TOPIC 6

MACROECONOMICS
CHAPTERS 12 & 14
ECONOMICS 100
Learning Objectives
1. What is macroeconomics?
2. The business cycle
3. GDP & economic growth
4. Unemployment
5. Inflation
In the long run, the Australian
economy has experienced
economic growth and rising
living standards, and in the short
run the economy has experienced
a series of business cycles.
Important macroeconomic
measures, such as gross
domestic product,
unemployment and inflation
enable economists to evaluate
the health of an economy.


Growth and the business cycle
GDP, income and economic
growth

Microeconomics: The study of how
households and firms make choices, how
they interact in markets, and how the
government attempts to influence their
choices.
Macroeconomics: The study of the
economy as a whole, including topics such
as inflation, unemployment, and economic
growth.

GDP, income and economic
growth
Economic growth: The expansion of societys
productive potential. Economic growth is usually
measured by the rate of growth in real GDP.
Business cycle: Alternating periods of economic
expansion and economic recession.
Expansion: The period of a business cycle
during which total production and total
employment are increasing.
Recession: The period of a business cycle
during which total production and total
employment are decreasing.

Gross domestic product
measures total production
Gross Domestic Product (GDP): The market
value of all final goods and services produced
in a country during a given period of time.
GDP does not includes the market value of
intermediate goods and services.
Intermediate good or service: A good or
service that is an input into another good or
service, such as a tyre on a truck.
GDP includes only current production. GDP does
not include the value of used (second-hand)
goods.




Calculating GDP
Examine a simple economy (Economy X) which
produces only three goods; sunglasses, suntan lotion
and swimming costumes. Use the information in the
table below to calculate GDP for this economy.

Production and Price Statistics for Economy X
Product Quantity Price per
unit ($)
Sunglasses 1000 20
Suntan lotion 500 10
Swimmers 100 80

STEP 3: Complete the table.
Calculating GDP
Production and Price Statistics for Economy
X
Product Quanti
ty
Price per
unit ($)
Value ($)
Sunglasses 1000 20 20 000
Suntan lotion 500 10 5 000
Swimmers 100 80 8 000
TOTAL (GDP): $33 000
Methods of measuring GDP
The Australian Bureau of Statistics (ABS) uses
three alternative methods to measure GDP:

1. The production method: The sum of the
value of all goods and services produced by
industries in the economy in a year minus the
cost of goods and services used in production
leaving the value added.
Methods of measuring GDP
2. The expenditure method: The sum of the
total expenditure on goods and services by
households, firms, government and net
exports (the value of exports minus the
expenditure on imports).
3. The income method: The sum of the income
generated in the production of goods and
services, including profits, wages and other
employee payments, income from rent and
interest earned.
Components of GDP
The ABS divides GDP into four major
categories of expenditures.
Consumption (C): Spending by
households on goods and services, not
including spending on new houses.
Investment (I): Spending by firms on new
factories, office buildings, machinery, and
inventories, and spending by households on
new houses.
Components of GDP
Government purchases (G): Spending by
federal, state, and local governments on
goods and services.
Net exports (NX): The value of exports
minus expenditure on imports.
An equation for GDP (where Y = GDP or total
output):


Y = C + I + G + NX
Components of GDP 2009-10
Components of GDP, 2009-10 ($ millions)
Consumption 686 379
Investment 286 514
Government 305 003
Net Exports 8 847
Exports 299 102
Imports 290 255
Stat Disc -2 947
TOTAL GDP 1 283 796
GDP 2009-10
0
10
20
30
40
50
60
Consumption Investment Government Net Exports
Components of GDP
Potential & Actual GDP
Potential GDP: The level of real GDP
attained when all firms are producing at
maximum capacity.
Potential real GDP increases every year as
the labour force & capital stock increase &
as technology improves
Growth in potential real GDP is estimated
to be about 3.5% per year.
Because of the business cycle, actual
real GDP may increase by more or less
than 3.5%.

