we must correct an inaccuracy in our
  measure of GDP
• Deduct all U.S. imports during the year, leaving
  us with just output produced in United States
• To properly account for output sold to, and
  bought from, foreigners
• We must include net exportsdifference between
  exports and importsas part of expenditure in GDP

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US GDP, 2007 (billions of dollars)
Consumption 9,732.0
Durable Goods 1,079.6
Non-durable Goods 2,833.0
Services 5,819.4
Investment 2,132.3
Business Fixed Investment 1,483.2
Residential 641.5
Inventory 7.6
Government Purchases 2,691.4
Net Exports 712.7
Exports 1,640.3
Imports 2,353.0
GDP 13,843.0
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Other Approaches to GDP The Value-Added Approach

• Value added
• Firms contribution to a product or
• Revenue it receives for its output
• Minus cost of all the intermediate goods that it
  buys
• GDP is sum of values added by all firms in economy

Company Revenues Cost of Purchased Inputs Value Added
ABC Grain 0.50 0.00 0.50
General Flour 1.20 0.50 0.70
Hot'n'Fresh 2.00 1.20 0.80
Total 2.00
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Other Approaches to GDP The Factor Payments
Approach

• In any year, value added by a firm is equal to
  total factor payments made by that firm
• Thus, GDP must equal total factor payments made
  by all firms in the economy
• All of these factor payments are received by
  households in the form of wages and salaries,
  rent, interest or profit
• GDP is measured by adding up all of the
  incomewages and salaries, rent, interest,
  royalties,and profitearned by all households in
  the economy
• Gives us an important insight into the
  macroeconomy
• Total output of economy (GDP) is equal to total
  income earned in the economy

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Measuring GDP A Summary

• Different ways to calculate GDP
• Expenditure Approach
• GDP C I G NX
• Value-Added Approach
• GDP Sum of value added by all firms
• Factor Payments Approach
• GDP Wages and Salaries interest rent
  profit
• Therefore, Total output Total household income

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GDP Global Perspective

• http//en.wikipedia.org/wiki/List_of_countries_by_
  GDP_28nominal29
• http//en.wikipedia.org/wiki/List_of_countries_by_
  GDP_28nominal29_per_capita
• http//en.wikipedia.org/wiki/List_of_countries_by_
  GDP_28PPP29_per_capita

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Problems With GDP

• Quality Changes
• Underground Economy
• Non-market Production
• Not a perfect measure of economic well-being

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Quality Change

• While BEA includes impact of quality changes for
  many goods and services (such as automobiles and
  computers)
• Does not have the resources to estimate quality
  changes for millions of different goods and
  services
• By ignoring these quality improvements, GDP
  probably understates true growth from year to
  year.

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The Underground Economy

• Some production is hidden from government
  authorities
• Either because it is illegal or
• Drugs, prostitution, most gambling
• Because those engaged in it are avoiding taxes
• Production in these hidden markets cannot be
  measured accurately

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Non-Market Production

• GDP does not include non-market production
• Goods and services that are produced, but not
  sold in the marketplace
• Whenever a non-market transaction becomes a
  market transaction GDP will rise
• Even though total production has remained the
  same
• Can exaggerate the growth in GDP over long
  periods of time
• What do these problems tell us about value of
  GDP?
• For certain purposesespecially interpreting
  long-run changes in GDPwe must exercise caution

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Not a perfect measure of economic well-being

• No value measured on leisure
• Bad things can raise GDP.
• Disasters, wars, etc.
• Externality ecological cost

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The Business Cycle

• Alternating increases and decreases in economic
  activity over time
• Phases of the business cycle
• Peak
• Recession
• Trough
• Expansion

