The Big Picture

1. Macroeconomics: The Big Picture
"If you can not measure it, you can not improve it.“
-Sir WilliamThomson
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2. Some key concepts follow here
In this module, we will learn some key concepts.
We’ll answer questions such as:
How do I measure the size of a
macroeconomy?
What measures do I use to
determine whether that
economy is ‘healthy’ or not?
Sometimes an economy seems
good…other times bad. What are
these differences?
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For Milestone #2, you’ll use these tools in assessing the
health of the nation you are studying for your research paper!

3. Let’s start with the broadest measure of an
economy: Gross Domestic Product
What is GDP?
(In general) It is a measure of
economic activity. It tells you the
total size of an economy as
measured by economic output
and income.
(Specifically) GDP is the total value
(measured in dollars) of all final
goods and services produced
during a particular year within the
borders of an economy.
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4. What do we mean by “Final
Goods and Services”
What IS included in GDP?
The value of final goods and services-
things that are newly produced goods and will
not be resold (in other words, they have
reached their final customer).
What is NOT included in GDP?
Nonproductive transactions such as:
Secondhand sales
Expenditures for stocks and bonds
Transfer payments
Sales of used items don’t
represent “new” production…so
they are not counted in GDP!
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5. There are two ways to measure GDP
• Expenditure Approach
• Income Approach
The expenditure
approach is the more
easily understood
approach. We’ll pay
more attention to this
one!
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6. The Expenditure Approach
The
expenditure
approach
measures
economic
activity here
It measures
the total value
of all goods
and services
produced in a
given area.
Think of it as the sum of all
spending (i.e. “expenditures”) that
occur in a country in one year.
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7. The Income Approach
(also called the Earnings or Allocations Approach)
GDP = Wages + Rents + Interest + Profits (+ an adjustment)
The expenditure approach determines the size of
an economy (i.e. GDP) by measuring all spending
on final goods and services.
Keep in mind that all that spending eventually turns
into someone’s income.
Therefore, in theory, you should be able to add
everyone’s income and arrive at the same number.
That approach to determining GDP is called the
Income Approach.
This approach also requires that you make several
complicated adjustments for taxes and other
factors.
I encourage you to understand the Income
Approach and other measures of income.
However, in this class we’ll primarily focus on GDP
as it is measured using the Expenditure Approach.
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8. The Income Approach
This income
approach
measures
economic
activity here
It measures
the total value
of income
earned in a
given area.
In theory, the
two numbers
should be the
same…
…someone
earns income
from all things
produced!
This is an important point: Regardless of
which method you use, you will (in theory
arrive at the same number for GDP.
Everything produced in an economy
eventually becomes someone’s income.
Therefore, GDP equals income.
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9. So how big IS our economy?
Source: Worldbank Data.org
In 2011, the U.S.
GDP was about
$15 trillion. That
is the value of all
things produced
here in that year.
Yes…that is
trillion with a “t”!
That was (and
still is) the largest
economy in the
world.
Today, we are on
pace to produce
about $16 trillion
in goods and
services.
China has
recently
overtaken Japan
for the second
ranking.
Many economists
expect they will
overtake the US
by 2030.
This chart gives us a
comparison for one point in
time. What about looking at
an economy OVER time?
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10. Looking at historic GDP data
Analysis of historic GDP data (or any dollar based
economic data) requires an inflation adjustment.
Why? Because prices have changed. See below!
Because of these changes
in prices, it simply isn’t fair
to compare older data with
newer data.
Similarly, it isn’t fair to
compare your income with
your great grandfather’s
income.
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He may have only made
$5,000 per year…but that
could have been a lot of
money in his time!

