1

MACROECONOMICS!

Macroeconomics: the study of the economy as a whole.

• Goals:1.Measure health of the

economy2.Guide government policy

2

1.Promote Economic Growth

2.Limit Unemployment

3.Limit Inflation

For all countries there are three major policy goals:

3

Goal #1Promote Economic Growth

How does a country measureeconomic growth?

4

How do we know how well the economy is doing?

• Economists collect statistics on production, income, investment, and savings.

The most famous statistic is GDP.

Gross Domestic Product (GDP): the dollar value of all final goods and services produced within a country’s borders in one year.

• *Final Goods - GDP does not include the value of intermediate goods (goods used in the production of final goods and services)

5

Basically, how much wealth a country produces

Uses of GDP1. Compare to previous years (Is there growth?)2. Compare policy changes (Did a new policy work?)3. Compare to other countries (Are we better off?)

What does GDP tell us?

6

We’re number 1!Countries by GDP (2014)

7

World map – land area

8

World map – population

World GDP Distribution

9

World GDP Distribution

10

Nominal GDP – 2014 rankings

11

U.S. State Rankings – Gross State Product

12

The GDP of US states is comparable to entire countries

How can we measure economic growth?

% Change in GDP

=Year 2 - Year 1

Year 1X 100

Mordor’s GDP in 2007 was $4000Mordor’s GDP in 2008 was $5000What is the % Change in GDP?

Transylvania’s GDP in 2007 was $2,000Transylvania’s GDP in 2008 was $2,100

What is the % Change in GDP?13

2. Nonproduction Transactions• Financial Transactions (nothing produced)

• Ex: Stocks, bonds, Real estate• Used Goods

• Ex: Old cars, used clothes

What is NOT included in GDP?1. Intermediate Goods

• No Multiple Counting, Only Final Goods• EX: Price of finished car, not the radio,

tire, etc.

3. Non-Market (Illegal) Activities • Ex: Illegal drugs, unpaid work

14

Calculating GDP

Two Ways to calculate GDP:

1. Expenditures Approach - Add up all the spending on final goods and services produced in a given year.

2. Income Approach - Add up all the income from sales of final goods and services

*Same result; all money spent is income to someone else

15

16

Four components of GDP:1. Consumer Spending

Ex: $5 Little Caesar's Pizza2. Investment Spending - When businesses put

money back into their own business.Ex: Machinery or tools

3. Government SpendingEx: Bombs or tanks, NOT social security

4. Net Exports - Exports (X) – Imports (M) Ex: Value of 3 Ford Fiestas minus 2 Honda Civics

GDP = C + I + G + Xn

Expenditures Approach

17

Calculating GDP

18

Included or not Included in GDP?For each situation, identify if it is included in

GDP the identify the category C, I, G, or Xn

1. $10.00 for movie tickets2. $5M increase in defense spending3. $45 for a used economics textbook4. Ford makes new $2M factory5. $20K Toyota made in Mexico6. $10K profit from selling stocks7. $15K car made in US, sold in Canada8. $10K Tuition to attend college9. $120 Social Security payment to Bob10.Farmer purchases new $100K tractor

19

Nominal GDP vs. Real GDP

20

How can you figure out which is the most popular movie of all time?

What is the problem with this method? Nominal Box Office Receipts

21

How can you figure out which is the most popular movie of all time?

Real Box Office Receipts (adjusted for inflation)

The Problem with GDP

If a country’s GDP increased from $4 Billion to $5 Billion in one year, is the country experiencing economic growth? Did the country definitely produce 25% more products?

What is Inflation?• A rising general level of prices

23

1. What is Macroeconomics?2. What is GDP?3. What are the four main components

of GDP (using the expenditures approach)?

4. What’s NOT included in GDP?5. What’s the difference between

nominal and real GDP growth?6. What’s the best movie of all time?

Warm UpAnswer the following with your neighbor:

1.What’s Macroeconomics?2.What is GDP?3.What are the four main

components of GDP?4.What’s NOT included in GDP?5.What’s the difference between

Nominal and Real GDP?6.What’s inflation?7.What’s the best movie of all time?

