© 2010 Jane Himarios, Ph.D.
Lecture 5
Chapter 5: Introduction to Macroeconomics
The Scope of Macroeconomics
Be sure that you can name the major events that led to the development of
macroeconomic analysis.
Stabilization Policy
Stabilization policy involves three macroeconomic goals: attaining high economic
growth, attaining full employment, and attaining price stability.
We will discuss why price level stability, full employment, and high economic
growth are deemed to be desirable goals as we work through the text. Not
everyone in the world agree that these are desirable goals but since these goals
are the ones that our policymakers pursue, we have to focus on them to build
models that describe the real world.
Conducting Stabilization Policy: Three Steps
Step 1: Measurement
Our policymakers authorize the spending of taxpayer dollars to measure the
price level, the growth rate of output, and the unemployment rate.
Note: You will learn how to find and use the government’s information for
yourself.
Step 2: Comparison
Next, our policymakers compare their measurements with “yardsticks” to see
whether or not the three goals are being achieved.
Note: You will learn how they do this and what yardsticks they use.
Step 3: Intervention if “Necessary”
If any of the three goals are not being achieved, our policymakers might decide
that it is necessary to take steps to stabilize our economy.
Note: You will learn how the Federal Reserve uses its tools (open market
operations, control over the discount rate, and control over the reserve
requirement) and how Congress and the President uses their tools
(control over government spending and tax levels) to intervene in our
economy.
© 2010 Jane Himarios, Ph.D.
Business Cycles
Business cycles are alternating increases and decreases in economic activity.
Economists use business cycle graphs to see if we are achieving our goal of high
economic growth. Economic growth has occurred if real GDP is higher in one
year than it was in the previous year. We want to see a positive trend line.
Real GDP
Trend
Time
This graph shows recurrent swings in real GDP.
Use this graph to identify the phases of the business cycle:
1. Peaks
2. Downturns or recessions
3. Troughs
4. Recoveries
5. Expansions
For practice, go to http://www.bea.gov/national/nipaweb/Index.asp selecting “List
of Selected NIPA Tables” then Table 1.1.6. Graph the business cycle for the last
10 years, and identify the phases of the business cycle that our economy has
experienced in this time period.
Rule-of-thumb Definition of Depression
“Decline in per-person GDP or consumption by 10% or more”—Economist
Robert Barro
Definitions of Recession
1.
A “rule-of-thumb” definition: A recession is two consecutive quarters of
falling real GDP.
2.
National Bureau of Economic Research definition: “A recession is a
significant decline in activity spread across the economy, lasting more than a few
months, visible in industrial production, employment, real income, and wholesaleretail sales. A recession begins just after the economy reaches a peak of activity
and ends as the economy reaches its trough.” The NBER gives relatively little
© 2010 Jane Himarios, Ph.D.
weight to real GDP because it is only measured quarterly and it is subject to
continuing, large revisions.
The National Bureau of Economic Research dates each business cycle. Go to
www.nber.org and choose “Historical Recessions and Recoveries, the NBER
Business Cycle Dating Committee and related topics” to find (1) the business
cycle dating committee’s latest release and business cycle dates and (2) and
FAQ about the NBER’s business cycle dating procedure.
The NBER’s Business Cycle:
Economic Activity
(not real GDP)
Time
Data problem: it sometimes takes a long time to figure out which stage of the
business cycle we are in. This makes it harder to intervene effectively.
National Income Accounting
Taxpayer dollars are used to collect data in order to reduce the data problem.
The National Income and Product Accounts (NIPA) measure output and income
so that we can track the performance of our economy.
The major components of the NIPA can be found by adding up income or adding
up spending. We can use the circular flow diagram to see why these approaches
are equivalent:
© 2010 Jane Himarios, Ph.D.
The Circular Flow Diagram
Economists developed the circular flow chart to show that the level of spending in
our economy is important to the health of our economy. This tool is based on
observation of the real world.
Solid lines show flows of goods and services and resources. Dotted lines show
flows of money.
Product
Markets
Firms
Households
Resource
Markets
Gross Domestic Product (GDP) is a measure of the economy’s total output. It
equals the total market value1 of all final goods and services2 produced3 by
resources in the United States4.
