Hand-outs

1. Macroeconomics is the branch of economics that deals with the entire economy. Most discussions in
macroeconomics focus on one or more of the following:
1. Macroeconomic problems
2. Macroeconomic theories
3. Macroeconomic policies
4. Different views of how the economy works
Macroeconomic Problems
Here are a few macroeconomic problems:
1. High inflation rate
2. High unemployment rate
3. High interest rates
4. Low economic growth
THE P-Q CATEGORY Many of the topics discussed in macroeconomics relate directly or indirectly to
the price level and Real GDP.
We use for the price level is P; the symbol we use for Real GDP is Q. Thus, we can talk about the P-Q
category. In macroeconomics, we have occasion to discuss numerous topics, such as inflation,
deflation, unemployment, and so on. Many of these topics relate directly or indirectly to either P or Q.
Here is a list of macroeconomic topics and how each relates to either P or Q.
• Gross Domestic Product (GDP). P times Q.
• Unemployment. Changes in unemployment are related to changes in Q.
• Inflation. A rising P.
• Deflation. A falling P.
• Economic growth. Related to increasing Q.
• Stagflation. A rising P combined with rising unemployment.
• Business cycle. Recurrent swings up and down in Q.
• Inflationary gap. The condition of the economy when Q is above its natural level.
• Recessionary gap. The condition of the economy when Q is below its natural level.
• Fiscal policy. Concerned with stabilizing P and increasing Q.
• Monetary policy. Concerned with stabilizing P and increasing Q.
Real GDP
The value of the entire output produced annually within a country’s borders, adjusted for price
changes.
THE SELF-REGULATING–ECONOMIC INSTABILITY CATEGORY
Some economists argue that the Great Depression is proof of the inherent instability of a market (or
capitalist) economy and demonstrates that natural economic forces, if left to themselves, may bring
on human suffering.

2. Other economists argue that the economy is inherently stable or self-regulating. The Great
Depression, they believe, was largely caused and made worse by government tampering with the
self-regulating and wealth-producing properties of a market economy.
Economist Axel Leijonhufvud notes:
The central issue in macroeconomic theory is—once again—the extent to which the economy, or at
least its market sectors, may properly be regarded as a self-regulating system. . . .How well or badly
do its “automatic” mechanisms perform?
THE EFFECTIVE-INEFFECTIVE CATEGORY Here the words effective and ineffective describe fiscal
policy and monetary policy.
Fiscal policy refers to changes in government expenditures and/or changes in taxes to achieve
particular macroeconomic goals (e.g., low unemployment, stable prices).
Monetary policy refers to changes in the money supply, or the rate of growth of the money supply,
to achieve particular macroeconomic goals.
Measuring Prices Using the CPI
The price level is a weighted average of the prices of all goods and services.
Economists measure the price level by constructing a price index. One major price index is the
consumer price index (CPI).
CPI is a widely cited index number for the price level; the weighted average of prices of a specific set
of goods and services purchased by a typical household.
Base Year
Is the year chosen as a point of reference or basis of comparison for prices in other years; a
benchmark year.
CPI= (Total dollar expenditure on market basket in current year/ Total dollar expenditure on market
basket in base year) x100
%change in P= CPI(current)- CPI(base) X 100
CPI(base)
Inflation and the CPI
Inflation is an increase in the price level and is usually measured on an annual basis. The inflation
rate is the positive percentage change in the price level on an annual basis.
Real Income
Nominal income adjusted for price changes.
Nominal Income
The current-peso amount of a person’s income.
MEASURING UNEMPLOYMENT
Who Are the Unemployed?
The total population can be divided into two broad groups:
 One group consists of persons who are (1) under 16 years of age, (2) in the armed forces, or
(3) institutionalized—that is, they are in a prison, mental institution, or home for the aged.
 The second group, which consists of all others in the total population, is called the civilian
noninstitutional population. The civilian noninstitutional population, in turn, can be divided into
two groups: persons not in the labor force and persons in the civilian labor force
Civilian noninstitutional population = Persons not in the labor force + Persons in the labor force
Civilian labor force = Employed persons + Unemployed persons

3. Unemployment rate (U )= No. of Unemployed persons
Civilian labor force
Employment rate (E )= No. of Employed persons
Civilian noninstitutional population
Labor force participation rate (LFPR)= Civilian Labor Force
Civilian Noninstitutional Population
Reasons for Unemployment
Usually, we think of an unemployed person as someone who has been fired or laid off from his or her
job. Certainly, some unemployed persons fit this description, but not all of them do. According to the
BLS, an unemployed person may fall into one of four categories.
1. Job loser. This is a person who was employed in the civilian labor force and was either fired or laid
off. Most unemployed persons fall into this category.
2. Job leaver. This is a person employed in the civilian labor force who quits his or her job. For
example, if Jim quit his job with company X and is looking for a better job, then he is a job leaver.
3. Reentrant. This is a person who was previously employed, hasn’t worked for some time, and is
currently reentering the labor force.
4. New entrant. This is a person who has never held a full-time job for two weeks or longer and is now
in the civilian labor force looking for a job.
Unemployed persons = Job losers + Job leavers + Reentrants + New entrants
Discouraged Workers=Those who are currently not working but no longer actively looking or seeking
for jobs. They are not included in the calculation for the unemployment rate by the BLS.
Types of Unemployment
1. Frictional Unemployment
-Unemployment due to the natural “friction” of the economy, which is caused by changing market
conditions and is represented by qualified individuals with transferable skills who change jobs.
2. Structural Unemployment
-Unemployment due to structural changes in the economy that eliminate some jobs and create other
jobs for which the unemployed are unqualified.
3. Natural Unemployment
-Unemployment caused by frictional and structural factors in the economy. Natural unemployment
rate =Frictional unemployment rate + Structural unemployment rate.
4. Cyclical Unemployment Rate
-The difference between the unemployment rate and the natural unemployment rate.
Full Employment
-The condition that exists when the unemployment rate is equal to the natural unemployment rate.
SELF-TEST
1. Explain how the CPI is calculated.
2. What is a base year?

4. 3. In year 1, your annual income is $45,000 and the CPI is 143.6; in year 2, your annual income is
$51,232 and the CPI is 150.7. Has your real income risen, fallen, or remained constant? Explain your
answer.
4. What is the major difference between a person who is frictionally unemployed and one who is
structurally unemployed?
5. If the cyclical unemployment rate is positive, what does this imply?
ECONOMIC GROWTH
- Annual economic growth has occurred if Real GDP in one year is higher than Real GDP in the
previous year.
THE “UPS AND DOWNS” IN THE ECONOMY, OR THE BUSINESS CYCLE
The following are the 5 phases of business cycle:
1. Peak. At the peak of the business cycle, Real GDP is at a temporary high.
2. Contraction. The contraction phase represents a decline in Real GDP. According to the standard
definition of recession, two consecutive quarter declines in Real GDP constitute a recession.
3. Trough. The low point in Real GDP, just before it begins to turn up, is called the trough of the
business cycle.
4. Recovery. The recovery is the period when Real GDP is rising. It begins at the trough and ends at
the initial peak.
5. Expansion. The expansion phase refers to increases in Real GDP beyond the recovery.