GDP does a good job at measuring
production, and provides an indication of
wellbeing, but it is not flawless.
Shortcomings of GDP as a measure
of total production. GDP does not
include:
Household production: Goods and
services people produce for themselves.
Examples: Home cooking, cleaning, child
care, gardening, maintenance.

Does GDP measure what
we want it to measure?
The black economy: Buying and selling of
goods and services that is concealed from the
government to avoid taxes or regulations or
because the goods and services are illegal.
The distribution of GDP is not captured in
GDP measures.
The value of leisure is not included in GDP.
The level, quality of, and access to health
care is not measured in GDP.

Does GDP measure what
we want it to measure?
Shortcomings of GDP as a measure
of wellbeing.
GDP is not adjusted for pollution or
other negative effects of production.
GDP is not adjusted for changes in crime
and other social problems
Does GDP measure what
we want it to measure?
It is important to separate a measured rise in
GDP that may be due only to price changes
from real quantity changes.
Calculating Real GDP
Nominal GDP: The market value of final
goods and services evaluated at current year
prices.
Real GDP: The market value of final goods
and services evaluated at base year prices.

Real GDP versus Nominal
GDP
Nominal GDP can change over time due to
changes in either price or output.
Real GDP shows changes in output only.
The ABS selects a base year and uses this
over a specified period.
A simple rule: Real GDP equals the base
year prices multiplied by current year
quantities.
Real GDP versus Nominal
GDP
Our economy produces only three goods; sunglasses,
suntan lotion and swimming costumes. Use the information
in the table below to calculate real GDP for this economy in
2010, assuming 2009 is the base year.

Calculating Real GDP
2009 2010
Product Quantity Price per
Unit ($)
Quantity Price per
Unit ($)
Sunglasses 1000 20 1500 25
Suntan Lotion 500 10 550 11
Swimmers 100 80 110 80
GDP $33,000 $52,350

Calculating Real GDP
Nominal GDP has increased by 5.9%
(52,350 33,000) / 33,000
Calculate real GDP for 2010 by multiplying the
prices of each item for 2009 times the quantity
of all three goods for 2010, and then summing
the three values.

Calculating Real GDP
2009 2010
Product Price per
Unit ($)
Quantity Value ($)
Sunglasses 20 1500 30 000
Suntan Lotion 10 550 5 500
Swimmers 80 110 8 800
REAL GDP: $44 300

Economic growth rate: The rate of change in
real GDP from one year to the next.



Real GDP has grown by 3.4%



Calculating the economic
growth rate
100 x
GDP Real
GDP Real - GDP Real
Growth Economic
Previous
Previous Current

Example: Real GDP for Australia was:

In 2008-09: $1 255 241 million.
In 2009-10: $1 283 796 million.
Calculate the economic growth as follows:
$1 283 796 m - $1 255 241 m = $28 555 m

Growth rate = $28,555m / $1,255,241m x 100/1
= 2.3%

Calculating the economic
growth rate
Long-run economic growth is
the key to rising living standards
Long-run economic growth: The
process by which rising productivity
increases the average standard of
living.
Real GDP per capita is used to measure
changing living standards over time.

population
GDP Real
capita per GDP Real
Why do growth rates matter?
An economy that grows too slowly fails to
raise living standards.
People living in economies with low or no
economic growth suffer from starvation,
disease, and lack basic facilities, care
and education.
Long-run economic growth is
the key to rising living standards
Real GDP per capita,
Australia







0
1000
2000
3000
4000
5000
6000
7000
1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001
1
9
6
6
-
6
7

p
r
i
c
e
s

(
$
)
Hubbard, Garnett, Lewis, OBrien: Macroeconomics 2009 Pearson Education Australia
GDP per capita 2007
Hubbard, Garnett, Lewis, OBrien: Macroeconomics 2009 Pearson Education Australia
Increases in real GDP per capita depend on
increases in labour productivity.

