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Macroeconomics Ch 4-10 STUDY.docx

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University of Guelph
ECON 1100
Eveline Adomait

Macroeconomics Chapter 4 4.1 The Major Macroeconomic Issues Macroeconomics is the study of the performance of national economies and of the policies that governments use to try to affect that performance. Issues Macroeconomists Study - The sources of long-run economic growth and development - The causes of high unemployment - Factors that determine the rate of inflation - How national economies interact Page 87. For RECAP Macroeconomic policies are government actions designed to affect the performance of the economy as a whole (as opposed to policies intended to affect the performance of the market for a particular good or service, such as lumber or haircuts) Average Labor Productivity is output per employed worker - Output per person is total output divided by # of people in an economy - Average labor productivity is output divided by # of employed workers Recessions are pronounced slowdowns in economic growth (extreme- depression) Expansions are periods of economic growth (extreme- boom) Rate of Inflation is the rate at which prices in general increase over time Trade imbalances occur when the quantity of goods and services that a country sells abroad (its exports) differs significantly from the quantity of goods and services its citizens buy from abroad (its imports). 4.2 Macroeconomic Policy There are three major types of macroeconomic policy: 1. Monetary Policy refers in normal times to central bank management of interest rates in order to achieve macroeconomic objectives. (Pg. 88 for abnormal times) Unconventional Monetary Policy 2. Fiscal Policy refers to decisions that determine the government’s budget, including the amount and composition of government expenditure and government revenues. - The balance between government spending and revenues (mainly from taxes) is an important aspect of fiscal policy known as the government budget balance - Revenues less than expenditures: government budget deficit - Revenues exceed expenditure: government budget surplus Government debt is a stock measure that reflects the sum of past government deficits and surpluses. Deficits add to the government debt; surpluses reduce the government debt 3. Structural Policy includes government policies aimed at changing the underlying structure or institutions of the nation’s economy. Pg. 91 Recap 4.3 Aggregations Aggregation: the adding up of individual economic variables to obtain economy- wide totals Example: explaining trends in movie theatre ticket sales relative to spending DVD rentals is a topic for MICROECONOMICS not MACROECONOMICS Instead, macroeconomists add up consumer spending on all goods and services during a given period to obtain aggregate, or total, consumer spending. And they explore connections between aggregate consumer spending and variables such as aggregate income and unemployment. The Fallacy of Composition occurs when it is falsely assumed that what is true at the level of a particular individual, household, firm or industry is necessarily true at a higher aggregate level. Example: the assumption is made that if one sporting fan can get a better view by standing up, then all fans at the event will get a better view if they all stand up at once. Pg. 92 Recap Macroeconomics Chapter 5 5.1 Gross Domestic Product: Measuring the Nation’s Output -The most commonly used measure of an economy’s output is called the gross domestic product (GDP) - GDP is intended to measure how much an economy produces in a given period, such as a quarter (three months) or a year. Gross Domestic Product (GDP) more precisely, is: the market value of the final goods and services produces in a country during a given period. Example In the imaginary economy of Orchardia, total production is - 4 million apples and - 6 million pears. Suppose we know that, - Apples have a market price of $0.25 each - Pears have a market price of $0.50 each - Shoes have a market price of $20 each The market value of this economy’s production or its GDP is equal to (4 million apples X $0.25/apple) + (6 million pears X $0.50/pear) + (3 million pairs of shoes X $20/pair) = $64 million A Final Good or Service is the end product of a process, the product or service that consumers actually use (example: bread). Intermediate Goods or Services are the goods or services produced on the way toward making the final product (example: grain and flour). The Value Added by any firm equals the market value of its product or service minus the cost of inputs purchased from other firms A Capital Good is a long-lived good, which is itself produced and used only to produce other goods and services (example: factories and machines) Recap on pg. 102 5.2 The Expenditure Method for Measuring GDP Four components of Expenditure: 1. Consumption (or personal expenditure) is spending by households on goods and services, such as food, clothing and entertainment. Consumption is divided into four subcomponents: Durable Goods, or consumer durables, are long-lived goods such as cars and furniture purchased for household use. Semi-durable goods are consumer goods that would typically be used on multiple occasions and be expected to last for a year or more (Examples are clothing and footwear) Non-durable goods are consumer goods that would typically be used only once, or be expected to last less than a year. Examples are food, gasoline, and heating fuel purchased by households Services, a large component of consumer spending, include everything from haircuts and taxi rides to legal and financial services 2. Private-Sector Investment, (sometimes called business investment or simply investment) is spending by firms on final goods and services, primarily capital goods and housing. Private-Sector Investment is divided into three subcomponents Investment in non-residential structures and equipment, or non- residential gross fixed capital formation, is the purchase by firms of new capital goods such as machinery, factories, office buildings, shopping malls, and transportation equipment (Remember that for the purposes of calculating GDP, long- lived capital goods are treated as final goods rather than as intermediate goods.) Investment in residential structures, or housing investment, refers to purchases of new dwellings, regardless of whether the dwelling is a new house purchased by a family for personal use or a new apartment building purchases by a landlord to earn rental income. Business investment in inventories, or inventory investment, refers to changes in company inventories. The goods a firm produces but does not sell during the current period are treated, for accounting purposes, as if the firm had bought those goods from itself. 