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Macroeconomics is the study of the behavior of the economy as a whole. It examines the forces
that affect firms, consumers, and workers in the aggregate.
Two central themes:
1. The short-term fluctuations in output, employment, financial conditions, and prices that we
call the business cycle
2. The longer-term trends in output and living standards known as economic growth
Gross Domestic Product (GDP) is the measure of the market value of all final goods and
services produced in a country during a year.
GDP tGDPt 1
100
GDPt 1
Economic Growth is a process wherein an economy exhibits a steady long-term growth in real
GDP and an improvement in living standards.
Potential GDP represents the maximum sustainable level of output that the economy can
produce.
1
When output rises above potential output, price inflation tends to rise
While a below-potential level of output leads to high unemployment.
Recession is a period of significant decline in total output, income, and employment, usually
lasting more than a few months and marked by widespread contractions in many sectors of the
economy.
Pt Pt1
100
Pt 1
Deflation occurs when prices decline (which means that the rate of inflation is negative)
Hyperinflation is a rise in the price level of a thousand or a million percent a year
International Linkages
Globalization is a phenomenon where nations increasingly participate in the world economy
and are linked together through trade and finance.
International trade has replaced empire-building and military conquest as the surest road
to national wealth and influence.
Current account balance represents the numerical difference between the value of exports
and the value of imports, along with some other adjustments. It is closely related to net exports,
which is the difference between the value of exports and the value of imports of goods and
services.
Remember: international trade and finance are not ends in themselves. Rather, international
exchange serves the ultimate goal of improving living standards.
Trade policies consist of tariffs, quotas, and other regulations that restrict or encourage imports
and exports.
Foreign exchange rate represents the price of its own currency in terms of the currencies of
other nations.
2. Government fiscal and monetary policies can affect output and thereby reduce
unemployment and shorten economic downturns
Employment Act of 1946 (JMK died this year): Responsibility of Federal Government to
promote maximum employment, production, and purchasing power.
1960s: Wartime Boom. President John Kennedy brought Keynesian economics to Washington.
His economic advisers recommended expansionary policies, and Congress enacted measures to
stimulate the economy
1963 to 1964: Cuts in personal and corporate taxes. GDP grew rapidly during this period,
unemployment declined, and inflation was contained.
1965: The US economy was at its potential output.
1965 to 1968: Buildup for the Vietnam War; defense spending grew by 55 %. President Johnson
postponed painful fiscal steps to slow the economy, thus overheating the economy
1968: Tax increases and civilian expenditure cuts was implemented but too late to prevent
inflationary pressures
1966 to 1981: The Great Inflation. Inflation began to rise under the pressure of low
unemployment and high factory utilization.
It was easier to stimulate the economy than to persuade policymakers to raise taxes to slow the
economy when inflation threatened. Economists during great inflation
1970s: Time of troubles: rising oil prices, grain shortages, a sharp increase in import prices, union
militancy, and accelerating wages.
1979 to 1982: Tight Money Policy. Paul Volcker, prescribed the strong medicine of tight
money to slow the inflation; interest rates rose sharply, stock market fell, and credit was hard to
find.
1979: Housing construction, automobile purchases, business investment, and net exports
declined sharply.
The effects of the tight money were twofold
1. Output moved below its potential and unemployment rose sharply
2. Tight money and high unemployment produced a dramatic decline in inflation, from an
average of 12% per year in the 19781980 period to an average of around 4% per year in
the subsequent period.
1900 to 2008: The Growth Century. Average earnings rose from $0.15 per hour in 1900 to
over $30 per hour in 2008.
Real GDP is calculated by tracking the volume or quantity of production after removing the
influence of changing prices or inflation.
Real GDP per capita = Real GDP / Population
GDP deflator (or Price of GDP) is the difference between nominal GDP and real GDP
GDP Deflator = 100 x Nominal GDP / Real GDP
One common approach is to use the first year as the base year. The base year is the year in
which we measure prices. Consumer Price Index (CPI) can be substituted to GDP deflator.
Consumption
Consumption expenditures are divided into three categories:
1. Durable goods such as automobiles
2. Nondurable goods such as food, and
3. Services such as medical care
Government Purchases
Some government purchases are consumption-type goods (like food for the military), while
some are investment-type items (such as schools or roads).
Note: Transfer Payments are not included in GDP
Official Government Budget = Government Spending + Transfer Payments
Taxes are included in the Income Approach but not in the Expenditure Approach to GDP
Net Exports
Net exports is the difference between exports and imports of goods and services
Disposable income (DI) is what actually gets into the hands of consumers to dispose of as they
please
DI = NI + Transfer Payments Taxes Net Business Saving