26

Real vs. Nominal GDPNominal GDP is measured in current prices.

Doesn’t account for inflation

Real GDP is expressed in constant, or unchanging, dollars

Real GDP adjusts for inflation.

REAL GDP IS THE BEST MEASURE OF ECONOMIC GROWTH

27

Real vs. Nominal GDP2013

10 cars at $15,000 each = $150,00010 trucks at $20,000 each = $200,000Nominal GDP = $350,000

201410 cars at $16,000 each = $160,00010 trucks at $21,000 each= $210,000Nominal GDP = $370,000

The GDP in year 2013 shows the dollar value of all final goods produced.

The nominal GDP in year 2014 is higher, which suggests that the economy is improving.

But did the economy really grow? How can we find out?

Use 2013 Prices

2014 GDP is the same as 2013 GDP after the inflation adjustment

201410 cars at $15,000 each = $150,00010 trucks at $20,000 each= $200,000REAL GDP = $350,000

28

Real GDP “deflates” nominal GDP by adjusting for inflation in terms of a base year prices.

29

Does GDP accurately measure standard of living?

Example: Norway and Nigeria have roughly the same GDP ($500 Billion). Is Nigeria as wealthy as Norway?

• Two adjustments: –1) divide GDP by population (GDP

per capita)–2) adjust for cost of living – PPP

(Purchasing Power Parity)

30

31

Country rankings – GDP per capita (PPP adjusted)

32

33

Why are some countries wealthier than others?

1. Economic System and InstitutionsCapitalism vs. fascism, socialism, totalitarianismGood governance vs. corruption

2. Physical CapitalEx: Machinery, tools, and man-made resources.Example#1: Bangladesh has over 100 million people but

relatively few capital resources => poverty

3. Human CapitalAn educated, knowledgeable workforce is more productive – E.g. Japan is wealthy despite limited natural resources

4. Natural ResourcesEx: Mauritania is mostly barren desert

35

Where-To-Be-Born Index (WTBBI)Even better than GDP (PPP) per capita!

WTBBI Includes:• Average Income• Life expectancy• Divorce rates• Political freedoms• Corruption• Climate

36

37

38

Bottom 10

39

According to results from a Gallup poll of over 140,000 people in 143 different countries, the happiest* country in the world is Paraguay. Paraguay ranks 110th in the world in GDP per capita and 111th on the Human Development Index. How do you explain this apparent discrepancy?

Warm Up

*The survey defines happiness as “experiencing positive emotions on a daily basis”

THE BUSINESS CYCLE

40

The Business Cycle• The Business Cycle describes

the fluctuations in economic activity (as measured by real GDP) that a national economy experiences over time

Expa

nsio

n

Peak

Contraction

Trough

Expa

nsio

n

PeakContraction

The Business Cycle

Expansion• During a period of expansion:

–Wages increase–Unemployment is low–Consumers spend more money–High demand for goods/services–More businesses are launched–Getting a loan is easier–Businesses make more profits and

stock prices rise

Peak• When the business cycle peaks:

–The economy stops growing –Real GDP reaches a maximum–Businesses stop expanding

and hiring workers–Economy begins to contract

Contraction

Contraction• During a period of contraction:

–Businesses cut back production and lay off workers

–Unemployment increases–Wages fall–Consumers become pessimistic

about the economy and decrease spending

–Banks cut back on lending

Trough• When the business cycle reaches a

trough:–Real GDP “bottoms-out” (reaches a low

point)–High unemployment and low spending–Stock prices drop

On the bright side, when an economy bottoms out, there’s nowhere to go but up!

Recession and Depression• A prolonged contraction is called a

recession (contraction for over 6 months)

• A really prolonged recession (generally a year or more) is called a depression

Causes of the Business Cycle1.External “shocks” to the economy

• e.g. sharp changes in oil prices, wars, droughts

2.Financial crises• e.g. the Great Depression and

Recession