UWW ECON 202 - Origins and Issues of Macroeconomics

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67 4A FIRST LOOK AT MACROECONOMICS*Key Concepts  Origins and Issues of Macroeconomics∗ Modern macroeconomics began during the Great De-pression, 1929–1939. The Great Depression was a decade of high unemployment and stagnant produc-tion throughout the world. Macroeconomics initially focused on short-term problems, such as high unem-ployment. Recently long-term problems, such as eco-nomic growth, are also considered vital.  Economic Growth Economic growth is the expansion of the economy’s production possibilities. It is measured by the increase in real gross domestic product, also called real GDP. Real GDP 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. Potential GDP is the quantity of real GDP that is produced when all the economy’s labor, capital, land, and entrepreneurial ability are fully employed. ♦ The productivity growth slowdown was the slow-ing of the growth rate of output per person that oc-curred during the 1970s. The periodic but irregular up-and-down movement in production is the business cycle. It occurs as real GDP fluctuates irregularly around potential GDP. A business cycle has four parts: ♦ Trough — the lower turning point, when a reces-sion ends and an expansion begins. ♦ Expansion — a period of time during which real GDP increases. ♦ Peak — the upper turning point, when an expan-sion ends and a recession begins. ♦ Recession — a period during which real GDP de-creases for at least two successive quarters. ∗ This is Chapter 20 in Economics. The most recent recession began in the first quarter of 2001 and ended in the third quarter of 2001. This recession was milder than previous recessions. ♦ Between 1972 and 2002, the growth rate of real GDP in the United States was about equal to that of the rest of the world but was more variable. ♦ Between 1992 and 2002, of the advanced econo-mies Japan grew the slowest and the newly industri-alized nations of Asia grew the fastest. The Lucas wedge is the accumulated loss of output that results from a slowdown in the growth rate of real GDP per person. The productivity growth slowdown of the 1970s has created a Lucas wedge of $48 trillion. The Okun gap (the output gap) is the gap between real GDP and potential GDP. The recessions since 1973 have created an accumulated Okun gap of $2.5 trillion. Economic growth expands future consumption possi-bilities. However, economic growth allows less current consumption as resources must be devoted to capital accumulation and might lead to more rapid depletion of resources and more pollution.  Jobs and Unemployment In 2003, 137 million people had jobs. More new jobs are created during expansions and jobs are lost during recessions. A person is unemployed if he or she does not have a job but is looking for work. The unemployment rate is the number of unemployed workers as a percentage of all the people who have jobs or are looking for one. ♦ Unemployment increases during a recession and decreases during an expansion. ♦ The average unemployment rate in the United States is higher than in Japan, but lower than in Canada and Europe. Unemployment is a serious problem because unem-ployed workers lose income and can find their future job prospects limited. ChapterCHAPTER 4 (20) 68 Inflation The price level is the average level of prices. Inflation occurs when prices rise. The inflation rate is the per-centage change in the price level. Deflation occurs when the inflation rate is negative so that the price level falls. In recent years, deflation has been rare in the United States. Inflation was high in the 1970s and early 1980s, but has been lower since then. The U.S. experience with inflation has been similar to that of other industrialized nations. Inflation reduces the value of money, so unpredictable inflation makes transactions spread over time more difficult to carry out. In times of high inflation, people use resources to predict inflation rather than to produce goods and services. A hyperinflation is a period when the inflation rate exceeds 50 percent per month. At such rates, inflation causes economic chaos.  Surpluses and Deficits A government budget surplus occurs when the gov-ernment collects more in taxes than it spends; a gov-ernment budget deficit occurs when the government spends more than it collects in taxes. The U.S. federal government had a surplus between 1998 to 2000 and a deficit after 2001. The current account balance equals exports minus imports plus interest income minus interest expense. Payments greater than (less than) receipts create a cur-rent account deficit (surplus). The United States has had a current account deficit since 1980. Deficits used to finance investment are not necessarily harmful; deficits used to finance consumption may be troublesome because such deficits do not create the income necessary to repay the debt incurred.  Macroeconomic Policy Challenges and Tools 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 gov-ernment 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 ac-complish some of the policy challenges. ♦ Monetary policy — changes in the interest rate and the amount of money in the economy. Mone-tary policy is under the control of the Federal Re-serve, or Fed. The Federal Reserve can use monetary policy in order to meet some of the policy chal-lenges. Helpful Hints 1. THE MACROECONOMIC CHALLENGES : The chap-ter discusses five widely agreed upon macroeco-nomic challenges. As you study the forthcoming chapters, keep these challenges in mind because ul-timately we return to see what policies, if any, the government might adopt to help meet these goals. While these challenges are widely agreed upon, there is dispute among economists about ranking their importance as well as dispute about the proper polices necessary to attain some of them. The first disagreement matters because at times the goals collide, so that achieving one causes setbacks in others. In this


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