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Chapter 19.docx

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Professor Cottrel

Chapter 19- Macroeconomics 1/24/2011 5:38:00 AM Macroeconomics- studies the overall or aggregate economy - the overall price level, not individual prices - total production in the economy, not the production by individual firms - adjustments to changes across the whole economy Unemployment Inflation Business cycles Exchange rates Economic growth Gross domestic Product (GDP)- Total output produced is the total value of all goods and services produced - Production of output generates income - The quantity of total output is measured in dollars Nominal National Income: (current dollar)- the dollar value of total output Real GDP- measures income at base-period prices (constant dollars) Nominal GDP – Inflation = Real GDP - if price level changes over time are removed - only changes in production remain Changes in Real GDP- measures changes in production Potential GDP (Y*)- Potential national income (output) - what the economy could produce if all resources were employed at their normal levels of utilization - often called full-employment income Output gap- the difference between potential and actual output Output gap = Y* - Y Denote potential output Y* and actual output by Y Recessionary gap- when actual income (output) is less than potential income Inflationary gap- when actual income (output) exceeds potential income When GDP is below potential- output and incomes are lost, can never recover these losses When GDP is above potential- can generate inflation, growth in potential GDP can increase future incomes -Although increase in average income doesn’t mean increase for all- not all benefit Employment- number of adult workers (15 and over) who hold jobs Unemployment- number of individuals not employed but actively searching for a job Labour force- total number of people who are either employed or unemployed Unemployment rate- percentage of the labour force that is unemployed Unemployment rate= # of people unemployed/ # of people in the labour force X 100 Full employment (Y = Y*): some unemployment exists- frictional and structural Frictional unemployment- caused by normal turnover of labour (retirement, quits, etc.) hiring takes time Structural unemployment- occurs because of a mismatch between available workers and jobs. Some examples of structural changes include track tapes, floppy disks, tube TVs, VCRs, records Full employment- occurs when all unemployment is frictional and structural - there is no cyclical unemployment - at potential GDP (Y*) - Natural rate of unemployment (U*) exists at Y* Unemployment (U) changes over the business cycle During recessions: U rises above U* During booms: U falls below U* Cyclical unemployment- when U>U* which exists at Y* Seasonal U: U may rise by 0.3% points in January - stats can seasonally adjusts figure to remove this - can see trends more clearly Effects of unemployment: Economic problems- loss of output, loss of skills, etc. immense human suffering- illness, breakdowns, etc social problems- homelessness, crime Price level- the average level of all prices in the economy Inflation- the rate at which the price level is changing Consumer Price Index (CPI)- the most common measure of the price level - based on the price of typical consumer basket of goods and services - CPI for the base period is set to 100 ALWAYS - CPI in later years shows prices as a ratio of the price in the base period CPI=auto sum PtQo Auto sum PpQo X100 Problem in the economy of ultimate pleasure, the typical urban household consumes the following goods and service base year= quantity X price current year= quantity X current price = Total expenditures for the base year, and current year a) what is the value of expenditures in the base year and current year? Base year $5600 and current year $6600 CPI in the base year = 100 B) find the value of the CPI in the current period. CPI current = 6600/ 5600 X100 CPI current – 117.86 C) what is the inflation rate between the base and current years? Inflation rate= (P2-P1/P1) X100 Eg. (117.86-100/100)x100=17.86% The CPI is a fixed, base weighted index number - CPI in the current year is 117.86 - Prices rose by 17.86% from base to current year d) have the relative prices changed? Yes , the price of chocolate has increased 50% =(15-10/10)x100 = 50% -while the price of back rubs has stayed the same Inflation rate: the percentage change in the CPI - usually calculated over a year- the annual inflation rate inflation is calculated between any two years eg. (P2-P1/P1)x100 CPI in January 1995:131.9 (135.2-131.9/131.9)x100=2.5% CPI in January 1996: 135.2 - the percentage change price level rose by 2.5% between the two years - an inflation rate of 2.5% Effects of inflation: money is the financial yardstick - purchasing power of money changes with inflation -eg. Real value of money changes with inflation (M/P) - inflation changes value of any sum that is fixed in nominal terms (M) Fully anticipated inflation: if included in all financial contracts inflation has no real effects Unanticipated inflation: benefits those with an organization to pay money (borrowers) - harms those who are entitled to receive money (leaders) eg. A house mortgage during unanticipated inflation the buyer benefits and the harms the lender - inflation is hard to forecast accurately - adds to the uncertainties of economic life - highly variable inflation rates cause great uncertainty Note: as the inflation rate falls, the price level can still be rising Interest rate: the price of borrowing funds - expressed as a percentage amount per period of time - many interest rates tend to move together - prime rate, bank rate inflation affects interest rate: nominal vs. real interest rates Nominal interest rate: the price expressed in money terms Real interest rate: price expressed in terms of purchasing power -eg. Nominal interest rate is 8% per year, inflation rate is 3%, real interest rate is 5% Nominal – Inflation = Real interest rates - the burden of borrowing depends on the real rate of interest, not the nominal rate of interest The international Economy Foreign exchange: includes foreign currencies Foreign-exchange market: where foreign currencies are traded Exchange rate: number of Canadian dollars required to purchase one unit of foreign currency -it is the Canadian dollar price of foreign currency Depreciation of the Canadian dollar: means the Canadian dollar is worth less on the foreign-exchange market - the exchange rate has increased we must all pay more to purchase foreign currency Internal value of C$: the purchasing power of the dollar in Canada External value of C$: the foreign currency price of the Canadian dollar -the opposite of the exchange rate - exchange rate at internal value costs 1.11C for 1USD, rate for external value of 1C is .90USD International trade accounted for in: Balance of payments account: records all international payments made for goods, services, and assets Trade account: part of the balance of payments that records transactions in goods and services - imports and exports Trade balance: difference between value of e
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