The Realm of Macroeconomics Where the telescope ends, the microscope begins. Which of the two has the grander view? VICTOR HUGO.

The Realm of Macroeconomics

Where the telescope ends, the microscope begins.Which of the two has the grander view?VICTOR HUGO

Drawing a Line Between Macro and Microeconomics

The Foundations of Aggregation– During economic fluctuations, markets tend to move

up or down together.

Drawing a Line Between Macro and Microeconomics

Macroeconomics focuses on economic aggregates

Three major economic aggregates Output / GDP General price level / Inflation Employment / Unemployment

Objectives

Output --- Growth General price level --- price stability, low

inflation rate Employment --- full employment, low

unemployment rate

Two evils: Recession and inflation Two evils: Recession and inflation

RecessionRecession– High unemploymentHigh unemployment– Stagnate economic growth Stagnate economic growth

InflationInflation– Rapid increase in the price levelRapid increase in the price level

Recession versus expansionRecession versus expansion

RecessionRecession– Slow/negative growth Slow/negative growth – High unemployment rate High unemployment rate

expansionexpansion– Raid growth Raid growth – Low unemployment rateLow unemployment rate

Major economic events Major economic events

The Great Depression, 1929-33The Great Depression, 1929-33 The New Economics and growth in the The New Economics and growth in the

mid-60smid-60s The Stagflation, 1973-1980The Stagflation, 1973-1980 Reaganomics, 1981-1992Reaganomics, 1981-1992 Clintonomics, 1993 – 2000Clintonomics, 1993 – 2000 Deficit surge and financial crisis under the Deficit surge and financial crisis under the

Bush’s term, 2001 – 2008Bush’s term, 2001 – 2008 Obama’s term: slow economic recoveryObama’s term: slow economic recovery

The growth rate of U.S. real GDP since 1870

Figure 5Figure 5

8

The inflation rate in the United States since 1870

Figure 6Figure 6

9

Growth and InflationGrowth and Inflation

Directly or inversely related?Directly or inversely related? Directly related prior to 1970sDirectly related prior to 1970s In the great depression: In the great depression:

GDP down and Price downGDP down and Price down In 1960sIn 1960s

GDP up rapidly as well as GDP up rapidly as well as inflationinflation

Growth and InflationGrowth and Inflation

Directly or inversely related?Directly or inversely related? In 1970s, the two evils come out In 1970s, the two evils come out

togethertogether GDP down but inflation acceleratesGDP down but inflation accelerates StagflationStagflation

Supply and Demand in Supply and Demand in MacroeconomicsMacroeconomics

Aggregate supply (AS)Aggregate supply (AS) Aggregate demand (AD)Aggregate demand (AD)

Demand side shiftsDemand side shifts

Demand-pull inflationDemand-pull inflation

GDP (y) GDP (y) and P and P Example: 1960sExample: 1960s

Insufficient Demand caused Insufficient Demand caused RecessionRecession

GDP (y) GDP (y) and P and P

Example: Great depressionExample: Great depression

Insufficient Demand caused Recession

Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

D2

B

Pri

ce L

evel

S

D0

D0

S

E

Domestic Product

D2

Demand-pull inflation

Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Q0

Pri

ce

P0

D1

A

S

D

D

S

E

Quantity(a)

Pri

ce

P0

S

D

D

S

E

Quantity(a)

D1

Supply-side shiftsSupply-side shifts

Cost-push inflationCost-push inflation

GDP (y) GDP (y) and P and P Example: In the 1970s, stagflationExample: In the 1970s, stagflation

Productivity-induced growthProductivity-induced growth

GDP (y) GDP (y) and P and P Example: In the 1990s during the Example: In the 1990s during the Clinton’s period. Rapid growth and Clinton’s period. Rapid growth and low inflation rate.low inflation rate.

Cost-push inflation and Cost-push inflation and StagnationStagnation

Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

S1

S1 D

D S0

S0

Pri

ce L

evel

Real GDP

A

E

Economic AggregatesEconomic AggregatesNational OutputNational Output

GDP (Gross Domestic Product)GDP (Gross Domestic Product)The sum of the money values of all final The sum of the money values of all final

goods and services produced in goods and services produced in the country the country during a yearduring a year

- Final goods: purchased by their ultimate - Final goods: purchased by their ultimate users. users.

- Intermediate goods: purchased as the - Intermediate goods: purchased as the inputs or for resale.inputs or for resale.

GNP (Gross National Product)GNP (Gross National Product)... produced by the citizens of the country ... produced by the citizens of the country

during a year.during a year.

