Unit Two

Macroeconomic Tools

Circular Flow

See the chart on the board A little more detail

Functions of Gov’t

A. Allocation B. Redistribution of Income C. International Trade Regulation D. Stabilization

A. Allocation

1. Produce public goods, like schools or roads

2. Encourage merit goods like seat belts or air bags

3. Discourage the production of negative external effects like pollution

B. Redistribution of Income

1. Transfer payments: direct $ from the government without expecting a product

2. Indirect policies: Corporate Welfare, and the purchase of goods and services

C. International Economic Policy

1. Trade and Tariff policies

2. Currency Exchange policies

D. Stabilization

1. Fiscal Policy: Using taxes, spending and borrowing to stabilize the economy

2. Monetary Policy: Using the money supply and interest rates to stabilize the economy

Macroeconomic goals of stabilization

1. Growth 2. Full Employment 3. Stable Prices

Economic Growth

1. Defined as an increase in real per capita income. Real means adjusted for inflation. Per capita means for each person.

2. Measured by the Gross Domestic Product or GDP

GDP

The Gross in GDP means that depreciation has not been deducted

Domestic means only that which is produced in the US by US companies

Product refers to goods and services produced for use in one year

GDP

The GDP for the US this year is estimated to be $10,371,000,000,000

There are two ways of measuring the GDP: 1. Expenditure 2. Income

GDP by Expenditure

GDP= C + I + G + (X-M) C= Consumption or what consumers

spend on goods and service I = Investment in capital goods G= Government expenditures on

goods and services X-M= Exports - Imports

GDP by Income

National Income NI = C + S + T C= Consumption S = Savings T = Taxes

Full Employment

Full employment is measured by the unemployment rate; the lower unemployed the closer we are to Full Employment

Unemployment Rate = # of unemployed / Work Force

Workforce

The work force includes all those working

It excludes the retired, children 15 and under, “house-spouses”, students, the disabled.

Types of Unemployment

A. Frictional: or natural People changing jobs People graduating from college or high

school People moving with a spouse for a new

jobB. Structural:Where skills don’t match the jobs available

Unemployment Rate August 2002

8,100,000 / 142,000,000 = 5.7%

CPI Consumer Price Index Measures price stability, mostly

measures inflation Uses a market basket of goods to

compare prices from one month or year to the next

Can be used to compare or adjust incomes from one year to another.

Base Year 1984

Cost of a Market Basket of Goods= $1,823

$1,823 / 1,823 = 1.00 or an index of 100

August 2002

Cost of a market basket of goods= $3294

$3,294 / $1,823 = 1.807 or 180.7

Using the CPI

When we use the CPI to adjust prices or wages for inflation, the result is a “real” price or wage, instead of just the nominal price or wage.

The Formula

To compare a price from “back in the day” to prices today, we use this formula:

Old Price / old CPI x new CPI = Real Price Examples: Prices at the end of WWII

Movie: .60 / .18 x 1.807 = Eggs: .85 / .18 x 1.807 =