Labour productivity: The quantity of
goods and services that can be produced by
one worker or by one hour of work.
What determines the rate
of long-run growth?
Two key factors determine labour
productivity

1. Increases in capital per hour worked
Physical Capital: manufactured goods that
are used to produce other goods and
services; e.g. are computers, buildings, and
machine tools.
Human capital: the accumulated
knowledge and skills that workers acquire
from education and training
What determines the rate
of long-run growth?
Two key factors determine labour
productivity

2. Technological Change
The change in the ability of a firm to produce a
given level of output with a given quantity of
inputs.

Technological change is the key to
sustaining economic growth.

What determines the rate
of long-run growth?
Economic growth has reduced poverty and
increased health, education and many other
measures of welfare.
Criticisms of economic growth include:
Globalisation undermines distinctive
cultures.
Multi-national firms exploit low wages and
poor health, safety and environmental
regulations in the developing world.
Economic growth contributes to global
warming, deforestation and other
environmental problems.
Is economic growth good
or bad?
Is economic growth good or bad?
The search for economic growth that
is sustainable has come to the
forefront of economic policy in high
income countries, and also in the
rapidly developing countries such as
China and India.
What determines how fast
economies grow?
Review
The largest component of GDP in
Australia, as measured by the
expenditure method, is
A. consumption expenditure.
B. government expenditure.
C. net exports.
D. investment expenditure.
Review
Which of the following is an example of
the investment component of GDP?
A. You purchase shares in BHP.
B. You put money into your bank
account.
C. You put money into your savings
account.
D. BHP buys a new drill press.
Review
Which of the following transactions
would be included in the official
calculation of GDP?
A. Bridgestone sells $2 million worth of
tyres to General Motors Holden.
B. A new iPod
C. A student buys a used text book at
the bookstore.
D. You illegally download music off the
Internet to put on your new iPod.


CHAPTER 14

UNEMPLOYMENT &
INFLATION
ECONOMICS 100
The labour force survey.
Unemployment rate: The percentage of the labour
force that is unemployed.
Labour force: The sum of employed and
unemployed workers in the economy.
Discouraged workers: People who are available for
work but have not looked for a job during the previous
four weeks because they believe no jobs are available
for them.




Measuring unemployment
Labour Force Concepts
WORKING AGE POPULATION
LABOUR FORCE Not in Lab. Force
EMPLOYED
Unemployed
The Australian Bureau of Statistics (ABS) labour
force survey:
Monthly sample of <0.5% of the population aged
15 and over.
To be classified as employed, a person must
have worked only 1 hour or more in the week
before the survey.
To be classified as unemployed, a person must
not have worked in the week before the survey,
must have been actively looking for work in the
past 4 weeks, and must be ready to start work.




Measuring unemployment
The unemployment rate measures the
percentage of the labour force that is
unemployed.







Measuring unemployment
The labour force participation rate measures the
percentage of the working-age population that is
in the labour force:







Measuring labour force
participation

Measuring unemployment and
labour force participation






Trend March 2011
Employed persons (000)
11,448.5
Unemployed persons (000)
594.7
Labour force
12,043.2
Working age population (000)
18,311.8
Unemployment rate
4.9%
Participation rate
65.8%
1. The number of discouraged workers
increases during a recession, therefore the
official unemployment rate appears lower
than it would otherwise be.
2. Under-employed workers people who work
part-time but would like to work more hours.
3. People who claim to be unemployed but are
not can lead to the unemployment rate being
overstated.