3. Government Purchases are purchases by federal, provincial/territorial, and municipal governments of final goods (such as computers) and services (such as teaching in public schools). Government purchases are divided into two major subcomponents. Net Government Current Expenditure on Goods and Services consists of purchases of office supplies and the services of government employees Government Gross Fixed Capital Formation, (or government investment in fixed capital,) corresponds to government purchases of new structures and equipment, including waterworks, sewage systems, roads, harbors, and airports. Net Investment refers to investment that adds to the total capital stock of the economy. If net investment is zero, the total capital stock is unchanged from one year to the next. If net investment is positive, as it usually is in the Canadian economy, then the capital stock grows from one year to the next. 4. Net Exports which equal exports minus imports, where - Exports are domestically produced final goods and services that are sold abroad (or to visiting tourists), and - Imports are purchases by domestic buyers of goods and services that were produced abroad. Imports are subtracted from exports to find the net amount of spending on domestically produced goods and services The relationship between GDP and expenditures on goods and services can be summarized by an equation. Let, Y = gross domestic product, or output C = consumption expenditure I = private-sector investment G = government purchases NX = net exports Using these symbols, we can write that GDP equals the sum of the four types of expenditure algebraically Y = C + I + G + NX Expenditure Components of GDP Recap Page 106. 5.3 GDP and the Incomes of Capital and Labor Broadly speaking, GDP can be divided into labor income and capital income. Four Major Components of GDP in Terms of Income - Wages, salaries, and supplementary labor income are the largest single income component of income-based GDP - Corporate and like profits before taxes is a term we have used to group together the net earnings of private-sector corporations and government business enterprises after deducting an allowance for the consumption of fixed capital - Net farm and small business income is a term we have used to group together the net income of farmers and net income of unincorporated businesses - Interest and miscellaneous investment income is basically interest and other investment income (excluding dividends (less net investment income received from abroad, less interest on the public debt The Three Faces of GDP 1. The market value of production 2. The total expenditure (consumption, private-sector investment, government purchases, net exports) 3. Total income (labor income and capital income) 5.4 Nominal GDP Versus Real GDP Real GDP is a measure of GDP in which the quantities produced are valued at the prices in a base year rather than at current prices (Also called constant- dollar GDP). It is GDP adjusted for inflation Nominal GDP is a measure of GDP in which the quantities produced are valued at current-year prices; measures the current dollar value of production GDP Deflator is a measure of the price level of goods and serviced included in GDP Real GDP= Nominal GDP/ GDP deflator X 100 Gross National Product (GNP) is the market value of goods and services produced by factors of production owned by the residents of a country; equivalent in magnitude to gross national income (GNI) 5.7 The Unemployment Rate 1. Employed 2. Unemployed 3. Not in the labor force The Labor Force is defined as the total number of employed and unemployed people n the economy (the first two categories respondents to the Labor Force Survey) The Unemployment Rate is then defined as the number of unemployed people divided by the labor force The Participation Rate (sometimes called the labor force participation rate) is the percentage of the working-age population in the labor force (that is, the percentage that is either employed or looking for work). The Employment Rate is the percentage of the working-age population that is employed Discouraged Workers are people who say they would like to have a job but have not made an effort to find one in the past four weeks because they believe no jobs are available to them Involuntary Part-Time Workers are people who say they would like to work full-time but are only able to find part-time work. Macroeconomics Chapter 6 6.1 The Consumer Price Index: Measuring the Price Level The Price Level is the overall level of prices at a point in time measured by a price index Consumer Price Index (CPI) for any given period, measures the cost in that period of a standard basket of goods and services relative to the cost of the same basket of goods and services in a fixed year, called the base year. CPI= Cost of base-year basket for goods and services in current year X100 Cost of base-year basket of goods and services in base year - Notice that the base-year CPI is always equal to 100. The CPI for a given period (such as a month or year) measures the cost of living in that period relative to what it was in the base year Price Index measures the average price of a class of goods or services relative to the price of those same goods or services in a base year 6.2 Inflation Inflation is a measure of how fast the average price level is changing over