Chapter 23 An Introduction to Macroeconomics McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Objectives • Long-run economic growth and short-run fluctuations • GDP, inflation, and unemployment • Sustained increase in living standards • Savings and investment • Shocks and sticky prices 23-2 Performance and Policy • Real GDP –Corrects for price changes • Nominal GDP –Uses current prices • Unemployment • Inflation –Increase in overall level of prices 23-3 Performance and Policy • Can governments: –Promote economic growth? –Reduce severity of recession? • Is monetary or fiscal policy more effective at mitigating recession? • Is there a tradeoff between inflation and unemployment? 23-4 Economic Performance • Output growth –3.1% per year 1995-2005 • Unemployment rate –4.6% in 2007 • Inflation rate –2.7% in 2007 23-5 Economic Growth • Standard of living measured by output per person • No growth in living standards prior to Industrial Revolution • Modern economic growth –Output per person rises –Not experienced by all countries 23-6 GDP Per Person 2007 U.S. dollars based on purchasing power parity United States Canada United Kingdom Japan France South Korea Saudi Arabia Russia Mexico China India North Korea Tanzania Burundi Zimbabwe $45,845 $38,345 $35,134 $33,576 $33,187 $24,782 $23,243 $14,692 $12,774 $5,292 $2,659 $1,900 $1,256 $371 $188 23-7 Savings and Investment • Saving –Tradeoff current for future consumption • Investment –Financial investment –Economic investment • Banks and financial institutions 23-8 Shocks • Demand shocks and flexible prices –Price falls if demand low –Sales unchanged • Demand shocks and sticky prices –Maintain inventory –Sales change –Business cycles 23-9 Expectations • The future is uncertain • Expectations affect investment • Shocks –What happens is not what you expected • Demand shocks • Supply shocks 23-10 Demand Shocks Flexible Prices Price $40,000 $37,000 $35,000 DH DM DL 900 Cars per week 23-11 Demand Shocks Price Fixed Prices $37,000 DH DL 700 900 1150 DM Cars per week 23-12 Sticky Prices • Explain fluctuations is GDP • Average months between price changes Coin-operated Laundry Machine Newspaper Haircut Taxi fare Veterinary service Magazine 46.4 29.9 25.5 19.7 14.9 11.2 Beer Microwave Ovens Milk Electricity Airline ticket Gasoline Computer software 4.3 3.0 2.4 1.8 1.0 0.6 5.5 23-13 Sticky Prices • Many prices sticky in short run –Consumers prefer stable prices –Firms want to avoid price wars • All prices flexible in long run –Firms adjust to unexpected, but permanent changes in demand 23-14 Inventory Management • Computerized inventory tracking • Unexpected changes in demand easier to observe • Firms make better output and employment decisions • Less severe business cycles • Only two mild recessions since adoption – Possible explanation 23-15 Key Terms • • • • • • • business cycle recession real GDP nominal GDP unemployment inflation modern economic growth • savings • investment • financial investment • economic investment • expectations • shocks • demand shocks • supply shocks • inventory • inflexible prices (“sticky prices”) • flexible prices 23-16 Next Chapter Preview… Measuring Domestic Output and National Income 23-17