11. We have to correct for price changes if we want to
see if a country’s economy is really growing.
No! Prices are
getting higher, but
they are producing
fewer items.
Look at this simple
example. In 1920, this
country produced 100 units
of a good that cost $1,000
per unit. If that is all they
produced, then GDP would
be $100,000.
In 2000, they produced 82
units of that good at a price
of $2,144. Therefore, GDP
was $175,774.
But…is this country’s
economy bigger?
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x =

12. So how do we control for those changes in
prices to see if a country is really growing?
We use a price index such as the Consumer Price Index (CPI)
Price Index – a measure of the price of a specified
collection of goods and services called a market basket in a
given year as compared to the price of an identical collection
of goods or services in a reference year.
If you took a basket of goods we all commonly
buy – like gas, milk, TVs, electricity, and bread -
you could add the prices together.
Think of it this way:
Perhaps it is $800 today.
TODAY
You could examine what that same basket of
goods cost in a different period…let’s use 1980
as an example.
Perhaps it was $600 in 1980.
1980
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13. Calculating a price index
We could then use our formula to determine a price index.
Let’s call today the base year and 1980 the specific year.
In this case, we’d have (600/800)*100
That equals 75!
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14. Using a price index
We could then use the price index to adjust GDP data.
Let’s say that GDP in this country was
$10 million in 1980 and $100 million
now.
These are nominal figures. In order to
compare them, we need to adjust for
inflation.
In other words, we need to adjust from
Nominal GDP to Real GDP
Real GDP is calculated by dividing
“nominal” GDP (which means GDP
that is not adjusted for price changes)
by the price index.
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15. Using a price index
Let’s try it using the formula below:
For 1980, Real GDP = $10 million / (75 / 100)
That equals $13.3 million…
…In today’s dollars!
Now we can fairly compare GDP from 1980 to
today….because they are in REAL TERMS
Changes in Real GDP are commonly observed as
“ups and downs” in economic activity…that up and
down movement is called the “business cycle” and
understanding that is a Key Learning Outcome! Slide 15 of 46

16. Let’s try a simple example
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Imagine we have a hypothetical
economy that produces only one
good…maybe that good is umbrellas.
In 1950, they produced 10 umbrellas
and each one sold for one dollar in that
year.
In 2000, they produced 30 umbrellas
and each one sold for three dollars in
that year.
With that information, we can calculate
nominal GDP. That is the value of all
output in the prices that were charged
in that year.
For 1950, that number is 10 times $1 or
$10.
For 2000, it is 30 times $3 or $90.
Here is where this concept gets
important:
It would not be fair to say that this
economy has grown from $10 to $90.
Here is where this concept gets
important:
If it did, that would mean it is nine times
larger!
Here is where this concept gets
important:
But it is only producing 3 times as
many umbrellas, each costing more.
We need to control for changes in
price!
To do that, we need to develop a price
index. And for that, we must pick a
base year.
You can pick any year but I recommend
using the most recent. Here we will
use the year 2000.
So the price index in 1950 will be the
price in that year (the specific year)
divided by the price in the base year
(2000)…times 100.
That is ($1 / $3) times 100.
That equals 33.33.
For 1975, it is $2/$3 times 100 or
66.67.
For 2000, it is $3/$3 times 100 or 100.
The price index is always 100 in the
base year.
Now we are ready to calculate Real
GDP.
To calculate Real GDP, we take
nominal GDP and divide it by:
(the price index/100)
For the year 1950, that number is:
$10 / (33.33/100).
That is the same as:
$10/0.3333
Which is $30.
For 1975, it is $40 / (66.67/100)
That equals $60.
For 2000, it is $90 / (100/100)
That equals $90.
Now we can compare Output in 1950
to Output in 2000. We have controlled
for price changes!
And we can conclude that Real GDP
has increased in this nation from $30 to
$90.
The economy is three times larger (in
real terms).
Let’s do some more complicated
practice……

