Economics Unit 7 – Macroeconomic policy

12.1 – measuring the nation’s output and income

• Macroeconomics – part of economics that deals with the economy as a whole and uses aggregate measures of output, income, prices, and employment
• Gross Domestic Product is one of the most important macro measures that keep track of nation’s production, consumption, saving, and investment.

GDP – The measure of national output

• Gross domestic product (GDP) – the dollar value of all final goods, services, and structures produced within a country’s national borders during a one-year period, measure of final output
• To calculate the GDP, you multiply the good/service produced in a year by their prices, then adds them up to get the total dollar value of production
• Intermediate products – products that are components of other final products included in GDP
• Secondhand sales – sales of used goods not included in GDP
• Nonmarket transaction – economic activity not taking place in the market and, therefore, not included in GDP
• Underground economy – unreported legal and illegal activities that do not show up in GDP statistics
• GDP must be adjusted for inflation using base year
• Base year – year serving as point of comparison for other years in a price index or other statistical measure
• Real GDP – gross domestic product after adjustments for inflation
• Current GDP – gross domestic product measured in current prices, unadjusted for inflation
• Adjust GDP for population by GDP per capita
• GDP per capita – gross domestic product on a per person basis; can be expressed in current or constant dollars
• Limitation of GDP
  • GDP tells us nothing about the composition of output
  • GDP tells little about the impact of production on the quality of life
  • GDP is produced to control activities that give us little utility or satisfaction, thus making GDP even larger
• GDP is our best measure of overall economic performance and well-being, because it is a measure of the voluntary transactions that take place in the market.

Economic sectors and circular flows

• Largest sector in the economy is the household – basic unit of consumer sector consisting of all person who occupy a house, apartment, or separate living quarters
• Unrelated individual – person living alone even though that person may have relatives living elsewhere
• Family – two or more persons living together who are related by blood, marriage, or adoption
• Second largest sector of macro economy is the business, or investment; consist of proprietorships, partnerships, and corporations that are responsible for producing the nation’s output
• The third sector is public sector, which includes all local, state, and federal levels of government.
• Forth sector is the foreign sector, which includes all consumers and producers outside of US.

The output expenditure model

• Output expenditure model – macroeconomic model describing aggregate demand by the consumer, investment, government, and foreign sectors
• GDP = consumer + investment + government + (X – M)
• (X-M) or net exports of goods and services – net expenditures by the foreign sector; equal to total exports less total imports

Chapter 13 – Economic instability

7B – section 1 – business cycles and fluctuations

• Business cycles – regular increases and decreases in real GDP
• Business fluctuations – irregular increases and decreases in real GDP

Business cycles and characteristics and causes

• The two phrases of business cycle are recession and expansion
• Recession – decline in real GDP lasting at least two quarters
• Peak – point in time when real GDP stops expanding and begins to decline
• Trough – point in time when real GDP stops declining and begins to expand
• Expansion – period of interrupted growth of real GDP
• Trend line – growth path the economy would follow if it were not interrupted by alternating periods of recession and recovery
• Depression – state of the economy with large numbers of unemployed people, declining real incomes, overcapacity in manufacturing plants, and general economic hardship
• Changes in capital expenditures are thought to be one cause of business cycle
• Innovation may be a cause also; competitions
• Another possible cause is Federal Reserve system’s policy on interest rates; low interest increase demand for loans
• External shocks such as oil prices, wars, and international conflicts

Forecasting business cycles

• Change in single statistics often indicates a change in GDP
• Leading economic indicator – statistical series that turns down before the economy turns down, or up before the economy turns up
• Several individual series of indicators are more accurate, often combined into an overall index
• Composite index of leading economic indicators (LEI) – composite index of 10 economic series that move up and down in advance of changes in the overall economy; statistical series used to predict turning points in the business cycle
• Econometric model – mathematical expression used to describe how the economy is expected to perform in the future
• GDP = C + I + G + (X – M)

13.2 – inflation

• Inflation – increase in the general level of prices of goods and services
• Deflation – decrease in the general level of prices for goods and services

Measuring prices and inflation

• Price index – statistical series used to measure changes in the price level over time
• Consumer price index (CPI) – series used to measure price changes for a representative sample of frequently used consumer items
• Market basket – representative selections of goods and services used to compile a price index
• Find the average price of each item in the market basket, then add up the prices to find the total cost of the market basket
• Base year – year serving as point of comparison for other years in a price index or other statistical measure
• Dividing the cost of every market basket by the base year market basket cost in order to convert it to index value
• Percentage change is found by dividing the change in the CPI by the beginning value of the CPI.
• Rate of inflation t4nds to change over long periods of time
• Creeping inflation – relatively low rate of inflation, usually 1 to 3 percent annually
• Hyperinflation – inflation in excess of 500 percent per year
• Usually the last stage before a total monetary collapse
• Stagflation – period of slow economic growth coupled with inflation
• Producer price index (PPI) – index used to measure prices received by domestic producers
• Implicit GDP price deflator – index used to measure price changes in GDP
• But CPI remains to be the most popular

Causes of inflation

• Demand pull inflation – explanation that prices rise because all sectors of the economy try to buy more goods and services than the economy can produce
• Prices are pulled up by demand, and consumers continue to purchase these items, leaving them in debt
• Cost push inflation – explanation that rising input costs, especially energy and organized labor, derive up the prices of products
• It may occur when there is an increase in oil prices
• Wage price spiral is the idea that workers ask for higher wages due to the high prices, producers try to recover these lost by raising their prices
• Excessive monetary growth is another explanation. Occurs when money supply grows faster than real GDP

