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Economics 2 Professor Christina Romer Spring 2017 Professor David Romer LECTURE 15 MACROECONOMIC VARIABLES AND ISSUES March 9, 2017 I. M ACROECONOMICS VERSUS M ICROECONOMICS II. R EAL GDP A. Definition B. Nominal GDP and real GDP C. A little

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Economics 2 Professor Christina Romer Spring 2017 Professor David Romer LECTURE 15 MACROECONOMIC VARIABLES AND ISSUES March 9, 2017 I. MACROECONOMICS VERSUS MICROECONOMICS

  • II. REAL GDP
  • A. Definition
  • B. Nominal GDP and real GDP
  • C. A little about measuring GDP
  • D. Facts
  • 1. Strong upward trend
  • 2. Huge differences across countries
  • 3. Short-run fluctuations
  • III. UNEMPLOYMENT
  • A. Measurement
  • B. Facts
  • 1. The normal unemployment rate is not zero
  • 2. Fluctuations in unemployment are negatively correlated with real GDP

growth

  • IV. INFLATION
  • A. Measurement
  • B. Facts
  • C. Why do we care about inflation?
  • D. Adjusting for price changes
  • E. Quality changes and new goods in calculating inflation
  • V. OVERVIEW OF MACRO FRAMEWORK
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LECTURE 15

Macroeconomic Variables and Issues

March 9, 2017

Economics 2 Christina Romer Spring 2017 David Romer

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Announcements

  • Research reading for Tuesday, March 14 (by

William Nordhaus):

  • Read only the assigned pages.
  • Read for approach and findings; think about

relevance for the measurement of inflation and growth in standards of living.

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  • I. MACROECONOMICS VERSUS MICROECONOMICS
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Macroeconomics

  • Definition:
  • The study of the aggregate economy.
  • Concerned with:
  • Total output.
  • Aggregate price level and inflation.
  • The unemployment rate.
  • The overall level of interest rates; the

exchange rate; overall exports and imports.

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  • II. REAL GDP
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Real Gross Domestic Product (Real GDP)

  • The market value of the final goods and services

newly produced in a country during some period

  • f time, adjusted for price changes.
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Nominal GDP

  • Nominal GDP: The market value of the final goods

and services newly produced in a country during some period of time, not adjusted for price changes.

  • Thus, for the United States, it is measured in dollars.
  • Example: Nominal GDP in 2016 = ∑ P

i,2016 • Qi,2016, i

where i represents each possible good in the economy (and ∑ is the symbol for a sum).

  • Note that we use 2016 prices in computing 2016

nominal GDP, 2015 prices in computing 2015 nominal GDP, ….

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Calculating Real GDP

  • Choose a base year (for example, 2009), and

always use prices from the base year to multiply the quantities.

  • Example: If 2009 is the base year:

2016 real GDP = ∑ P

i,2009 • Qi,2016. i

  • That is, if 2009 is the base year, 2016 real GDP is

the answer to the question, “How much would all the final goods and services newly produced in the United States in 2016 have been worth at 2009 prices?”

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Growth Rate of Real GDP

  • The percentage change in real GDP from one year

to the next.

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A Little about Measuring GDP

  • Key points:
  • Final goods and services.
  • Newly produced.
  • Within the country.
  • In some period of time.
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3 Approaches to Measuring GDP

  • Expenditure: Use market prices and the quantities of

final goods.

  • Can divide into consumption (C), investment (I),

government purchases (G), and net exports (NX).

  • Production (value added): follow goods through each

stage of production.

  • Income: Income from producing new goods and

services within the country.

  • Can divide into labor income and capital

income.

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Real GDP in the United States, 1950–2016

Source: FRED (Federal Reserve Economic Data); data from Bureau of Economic Analysis.

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Real GDP per Capita in the U.S., 1950–2016

Source: FRED; data from Bureau of Economic Analysis.

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GDP per Capita over Time and Regions

Source: Bloom and Sachs, “Geography, Demography, and Economic Growth in Africa.”

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U.S. Real GDP, 2004–2011

Source: FRED; data from Bureau of Economic Analysis.

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U.S. Real GDP, 1929–1940

Source: FRED; data from Bureau of Economic Analysis.

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U.S. Real GDP, 2011–2016

Source: FRED; data from Bureau of Economic Analysis.

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  • III. UNEMPLOYMENT
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Definitions

  • Employed: The number of people who are

working.

  • Unemployed: The number of people who are not

working and who are actively looking for work.