Economic AggregatesEconomic AggregatesNational OutputNational Output

Nominal GDPNominal GDP

calculated at current pricescalculated at current prices Real GDPReal GDP

calculated at constant pricescalculated at constant prices

Calculating Nominal GDP Calculating Nominal GDP Data from a model economy:

1990 2000

Price ($) Quantity (b)

Price Quantity (b)

Hamburger 0.50 10 1.00 13

CDs 3.00 1 2.50 0.8

T-Shirts 2.50 2 8.00 3

Calculating Nominal GDPCalculating Nominal GDP

Nominal GDP in 1990Nominal GDP in 1990

= 0.50 X 10 + 3.00 X 1 + 2.50 X 2 = 0.50 X 10 + 3.00 X 1 + 2.50 X 2

= 5 + 3 + 5 = 5 + 3 + 5

= 13 (billion)= 13 (billion) Nominal GDP in 2000Nominal GDP in 2000

= 1.00 X 13 + 2.50 X 0.8 + 8.00 X 3 = 1.00 X 13 + 2.50 X 0.8 + 8.00 X 3

= 13 + 2 + 24 = 13 + 2 + 24

= 39 (billion)= 39 (billion)

GDP Growth Rate GDP Growth Rate • The growth rate of GDP

t t-1

t-1

GDP= 100%

GDPGDP - GDP

= 100%GDP

Nominal GDP Growth Rate Nominal GDP Growth Rate • The nominal growth rate of GDP

between 1990 – 2000 is:

39 13= 100%

1326

= 100%13

= 200%

Real Growth RateReal Growth Rate

Nominal Growth is misleading Nominal Growth is misleading because it has NOT corrected for because it has NOT corrected for inflationinflation

To correct for inflation, we rely on the To correct for inflation, we rely on the concept of real growth.concept of real growth.

Real GDP Real GDP

Real GDP is calculated at common Real GDP is calculated at common price (base-year price, constant price (base-year price, constant price). price).

Real GDP can be derived by Real GDP can be derived by

1. Adding up at common prices1. Adding up at common prices

2. Deflating the Nominal GDP 2. Deflating the Nominal GDP by the inflation rateby the inflation rate

Calculating Real GrowthCalculating Real Growth Use the 1990 price as the common pricesUse the 1990 price as the common prices Real GDP in 1990 (at 1990 price)Real GDP in 1990 (at 1990 price)

= 0.50 X 10 + 3.00 X 1 + 2.50 X 2 = 5 + 3 = 0.50 X 10 + 3.00 X 1 + 2.50 X 2 = 5 + 3 + 5 + 5

= 13 (billion)= 13 (billion) Real GDP in 2000 (at 1990 price)Real GDP in 2000 (at 1990 price)

= 0.50 X 13 + 3.00 X 0.8 + 2.50 X 3 = 0.50 X 13 + 3.00 X 0.8 + 2.50 X 3 = 6.5 + 2.4 + 7.5 = 6.5 + 2.4 + 7.5 = 16.4 (billion)= 16.4 (billion)

The real growth rate of GDP is The real growth rate of GDP is (16.4 - 13) / 13 X 100% = 26.1%(16.4 - 13) / 13 X 100% = 26.1%Only 26.1%.Only 26.1%.

Nominal versus Real TermNominal versus Real Term Learn how to read the table for Learn how to read the table for

macroeconomic datamacroeconomic data Data (in billions of dollars) Data (in billions of dollars)

means using the current pricemeans using the current price

or in nominal termor in nominal term Data (in billions of 2000 dollars) Data (in billions of 2000 dollars)

means using the constant price in means using the constant price in the year of 2000the year of 2000

or in real termor in real term

Nominal versus Real Growth Nominal versus Real Growth in the recessionsin the recessions

Nominal growth data is misleading Nominal growth data is misleading in economic recessionin economic recession

Nominal versus Real Growth Nominal versus Real Growth Nominal growth data is misleading in Nominal growth data is misleading in

economic recessioneconomic recession

YearYear NominalNominal Real (at 2000 price)Real (at 2000 price)

19731973 1382.71382.7 4917.04917.0

19741974 1500.01500.0 4889.94889.9

19751975 1638.31638.3 4879.54879.5

19811981 3128.43128.4 5987.25987.2

19821982 3255.03255.0 5870.95870.9

Nominal GDP, Real GDP, and Real GDP per Capita

Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

1955 1960 1965 1970 1975 1980 1985 1990 2000 1995 Year

Nominal GDP (right scale)

Bill

ion

s o

f

Do

llars

per

Yea

r

$10,000

$9,000

7,000

5,000

3,000

8,000

6,000

4,000

1,000

2,000

0

Per-capita real GDP (left scale)

Do

llars

per

Yea

r

$35,000

25,000

15,000

Real GDP (right scale)

30,000

20,000

5,000

10,000

0

Limitations of GDP Limitations of GDP

Only market activity is included in Only market activity is included in GDP (underground, housekeeping GDP (underground, housekeeping work by housewives, etc). work by housewives, etc).

Other welfare factors are Other welfare factors are overlooked, such as leisure, security, overlooked, such as leisure, security, education, health, etc.education, health, etc.

International comparison can be International comparison can be misleading. (undervalued misleading. (undervalued currencies in developing countries)currencies in developing countries)