Problems with measuring the
unemployment rate.
The higher the participation rate, the more
labour is available and the higher the level of
potential GDP.
Who has the higher participation rate
males or females? Why?
1978 2010: male participation rate fell from
79% to 72%.
1978 2010: female participation rate
increased from 44% to 59%




Trends in labour force
participation











Labour force participation
Source: Australian Bureau of Statistics (2008), Labour Force-Detailed Electronic Delivery,
Table 01, Cat. No. 6291.0.55.001.
Labour Force
Costs to the economy as a whole.
Loss of Gross Domestic Product.
Loss of human capital.
Re-training costs.
Unemployment benefit payments are a net drain on
the budget.
Loss of tax revenue personal income tax,
company tax, GST and excise taxes
The opportunity cost of funds directed towards
unemployment benefits.
The costs of unemployment
Costs to the unemployed people.
Loss of income.
Loss of skills.
Loss of self esteem.
Unemployment may contribute to family break-ups,
health problems, mental illness, crime and political
unrest.
The costs of unemployment
Unemployment follows the business cycle.
Rises during recessions.
Falls during upturns.
When the economy begins to recover, the
unemployment rate usually continues to rise for 1-2
years because:
Discouraged workers re-enter the workforce.
Some firms wait until the recovery is lasting
before hiring new workers.






Unemployment
1. Frictional unemployment: Short-term
unemployment arising from the process of matching
workers with jobs.
School leavers, college and university graduates
looking for their first job.
People re-entering the workforce after an absence.
People who have lost or quit their job and are
looking for their new job.
Seasonal unemployment: due to factors such as
weather, tourism



Types of unemployment
2. Structural unemployment: Unemployment arising
from a persistent mismatch between the skills and
characteristics of workers and the requirements of
jobs.
Eg: New technology and changes in consumer
tastes may make some workers redundant.
Re-training needed to reduce this type of
unemployment

Types of unemployment
3. Cyclical unemployment: Unemployment caused by a
business cycle recession.
Also known as demand deficient unemployment.
Falling sales lead to cut-backs on production and
the sacking of workers.


Types of unemployment
Occurs where there is no cyclical
unemployment.
Natural rate of unemployment: The normal
rate of unemployment consisting of structural
unemployment plus frictional unemployment.
(around 4.75% for Australia)
Non-accelerating inflation rate of
unemployment: The level of unemployment
that will not lead to increases in the rate of
inflation.




Full employment
Types of Unemployment
A. A textile worker who quits one job and waits
for the new job to begin. Frictional
B. An engineer permanently laid off due to
advances in technology. Structural
C. A computer programmer who becomes rich
and leaves the labour force. Not
unemployed
D. A factory worker permanently laid off due to
jobs lost to imports. Structural
E. Auto worker who is temporarily laid off due to
a decline in the demand for cars.
Cyclical
F. A person who is laid off from their job as a ski
instructor over summer Frictional/Seasonal
Which of the following groups is
included in the labour force?
a. The unemployed.
b. Retirees, homemakers, and full-time
students.
c. People who could have a civilian job but
are on active military service, in prison,
or in mental hospitals.
d. None of the above.
Check Your Knowledge
Suppose that Matt quits a job with the XYZ
Corporation in order to look for more
rewarding employment. Matt would be
A. cyclically unemployed.
B. included in the economy's "hidden
employment."
C. frictionally unemployed.
D. structurally unemployed.
Check Your Knowledge
If a video recorder manufacturer sacks
workers due to a fall in demand for video
recorders as sales of DVD players rise,
this type of unemployment would be
classified as
A. natural unemployment.
B. cyclical unemployment.
C. frictional unemployment.
D. structural unemployment.
Check Your Knowledge
Jenny quits her job and immediately begins
looking for another. Other things equal,
A. the unemployment rate increases and the
labour force participation rate decreases.
B. the unemployment rate increases and the
participation rate is unaffected.
C. the unemployment rate increases and the
participation rate increases.
D. the unemployment rate is unaffected and
the participation rate increases.
Check Your Knowledge
Price level: A measure of the average
prices of goods and services in the
economy.
Inflation: The sustained increase in the
general level of prices in the economy.
Inflation rate: The percentage increase
in the general price level in the economy
from one year to the next.

