Chapter 20 Macroeconomics The study of the behaviour of the economy as a whole Two central themes 1.

1. Business cycle short-term fluctuations in output, employment and prices 2. Economic growth longer-term trends in output and living standards Central macroeconomic questions 1. Why do output and employment sometimes fall, and how can employment be reduced? 2. What are the sources of price inflation, and how can it be kept under control? 3. How can a nation increase its rate of economic growth? (economic growth growth in the productive potential of the economy) Macroeconomic objectives 1. Output Gross Domestic Product (GDP) Most comprehensive measure of total output in a economy Measure of the market value of all final goods and services Two main themes short-term fluctuation, long term growth Two ways of measuring a. Nominal GDP measured in actual market prices b. Real GDP calculated in constant or invariant prices Potential GDP o The maximum sustainable level of output that the economy can produce o Determined by the economys productive capacity, which depends on INPUT and TECHNOLOGICAL EFFECIENCY o Tends to grow steadily, while actually GDP has large business-cycle swings Recession period of significant decline in total output, income and employment Depression a severe and protracted downturn 2. Employment Most directly felt by individuals Measures a. Unemployment rate b. Labor force include those unemployed, but trying to get a job c. Level of employment reflects the state of the business cycle Indication of productivity 3. Price Stability

Overall price level is unchanged or rising very slowly Prices reflect scarcity of resources Price indexes measures of overall price level, used to track prices Consumer Price Index (CPI) Measure the average price of goods and services bought by consumers Inflation rate Percentage change in the overall level of prices from one year to the next Inflation = [P(current year) P(previous year)] / P(previous year) x 100% Deflation prices decline, inflation rate is negative Hyperinflation a rise in the price level of a thousand or a million percent a year Macroeconomic Tools of the Government *policy instrument an economic variable under the control of government that can affect one or more of the macroeconomic goals 1. Fiscal Policy Denotes the use of taxes and government expenditures Two forms of government expenditures a. Government purchases comprise spending on goods and services b. Transfer payments boost the incomes of targeted groups such as the elderly or unemployed Taxation affects the economy in two ways a. Leaves households with more or less disposable income, affects how much people spend, savings b. Affect the prices of goods and factors of production, affecting incentives and behaviour 2. Monetary Policy Conducted by the central bank Management of the nations money, credit and banking system By changing money supply, BSP influence interest rates Less money supply higher interest rates, less investment, decline GDP, lower inflation More money supply lower interest rates, more investment Aggregate Supply (AS) Refers to the total quantity of goods and services that businesses willingly produce and sell in a given period Depends on 1. Price level 2. Productive capacity of economy 3. Level of costs

Together with AD, determine national output and overall price level Aggregate supply schedule (AS curve) Represents the quantity of goods and services that businesses are willing to produce and sell at each price level (with other factors affecting aggregate demand held constant) Aggregate Demand (AD) Total amount that different sectors of the economy willingly spend in a given period Sum of spending by consumers, businesses and governments Depends on 1. Level of prices 2. Monetary policy 3. Fiscal policy 4. Other factors Aggregate demand schedule (AD curve) Represents what everyone in the economy would buy at different aggregate price levels (all other factors affecting aggregate demand held constant) Downward-sloping Macroeconomic equilibrium Combination of overall price and quantity at which all buyers and sellers are satisfied with their purchases, sales and prices

Chapter 21 GDP

total market value of the finals goods and services produced in a nation within a given year GDP = C + I + G +X, where C=consumption, I=investments, G= government purchases of goods and services, X = net exports produced within a nation during a given year Not reliable because : 1. Doesnt count informal sector 2. Doesnt count opportunity cost How to calculate 1. Flow-of-Product Approach Include only final goods (goods ultimately bought and used by consumers) Market prices reflect the relative market value of diverse goods and services, weight to value different commodities 2. Earnings or Cost Approach Total of factor earnings (wages, interest, rents and profits) that are the costs of producing societys final products Includes profits, making it equal to flow of product Profit what remains from the sale of a product after you have paid other factor costs (like wages, interest and rents) National accounts

