Chapter 19: What Macroeconomics is All About
- Macroe is concerned w/ the behaviour of economic aggregates and averages (eg. total
output, total investment) and how they may be influenced by gov’t policy
- A full understanding of macroe requires understanding short run fluctuations and long
run economic growth
- Economic growth: how investments and tech change affect our living standards over
long periods of time
National Product and National Income
- National product/ output: total production of goods and services which generates
income. It measures a national’s overall level of economic activity
- All economic value that’s produced belongs to someone in the form of an income claim
on that value
- National product= national income
Aggregation
- Add up the values of the many goods and services produced to measure national
income
- Nominal national income: # of units of each good produced x price at which each unit is
sold. This is measured in dollars
- Current dollar national income
- Real national income: to determine the extent to which change is due to quantities or the
price at which they’re sold.
- Changes only when quantities change
- Constant dollar national income
- Current output measured at constant prices
- Sum of quantities valued at prices that prevailed in base period
Recent History
- Long term economic growth: positive trend that increases real output
- Recessions: periods where GDP falls
- Real GDP measures the quantity of total output produced by the nation’s economy
during a year
- Business cycle: continual ebb and flow of business activity that occurs around the long
term end
- Eg. a cycle will include intervals of quickly growing output and intervals of slowly growing
or falling output
Potential Output and the Output Gap
- National output rep what the economy actually produces
- Potential output: level of output the economy would produce if all resources were fully
employed
- Y= actual output. Y*= potential output
- Output gap: Y - Y*
, - Recessionary gap: when Y<Y* the gap measures the market value of goods and
services that are not produced bc the economy’s resources are not fully employed
- Inflationary gap: when Y>Y* the gap measures the market value of production in excess
of what the economy can produce. This causes an upward pressure on wages and
prices
Why National Income Matters
- When actual GDP is below potential GDP, economic waste and human suffering result
from the failure to employ the economy’s resources
Employment, Unemployment, and the Labour Force
- Employment: workers 15 and over who have jobs
- Unemployment: workers who are not employed but are actively searching for a job
- Labour force: total # of ppl who are either employed or unemployed
- Unemployment rate: # of ppl unemployed/ # of ppl in the labour force x 100%
Frictional, Structural, and Cyclical Unemployment
- Full employment: when the economy is at potential GDP
- There’s still some unemployment when economy is at potential GDP bc
- 1. Frictional unemployment: constant change in job opportunities caused by
turnover of labour. New ppl enter the workforce, some ppl quit their jobs, some
get fired
- 2. Structural unemployment: there’s mismatch between characteristics of the
labour force and characteristics of the available jobs
- Cyclical unemployment rises and falls with the ebb and flow of business cycle
- Unemployment rate is seasonally adjusted
Why Unemployment Matters
- Involves economic waste and human suffering
- Loss of income pushes ppl to poverty
- Crime, mental illness, and social unrest are associated w/ unemployment
Productivity
- Canadian real GDP has increased steadily for years, reflecting on steady growth in
productive capacity bc
- Employment has significantly increased
- Stock of physical capital (machines, buildings) used to produce output, has
increased over time
- Productivity (a measure of the amt of output that the economy produces per unit
of input) has increased almost every year
- Labour productivity: real GDP/ level of employment (total hrs worked)
- Significant increases in labour productivity over the years
Why Productivity Matters
, - Productivity growth is the largest cause of rising material living standards over long
periods of time
- Greater productivity is from better physical capital and greater skills
Inflation and the Price Level
- Def: the prices of goods and services are going up on avg
- Hyperinflation: way too high inflation
- Price level: avg level of all prices in the economy
- Rate of inflation: rate at which price level is rising
- Price index: avg prices of various goods and services depending on how important they
are
- When we construct a price index, all units are eliminated bc price index shows the price
of a basket of goods at some specific time relative to the price of the same basket of
goods in some base period
- Since price lvl is measured w/ an index #, its value at any specific time has meaning only
when it’s compared w/ its value at some other time
- Consumer price index (CPI): avg price of goods and services bought by a typical CAN
household
- Eg. value of CPI in 2019 was 133.8 and in 2017 it was 130.4.
