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Unit 3 Macroeconomics

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Key Issues in Macroeconomics 1. Macroeconomic Indicators (Chapters 12 and 13- Friday and Monday) Gross Domestic Product (World Factbook)World Factbook Employment (The Vast Effects of Joblessness)The Vast Effects of Joblessness Inflation (Calculator)Calculator Health of Financial Institutions 2. Domestic Policy (Chapters 14, 15 and 16-Tuesday and Wednesday) Domestic Policy Fiscal Policy Monetary Policy 3. Foreign Policy (Chapters 17 and 18- Thursday and Friday) Globalization Trade Humanitarian Aid 4. Quiz (Monday) 5. Project (Due Tuesday) Macroeconomics Project

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Gross Domestic Product The main indicator used to determine overall health of the economy is gross domestic product (GDP) which is the dollar value of all final goods and services produced within a countrys borders in a given year. Breaking down the definition: Value Produced (based on current market prices) Final good or service A good or service that is produced for its final user and not as a component of another good or service Not an intermediate good or service (A good or service that is produced by one firm, bought by another firm, and used as a component of a final good or service) Gross domestic product is used by the government to analyze upcoming business cycles to determine prosperity, recession or depression.

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MEASURING U.S. GDP The Expenditure Approach Measures GDP by using data on consumption expenditure, investment, government expenditure on goods and services, and net exports. Expenditures Not in GDP Used Goods- Expenditure on used goods is not part of GDP because these goods were part of GDP in the period in which they were produced and during which time they were new goods. Financial Assets- When households buy financial assets such as bonds and stocks, they are making loans, not buying goods and services.

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MEASURING U.S. GDP The Income Approach Measures GDP by summing the incomes that firms pay households for the factors of production they hire. Incomes are divided into two big categories: Wages- (Compensation of employees) The payment for labor services. It includes net wages and salaries plus fringe benefits paid by employers such health care insurance, social security contributions, and pension fund contributions. Interest, rent, and profit- (Net operating surplus) The sum of the incomes earned by capital, land, and entrepreneurship. oInterest is the income households receive on loans they make minus the interest they pay on their borrowing. oRent includes payments for the use of land and other rented inputs. oProfit includes the profits of corporations and small businesses.

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MEASURING U.S. GDP Statistical Discrepancy The income approach and the expenditure approach do not deliver exactly the same estimate of GDPthere is a statistical discrepancy (the discrepancy between the expenditure approach and income approach estimates of GDP, calculated as the GDP expenditure total minus the GDP income total)

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MEASURING U.S. GDP vs. GNP Gross national product or GNP- The market value of all the final goods and services produced anywhere in the world in a given time period by the factors of production supplied by residents of the country. U.S. GNP = U.S. GDP + Net factor income from abroad GDP vs. GNP Annual income earned by US owned firms and citizens regardless of origin.

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THE LIMITATIONS OF GDP Standard of Living Across Countries Non-market Activities Household production Underground production Quality of Life Environment quality

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Unemployment

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LABOR MARKET INDICATORS Two Main Labor Market Indicators The unemployment rate (The percentage of people in the labor force who are unemployed.) The labor force participation rate (The percentage of the working-age population who are members of the labor force.) Unemployment rate = Number of people unemployed x 100 Labor force Labor force participation rate = Working-age population x 100 Labor force

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SOURCES AND TYPES OF UNEMPLOYMENT Types of Unemployment Frictional unemployment The unemployment that arises from normal labor turnoverfrom people entering and leaving the labor force and from the ongoing creation and destruction of jobs. Structural unemployment The unemployment that arises when changes in technology or international competition change the skills needed to perform jobs or change the locations of jobs. Seasonal unemployment The unemployment that arises because of seasonal weather patterns. Cyclical unemployment The fluctuating unemployment over the business cycle that increases during a recession and decreases during an expansion.

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SOURCES AND TYPES OF UNEMPLOYMENT Duration and Demographics of Unemployment On the average from 1995 to 2005, blacks experienced more than twice the unemployment rate of whites.

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SOURCES AND TYPES OF UNEMPLOYMENT Duration and Demographics of Unemployment Teenagers experienced more than three times the unemployment of workers aged 20 and over. Women have lower unemployment rates than men.

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Full Employment Full employment When there is no cyclical unemployment or, equivalently, when all the unemployment is frictional, structural, or seasonal. Natural unemployment rate The unemployment rate when the economy is at full employment.

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SOURCES AND TYPES OF UNEMPLOYMENT Unemployment and Real GDP Cyclical unemployment is the fluctuating unemployment over the business cycleunemployment increases during recessions and decreases during expansions. At full employment, there is no cyclical unemployment. At the business cycle trough, cyclical unemployment is positive. At the business cycle peak, cyclical unemployment is negative.

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The figure below shows the unemployment rate in the United States from 1975 to 2005. As the unemployment rate fluctuates around the natural rate unemployment SOURCES AND TYPES OF UNEMPLOYMENT Cyclical unemployment is negative (shaded red) and positive (shaded blue).