Consequences of inflation

• The devalue of dollar and erode purchasing power
• Change people’s spending habits
• Tempts some people to speculate heavily in an attempt to take advantage of rising prices
• Alter the distribution of income
• Creditors – person or institution to whom money is owed
• Debtors – person who borrows and therefore owes money

7C – 13.3 – unemployment

Measuring unemployment

• Civilian labor force or labor force – non institutionalized part of the population aged 16 and over, either working or looking for a job
• unemployed – working for less than one hour per week for pay or profit in a non family owned business, while being available and having made an effort to find a job during the past month
• unemployment rate – percentage of people in the civilian labor force who are classified as unemployed
• number of unemployed persons/ civilian labor force
• unemployment rates are underestimated
  • does not count those too frustrated or discouraged
  • considered employed even when they only hold part time jobs

sources of unemployment

• frictional unemployment – unemployment involving workers changing jobs or waiting to go to new ones
• structural unemployment – unemployment caused by a fundamental change in the economy that reduces the demand for some workers
• outsourcing – hiring outside firms to perform non-core operations to lower operating costs
• technological unemployment – unemployment caused by technological developments or automation that makes some workers’ skills obsolete
• cyclical unemployment – unemployment directly related to swings in the business cycle
• seasonal unemployment – unemployment caused by annual changes in the weather or other conditions that reduce the demand for jobs

costs of instability

• economic instability carries enormous costs and can be measured
• GDP gap – difference between what the economy can and does produce
• Misery index or discomfort index – unofficial statistic that is the sum of the monthly inflation and unemployment rates
• When its unstable, there is a factor of uncertainty
• Politicians are also affected
• Higher crime rates

14.3 – conducting monetary policy

• Monetary policy – actions by the federal reserve system to expand or contract the money supply in order to affect the cost and availability of credit
• Interest rate – the price of credit to a borrower
• Easy money policy – monetary policy that results in lower interest rates and greater access to credit
• Tight money policy 0 monetary policy that results in higher interest rates and restricted access to credit
• For reserve requirements that congress passed, the Fed can change it around within border
• Total MBRs/reserve requirements
• Open market operations – sales or purchases of US government securities by the Fed

15.1 – 7d – Macroeconomic equilibrium

• Macroeconomics – part of economics that deals with the economy as a whole

Aggregate supply and demand

• Equilibrium price – price where quantity supplied equals quantity demanded
• Aggregated supply – the total value of all goods and services that all firms would produce in a specific period at various price levels
• Aggregate supply curve – hypothetical curve showing different levels of real GDP that would be produced at various price levels
• Price level includes price of everything produced
• Increases in aggregate supply are tied to the cost of production for an individual firm
• Factors such as higher oil prices, higher interest rates, and lower labor productivity contributes
• Aggregate demand – the total value of goods and services demanded at all different price levels
• Aggregate demand curve – hypothetical curve showing different levels of real GDP that would be purchased at various price levels
• Aggregate demand is affected by how much people decides to save compare to spend

Macroeconomic equilibrium

• Aggregate supply and demand provide a framework to help us analyze the impact of economic policy on economic growth and price stability
• Macroeconomic equilibrium – level of real GDP consistent with a given price level and marked by the intersection of aggregate supply and aggregate demand

15.2 – stabilization policies

• Medicare – federal health care program for senior citizens regardless of income

Demand side policies

• Designed to increase or decrease total demand in the economy
• Fiscal policy – use of government spending and revenue collection measures to influence the economy
• Keynesian economics – government spending and taxation policies suggested by john Maynard Keynes to stimulate the economy
• Consumer sector among the equation is the most stable, and investment spending would be the least stable
• Multiplier – magnified change in overall spending caused by a change in investment spending
• Accelerator – change in investment spending caused by a change in overall spending
• Temporary federal deficits can recover economy to its stable state.
• Automatic stabilizers – program that automatically provides benefits to offset a change in people’s incomes
• Entitlements – broad social programs that uses established eligibility requirements to provide health, nutritional, or income supplements to individuals
• Unemployment insurance – government program providing payments to unemployed workers
• Stabilizers are more effective due to the speed they can be implemented

Supply side policies

• Supply side policies – economic policies designed to stimulate the economy by increasing production
• Supply siders is reducing government’s role in the economy by
  • Reducing government agencies
  • Sped less at federal level
• Goal of supply side policies and demand side policies have the same goal: increasing production and decreasing unemployment without increasing inflation
• Deregulation – relation or removal of government regulations on business activities
• Lower tax rates allow individuals to keep more of the money they earn, which encourages them to work harder
• Limitation of supply side policies is lack of experience

Monetary policies

• Monetarism – school of thought stressing the importance of stable monetary growth to control inflation and stimulate long term economic growth
• Fluctuations in the money supply can be destabilizing element that leads to unemployment and inflation
• Monetary policy in which the money supply is tightened is called a contractionary monetary policy
• It changes the interest rate, which changes the GDP
• Expansionary monetary policy with larger money supply, over longer period of time, can lower interest rates
• Can act as inflation control
• Wage price controls – policies and regulations making it illegal for firms to give raises or raise prices without government permission

15.3 – economics and politics

Changing nature of economic policy

• Discretionary fiscal policy is policy that someone must choose ito implement
• Passive fiscal policies do not require new or special action to go into effect
• Structural fiscal policies are policies designed to strengthen the economy over a longer period of time
• Less used today because
  • Various lags that inevitably occur between recognizing that there is a problem and actually doing something about it
  • Decline of discretionary fiscal policy is the gridlock that can occur when the political parties in congress oppose each other’s views on the budget
  • Ideology
• Monetary policy – actions by the federal reserve system to expand or contract the money supply in order to affect the cost and availability of credit