1monetary
value at the current year’s prices, unadjusted for inflation
2intermediate
goods (production goods) aren’t included in order to avoid double
counting
3our
goal is to measure production. Therefore, GDP intentionally excludes the
following nonproductive transactions:
-sales of used goods (not current production)
-financial transactions (not market production)
-government transfer payments (since no current production is needed to
receive the transfer)
For better or worse, GDP also excludes the following productive transactions:
-certain nonmarket goods and services (argument for exclusion: the value
of nonmarket goods and services are difficult to measure since no
payment is received)
-underground activities, both legal and illegal (argument for exclusion:
underground activities are difficult to measure since payment is not
reported to government)
4regardless
of whether citizens or foreigners own the resources
© 2010 Jane Himarios, Ph.D.
GDP Problem: GDP is not a measure of well being
GDP is an estimate of our productive capability. It does not measure happiness
or well-being since it does not account for leisure, friendship, pollution, crime, etc.
If you are interested, read Jane Spencer, “Why Beijing is Trying to Tally the
Hidden Costs of Pollution as China’s Economy Booms,” The Wall Street Journal,
10/2/2006.
The Expenditures Approach to Measuring GDP
GDP = C + I + G + (EX - IM)
Go to http://www.bea.gov/national/nipaweb/Index.asp and choose “List of
Selected NIPA tables” then table 1.1.5, then choose one year to look at). Never
compare nominal GDP figures across time (for instance, across different
years)!!!!
Consumption expenditures (C):
spending on durable goods
spending on nondurable goods
spending on services
Investment expenditures (I):
spending on fixed investment (new capital
goods, including housing)
spending on inventory investment (changes
in stock of unsold goods)
Government expenditures (G):
government consumption expenditures
gross investment
(excludes government transfer payments!)
Net Exports (EX - IM):
spending by foreigners on American goods
less spending by Americans on foreign goods
Another GDP Problem:
GDP figures cannot be compared across time because they are denominated in
prices, which change across time. If a GDP figure changes we don’t know
whether there was an actual change in production or whether prices also
changed. To overcome this problem in order to see whether our production
actually grew, we use real GDP figures, which have price changes wiped out:
Real GDP = (Nominal GDP ÷ the GDP deflator) x 100
Real GDP figures are available by visiting
http://www.bea.gov/national/nipaweb/Index.asp and choose “List of Selected
NIPA Tables” then Table 1.1.6. Real GDP is only useful for making comparisons
across time! It isn’t really “real.” Always look at more than one quarter or year at
a time!!!!
© 2010 Jane Himarios, Ph.D.
Policymakers use real GDP figures to compare economic output in different
periods, in order to see if we are achieving the goal of high economic growth.
Real GDP figures can be compared to see whether an economy has grown
because they have been adjusted to take price changes into account.
For example, if we find that real GDP in 2007.3 = $8272.6, and if real GDP for
2007.4 = $8,396.3, we know that the economy grew over this period. (A second
question to be addressed later is whether or not this economy grew by “enough.”)
G.
Using Real GDP to See If We are Achieving the Macroeconomic Goal
of High Economic Growth
*Economic growth has occurred if real GDP is higher in one year than it was in
the previous year.*
Economic growth rate = ((Real GDPlatest period – Real GDPearlier period )/Real
GDP earlier period) x 100
Another approach to overcoming data problems is to not rely exclusively on real
GDP. For example, forecasters use an index of ten leading economic indicators
to predict what will happen to real GDP in the near future. Collection of this
information, which used to be done by the U.S. Department of Commerce, has
been privatized and is performed by The Conference Board. To view the
Conference Board’s latest leading economic indicators news release, go to
www.tcb-indicators.org and click on “Business Cycle Indicators U.S.” on the left
side of the screen to view “Latest Release.”
The Conference Board’s Business Cycle, along with leading and lagging
indicators:
Business
Cycle
Time
Schumpeter and Creative Destruction
Leading
Indicators
Lagging
Indicators
© 2010 Jane Himarios, Ph.D.
Innovation helps some industries grow while making other industries obsolete,
throwing some workers out of work while creating jobs for other workers.