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Chapter 1 -- The Macro Goal Variables

Chapter 1 -- The Macro Goal Variables . Measures of Economy’s “Health” Definitions, Realistic Goals, and Recent (US) Performance. #1 -- Real Gross Domestic Product (Real GDP).

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Chapter 1 -- The Macro Goal Variables

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  1. Chapter 1 -- The Macro Goal Variables • Measures of Economy’s “Health” • Definitions, Realistic Goals, and Recent (US) Performance

  2. #1 -- Real Gross Domestic Product (Real GDP) • Real GDP (Y) -- The total production of final goods and services over a period of time, expressed in constant prices of a base year. • Why Real GDP (GDP in constant dollars), instead of Nominal GDP (GDP in current dollars)?

  3. Real GDP -- Realistic Goal • Realistic Goal for Real GDP -- to be as high as possible without accelerating inflation (overstimulated economy). • Can state this goal in a more formal way.

  4. The Natural Level of Real GDP (Potential Real GDP) • The Natural Level of Real GDP (YN) -- that level of real GDP in which inflation has no tendency to accelerate or decelerate.

  5. Comparing Real GDP to the Natural Level of Real GDP Y < YN -- sluggish economy with decelerating inflation (inflation rate) Y > YN -- economy with accelerating inflation Y = YN -- economy with constant inflation rate

  6. Characteristics of YN • Unobservable • Grows at 2.5% per year for the US • Affected by -- labor productivity -- the price of energy -- the capital stock -- the labor force

  7. Getting and Keeping Y at YN: The “Two Cars” • If Y = YN, then seek annual real GDP growth = 2.5%. • If Y < YN, then seek annual real GDP growth > 2.5%, for awhile. • If Y > YN, then seek annual real GDP growth < 2.5%, for awhile. • Special Case -- The Recession

  8. Goal Variable #2 -- The Inflation Rate • Inflation Rate -- the growth or percentage change in the overall price level. • First, measure the price level (P). -- Consumer Price Index (CPI) -- GDP Deflator • Inflation Rate = Percentage Change in P

  9. Realistic Goal -- Inflation • Ideal Goal: Inflation Rate = 0%. • Realistic Goal (US): |Inflation Rate| < 3%.

  10. An Inflation Problem Versus Accelerating Inflation • Inflation Problem -- |Inflation Rate| < 3%. • Accelerating Inflation -- Inflation Rate • Consider -- Inflation Rates of 1981 versus 1985 (Y = YN) 1981 Inflation Rate = 9.0% 1985 Inflation Rate = 2.5%

  11. Goal Variable #3 -- The Unemployment Rate (u) u = (# of people unemployed) (total labor force) Does not measure -- discouraged workers -- part-time versus full-time employment -- people with multiple jobs

  12. Types of Unemployment • Frictional Unemployment -- Unemployment due to normal labor market frictions. • Structural Unemployment -- Unemployment due to a mismatch of available workers and jobs. • Cyclical Unemployment -- Unemployment due to a generally slow economy.

  13. Realistic Goal -- Unemployment Rate • Realistic Goal -- zero cyclical unemployment • Natural Rate of Unemployment (uN) -- The unemployment rate in which inflation has no tendency to accelerate or decelerate. • Realistic Goal: u = uN

  14. Interpretation: u versus uN • u = uN Inflation Rate Unchanged (Desired State of Economy) • u > uN Inflation Rate (Sluggish Economy) • u < uN Inflation Rate (Overstimulated Economy)

  15. Real GDP and the Unemployment Rate • u = uN Y = YN, (Desired State of Economy) • u > uN Y < YN, (Sluggish Economy) • u < uN Y > YN, (Overstimulated Economy)

  16. Goal Variable #4 -- The Federal Budget • Budget = Tax Revenues - Government Expenditure (over a given period) • Budget = Tax Revenues - (Government purchases of goods and services + Transfer Payments + Interest on the National Debt)

  17. Budget Definitions • Budget < 0 -- Budget Deficit • Budget > 0 -- Budget Surplus • Budget = 0 -- Balanced Budget

  18. Realistic Goal -- The Federal Budget • Realistic Goal -- Balanced Budget when Y = YN. • Sluggish economies tend toward deficits. • Hierarchy of economic problems.

  19. Goal Variable #5 -- The Balance of Trade • Balance of Trade (BOT) -- approximated by net exports. • BOT = Exports - Imports • BOT < 0 -- Balance of Trade Deficit • BOT > 0 -- Balance of Trade Surplus • BOT = 0 -- Balanced Trade Position

  20. Realistic Goal -- Balance of Trade • Realistic Goal -- BOT close to zero.

  21. Diagnosing the “Patient” -- The Current US Economy and Prospects For the Near Future

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