  • Labor force: Employed + unemployed.
  • Unemployment rate:

u = Unemployed Labor force • 100.

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The U.S. Unemployment Rate, 1948–2017

Source: FRED; data from Bureau of Labor Statistics.

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The Natural Rate of Unemployment

  • The economy’s normal or usual unemployment

rate.

  • The natural rate of unemployment is more than

zero.

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Real GDP Growth (Percent, Red) and Change in the

  • Unemp. Rate (Percentage Points, Blue), 1961–2016

Source: FRED; data from Bureau of Economic Analysis and Bureau of Labor Statistics.

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  • IV. INFLATION
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Calculating the Consumer Price Index

  • Choose a base year (for example, 1983), and find the

basket of goods and services households purchased in 1983.

  • Then the CPI in 2016 is:

CPI2016 = Price of 1983 market basket in 2016 Price of 1983 market basket in 1983 • 100.

  • That is, if 1983 is the base year, the 2016 CPI is the

answer to the question, “By what ratio would households’ spending have to be higher in 2016 than it was in 1983 for them to buy the same things they bought in 1983?”

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Calculating the Consumer Price Index— Algebra

  • Choose a base year (for example, 1983), and

always use quantities from the base year to multiply the prices.

  • Then the CPI in 2016 is:

CPI2016 = ∑ P

i,2016 • Qi,1983 i

∑ P

i,1983 • Qi,1983 i

  • 100.
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Inflation

  • The percent change in a price index.
  • Example: the inflation rate from 2015 to 2016 is:

π2016 = P

2016 − P 2015

P

2015

  • 100.
  • Note: If inflation is negative, we say there is

“deflation.”

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U.S. Inflation (Percent Change in the Price Index for Personal Consumption Expenditures), 1953–2016

Source: FRED; data from Bureau of Economic Analysis.

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U.S. Inflation (Percent Change in the Price Index for Personal Consumption Expenditures), 1930–1933

Source: FRED; data from Bureau of Economic Analysis.

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Why Do We Care about Inflation?

  • An argument for not caring.
  • Redistribution.
  • Psychology.
  • Efficiency.
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Adjusting Variables for Price Changes

  • What would $X in Year A be equivalent to in terms of

Year B dollars? $X P

B

P

A

, where PA and PB are the price index in year A and year B.

  • Example: What was Richard Nixon’s final salary

equivalent to in today’s dollars?

  • His salary was $200,000; the CPI in August 1974

was 49.9; the CPI now is 244.2. Thus: $200,000 244.2 49.9 = $979,000.

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Quality Changes and New Goods in Calculating Inflation

  • If the quality of a good improves and its price

rises, we try to take out the part of the price increase that is due to the quality improvement (and count only the remainder in calculating inflation).

  • If there are new goods, we try to account for the

fact that they give households a new way of

  • btaining utility.
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Quality Changes, New Goods, and Real GDP

  • We can think of real GDP as nominal GDP divided by a

price index:

  • If 2009 is the base year, define:

GDP Price Indext = ∑ P

i,t • Qi,t i

∑ P

i,2009 • Qi,t i

. (∗)

  • Then our earlier definition of real GDP implies:

Real GDP

t =

Nominal GDP

t

GDP Price Indext .

  • In practice, rather than using a simple price index like

(*), we use a price index that tries to account for quality changes and new goods.

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  • V. OVERVIEW OF MACRO FRAMEWORK
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Determinants of the Long-Run Trend

  • Potential Output:

The amount of output (real GDP) that the economy can produce when using its resources at normal rates.

  • Key resources:
  • Labor
  • Capital
  • Technology
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Determinants of Short-Run Fluctuations

  • Aggregate demand:

The total demand for final goods and services.

  • Key features of the short-run model:
  • In the short run, output depends on aggregate

demand.

  • Developments in the private sector, monetary

policy, and fiscal policy all affect aggregate demand.

  • The level of output relative to potential affects

inflation, which in turn affects aggregate demand through monetary policy.

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SLIDE 37

International Macroeconomics

  • Interactions between aggregate economies.
  • Key issues:
  • Exchange rates
  • The trade deficit or surplus
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Real Broad Effective Exchange Rate for the U.S., 1994–2017

Source: FRED; data from Bank of International Settlements.

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Net Exports as a Share of GDP, 1975–2016

Source: FRED; data from Bureau of Economic Analysis.

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The Federal Funds Rate, 1954–2017

Source: FRED; data from Board of Governors of the Federal Reserve System.