- Rate of inflation: (133.8 - 130.4/ 130.4) x 100% = 2.6%
-
Why Inflation Matters
- Purchasing power of money: amt of goods and services that can be purchased w/ a
given amt of money
- Negatively related to the price level
- Eg. if a price lvl doubles, a dollar will buy half as much. If the price lvl halves, a
dollar will buy twice as much
- Inflation reduces the purchasing power of money. It also reduces the real value of any
sum fixed in nominal (dollar) terms
, - If households and firms anticipate inflation, they’ll be able to adjust many nominal prices
and wages to maintain their real values
- Unanticpiated inflation leads to more changes in the real value of prices and wages
- The economy’s allocation of resources will be affected more when there’s unanticipated
inflation
Interest Rates
- If a bank lends you money, it will charge you interest for the privilege of borrowing the
money
- Interest rate: price that’s paid to borrow money for a stated period of time
- Eg. 8% interest rate per year means you must pay 8 cents per year for every
dollar that’s borrowed
- Prime interest rate: rate that banks charge to their best business customers
- Bank rate: interest rate that the Bank of Canada charges on short term loans to
commercial banks like RBC
Interest Rates and Inflation
- Eg. your friend lends you $100 which is repayable in a year. The amt you pay her for
making this loan is determined by nominal interest rate. If you pay her $108, $100 is the
principal and $8 is the payment of interest
- Nominal interest rate is 8% per year
- The more the price level rises, the worse off your friend will be and the better the
transaction will be for you
- This is bc the more the price rises, the less valuable are the dollars that you use to repay
the loan
- Real interest rate: nominal interest rate - rate of inflation
- Nominal rate of interest adjusted for the change in the purchasing power of
money
- If price lvl remains constant, real rate of interest your friend earns is 8%
- If the price lvl rises by 8%, the real rate of interest is 0
- If she lends money at 8% in a year and prices rise by 10%, the real rate of interest she
earns is -2%
- The burden of borrowing depends on the real, not the nominal, rate of interest
- Eg. a 6% real rate is a greater real burden on borrowers than a 2% real rate
Why Interest Rates Matter
- Changes in interest rates affect the standard of living of savers and borrowers
- Eg. retirees will benefit when real interest rates rise while borrowers benefit from low real
interest rates
- Real interest rates has been less than nominal interest rates due to inflation
Interest Rates and Credit Flows
- A loan rep a flow of credit between lenders and borrowers w/ the interest rate rep the
price of this credit
- Macroe is concerned w/ the behaviour of economic aggregates and averages (eg. total
output, total investment) and how they may be influenced by gov’t policy
- A full understanding of macroe requires understanding short run fluctuations and long
run economic growth
- Economic growth: how investments and tech change affect our living standards over
long periods of time
National Product and National Income
- National product/ output: total production of goods and services which generates
income. It measures a national’s overall level of economic activity
- All economic value that’s produced belongs to someone in the form of an income claim
on that value
- National product= national income
Aggregation
- Add up the values of the many goods and services produced to measure national
income
- Nominal national income: # of units of each good produced x price at which each unit is
sold. This is measured in dollars
- Current dollar national income
- Real national income: to determine the extent to which change is due to quantities or the
price at which they’re sold.
- Changes only when quantities change
- Constant dollar national income
- Current output measured at constant prices
- Sum of quantities valued at prices that prevailed in base period
Recent History
- Long term economic growth: positive trend that increases real output
- Recessions: periods where GDP falls
- Real GDP measures the quantity of total output produced by the nation’s economy
during a year
- Business cycle: continual ebb and flow of business activity that occurs around the long
term end
- Eg. a cycle will include intervals of quickly growing output and intervals of slowly growing
or falling output
Potential Output and the Output Gap
- National output rep what the economy actually produces
- Potential output: level of output the economy would produce if all resources were fully
employed
- Y= actual output. Y*= potential output
- Output gap: Y - Y*
, - Recessionary gap: when Y<Y* the gap measures the market value of goods and
services that are not produced bc the economy’s resources are not fully employed
- Inflationary gap: when Y>Y* the gap measures the market value of production in excess
of what the economy can produce. This causes an upward pressure on wages and
prices
Why National Income Matters
- When actual GDP is below potential GDP, economic waste and human suffering result
from the failure to employ the economy’s resources
Employment, Unemployment, and the Labour Force
- Employment: workers 15 and over who have jobs
