C h a p te r 20 A fir s t lo o k a t macroeconomics

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Ch a p t e r
2 0

A

f i r s t l o o k a t
*

macroeconomics

I.

Origins and Issues of Macroeconomics

A.

Modern macroeconomics emerged during the
Great Depre
s
sion

(1929
-
1939) a decade of
high unemployment and stagnant production throughout the world economy.

B.

Short
-
Term Ve
rsus Long
-
Term Goals

1.

With high unemployment during the Great Depression, the initial focus of
macroeconomics was on the
short term
.

2.

During the 1970s, inflation increased and economic growth slowed, shifting the focus of
macroeconomics to the
long ter
m
.

C.

The Road Ahead

1.

During the 1990s, as information technologies further shrank the globe, the international
dimension of macroeconomics became more prominent.

2.

Modern macroeconomics is a broad subject that studies long
-
term economic growth,
unemplo
yment, inflation, the government budget deficit, and the U.S. intern
a
tional deficit.

II.

Economic Growth and Fluctuations

A.

Economic growth

is the expansion of the economy’s production possibilities.

1.

We measure economic growth by the increase in real
gross domestic product.

2.

Real gross dome
s
tic product

(also called
real GDP
) is the value of the total
production of all the nation’s farms, factories, shops, and offices measured in the prices
of a single year, currently 2000.




*

*
This is Chapter 20 in
Economics
.

78

C H A P T E R 4

B.

Economic Growth in the U
nited States

1.

Figure 4.1 shows real GDP in
the United States since 1962.

2.

Potential GDP

is the real
GDP that the nation produces
when all the economy’s l
a
bor,
capital, land, and
entrepreneurial ability are fully
employed.

a)

Figure 4.1 shows that
ther
e is persistent growth
in potential GDP. The
long
-
term rate of economic
growth is measured by
growth in potential GDP.

b)

Potential GDP grew more
rapidly in the 1960s than
in the 1970s and early
1980s. The slow growth
during the 1970s and early 1980s refle
cted the
productivity growth slowdown.

The growth rate of potential GDP increased during the 1980s and 1990s.

3.

Real GDP fluctuates around potential GDP in a
business cycle
.

a)

A
bus
i
ness cycle

is the periodic but irregular up
-
and
-
down movement in
produc
tion.

b)

A business cycle has two turning points, a
peak

and a
trough,

and two phases,
recession and expa
n
sion.

i)

A peak is the upper turning point, the end of an expansion and the beginning
of a recession.

ii)

A trough is the lower turning point, the en
d of a recession and the start of an
expansion.

iii)

A
recession

is commonly defined as a period during which real GDP
d
e
creases for at least two successive quarters.

iv)

An
expansion

is the period during which real GDP increases.


A FIRST LOOK A T MA CR
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79

4.

Figure 4.2 shows the
most recent U.S. business cycle, including the most recent
recession in 2001
.

5.

Recessions in recent years have been much less severe than the Great Depression.

C.

Economic Growth around the World

1.

U.S. real GDP growth fluctuates much more than the grow
th rate of real GDP in the rest of
the world as a whole.

2.

Among advanced economies, since 1992 Japan has grown the slowest and the newly
industrialized economies have grown the fastest. Among the developing economies, the
most rapid growth has occurred i
n Asia and the slowest growth has occurred in Africa
and the Western Hemisphere.

3.

The U.S. share of world real GDP is almost constant and is about 21 percent, but some
fast growing nations such as China have gone from 4 percent in 1982 to 13 percent in
2
002.

D.

The Lucas Wedge and the Okun Gap

1.

The
Lucas wedge

is the accumulated loss of output that results from a slowdown in the
growth rate of real GDP per person. Since 1970, the Lucas wedge has amounted to a
staggering $50 trillion.

2.

The
Okun gap

is
the gap between real GDP and potential GDP
. Since 1970, it has
amounted to an estimated $2.7 trillion.

80

C H A P T E R 4

3.

Figure 4.5 shows the Lucas
wedge and the Okun Gap.

E.

Benefits and Costs of Economic
Growth

1.

The main cost of fast growth is
foregone current consu
mption.

2.

Two other possible costs are
more rapid depletion of
exhaustible natural resources
and/or more pollution, although
technological advances that
bring economic growth help
economize on natural resources
and clean up the e
n
vironment.

III.

Jobs and
Unemployment

A.

Jobs

1.

In 2003, 137 million people in the
United States had jobs

17
mi
l
lion more than in 1993 and 37
million more than in 1983.

2.

The pace of job creation
fluctuates with the business
cycle. During the 2001 recession,
2 million jobs disap
peared.
During the expansion of the
1990s, 2 million jobs were
created each year.

3.

Most new jobs are in the
services industries and are, on
the average, higher paying than
the ones lost.

B.

Unemployment

1.

On any one day in a normal or average year, in
the United States 7 million people are
unemployed.

2.

