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Chapter 5 macro

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  • 1. Macro McEachern 2011 ECON 5 2010- CHAPTER Introduction Designed by Amy McGuire, B-books, Ltd. Chapter 5 to Macroeconomics Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 1
  • 2. The National Economy  Gross domestic product GDP  Market value  All final goods and services  Produced in U.S.  During a given period LO1 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 2
  • 3. The National Economy  Millions of decision makers  Some independence  Connected with the economy  Money  Medium of exchange LO1 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 3
  • 4. The National Economy  Circular flow  Money  Products  Resources LO1 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 4
  • 5. The National Economy  Flow variable   Amount per unit of time Stock variable  Amount at a particular point in time  Testing new theories  Knowledge and performance  Essential relationships  Key variables LO1 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 5
  • 6. Economic Fluctuations and Growth  Rise and fall of economic activity  Business cycles  Expansions: Output increases  Contractions: Output decreases  Depression  Sharp reduction in output  Lasts > 1 year  High unemployment  Recession  Lasts > 6 months LO2 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 6
  • 7. Economic Fluctuations and Growth  Inflation  Economy’s average price level increase  U.S. economic fluctuations  14 times more output than in 1929  Increased production  Quantity and quality of resources  Better technology  Rules of the game LO2 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 7
  • 8. Exhibit 1 LO2 Hypothetical Business Cycles Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 8
  • 9. Economic Fluctuations and Growth  Business cycle  Peak-to-trough-to-peak  Contraction  Between peak and trough  Expansion  Between trough and peak  Longest  10 years (March 1991 to March 2001) LO2 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 9
  • 10. Exhibit 2 LO2 Annual Percentage Change in U.S. Real GDP Since 1929 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 10
  • 11. U.S. and U.K. Annual Growth Rates in Output Are Similar Exhibit 3 LO2 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 11
  • 12. Leading Economic Indicators  Leading economic indicators  Predict a change in economy  Recovery  Downturn  Coincident economic indicators  Reflect changes as they occur  Lagging economic indicators  Follow changes in economy LO2 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 12
  • 13. Leading Indicators The 10 components of the Index include: 1. Average weekly hours worked by manufacturing workers 2. Average number of initial applications for unemployment insurance 3. Number of manufacturers' new orders for consumer goods and materials 4. Speed of delivery of new merchandise to vendors from suppliers Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 13
  • 14. 5. Amount of new orders for capital goods unrelated to defense 6. Amount of new building permits for residential buildings 7. The S&P 500 stock index 8. Inflation-adjusted monetary supply (M2) 9. Spread between long and short interest rates (the yield curve) 10. Consumer sentiment (the Index for Consumer Expectations) Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 14
  • 15. http://www.census.gov/cgibin/briefroom/BriefRm Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 15
  • 16. “Economists have correctly predicted nine of the last five recessions.“ Paul Samuelson Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 16
  • 17. Coincident indicators     Number of employees on non-agricultural payrolls. Personal income less transfer payments. Industrial production. Manufacturing and trade sales. Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 17
  • 18. Lagging Indicators The components are: 1. The average duration of unemployment (inverted) 2. The value of outstanding commercial and industrial loans 3. The change in the Consumer Price Index for services 4. The change in labor cost per unit of output Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 18
  • 19. Lagging Indicators 5. The ratio of manufacturing and trade inventories to sales 6. The ratio of consumer credit outstanding to personal income 7. The average prime rate charged by banks Economists' use the Index of Lagging Indicators to validate assessments of current economic conditions. Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 19
  • 20. So, where are we??? http://www.bloomberg.com/news/print/2010-08-19/indexof-u-s-leading-economic-indicators-increase-0-1-insign-of-slowing.html Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 20
  • 21. Aggregate Demand; Aggregate Supply  Aggregate output  Total amount of goods and services  Produced in economy  Given period  Real GDP  Aggregate demand  Price level  Quantity of aggregate output demanded Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 21
  • 22. Aggregate Demand; Aggregate Supply  Price level  Index number  Base year = 100  Real GDP  GDP adjusted for price level changes Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 22
  • 23. Aggregate Demand Curve  Sum of D of economic decision makers  Households; Firms;  Governments; Rest of the world  Inverse relationship  Price level  Real GDP demanded  Other things constant  Price levels in other countries  Exchange rates LO3 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 23
  • 24. Aggregate Demand Curve Price level (2000 = 100) Exhibit 4 LO3 150 100 50 0 Chapter 5 The quantity of aggregate output demanded is inversely related to the price level, other things constant. This inverse relationship is reflected by the aggregate demand curve AD. AD Real GDP 2 4 6 8 10 12 14 16 (trillions of 2000 dollars) Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 24
  • 25. Aggregate Supply Curve  Positive relationship  Price level  Real GDP supplied  Other things constant  Resource prices  State of technology  Rules of the game LO3 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 25
  • 26. Exhibit 5 LO3 Aggregate Demand and Aggregate Supply in 2008 Chapter 5 The total output of the economy and its price level are determined at the intersection of the Ad and AS curves. This point reflects real GDP and the price level for 2008 using 2000 as the base year. Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 26
