59.Origins and issues of macroeconomics

Economists began to study economic growth, inflation, and international payments during the 1750s.

Modern macroeconomics dates from the Great Depression, a decade (1929-1939) of high unemployment and stagnant production throughout the world economy.

John Maynard Keynes book, The General Theory of Employment, Interest, and Money, began the subject.

Short-Term Versus Long-Term Goals

Keynes focused on the short-term—on unemployment and lost production.

“In the long run,” said Keynes, “we’re all dead.”

During the 1970s and 1980s, macroeconomists became more concerned about the long-term—inflation and economic growth.

Economic growth is the expansion of the economy’s production possibilities—an outward shifting PPF.

We measure economic growth by the increase in real GDP.

Real GDP—real gross domestic product—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.

61. Five widely agreed upon challenges for macroeconomic

policy are:

♦ Boost economic growth

♦ Keep inflation low

♦ Stabilize the business cycle

♦ Reduce unemployment

♦ Reduce the government and international deficits

Five widely agreed upon challenges for macroeconomic

policy are:

♦ Boost economic growth

♦ Keep inflation low

♦ Stabilize the business cycle

♦ Reduce unemployment

♦ Reduce the government and international deficits Achieving these challenges will help the economy.

The two general macroeconomic policy tools the government

has at hand to help attain the five goals are:

♦ Fiscal policy — setting and changing tax rates and

the amount of government spending. The federal

government can use fiscal policy in efforts to accomplish

some of the policy challenges.

♦ Monetary policy — changes in the interest rate

and the amount of money in the economy. Monetary

policy is under the control of the Federal Reserve,

or Fed. The Federal Reserve can use monetary

policy in order to meet some of the policy challenges.

61. GDP-The monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.

61. DP = C + G + I + NX

where: "C" is equal to all private consumption, or consumer spending, in a nation's economy "G" is the sum of government spending "I" is the sum of all the country's businesses spending on capital "NX" is the nation's total net exports, calculated as total exports minus total imports. (NX = Exports - Imports)

Nominal GDP measures the value of output during a given year using the prices prevailing during that year. Over time, the general level of prices tends to rise due to inflation (but may also fall, due to deflation), leading to an increase (or decrease) in nominal GDP even if the volume of goods and services produced is unchanged.

Real GDP measures the value of output in two or more different years by valuing the goods and services adjusted for inflation. For example, if both the "nominal GDP" and price level doubled between 1995 and 2005, the "real GDP " would remain the same. For year over year GDP growth, "real GDP" is usually used as it gives a more accurate view of the economy.

61. Economists use estimates of real GDP for two main purposes

1) To compare the standard of living over time,

2)To compare the standard of living across countries

Long-Term Trend

A handy way of comparing real GDP per person over time is to express it as a ratio of some reference year.

Two features of our expanding living standard are

■ The growth of potential GDP per person

■ Fluctuations of real GDP around potential GDP

The value of real GDP when all the economy’s labor, capital, land, and entrepreneurial ability are fully employed is called potential GDP.

Lucas wedge is the dollar value of the accumulated gap between what real GDP per person would have been if the 1960s growth rate had persisted and what real GDP per person turned out to be.

An expansion is a period during which real GDP increases.

Recession is a period during which real GDP decreases—its growth rate is negative—for at least two successive quarters

Standard of Living Across Countries

Two problems arise in using real GDP to compare living standards across countries:

1. The real GDP of one country must be converted into the same currency units as the real GDP of the other country.

2. The goods and services in both countries must be valued at the same prices.

Using the exchange rate to compare GDP in one country with GDP in another country is problematic because, prices of particular products in one country may be much less or much more than in the other country.

Limitations of Real GDP

Real GDP measures the value of goods and services that are bought in markets. Some of the factors that influence the standard of living and that are not part of GDP are

• Household production

• Underground economic activity

• Health and life expectancy

• Leisure time

• Environmental quality

• Political freedom and social justice

61. The Basics of Economic Growth

• The economic growth rate is the annual percentage change of real GDP. This growth rate is equal to:

Real GDP growth rate =

(RealGDPincurrentyear-RealGDPinpastyear/Realgdpinpastyear)*100

• The standard of living depends on real GDP per person, which is real GDP divided by the population. The growth rate of real GDP per person can be calculated using the formula above, though substituting real GDP per person.

• The growth rate of real GDP per person also approximately equals the growth rate of real GDP minus the population growth rate.

• The Rule of 70 is useful for determining how long it will take for a variable to double. The Rule of 70 states that the number of years it takes for the level of any variable to double is approximately 70 divided by the annual percentage growth rate of the variable.