The
unemployment rate

is the number of unemployed people e
x
pressed as a
percentage of all the people who have jobs or are looking for one. The unemployment
rate is not a perfect measure of the u
n
derutil
ization o f l
a
bor for two main reasons:

a)

It excludes people who are so discouraged that they’ve given up the effort to find
work.

b)

Part
-
time workers, who desire full
-
time work but cannot find it, are not counted as
unemployed.

C.

Unemployment in the Un
ited States

1.

The unemployment rate reached a peak during the Great Depression in the early 1930s. It
has been high, but not nearly as high, during r
e
ce
s
sions in recent years.

2.

Figure 4.6 shows the unemployment rate in the United States from 1929 throug
h 2003.


A FIRST LOOK A T MA CR
OECONOMICS

81


D.

Unemployment Around the World

1.

Since 1983, the unemployment rate has been generally higher in the United

States than in
Japan, but higher still in Canada and Western Europe. Business cycle fluctuations in
unemployment occurred at similar times in the United States and Canada, but were out of
phase when compared to Western Europe.

2.

Figure 4.7 shows the
une
mployment rate in the
United States, Canada,
Western Europe, and Japan
.

E.

Why Unemployment Is a Problem

1.

Unemployment represents
lost production and i
n
come.

2.

Prolonged unemployment
can cause lost human
capital, which ser
i
ously
hurts the person’s futur
e job
prospects.

82

C H A P T E R 4

I V.

I nf l a t i on

A.

Inflation

is a process of rising prices. The average level of prices is called the
price level
,
and the
inflation rate

is measured as the percentage change in the price level. A common
measure of the price level is the
Con
sumer Price Index

(CPI).

B.

Inflation in the United States

1.

Figure 4.8 shows the U.S. inflation rate from 1963 through 2003
.


2.

In the early 1960s the U.S. inflation rate was low; it reached its hig
h
est levels in 1974 and
1980. Inflat
ion then decreased during the 1980s and has stayed relatively low in the
1990s.

3.

Deflation

occurs when the inflation rate is negative so that the price level is falling.


A FIRST LOOK A T MA CR
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83

C.

Inflation Around the World


1.

Figure 4.9 shows inflation
around the world since

1983
.

2.

Other industrial countries
shared the same pattern of
inflation as the United States.
Developing countries have
displayed much higher rates
of inflation, although inflation
has dropped closer to the
levels of i
n
dustrial countries
in recent years.

D.

Is Inflation a Problem?

1.

Unanticipated changes in the
value of money mean that the
amounts actually paid and
received vary unpredictably.

2.

People use resources to
predict the inflation rate
rather than to pr
o
duce
additional goods and
services.

3.

A
t high inflation rates money
loses value very quickly;
therefore people try to spend
their money more rapidly. In
the extreme case of a
hype
r
inflation



defined as
an inflation rate that exceeds
50 percent per month


inflation brings economic
chaos and so
cial disruption.

4.

Getting rid of inflation is
costly in terms of higher unemplo
y
ment, although most economists believe this cost is
temporary.

V.

Surpluses and Deficits

A.

Government and Budget Surplus and Deficit

1.

The federal government has a
governme
nt budget surplus

if it co
l
lects more in taxes
than it spends.

2.

The federal government has a
gover
n
ment budget deficit

if it spends more than it
collects in taxes.

3.

Figure 4.10(a) shows the federal government and total government budget surplus and
de
ficit measured as a percentage of GDP since 1962
.

84

C H A P T E R 4


4.

Since 1970, the government has had a budget surplus fr
om 1998 to 2000 and a budget
deficit in the other years. As a fraction of GDP, the budget deficit was highest in the
1980s.

B.

International Deficit

1.

The value of the goods and services sold to other countries (exports) plus net interest
receipts minus t
he value of the goods and services purchased from other countries
(imports) is the
current account

ba
l
ance.

2.

Figure 4.10(b) shows the history of the U.S. current account balance from 1962 to 2002
.

3.

Until 1982, the United States generally had a current
account su
r
plus; that is, it sold more
to the rest of the world than it purchased. From 1982 to 1987, the current account deficit
became large. It then d
e
creased significantly between 1988 and 1991, after which it has
i
n
creased once more and is currently n
ear 5 percent of GDP.

C.

Do Deficits Matter?

1.

Deficits can be harmful if the borrowing is used to buy consumption goods rather than
more investment.

VI.

Macroeconomic Policy Challenges and Tools

A.

Until the development of modern macroeconomics, it was widely believed that the only
economic role for government was to enforce property rights.

B.

Policy Challenges and Tools

1.

There are now five widely agreed challenges for macroeconomic po
l
icy:

a)

Boost economic growth

b)

Keep inflation low

c)

Stabilize the business cycle

d)

Reduce unemployment


A FIRST LOOK A T MA CR
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85

e)

Reduce government and international deficits

2.

Making changes in tax rates and government spending programs is called
fiscal policy
.

3.

Changing interest

rates and the amount of money in the economy is called
monetary
po
l
icy
. The Federal Reserve (Fed) is in charge of monetary policy.