17. Try to follow this example Nominal GDP is output
times current prices at
the time that output
was sold
A price index shows us how prices
have changed over time. In 1995,
prices were $1 versus $6 in 2000.
Therefore the 1995 price index is
1/6*100 or 16.67 Note that the
selection of 2000 for a base year is
arbitrary.
Real GDP is Nominal GDP * (price
index/100).
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18. Try this one on your own. You’ll see
questions like this on the test!
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19. Here is another example.
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20. Nominal GDP Versus Real GDP
The U.S. has experienced real
economic growth!
Nominally (the blue line), we have
experienced a lot of growth.
Total nominal GDP increased
from about $500 billion in 1950 to
$11trillion in 2003.
But much of that growth is due to
increases in prices.
The pink line controls for price
changes and shows us if we have
had “real growth”.
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21. Most economies wobble
between period of rapid growth
and periods of slow growth or
even decline.
It might look like this:
Now the we understand the REAL GDP,
we can analyze changes in an economy
Growth begins…Then accelerates…And eventually tops
out.
Every so often, the
economy even
retracts.
This up and down pattern of economic
growth is referred to as the BUSINESS
CYCLE…a Key Learning Outcome.
Source: Pretend, made up data by Sean  Slide 21 of 46

22. The business cycle has four phases
• Peak
– The high point, a temporary maximum
• Trough
– Output has “bottomed out”
• Recession
– Real GDP, income and employment is declining
• Expansion (also called a recovery)
– Real GDP, income, and employment are rising Here we see U.S. Real
GDP from 1990 to
2003.
Note how it has grown
from 1990 to 2003 but
not steadily.
In fact, it declined in
both 1990 ad
2001…each of which
were recessions.
That is the core of this
chapter. Over the long
term, we expect the
economy to grow…
In the short run, we
see these minor
fluctuations. This
chapter studies their
causes and their
impacts.
These are actual historical phases of the U.S.
business cycle. You’ll see them numerous times
in your life. They are a Key Learning
Outcome…But even more, knowing them is an
important skill for any business person!
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23. One cause is “momentous
innovation”.
Why isn’t growth more regular?…In other words,
What are some of the causes the business cycle?
New developments such as the
railroad, the microchip, and cell
phones have all ushered in an
era of new growth.
Another cause is productivity.A good example of this is the
feminization of the workforce.
Prior to the 1960s, many women
did not work.
As they entered the workforce in
large numbers in the 1960s, the
amount we produced increased.
In economic terms, the use of
this resource caused Real GDP
to increase more
rapidly…leading to an expansion!
There are other factors that
cause the business cycle such as
political events, war, terrorism
and many more
Each either adds to or takes
away from growth causing that
irregular pattern.
In other words, our economy is
CYCLICAL!
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24. Dates of last 10 business
cycles in the U.S.
Here are the dates for the
peak and trough in each of
the last 10 business cycles.
These are estimated by
NBER, the National Bureau
of Economic Research.
Look at it this way: In
October 1949, an expansion
started. It lasted 45 months.
When it ended, we went
through a recession that
lasted 10 months.
You do NOT need to
memorize any of these
numbers.
But study the pattern –
which is longer recessions
or expansions?
How long can you expect an
expansion or recession to
last…in general?
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25. An Irregular Pattern Indeed!
What we observe is that
even this pattern is irregular.
Sometimes, expansions last
120 months…that is ten
years!
Other times they can be
much shorter. In the early
1980s we suffered through
back to back recessions in
what is called a “Double
Dip”.
Some recessions can be
short…like this 8 month
recession.
Others, like our most recent
can be much longer. The
recession resulting from the
financial crisis lasted 18
months!
Here is what you need to know:
The average expansion lasts
about 60 months. The average
recession lasts about 10
months.
Knowing these numbers can help you plan.
Being aware of where you are in the
business cycle can help with decisions like:
“Should I open a business?”
“Should I get a graduate degree?”
“Is this a good time to quit my job and
change careers?”
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26. Let’s turn our attention to the
byproducts of the business cycle
When an economy is growing
to slowly, unemployment
usually occurs. Think of this
as an economy that is to
COOL! Business is slow and
people are being laid off.
When an economy is growing to
quickly, inflation usually occurs.
Think of this as an economy that
is to HOT! Supply can’t keep up
with a rapidly growing demand
and prices start getting bid up.
This irregular pattern of
growth has consequences.
We’ll study two of them.
The first is UNEMPLOYMENT
The second is INFLATION
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These byproducts or ‘problems’
(inflation and unemployment)
associated with the business cycle
are a key learning outcome!
We will focus a lot of out attention
on these two important variables!