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Figure 1 The Business Cycle
Peak
Peak
Trend
Peak
Expansion
Growth
Level of real output
Recession
Expansion
Trough
Recession
Trough
Time
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The Business Cycle
U.S. Recessions since 1950 U.S. Recessions since 1950 U.S. Recessions since 1950
Period Duration, Months Depth (Decline in Real Output)
1953-54 10 -2.6
1957-58 8 -3.7
1960-61 10 -1.1
1969-70 11 -0.2
1973-75 16 -3.2
1980 6 -2.2
1981-82 16 -2.9
1990-91 8 -1.4
2001 8 -0.4
2007-09 18 -3.7
Source National Bureau of Economic Research,
http//www.nber.org and Minneapolis Federal
Reserve Bank, http//www.minneapolisfed.org/
Output data are in 2000 dollars
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Types of Unemployment

• In United States, people are considered
  unemployed if they are not working AND actively
  seeking a job
• Unemployment can arise for a variety of reasons,
  each with its own policy implications
• This is why economists have found it useful to
  classify unemployment into four different
  categories
• Frictional unemployment
• Seasonal unemployment
• Structural unemployment
• Cyclical unemployment

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Frictional Unemployment

• Short-term joblessness experienced by people who
  are between jobs or who are entering the labor
  market for first time or after an absence
• Because frictional unemployment is, by
  definition, short-term, it causes little hardship
  to those affected by it
• By spending time searching rather than jumping at
  the first opening that comes their way
• People find jobs for which they are better suited
  and in which they will ultimately be more
  productive

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Seasonal Unemployment

• Joblessness related to changes in weather,
  tourist patterns, or other seasonal factors
• Is rather benign
• Short-term
• predictable
• Workers are often compensated in advance for
  unemployment they experience in off-season
• To prevent any misunderstandings, government
  usually reports the seasonally-adjusted rate of
  unemployment

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Structural Unemployment

• Joblessness arising from mismatches between
  workers skills and employers requirements
• Or between workers locations and employers
  locations
• Generally a stubborn, long-term problem
• Often lasting several years or more

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Cyclical Unemployment

• When the economy goes into a recession and total
  output falls, the unemployment rate rises
• Since it arises from conditions in the overall
  economy, cyclical unemployment is a problem for
  macroeconomic policy

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Figure 2 U.S. Unemployment Rate, 19602007
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Figure 3 Unemployment in Western Europe, 1980 -
2007
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High Unemployment in Europe

• Unemployment rates have increased since 1980
• 2007 unemployment rates

Country Italy France Germany UK US
Unemployment Rate 6.0 8.2 8.0 5.3 5.5

• Structural rigidities explain persistently high
  rates
• Regulated labor markets
• High minimum wages
• Generous unemployment benefits
• Powerful labor unions

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Definition of Full Employment

• Natural Rate of Unemployment (NRU)
• Full employment level of unemployment
• Can vary over time
• Demographic changes
• Changing job search methods
• Public policy changes
• Actual unemployment can be above or fall below
  the NRU

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Economic Cost of Unemployment

• GDP Gap
• GDP gap actual GDP potential GDP
• Can be negative or positive
• Okuns Law
• Every 1 of cyclical unemployment creates a 2
  GDP gap

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How Unemployment is Measured

• The unemployed are those willing and able to
  work, and who are actively searching for jobs
• Others were able to work, but preferred not to
• Including millions of college students,
  homemakers, and retired people
• Still others not counted when calculating
  civilian employment statistics
• In the military, in hospital, and in prison

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Figure 4 Employment Status of the U.S.
Population An Illustration
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Figure 5 How BLS Measures Employment Status
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US Employment Data, Jan 2008
Employed 146.2 million
Unemployed 7.6 million
Labor Force 153.8 million
Not in the Labor Force 78.8 million
Working-Age Population 232.6 million
Unemployment Rate 4.9
Participation rate 66.1
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Problems In Measuring Unemployment

• Treatment of involuntary part-time workers
• Some economists have suggested that involuntary
  part-time workers should be regarded as partially
  employed and partially unemployed
• Treatment of discouraged workers
• Individuals who would like to work but, because
  they feel little hope of finding a job, have
  given up searching

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Some Data Sources

• Bureau of Economic Analysis
• www.bea.gov
• Federal Reserve Bank of St. Louis
• http//www.stlouisfed.org/