MBA Lectures 1 - 3 Part1

8/6/2019 MBA Lectures 1 - 3 Part1

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ECO 502

BRAC University,Spring, 2006

Lectures 1 3 part 1

Lutfun N. K. Osmani

Chapter 1

What IsMacroeconomics?


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Course details

Course details: Will be given next week Reading list: Main Text:

Robert J. Gordon, Macroeconomics, 10th

Edition, 2006.

Supplimentary Texts: R. H. Frank & B. S. Bernanke, Principles of

Macroeconomics, 2nd edition Mankiw, Gregory. Macroeconomics, 4th edition

& Dornbusch, Fischer and Startz,Macroeconomics, 7th edition.


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Basic Concepts of Macroeconomics

Some basic concepts:

Defining macroeconomics

Differentiating macroeconomics and

microeconomics Three big concepts of macroeconomics

Actual and natural GDP

Macroeconomics in the short-run and long-run

Stabilization Policy

Internationalization of macroeconomics


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Difference between Microeconomics andMacroeconomics

Macroeconomics is the study of theperformance of national economies, and ofthe policies that governments use to try to

improve that performance.


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Difference between Microeconomics andMacroeconomics

Macro comes from Greek word meaninglarge and Micro comes from Greek wordmeaning small.

Macroeconomics deals with total or aggregate like national income andunemployment rate but Microeconomics

deals with the parts examines thebehaviour of individuals households andfirms, e.g., price of a particular commodity.


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Big Three Concepts of Macroeconomics

The basic task of Macroeconomics is to studythe good or bad performances of the threeimportant concepts rate of unemployment,inflation rate and economic growth - the BigThree Concepts of Macroeconomics.


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Unemployment rate: It is the number ofpersons unemployed divided by the total ofthose employed and unemployed (labour

force). or

% of the labor force that is out of work

Labor force: adult people who are able to and

willing to work at the going wage.

Labor force = employed + unemployed


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Measuring Unemployment

Total labour force:

A. Civilian employed B. Armed forces

C. Unemployed.

Measurement: The actual unemploymentrate is defined as the ratio:

number of unemployedU = ----------------------------------------------

(civilian employed + unemployed)


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Unemployment

Ex: In February 2005 the BLS reported anunemployment rate of5.4% in the US. It wascalculated as:

number of unemployedU = ----------------------------------------------(civilian employed + unemployed)

7,988,000U = -------------------------------- = 5.4%

140,144,000 + 7,988,000


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Unemployment

Problems:

Not an accurate measure of social,psychological and economic distress

Does not distinguish between full time andpart time unemployment

Does not account well for discouragedworkers and disguised unemployment


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Figure 2-5 Employment From the Householdand Payroll Survey, 19902004


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Conflicting Measurement

Observations:

BLS has two kinds of survey household

survey and the payroll employment survey. Payroll survey considered more reliable as

the sample size is larger400,000establishment as opposed to 60,000households in the household survey.


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Observations: Unemployment rises during recessions Always greater than zero

Actual vs. natural unemployment: Actual unemployment is unemployment that

exists in an economy at a particular point intime.

Natural Rate of Unemployment: rate ofunemployment that persists (e.g., structural,frictional, etc.) even when the economy is atfull-employment


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Full Employment: the situation when there isno cyclical or involuntary unemployment. In

this situation all those who are willing to workat the going wage rate are at work


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Inflation

Measures how fast the average price levelis increasingover time

Rate of Inflation

The annual percentage increase in the

price level


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Hyperinflation: A situation in which the rate ofinflation is extremely high ranging from 50%or more per month..

Observation:

1. Purchasing power of currency goes down

2. Inflation exerts pervasive uncertainty

-livesbecome unpredictable.


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Big Three Concepts of

Macroeconomics

Productivity

Average output produced per hour of work.

In the US it was about $49 per worker-hour in

2005

Productivity growth: The faster averageproductivity grows, the easier it is formembers of society to improve their standard

of living.

Economic growth is sustained growth in realGDP over periods of a decade or more


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Actual and natural gross domestic

product (GDP).

Gross domestic product (GDP) & real GDP:

GDP: The official measure of the economys

total output is called gross domesticproduct (GDP).

Real GDP - is the measure of output

reflecting the quantity of output producedcorrected for any changes in prices.


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Actual and natural gross domestic product

(GDP).

Actual real GDP vs. natural real GDP

Actual real GDP is the amount the economy

actually produces at any given time.

Actual real GDP could be too low causingunemployment rate to be higher than

necessary, wasting resources anddepriving people of jobs.


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Actual and natural gross domestic product

(GDP).

Actual real GDP could be too high strainingthe nations ability to produce and puttingupward pressure on the inflation rate.

The compromise between too low and toohigh level of real GDP is called natural realGDP, a level of real GDP in which there is

no tendency for inflation to accelerate ordecelerate (that is, when the economy isproducing at a normal rate).


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Figure 1-1

The Relation Between

Actual and Natural RealGDP and the InflationRate

When actual real

GDP is below thenatural real GDPinflation rate slowsdown

When actual realGDP is above thenatural real GDPinflation rate speedsup


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Figure 1-2The Behavior over Time of

Actual and Natural Real GDPand the Actual and NaturalRates of Unemployment

When actual real GDPis below the naturalreal GDP rate ofunemployment risesabove the natural rate

When actual real GDP

is above the naturalreal GDP rate ofunemployment fallsbelow the natural rate


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Real GDP and the Three Macro Concepts

Therefore, actual real GDP is closely relatedto the three central concepts ofmacroeconomics.