27. Let’s turn our attention to
unemployment
Unemployment is the failure of
the economy to fully use its
labor force
Let’s assume we live in an
economy that has 100
people in it.
It includes:
10 children
It measures the fraction of
people that would like to work,
are able to work, and are
willing to work…but can not
find work.
15 retired people
75 working aged people
And 60 of them are working
The unemployment rate =
the number of people
unemployed divided by the
labor force.
Meaning there are 15 people
that want to work but are not.
In this scenario, the labor
force is 75…
And unemployment is 15…
So the unemployment rate
is 15/75, which is 20%
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28. Individual exercise
Try to determine the unemployment rate for these two economies
? ?
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29. What has been the U.S.
experience with unemployment?
Like many economic indicators, it is
volatile.
One thing you might note: it has taken longer for the unemployment
rate to start falling after the last several recessions have ended. This
is due to a reluctance on the part of business to hire until they are
sure we are recovering and is called a “jobless recovery”.
You might also
note the recent
spike…the last
recession was
certainly painful.
Periods in the grey bars are
recessions. Periods in the white
sections are expansions
(recoveries). As we would expect,
unemployment goes up in
recession and falls afterwards.
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30. In our nation’s worst recession,
unemployment hit 25%
In the Great Depression, one
in four men were unemployed.
There were no social
programs like unemployment
insurance.
If you were out of work, you
were on your own. Many
people lost everything.
In some cases,
private citizens or
businesses gave
bread to
unemployed men.
This man might
have been on a
“bread line”.
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31. Unemployment rates in the U.S.
are relatively low
Once again, proof that we are fortunate to
live in a big stable economy.
We are lucky. Imagine
trying to get a job in
Zimbabwe with 90%
unemployment.
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32. Unemployment can be
classified into three types
• Frictional – voluntary movement from one
job to another. “Between jobs”.
• Structural – unemployment due to
changes in industrial composition or
geographical distribution of business
• Cyclical – unemployment due to the cycle
of the economy
This type isn't bad.
Typically, this means an
employee is leaving
voluntarily because they
have a better job
coming.
Example: the recent
Ford plant shutdown.
While painful for
employees it is usually
beneficial for the
company.
This is the one that
really hurts. There just
aren’t enough jobs to go
around.
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33. No, some unemployment is
expected
Specifically, we want:
Frictional
Structural
This is a sign of
improvement!
Full employment rate of unemployment
(natural rate of unemployment or NRU)
Is an unemployment rate of zero a reasonable goal?
The natural rate of
unemployment (which means
we are at Full Employment) is
between 4% and 6%
It includes frictional and
structural unemployment but
does not include cyclical
unemployment.
XWe’ll discuss full
employment and the natural
rate of unemployment (NRU)
a lot this semester. Make
sure you understand it! Slide 33 of 46