- Unemployment: workers who are not employed but are actively searching for a job
- Labour force: total # of ppl who are either employed or unemployed
- Unemployment rate: # of ppl unemployed/ # of ppl in the labour force x 100%
Frictional, Structural, and Cyclical Unemployment
- Full employment: when the economy is at potential GDP
- There’s still some unemployment when economy is at potential GDP bc
- 1. Frictional unemployment: constant change in job opportunities caused by
turnover of labour. New ppl enter the workforce, some ppl quit their jobs, some
get fired
- 2. Structural unemployment: there’s mismatch between characteristics of the
labour force and characteristics of the available jobs
- Cyclical unemployment rises and falls with the ebb and flow of business cycle
- Unemployment rate is seasonally adjusted
Why Unemployment Matters
- Involves economic waste and human suffering
- Loss of income pushes ppl to poverty
- Crime, mental illness, and social unrest are associated w/ unemployment
Productivity
- Canadian real GDP has increased steadily for years, reflecting on steady growth in
productive capacity bc
- Employment has significantly increased
- Stock of physical capital (machines, buildings) used to produce output, has
increased over time
- Productivity (a measure of the amt of output that the economy produces per unit
of input) has increased almost every year
- Labour productivity: real GDP/ level of employment (total hrs worked)
- Significant increases in labour productivity over the years
Why Productivity Matters
, - Productivity growth is the largest cause of rising material living standards over long
periods of time
- Greater productivity is from better physical capital and greater skills
Inflation and the Price Level
- Def: the prices of goods and services are going up on avg
- Hyperinflation: way too high inflation
- Price level: avg level of all prices in the economy
- Rate of inflation: rate at which price level is rising
- Price index: avg prices of various goods and services depending on how important they
are
- When we construct a price index, all units are eliminated bc price index shows the price
of a basket of goods at some specific time relative to the price of the same basket of
goods in some base period
- Since price lvl is measured w/ an index #, its value at any specific time has meaning only
when it’s compared w/ its value at some other time
- Consumer price index (CPI): avg price of goods and services bought by a typical CAN
household
- Eg. value of CPI in 2019 was 133.8 and in 2017 it was 130.4.
- Rate of inflation: (133.8 - 130.4/ 130.4) x 100% = 2.6%
-
Why Inflation Matters
- Purchasing power of money: amt of goods and services that can be purchased w/ a
given amt of money
- Negatively related to the price level
- Eg. if a price lvl doubles, a dollar will buy half as much. If the price lvl halves, a
dollar will buy twice as much
- Inflation reduces the purchasing power of money. It also reduces the real value of any
sum fixed in nominal (dollar) terms
, - If households and firms anticipate inflation, they’ll be able to adjust many nominal prices
and wages to maintain their real values
- Unanticpiated inflation leads to more changes in the real value of prices and wages
- The economy’s allocation of resources will be affected more when there’s unanticipated
inflation
Interest Rates
- If a bank lends you money, it will charge you interest for the privilege of borrowing the
money
- Interest rate: price that’s paid to borrow money for a stated period of time
- Eg. 8% interest rate per year means you must pay 8 cents per year for every
dollar that’s borrowed
- Prime interest rate: rate that banks charge to their best business customers
- Bank rate: interest rate that the Bank of Canada charges on short term loans to
commercial banks like RBC
Interest Rates and Inflation
- Eg. your friend lends you $100 which is repayable in a year. The amt you pay her for
making this loan is determined by nominal interest rate. If you pay her $108, $100 is the
principal and $8 is the payment of interest
- Nominal interest rate is 8% per year
- The more the price level rises, the worse off your friend will be and the better the
transaction will be for you
- This is bc the more the price rises, the less valuable are the dollars that you use to repay
the loan
- Real interest rate: nominal interest rate - rate of inflation
- Nominal rate of interest adjusted for the change in the purchasing power of
money
- If price lvl remains constant, real rate of interest your friend earns is 8%
- If the price lvl rises by 8%, the real rate of interest is 0
- If she lends money at 8% in a year and prices rise by 10%, the real rate of interest she
earns is -2%
- The burden of borrowing depends on the real, not the nominal, rate of interest
- Eg. a 6% real rate is a greater real burden on borrowers than a 2% real rate
Why Interest Rates Matter
- Changes in interest rates affect the standard of living of savers and borrowers
- Eg. retirees will benefit when real interest rates rise while borrowers benefit from low real
interest rates
- Real interest rates has been less than nominal interest rates due to inflation
Interest Rates and Credit Flows
- A loan rep a flow of credit between lenders and borrowers w/ the interest rate rep the
price of this credit
