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PowerPoint Slides prepared by: Andreea CHIRITESCU
Eastern Illinois University1© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
The Goals of
Macroeconomic PolicyWhen men are employed, they are best contented.
BENJAMIN FRANKLIN
Inflation is repudiation.CALVIN COOLIDGE
Goals of Macroeconomic Policy
• Economic growth – ingredients– Aggregate supply
– Aggregate demand
• Inputs– Labor, machinery, other resources
– Used to produce outputs
• Output – Goods and services
– Produced in economy2© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Goals of Macroeconomic Policy
• Macroeconomics policy– Growth policy
• Make the economy grow faster in the long-run
– Stabilization policy• Manage aggregate demand• Avoid high unemployment• Avoid high inflation
3© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Productivity and Growth
• Small differences in growth rates– Enormous difference in the long run
• 109 years; 1870 – 1979– GDP per capita annual growth
• U.S. – 2.3%• U.K. – 1.8%• Japan – 3%
4© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Productivity and Growth
• Labor productivity– Amount of output
– One worker produces• In an hour (or a week, or a year) of labor
– If output is measured by GDP• Labor productivity = GDP per hour of work
5© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Productivity Growth
• Productivity growth– Almost everything in long run
• Rising productivity– Raising standard of living – long run
• Long periods of time– Small differences in rates of productivity
growth - compound over time
– Enormous difference to society’s prosperity
6© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Productivity Growth
• Productivity growth– Reduction of poverty
– Increases in leisure time
– Increases in country’s ability to finance• Education• Public health• Environmental improvement• Arts
7© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Potential GDP
• The capacity to produce: potential GDP and the production function
• Potential GDP– Real GDP the economy would produce
– If labor and other resources were fully employed
• Labor force– Number of people holding or seeking jobs
8© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Potential GDP
• Estimate potential GDP– Count up the available supplies of labor,
capital, and other productive resources• Estimate how much output these inputs could
produce if they were all fully utilized
– Transformation of inputs into outputs• Assessment of the economy’s technology
9© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Potential GDP
• Production function– Shows the volume of output that can be
produced
– From given inputs (such as labor and capital)
– Given the available technology
10© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Potential GDP
• Along the production function– Constant capital and technology
• Better technology or more capital– Shift upward the production function
– Raise the potential GDP
11© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Figure 1The Economy’s Production Function
12
0 Labor input
(hours)
Rea
l GD
P
(a) Effect of better technology (b) Effect of more capital
L0
Y0
K
M
Y1
A
0 Labor input
(hours)R
eal G
DP
L0
Y0
K0
K1
Y1
A
B
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Growth Rate of Potential GDP
• Growth rate of potential GDP– Depends on
• Growth rate of labor force• Growth rate of capital stock• Rate of technical progress
• GDP = Hours of work ˣ Output per hour
= Hours of work ˣ Labor productivity
13© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Growth Rate of Potential GDP
• Growth rate of potential GDP = = Growth rate of labor input +
+ Growth rate of labor productivity
• Growth rates: actual and potential GDP– Over long periods of time: similar
– Over short periods of time• Diverge sharply due to cyclical fluctuations
14© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Table 1Recent Growth Rates of Real GDP in the United States
15© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
The Goal of Low Unemployment
• Unemployment rate– Number of unemployed people
– As percentage of labor force
• If GDP grows slower than the economy’s potential– Unemployment rate rises
• If GDP grows faster than the economy’s potential– Unemployment rate falls
16© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Table 2The Economic Costs of High Unemployment
17© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Figure 2Actual and Potential GDP in the United States since 1954
18© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
The Goal of Low Unemployment
• Cumulative gap between actual and potential GDP – Over the three years 2008 to 2010
• Evaluated in 2005 prices
– Is roughly $2.3 trillion
– At 2010 levels, this loss in output as a result of unemployment • Over two months worth of production
19© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
High Unemployment
• Human costs of high unemployment– Income loss
– Hunger, cold, ill health
– Psychological cost
• Some help for the unemloyed – System of unemployment insurance
– Social welfare programs
20© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
High Unemployment
• Unemployment rates– Lower for
• Married men• Whites• Well-educated people
– Higher for• Teenagers • Nonwhites • Blue-collar workers
21© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Figure 3Unemployment Rates for Selected Groups, 2009
22© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Counting the Unemployed
• Employed– Everyone currently at work, including part
time workers
• Unemployed– People not currently working
• Temporarily laid-off, expected to return• Actively looking for a job (4 weeks)
• Out of the labor force– Nor looking for work
23© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Counting the Unemployed
• Discouraged worker– Unemployed person
– Gives up looking for work
– No longer counted as part of labor force
• Hidden / disguised unemployment– Involuntary part-time
– Loss of overtime
– Shortened work hours
– Discouraged workers 24© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Types of Unemployment
• Frictional unemployment– Due to normal turnover in the labor market
– People who are temporarily between jobs• Moving or changing occupations• Unemployed for similar reasons
• Structural unemployment – Workers displaced by automation
– Their skills are no longer in demand
25© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Types of Unemployment
• Cyclical unemployment– Portion of unemployment that is
attributable to a decline in the economy’s total production
– Rises during recessions
– Falls as prosperity is restored
26© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Full Employment
• Full employment– Everyone who is willing and able to work
can find a job
– Unemployment rate is still positive• Difficult to estimate
27© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Unemployment Insurance
• Unemployment insurance– Government program
– Replaces some wages lost by eligible workers who lose their jobs
– Helps prop up aggregate demand during recessions
– Benefits the unemployed• And the economy - greater spending
28© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Unemployment Insurance
• Payroll taxes and unemployment benefits– Spreads the cost of unemployment over
the entire population
– Doesn’t eliminate the basic economic cost
• Higher unemployment benefits– Disincentive to look for job
29© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
The Goal of Low Inflation
• Purchasing power of a given sum of money– Volume of goods and services that it will
buy
• Real wage rate - purchasing power of wages– Wage rate – adjusted for inflation
– Nominal wage divided by price index• Volume of goods and services that the
nominal wages will buy 30© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Figure 4Rates of Change of Wages and Prices in the United States since 1948
31© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Inflation: Myth and Reality
• Myth: inflation erodes real wages– No inflation, and wages increase 2% per
year due to increased labor productivity
– Inflation 3%, and wages increase 5%
32© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Inflation: Myth and Reality
• Inflation– Increase in “average price”
• Relative price of an item– Its price in terms of some other item
• Inflation– Not to blame when some goods become
more expensive relative to other goods
33© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Table 3Pure Inflation
34© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Table 4Real-World Inflation
35© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Inflation as Redistributor
• Inflation as a redistributor of income and wealth
• Redistribution caused by inflation– Harm: lenders
– Gain: borrowers
– Arbitrarily
36© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Real vs. Nominal Interest Rates
• Expected rate of inflation– Anticipated inflation
• Unexpected inflation• Real rate of interest
– Percentage increase in purchasing power• That the borrower pays to the lender for the
privilege of borrowing
– Increased ability to purchase goods and services that the lender earns
37© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Real vs. Nominal Interest Rates
• Nominal rate of interest– Percentage by which the money the
borrower pays back
– Exceeds the money that was borrowed
– Making no adjustment for any decline in the purchasing power of this money that results from inflation
38© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Real vs. Nominal Interest Rates
• Nominal interest rate =
= Real interest rate + Expected inflation rate
• If inflation is accurately predicted– No income redistribution
– Expected rate of inflation = Actual rate of inflation
39© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Inflation Distorts Measurements
• Capital gain – Difference between the price at which an
asset is sold
– And the price at which it was bought
• Malfunctioning tax system– Taxes on nominal interest
– Taxes on nominal capital gain
– High tax rates when inflation is high• Discourage saving, lending, and investing
40© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Other Costs of Inflation
• Rapidly changing prices– Riskier to enter long-term contracts
– Economic stagnation
– Shop around more
41© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Costs of Low vs. High Inflation
• Steady inflation– More predictable than variable inflation
– Smaller social and economic costs
• Average level of inflation– Steady inflation at 6% per year
• More damaging than steady inflation at 3% per year
• Hyperinflation – Very high inflation
42© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Costs of Low vs. High Inflation
• Low inflation– Doesn’t necessarily lead to high inflation
• Inflation– Sometimes speeds up
– Sometimes slows down
• Runaway inflations– When government prints incredible
amounts of money• Finance wartime expenditure
43© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Appendix How statisticians measure inflation
• Index numbers for inflation• Index number
– Cost of a market basket of goods relative to its cost in some “base” period
• Base year– Year used as a basis of comparison
44
100
year base in
basket market of Costyear given in
basket market of Cost
year given in CPI
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Appendix Index numbers for inflation
• Index number problem– Changing relative prices
– No “perfect price index” correct for every consumer
– Statistical index• Understate increase in cost of living for some
families• Overstate increase in cost of living for other
families
– Index - “average” family45© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Appendix Consumer price index
• Consumer price index (CPI)– Bureau of Labor Statistics (BLS)
– Monthly
– Representative typical urban household budget
– Same bundle of goods and services
46© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Table 5Results of Student Expenditure Survey, 1983
47© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Table 6Prices in 2009
48© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Table 7Cost of 1983 Student Budget in 2009 Prices
49© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Appendix Consumer price index
• Student price index (SPI)
50© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
100
100 142
Cost of budget in 2009SPI=
Cost of budget in 1983$142
SPI=$100
Appendix Using price index to ”deflate” monetary figures
• Deflating– Process of finding the real value of some
monetary magnitude
– By dividing by some appropriate price index
51
100Real spending Nominal spending in 2009
Price index of 2009 in 2009
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Appendix Using a price index to measure inflation
• Inflation– Rate of increase in price level
– CPI2009 = 214.5
– CPI2010 = 218.1
– CPI2010 / CPI2009 = 218.1/214.5 = 1.017
– Inflation rate = 1.7%
52© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Appendix GDP deflator
• GDP deflator– Price index used to deflate nominal GDP
– Broad measure of economy-wide inflation• Includes the prices of all goods and services
in the economy
53
100deflator GDP
GDP Nominal GDP Real
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.