Account numerical record of all flows (outputs, costs, etc) during a given period National accounts add together or aggregate the outputs and costs to get the two different measures of GDP Double counting Final product one that is produced and sold for consumption or investment Intermediate goods goods used up to produce other goods Value added difference between a firms sales and its purchases of materials and services from other firms Business costs in the form of wages, salaries, interest are included in value added Only include final goods to prevent double-counting Real vs. Nominal (use market price as measure) 1. Nominal GDP at current prices 2. Real index of the volume or quantity of goods and services produced *difference between real and nominal GDP deflator (real GDP = nominal / GDP price index, Q = PQ/P) Chain weighting To correct bias for using prices of a fixed year (real GDP) Weights of different goods are changed each year to reflect changes in spending patterns of the economy real GDP in chained dollars, chain type index for GDP Calculation of chain weights involves linking the output or price series together by multiplying the growth rates from one period to another Consumption Personal consumption expenditures The largest component of GDP Categories 1. Durable goods cars 2. Nondurable goods food 3. Services medical care Investment Consists of the additions to the nations capital stock of buildings, equipment, software and inventories during the year Net vs. Gross investment a. Gross investment all investment goods produced, not adjusted for depreciation (amount of capital used in a year) b. Net investment gross investment minus depreciation Government Government consumption expenditures and gross investment All government payroll expenses plus cost of goods it buys from the private industry Excludes transfer payments (because its not made in exchange for goods supplied)

Includes both indirect and direct tax as elements of the cost of producing final output Net exports Difference between exports and imports of goods and services NDP net domestic product includes only net investment, but depreciation is hard to estimate NDP = GDP depreciation Gross National Product (GNP) Total output produced with labor or capital owned by residents of a country during a year (not necessarily in the country, unlike GDP) Flow of product approach: Gross Private Domestic Investment includes all new business fixed investment, residential construction, and increase in inventory of goods, depreciation of capital not subtracted Flow of cost approach Costs of production + taxes + depreciation Compensation of employees represents wages, salaries and other employee supplements Net interest (no interest on government debt) Rent income rents received plus rent paid to self when you own the home Depreciation Profit residual, whats left over after all costs have been subtracted from total sales 1. Income of unincorporated enterprises consists of earnings of partnerships and single-ownership businesses 2. Corporate profits before taxes (includes undistributed corporate dividends, plow back or net corporate saving) National Income (NI) Represents the total incomes received by labor, capital and land Constructed by subtracting depreciation from the GDP Disposable income calculate the market and transfer incomes received by households and subtract personal taxes, or national income minus taxes and net business savings plus transfer payments Savings and Investment Investment - an essential economic activity because it increases capital stock available for future production Measured saving = measured investment National investment = private investment + net exports = private savings + government savings = national savings (It = I + X = Sp + SG = St) Components of investment : private domestic investment and foreign investment (net exports) Sources of saving: private saving and government saving (government budget surplus) Omitted from GDP Omitted Nonmarket Activities

Ex. Services of housewives, students investing in their education, value of leisure activities Illegal activities not included Tips estimated by IRS Omitted Environmental Damage Price Indexes Price Index measure of average level of prices a. Consumer Price Index (CPI) o Measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services o Constructed by weighing each price according to the economic importance of the commodity in question b. GDP Price Index or GDP deflator o Not just consumer goods, unlike CPI o Takes into the changing shares of different goods through chain weights, unlike CPI c. Producer Price Index o Oldest continuing statistical series published by the BLS o Measures level of prices at wholesale / producer stage o Fixed weights = net sales of each commodity Inflation denotes a rise on the rate of change of general price level Rate of inflation rate of change of general price level price level current year price level base year / price level base year