  • 27. Equilibrium  AD curve intersects AS curve  Equilibrium price level  Equilibrium real GDP  Higher real GDP  More goods and services  Higher employment LO3 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 27
  • 28. Short History of the U.S. Economy 1. Before and during Great Depression 2. After Great Depression to early 1970s  The Age of Keynes 3. From early 1970s to early 1980s  Stagflation 4. Since early 1980s LO4 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 28
  • 29. The Great Depression and Before  1873 – 1879: Longest contraction  80 railroads – bankrupt  1890s  Contractions  18% unemployment rate  1929: The Great Depression LO4 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 29
  • 30. The Great Depression and Before  1929 - 1933: Deepest economic contraction  Stock market crashed;  Investment dropped  Consumer spending fell;  Banks failed  Money supply dropped by 1/3  High tariffs – restricted trade  Big decline in AD  Real GDP dropped 27%  Price level dropped 26%  Unemployment rate 33% LO4 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 30
  • 31. What was happening during the Great Depression? Please read “Lessons from the Great Depression” here as well!! GREAT READ!!! Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 31
  • 32. A little more about the Great Depression  What was happening??? – The stock market was collapsing!!! – Real GDP was falling – Unemployment was at record highs Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 32
  • 33. Dow Jones Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 33
  • 34. Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 34
  • 35. Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 35
  • 36. A few other thoughts  Money Supply?!? – The Federal Reserve decreased the money supply by 1/3, meaning there was NO money left to invest in the economy. Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 36
  • 37. Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 37
  • 38.  Income Taxes??? – The highest branch of taxed people were taxed at 95%, which decreased the investments into the economy. Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 38
  • 39. Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 39
  • 40.  A few policies, pigs anyone? – The Hoover Administration destroyed crops and killed livestock trying to get the price levels to increase and not deflate – The prices did not increase and people where left hungry Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 40
  • 41. Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 41
  • 42. Exhibit 6 LO4 The Decrease in Aggregate Demand from 1929 to 1933 Price level (2000 = 100) AS The Great Depression of the 1930s can be represented by the shift to the left of the AD curve, from AD1929 to AD1933. 12.0 8.9 AD1929 AD1933 0 Chapter 5 In the resulting depression, real GDP fell from $865 billion to $636 billion, and the price level dropped from 11.9 to 8.9, measured relative to a price level of 100 in the base year 2000. Real GDP 636 865 (billions of 2000 dollars) Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 42
  • 43. The Age of Keynes  After the Great Depression to early 1970s  1936 John Maynard Keynes  The general theory of employment, interest, and money  AD – inherently unstable  Government - increase AD  Expansionary fiscal policy  Increase government spending  Cut taxes  Federal budget deficit LO4 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 43
  • 44. The Age of Keynes  Increase in AD  Increase real GDP  Increase employment  Demand-side economics  WWII  Increased employment  Increased government spending  Federal deficits LO4 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 44
  • 45. The Age of Keynes  Employment act of 1946  1950s: Prosperity, no fiscal policy  1960s: Golden age Keynesian economics  Fiscal policy ‘ fine tune’  Low unemployment;  Healthy growth  Modest inflation  Early 1970s  Recession  High inflation LO4 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 45
  • 46. Stagflation: 1973 to 1980  1970 Inflation rate: 5.3%  1971 Ceilings: prices, wages  1973 Crop failures  Soaring grain prices  OPEC cut oil supply  Increased oil prices LO4 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 46
  • 47. Stagflation: 1973 to 1980  1973 - 1975: Decrease in AS  Stagflation  Stagnation or contraction in output  Inflation  Real GDP decreased  Unemployment increased to 8.5%  Price level increased 19%  1979 - 1980: Stagflation; decrease AS  OPEC cutbacks LO4 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 47
  • 48. Exhibit 7 LO4 Stagflation from 1973 to 1975 Price level (2000 = 100) AS1975 AS1973 The stagflation of the mid1970s can be represented as a leftward shift of the AS curve from AS1973 to AS1975. 38.0 31.9 AD 0 Chapter 5 Aggregate output fell from $4.34 trillion in 1973 to $4.31 trillion in 1975, for a decline of about $30 billion (stagnation). The price level rose from 31.9 to 38.0, for a growth of 19% (inflation). Real GDP 4.31 4.34 (trillions of 2000 dollars) Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 48
  • 49. Since 1980  Combat stagflation  Increase AS  Supply-side economics  Lower price level  Increase output  Increase employment  Through lower taxes LO4 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 49
  • 50. Since 1980  1981: Recession  Unemployment rate 10%  Lower output  Economic growth for 10 years  Federal budget deficit  1990: higher taxes  1993: higher taxes  1995: slower growth in federal spending  Lower federal deficits LO4 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 50
  • 51. Since 1980  1998: Federal budget surplus  Longest expansion: 1991-2001  22 millions new jobs  Unemployment rate 4.2%  Modest inflation  2001: Recession (8 months)  Slow recovery  2003, unemployment rate 6.3%  Tax cuts  Increased output  Federal budget deficit  December 2007: Recession  2.5 million jobs lost in 2008  2008 Federal deficit: $450 billion LO4 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 51
  • 52. Tracking U.S. Real GDP and Price Level Since 1929 Exhibit 8 LO4 Chapter 5 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 52