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ECO101H1 (177)
Chapter 9

ECO100Y1 Chapter 9 Notes

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Robert Gazzale

ECO100Y1 Textbook Notes Chapter 19  Macroeconomics: the study of the determination of economic aggregates, such as total output, total employment, the price level, and the rate of economic growth.  Changes in economic aggregates matters for most individuals because they influence the health of the industries in which they work and the prices of the goods that they buy.  Macroeconomists consider two aspects of the economy: o The short-run behaviour of macroeconomic variables, such as output, employment, and inflation, and how government policy can influence these variables.  The study of business cycles. o The long-run behaviour of the same variables.  The study of economic growth and is concerned with explaining how investment and technological change affect our material living standards over long periods of time.  A full understanding of macroeconomics requires understanding the nature of short-run fluctuations as well as the nature of long-run economic growth.  There are two groups of economists: o First group takes an approach to macroeconomics that is based explicitly on microeconomic foundations.  Build models of the economy that are populated by workers, consumers, and firms, all of whom are assumed to be optimizers.  These agents’ optimization problems are then modelled with their resulting choices for work effort, consumption, and investment.  Economists then proceed to aggregate the choices of these agents to arrive at the model’s values for aggregate employment, consumption, output etc. o The second group builds macroeconomic models based only implicitly on these same micro foundations.  They do no explicitly model the choices of optimizing agents.  They construct their models by using aggregate relationships for consumption, investment, and employment.  Each subjected to empirical testing and assumed to represent the behaviour of the many firms and the consumers in the economy.  Economists using the first approach usually assume that wages and prices are perfectly flexible and thus adjust quickly to clear their respective markets.  Economists using the second approach usually assume that because of the nature of well-established institutions in both labour and product markets, such as labour unions, long-term employment contracts, or costs associated with changing prices, wages and prices are slow to adjust, and thus markets can be in disequilibrium for longer periods of time. 19.1 Key Macroeconomic Variables  National product: the value of a nation’s total production of goods and services.  One of the most important ideas in economics is that the production of output generates income. o Therefore, by definition, national product = national income.  Nominal national income (Y): total national income measured in current dollars. Also called current-dollar national income. o I.e. a steel and wheat producing country will calculate its nominal national income by multiplying the amount of steel produced by its price and the amount of wheat produced by its price and the sum is the nominal national income.  Real national income (Y): national income measured in constant (base- period) dollars. It changes only when quantities change. o Often called constant-dollar national income. o This helps determine the extent to which any change in nominal national income is due to quantities or prices.  Gross domestic product (GDP): a measure of national income that can be measured in either real or nominal terms.  Long-term economic growth: growth over a long period of time.  Short-term fluctuations: fluctuations in the GDP that happen in the short- term.  Business cycle: fluctuations of national income around its trend value that follow a more or less wavelike pattern. o A single cycle usually includes an interval of quickly growing output, followed by and interval of slowly growing or even falling output (may last several years). o No two business cycles are the same (variations in magnitude and duration).  Potential output (Y*): a measure of what the economy would produce if all resources – land, labour, and productive capacity – were employed at their normal levels of utilization. Also called potential GDP or full-employment output. o Economists use advanced statistical technique to estimate it.  Output gap: actual national income minus potential national income, Y – Y*.  Recessionary gap: a situation in which actual output is less than potential output, Y < Y*. o This is the market value of goods/services that are not produced because the economy’s resources are not fully employed.  Inflationary gap: a situation in which actual output exceeds potential output, Y > Y* (upward pressure on prices). o This is market value of production in excess of what the economy can produce on a sustained basis. o Y can be > than Y* because Y* is defined for a normal rate of utilization of factors of production (i.e. workers can work overtime).  Upward trends in GDP can be the result of a growth in productive capacity caused by increases in the labour force, capital stock, and the levels of technological knowledge.  Recession: a downturn in the level of economic activity. Often defined precisely as two consecutive quarters in which real GDP falls. o Associated with unemployment and lost output.  When income per person grows, each generation can expect, on average, to be better off than preceding ones. o Not everyone has to be better off (i.e. growth associated with a move from agriculture to manufacturing).  In order for more to be produced one of two things needs to happen: o A rise in employment  The cause of most of the short-run changes that occur. o A rise in output per person employed (rise in productivity)  In the short-run, changes in productivity tend to be small.  Employment: the number of persons 15 years of age or older who have jobs.  Unemployment: the number of persons 15 years of age or older who are not employed and are actively searching for a job.  Labour force: the number of persons employed plus the number of persons unemployed.  Unemployment rate: unemployment expressed as a percentage of the labour force, denoted U.  Labour Force Survey conducted each month by Statistics Canada estimates the level of unemployment each month.  Economists say there is full employment when the economy is at potential GDP.  Even when the country is at “full employment,” some unemployment exists because of natural turnover in the labour market (frictional unemployment) and mismatch between jobs and workers (structural unemployment). o Full employment is said to occur when the only unemployment is frictional and structural.  Cyclical unemployment: unemployment that changes with the ebb and flow of the business cycle. o When GDP is below potential GDP, unemployment rises above its full- employment level. o When GDP is above potential GDP, unemployment falls below its full- employment level.  Unemployment also has seasonal fluctuations (i.e. fishery industry in the winter). o Statistics Canada seasonally adjusts the unemployment statistics to remove seasonal fluctuations, thus revealing more clearly the cyclical and trend movements in the data (look at normal seasonal increases).  Employment has grown roughly in line with the growth in the labour force over the past 50 years.  The short-term fluctuations in the unemployment rate over the last 50 years have been substantial (from as low as 3.4% in 1966 to as high as 12% in 1982).  The social significance of unemployment is enormous because it involves economic waste and human suffering. o I.e. an economy with 18 million willing to work but only 16 million are employed, there is a waste of 2 million that is gone forever.  The loss of income associated with unemployment is clearly harmful to individuals (can push people into poverty).  Research has shown that crime, mental illness, and general social unrest tend to be associated with long-term unemployment.  Employment insurance and welfare provide a safety net for those who are employed (recent innovations).  Canada’s steady long-run growth in GDP can be attributed to three factors: o The level of employment has increased significantly.  Can be the result of a growing population or an increase in the people who choose to participate in the labour force. o The stock of physical capital - the buildings, factories, and machines used to produce output – has increased (more or less) steadily over time. o Productivity has increased in almost every year since 1960  Productivity: a measure of the amount of output that the economy produces per unit of input. o Labour productivity: the level of real GDP divided by the level of employment (or total hours worked).  Productivity expressed by the amount of real GDP per hour worked is more accurate because the average number of hours worked per employed worker changes
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