34. How does the current unemployment
rate compare to this standard?
At around 7.6%, we
are out of the
normal range!
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35. Let’s look at Inflation - the second
byproduct of economic instability
The technical definition of inflation:
a persistent, substantial rise in the
general level of prices
I am sure you have noticed increased prices in the grocery store.
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36. How is inflation measured?
Most commonly measured using
the Consumer Price Index (CPI)
published by the Bureau of Labor
Statistics (BLS).
The Federal Government's Bureau
of Labor Statistics collects data on
hundreds of goods that we all
routinely buy.
These things include gas, milk,
bread, TVs, cars, and many other
things.
They then use this data to develop
a “Price Index”.
Think of it this way: If that “Basket
of goods” cost $2000 in 1990 and
cost $2500 today, they could
assume prices have gone up by
25% (which is $500/$2000).
This is the same price index we
used earlier to adjust nominal GDP
data.
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37. Calculating a Price Index
To develop the “Price Index, you
first select a year…any year.
Then you compare the price of that
basket of goods in that year to all
other years.
Year
Let’s try an example.
Say we pick the year 2000 for our
base year…
Price of the basket
of goods Price Index
2000 $10,000 100
2001 $11,000 110
That’s $10,000 divided by
$10,000 times 100.
That’s $11,000 divided by
$10,000 times 100.
2002 $13,000 130
That’s $13,000 divided by
$10,000 times 100.
2003 $17,000 170
That’s $17,000 divided by
$10,000 times 100.
Now that we understand the CPI, we
can look at its history to see how
prices have changed in the U.S.
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38. The Consumer Price Index (CPI)
Here are the actual data.For this graph, the government has
used 1983 as its base year.
The index will always equal 100 in
the base year.
In 1975, it equaled 50, meaning
things cost half as much then as
they did in 1983.
That suggests a rapid increases in
prices between 1976 and 1983. If
you were alive (as an adult) then…I
bet you remember that.
Move forward to 2007, where the
CPI was 200. That means prices
doubled between 1983 and
2007…a much more modest period
of price increases.
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39. Inflation is relatively low in the U.S. (and
most all other developed countries)
However price increases are modest in the
U.S.
Inflation in Zimbabwe is
has reached more than
1 million percent!
That means prices
double everyday!
Can you even imagine
living in an environment
like that?!?!
Once again, proof that we are fortunate to
live in a big stable economy.
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40. The opposite side of the coin:
Deflation
During the great depression, the
U.S. experienced a relatively long
period of price decline or
stagnation.
For example, something that cost
$1.00 in 1920… …Cost $0.68 by 1933
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41. What is the problem with deflation?
The #1 problem: It reduces demand.
No one buys anything because
everyone thinks it will be cheaper
tomorrow.
Shop keepers get desperate and lower
prices. This becomes a self fulfilling
prophecy!
That is called a “Deflationary
spiral”
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42. Sometimes inflation
can get out of control
As people start expecting inflation
to occur, they build it into contracts
and regularly add it to prices.
Eventually, this can become a self
fulfilling prophecy.
People expect higher prices, so
they charge more… which leads to
higher prices.
If that happens long enough, price
increases can get out of control-
that is called hyperinflation.
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43. Examples of bad hyperinflation:
Germany
Germany went through its
worst inflation in 1923-24.
After losing World War I,
winning countries demanded
payment for damages.
The German government
decided to simply print the
money.
That meant that more money
was chasing the same amount
of goods and services, so
prices started to rise.
Prices got so high, they had to
print a bill with the number
100,000,000,000,000 on it to
accommodate high prices!
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44. When prices start to spiral
upward, governments print
bigger bills to accommodate
high prices.
Here are some examples of large
bills printed in the past:
With bad inflation, bills get big
Italy: 10,000 Lira
Croatia: 100,000 Dinara
Yugoslavia: 10 billion Dinara
Zimbabwe: 100 Trillion Zim Dollars
Can you imagine carrying around
bills of that size?
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45. Inflation overview
We have learned that
hyperinflation is bad.
We have learned that deflation
is bad.
Developed economies try to
walk a fine line…
Keep a little bit of inflation
around to avoid deflation- but
don’t let it get out of control!
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46. What does a healthy economy look like?
A government’s goal is to promote
economic growth without igniting inflation.
Strong economic growth drives down
unemployment.
The best recent U.S. example of this type
of growth was the 1990s “Tech Boom”.
Growth was strong, unemployment was
low and inflation was low but above zero.
That is why some called the 1990s expansion
(which had a lot of growth with little inflation)
“The Goldilocks Economy”!)
It wasn’t too cool
and it wasn’t too
hot!
Just right!
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47. In summary
A nation’s total output can be measured by adding
the value of all products produced or all income
earned. That will equal Gross Domestic Product.
Unfortunately, GDP wobbles from rapid growth to
decline. That wobbling is a pattern that repeats over
time and is called the business cycle.
Over time, prices change so when comparing GDP
from one year to another, we must adjust for
inflation.
When GDP is adjusted for inflation, it is called Real
GDP or RGDP.
Economists, politicians and others use RGDP to
measure the health of our economy!
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