Measuring Inflation
Inflation
Inflation is an increase in the general
(average) price level of goods and
services in the economy.
It is not an increase in the price of
any specific product.
Inflation is measured by the
consumer price index which
measures changes in the average
prices of consumer goods and
services.
Australias Inflation Rate
Consumer Price Index: An average of the
prices of the goods and services purchased by
the typical urban family of four.
The ABS surveys households on their
spending habits.
The goods and services typically purchased by
households is the market basket.
The prices of goods and services in the market
basket are given a weight according to their
fraction of a typical family budget.
The CPI measures the rate of change in the
prices of the goods and services in the market
basket.
Measuring Inflation












The CPI market basket
The CPI for Dec 2009 = 169.5

The CPI for Dec 2010 = 174.0

The annual rate of inflation =
(174.0 169.5) / 169.5 x 100/1
= 2.7%
Calculating the CPI
Is the CPI accurate?
The CPI is the most widely used measure
of inflation.
Four sources of bias in the CPI may lead
to its overstating the inflation rate.
Substitution bias
Increase in quality bias
New product bias
Outlet bias




Measuring Inflation
Headline & Underlying Inflation
The CPI rate of inflation is the
headline rate
The underlying rate attempts to
remove the effects of extreme price
changes
3 measures
1. CPI excluding volatile items
2. Trimmed mean
3. Weighted median
Headline & Underlying Inflation
Dec 2010
CPI 2.7%
CPI (ex vol) 2.5%
Trimmed mean 2.2%
Weighted median 2.3%
In general, wages rise with inflation.
Inflation can, however, affect the
distribution of income.
The extent of redistribution depends,
in part, on the degree to which
inflation was anticipated or
unanticipated.






Does inflation impose costs on
the economy?
The problem with anticipated inflation:
Menu costs the costs to firms of changing
prices.
The problem with unanticipated inflation:
There are winners and losers, depending on
whether inflation is higher or lower than
anticipated.
For example: those on fixed incomes, such as
aged pensions, will lose if inflation is higher
than anticipated.
Borrowers may gain and lenders lose when
inflation is higher than anticipated.








Does inflation impose costs on
the economy?
Hyperinflation: Extremely rapid
increases in the general price level.
In periods of hyperinflation, money loses
value so rapidly, that firms and households
try to avoid holding it.
Hyperinflation is often associated with
political instability and usually accompanied
by recession.






Does inflation impose costs on
the economy?
Deflation: A decline in the general price level
in the economy - the inflation rate is negative.
Problems with deflation include:
Increases debt burdens.
Reduces asset values and wealth.
Gains to consumers from falling prices
may be negated by falling wages.
The real interest rate increases,
discouraging business investment.





Does inflation impose costs on
the economy?
It redistribute income in arbitrary ways
It diverts resources from productive
activities to inflation forecasting.
It increases uncertainty & reduces
investment
It decreases our international
competitiveness
Eliminating inflation is costly because it brings
a period of greater than average
unemployment.




Does inflation impose costs
on the economy? . . . Yes
Causes of Inflation
Demand-pull inflation is a rise in the
general price level resulting from an
excess of total spending (demand)
over supply.
Prices are pulled up by the pressure
from buyers total expenditures.
Demand-pull inflation tends to occur
when the economy is operating close
to full employment boom conditions
Causes of Inflation
Cost-push inflation is a rise in the
general price level resulting from an
increase in the cost of production,
irrespective of demand conditions.
This could be caused by cost
increases for labour, raw materials
e.g. oil, construction, equipment,
borrowing (interest rates) etc.

Which of the following is a correct
description of inflation?
A) Inflation refers to an increase in
relative prices throughout the
economy.
B) Inflation is the change in the price
level from one year to another.
C) Inflation is when there is a one-time
jump in the price level.
D) Inflation is a sustained increase in
the price level.
Check Your Knowledge
If the anticipated rate of inflation is 3%
but the subsequent actual rate of
inflation is 5%, the likely outcome will be
that the purchasing power of money will
A) fall and lenders will benefit.
B) increase and lenders will benefit.
C) fall and borrowers will benefit.
D) increase and borrowers will benefit.
Check Your Knowledge