time The Rate of Inflation is defined as the annual percentage rate of change in the price level, typically as measured by the CPI For Example, The Canadian CPI had a value of 114.7 in August 2009 and a value of 116.7 in August 2010. The Inflation rate between August 2009 and 2010 is the percentage increase in the price level, or 100 times the increase in the price level (116.7 – 114.7 = 2.0) divided by the initial price level (114.7), which is equal to 1.7 percent Deflation is a situation in which the prices of most goods and services are falling over time so that inflation is negative 6.3 Adjusting For Inflation Nominal Quantities are quantities measured at their current dollar values- for the effects of inflation A Real Quantity is one that is measured in base-year dollars, also known as constant dollars. Deflating (a nominal quantity) is the process of dividing a nominal quantity by a price index (such as the CPI) to express the quantity in real terms. (Be careful not to confuse the idea of deflating a nominal quantity with deflation, or negative inflation. The two concepts are different) Real Wage is the wage paid to workers measured in terms of real purchasing power. The real wage for any given period is calculated by dividing the nominal (dollar) wage by the CPI for that period Indexing is the practice of increasing a nominal quantity each period by an amount equal to the percentage increase in a specified price index; prevents the purchasing power of the nominal quantity from being eroded by inflation Recap on pg. 134 6.4 Nominal Versus Real Interest Rates The Nominal Interest Rate is the type of interest rate you are apt to see reported in the financial pages of newspaper or posted on a sign in your bank branch- the price paid per dollar borrowed per year The Real Interest Rate, like the real wage rate, is something we calculate given the inflation rate and the relevant nominal rate. It is the nominal interest rate minus the inflation rate We can write this definition of the real interest rate in mathematical terms” r = i– π where r = the real interest rate i = the nominal, or market, interest rate π = the inflation rate * Anticipated and Unanticipated Inflation (pg. 136) The Fisher Effect is the tendency for nominal interest rates to be high when inflation is high and low when inflation is low 6.5 Types of Price Changes Relative Price is the price of a specific good or service in comparison to the prices of other goods and services - Changes in relative prices are not the same as a rise in the overall price level - How to calculate changes in relative prices pg. 139 Rates of Change in Inflation Zero Inflation is when the price level stays roughly constant from one year to the next Stable Inflation is when the inflation rate stays roughly constant from one year to the next Accelerating Inflation is when the inflation rate rises from one year to the next (often unanticipated) Disinflation is when the inflation rate falls from one year to the next (often unanticipated) Deflation is when the CPI falls from one period to the next (the inflation rate turns negative, as it did in the Great Depression) Good exercise to do on page 140 Exercise 6.5 The Intensity of Inflation Low Inflation typically means inflation between 1 and 3 percent per year Moderate Inflation typically means inflation between 3 and 6 percent per year High Inflation typically means inflation greater than 6 percent per year Hyperinflation typically means inflation greater than 500 percent per year Macroeconomics Chapter 7 The Business Cycle (or cyclical fluctuations)  Recession (or contraction): a period in which the economy is growing at a rate significantly below normal o Period during which the real GDP falls for at least two consecutive quarters  Depression: a particularly severe or protracted recession o Great Depression occurred between 1929-1933  Peak: the beginning of a recession, the high point of economic activity prior to a downturn  Trough: the end of a recession, the low point of economic activity to a recovery  Expansion: a period in which the economy is growing at a rate significantly above normal  Boom: a particularly strong and protracted phase of an expansion Characteristics of Short-term Fluctuations  Expansions and recessions are not limited to a few industries or regions, but impact the whole economy. The largest fluctuations may have a global impact.  Unemployment is a key indicator of short-term economic fluctuations o Unemployment rate typically rises sharply during recessions and recovers (more slowly) during expansions o Labor markets become less favourable to workers during recessions  Real wages grow more slowly or decline  Workers are less likely to receive promotions or bonuses in recessions than during expansionary periods  Inflation follows a typical pattern in recessions and expansions (not sharply defined) o Recessions tend to be followed soon after by a decline in the rate of inflation o Some recessions have been preceded by increases in inflation  Industries that produce durable goods (cars, houses, capital equipment) are more affected than other in recessions and booms  Industries that provide services and non-durable goods (food) are less affected by short-term fluctuations o Example: automobile or construction worker is more likely to lose job in recession than a hairstylist or baker Measuring Fluctuations: Output Gaps and Cyclical Unemployment  “Big” recession or expansion is one which output and unemployment rate deviate significantly from their normal or trend levels  Output gaps: measures how far output is from its normal level at a particular time  Cyclical unemployment: deviation of employment from its normal level  Potential output (or potential GDP for full-employment output): the amount of output (real GDP) that an economy can produce when using its resources, such as capital and labour, at normal rates o Fixed number, but grows overtime, reflecting increases in both the amounts of available capital and labour and their productivity o U
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