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Inflation

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Going.UP!!!!!!!!!! Inflation is a general increase in prices. Purchasing power (the ability to purchase goods and services) is decreased by rising prices. A price index is a measurement that shows how the average price of a standard group of goods changes over time. The consumer price index (CPI) is computed each month by the Bureau of Labor Statistics. The CPI is determined by measuring the price of a standard group of goods meant to represent the typical market basket of an urban consumer. What is in the market basket? There are over two hundred categories of products that are included in the basket. These categories fall under 8 major groups: FOOD AND BEVERAGES HOUSING APPAREL TRANSPORTATION MEDICAL CARE RECREATION EDUCATION/COMMUNICATION OTHER GOODS AND SERVICES

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Inflation Theory 1. Quantity Theory- Too much $ in the economy 2. Demand-Pull- Demand exceeds supply 3. Cost-Push- Increased input costs for the supplier

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The impact of inflation High inflation is a major economic problem, especially when inflation rates change greatly from year to year. The three main problems are: Reduced Purchasing Power Erosion of Interest Income Erosion of Wages

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The Financial System The United States financial system includes banks, securities exchanges, pension funds, insurers, the Federal Reserve and national regulators. These firms and institutions: 1. Provide infrastructure for economic transactions 2. Channel funds from savings to investment 3. Control monetary policy A sound financial system is essential for macroeconomic growth and financial stability.

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Result of Instability in the Financial System 1. Diminished monetary policy 2. Prolonged economic downturn 3. Capital flight 4. Costs of rescue 5. Impact global markets

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Managing the Economy Types of Economic Policies Fiscal Policy: Tax and spend (the federal budget). Handled primarily by Congress and the President. Monetary Policy: Regulation of the money supply. Handled primarily by the Federal Reserve Board (the Fed). Types of Economic Policies Fiscal Policy: Tax and spend (the federal budget). Handled primarily by Congress and the President. Monetary Policy: Regulation of the money supply. Handled primarily by the Federal Reserve Board (the Fed). Economic Theories for Managing the Economy: 1.Keynesian economics: Government can manipulate the health of an economy through spending 2.Supply-side economics: Cuts in taxes will produce business investment that will offset loss of money due to lower taxes 3.Monetarism: Money supply is the most important factor for determining the health of the economy 4.Economic planning: The free market is unstable and therefore the government must plan parts of the countrys economic activity Economic Theories for Managing the Economy: 1.Keynesian economics: Government can manipulate the health of an economy through spending 2.Supply-side economics: Cuts in taxes will produce business investment that will offset loss of money due to lower taxes 3.Monetarism: Money supply is the most important factor for determining the health of the economy 4.Economic planning: The free market is unstable and therefore the government must plan parts of the countrys economic activity

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Funding the Government We authorize the government, through the Constitution and elected officials, to raise money through taxes. We authorize the government, through the Constitution and elected officials, to raise money through taxes. Taxation is the primary way that the government collects money. Taxation is the primary way that the government collects money. Without revenue, or income from taxes, government would not be able to provide public goods and services. Without revenue, or income from taxes, government would not be able to provide public goods and services. The Power to Tax Article 1, Section 8, Clause 1 of the Constitution grants Congress the power to tax. The Sixteenth Amendment gives Congress the power to levy an income tax. Limits on the Power to Tax 1. The purpose of the tax must be for the common defense and general welfare. 2. Federal taxes must be the same in every state. 3. The government may not tax exports.

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Tax Structures Proportional Taxes (PA State Tax) Proportional Taxes (PA State Tax) A proportional tax is a tax for which the percentage of income paid in taxes remains the same for all income levels. Progressive Taxes (Federal Income Tax) Progressive Taxes (Federal Income Tax) A progressive tax is a tax for which the percent of income paid in taxes increases as income increases. Regressive Taxes (Sales Tax) Regressive Taxes (Sales Tax) A regressive tax is a tax for which the percentage of income paid in taxes decreases as income increases.

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Spending Categories Mandatory Spending Money that lawmakers are required by law to spend Interest payments on the national debt Entitlement programs (Social Security, Medicare and Medicaid) Discretionary Spending Money that government planners can choose how to spend. Defense Education Training Environmental cleanup National parks and monuments Scientific research Land management Farm subsidies Foreign aid

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Source of Federal Revenue Social Security and Medicare Taxes (21%) Unemployment Taxes (12%) Federal Income Taxes (49%) Corporate Taxes (10%) Excise Taxes (3%) Other (4%) Estate Taxes Gift Taxes Import Taxes The Presidents Message on the 2010 budget

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Taxing and Spending Entitlements: Programs where money is automatically spent without annual review of programs. 1.Social Security 2.Medicare 3.Federal Pensions 4.Interest on National Debt Makes up almost 2/3 of federal budget Problem because Congress and the President cannot control much of spending...wait till 2040! Entitlements: Programs where money is automatically spent without annual review of programs. 1.Social Security 2.Medicare 3.Federal Pensions 4.Interest on National Debt Makes up almost 2/3 of federal budget Problem because Congress and the President cannot control much of spending...wait till 2040!

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Budget Process 1. Agencies prepare their budget needs and submit to Presidents Office of Management and Budget (OMB) 2. OMB makes recommendations to President 3. President submits budget to Congress 4. Congressional Budget Office (CBO) checks Presidents budget 5. Ways and Means committee in House review taxes and revenues. 6. Appropriations committee review spending 7. Agencies lobby for money 8. Majority vote in both houses passes budget 9. President signs or vetoes bill (no line-item veto)

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The Federal Budget Debate

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The Federal Reserve The Federal Reserve (Fed) serves as the nations central bank, which is designed to oversee the banking system and regulate the quantity of money in the economy. The Fed is a privately owned institution, authorized in 1914 by Congress to ensure the health of the nations banking system. The Fed is run by its Board of Governors. Seven members appointed by the President of the United States. The Chairman of the Board is the most important position: presiding, directing, and testifying about Fed policy. He is appointed by the President and confirmed by the Senate. The Federal Reserve System is made up of the Federal Reserve Board in Washington, D.C. and twelve regional Federal Reserve Banks.

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Three Primary Functions of the Fed Regulate the private banking industry to make sure banks follow federal laws intended to promote safe and sound banking practices. Act as a bankers bank, making loans to other banks and as a lender of last resort. Control of the supply of money