The difference between actual and natural

real GDP moves inversely with the differencebetween the actual and naturalunemployment rates (we saw in figure)

Inflation tends to speed up when actual realGDP is higher than natural real GDP.

And the third link is with productivity, that isthe actual real GDP per hour.


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Macroeconomics in the Short and Long

Runs

Macroeconomic theories and debates can bedivided into two main groups:

1. Those concern the short-run stability of the

economy and 2. Those concern the long-run growth rate.

Short run: Much of macroeconomic analysisconcerns the first group of topics involving the

short-run - period lasting from one year to fiveyears and focuses on the ups and downs oftwo major concepts: unemployment andinflation.


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Runs

Business cycles: The ups and downs ofunemployment and inflation are called short-term economic fluctuations or business

cycles.

Therefore, the main concern ofmacroeconomists in the short-run is tominimize fluctuations in the unemploymentand inflation rates

And that requires fluctuations in the real GDPto be minimized


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Figure 1-3 Business Cyclesin Volatilia and Stabilia


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Runs

In the imaginary nation Volatilia we see hugebusiness cycles creating huge gap betweenactual real GDP and natural real GDP

In Stabilia, on the other hand, short-runmacroeconomics tries to dampen businesscycles so that the path of actual real GDP is

as close as possible to natural real GDP


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Figure 1-4 Basic Business-Cycle Concepts


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Basic Business-Cycle Concepts

Short run: Business cycles

Peak the highest point reached by realoutput in each business cycle

Trough - the lowest point reached by realoutput in each business cycle

Expansion the period in the business cycle

between the trough and the peak Recession - the interval in the business cycle

between the peak and the trough


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Long run: The other main topic inmacroeconomics concerns the long-run,which is a longer period ranging from one

decade to several decades. It attempts toexplain the rate of productivity growth or moregenerally, economic growth.

And this economic growth is the long-runconcern of macroeconomists


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Figure 1-5 Economic Growthin Stag-Nation and Speed-Nation


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The two hypothetical nations, Stag-nation(include Germany and Japan) and speed-nation (include China and India) mayexperience mild business cycles.

Stag-nation, however, experiencing slow growthin real GDP whereas Speed-nation is

experiencing a very fast growth in real GDP.


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Figure 1-6Actual and Natural

GDP andUnemployment, 19002001

Actual real GDPwas below natural

real GDP during theGreat Depressionof1930s and aboveit during World WarII

On the contrary,actualunemployment wasvery high during theGreat Depressionof1930s


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For contrast with the 1930s, the USunemployment rate fell as low as 4% duringthe prosperity year of2000 and was neverhigher than 7.5% the rate reached in 1992.

During the Great Depression it went up from

3.2% in 1929 to 25.2% in 1933 and never fellbelow 10% until 1941.


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Figure 1-7 The Unemployment Ratefrom 192941Compared with 19922004


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Figure 1-8

The German Hyperinflation of192023


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The German Hyperinflation of192023

The German Price Level increased from alittle above 1 in 1920 and 1921 to 550 at theend of1922 and to 100,000,000,000 in

November1923.


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Fast and slow growth in Asia

However, the effects that really matter overthe decades is the productivity growth.

Difference in growth rates that may appearsmall can compound over the decades andcreate enormous difference in the standard ofliving.

A classic example of the importance of rapidgrowth is displayed in the next figure


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Figure 1-9 Per-Capita Real GDP, South Koreaand the Philippines, 19602005


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Per-Capita Real GDP, South Korea and thePhilippines, 19602000

In 1960, per-Capita Real GDP inPhilippines was 14% higher than in South

Korea.

But between 1960 to 2005 the real GDP percapita grew at 5.7%per year in South

Korea compared to only 1.4% in thePhilippines.


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Stabilisation Policy

Two tasks of Macroeconomic analysts:

1. To analyze the causes of changes inimportant aggregates called targetvariables

2. To predict the consequences ofalternative policy changes

Target variables or goals

Inflation Unemployment Long term growth rate


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Policy instruments are elements thatgovernment policymakers can manipulatedirectly to influence target variables.


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Stabilization policy is any policy that seeksto influence the level of aggregatedemand.

Policy instruments three broadcategories:

Fiscal policies include changes ingovernment expenditures and tax rates

Monetary policies include control of themoney supply and interest rates


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Third miscellaneous group includespolicies to equip workers with skills theyneed to qualify for jobs.


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Problem:

Closed economy

Open economy

As economies have become internationalized,

fiscal policy and monetary policy can not be

used in isolation with their effects abroad.

Repercussions abroad affect the way fiscal andmonetary policy work and how the inflation

process operates.


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How Does U.S. Economic PerformanceRank?

As a result of internationalization ofmacroeconomics there has been an

increased attention to the comparative

performance of the US.

The figure shows how the US compareswith Japan and the major European

nations in unemployment, inflation andproductivity growth rates


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International Perspective How Does U.S.Economic Performance Stack Up?


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How Does U.S. Economic PerformanceRank?

Despite recent problems, economicperformance of Japan is superior to both

the US and Europe in most periods:

Lower unemployment,

Lower inflation

Faster economic growth rates

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