Chapter 6 & 9 Study Notes PDF

Chapter 6 & 8– Study notes Welcome to your first chapter in Macroeconomics! So what is Macroeconomics? It goes beyond the study of how markets work, and looks at how all markets work together to achieve our economic goals! We will be working in “totals” rather than specific prices or quantities. We...

Chapter 6 & 8– Study notes Welcome to your first chapter in Macroeconomics! So what is Macroeconomics? It goes beyond the study of how markets work, and looks at how all markets work together to achieve our economic goals! We will be working in “totals” rather than specific prices or quantities. We will look at “total” production (or total supply), total spending (or total demand), and price indexes (inflation or deflation) instead of just prices. But we will go further—we can use such things as the unemployment rate or the short-run expansion or contraction of production to judge how well the economy is doing. We also look at investment (remember, that is the purchase of new capital by firms) to judge how the capacity to produce (remember, that’s economic growth) is increasing. And, it is especially important to know whether we are in the long run or the short run. We will also be looking at the role of government in our economy, from a macro perspective. The Executive branch constructs a budget and presents it to Congress who authorizes changes in spending and taxation. As we know, they often disagree! Government borrowing is important—you might have heard we have a rather large national debt. Also we have the Federal Reserve that is important in monitoring the supply of money in circulation and keeping the economy stable in terms of prices and employment. In that role, it influences interest rates. And there’s even more—we study banks and financial markets. In other words, macro takes everything into account—and as I always say, you cannot memorize this stuff—you have to understand it. You may not think this will ever be of use to you, but as you get into it, I hope you will see how interesting it is! First things first. Our study focuses a lot on “Gross Domestic Product,” usually the defining statistic on how well the economy is doing. Your textbook defines GDP in chapter 7 as: “… gross domestic product defines aggregate output as the dollar value of all final goods and services produced within the borders of a country during a specific period of time, typically a year.” Gross means total. Domestic means “produced within the borders of the nation” Product is an old-fashioned way of saying “production.” The dollar value is actually the price the product sells for. When we measure GDP, the idea is simple but doing it is complicated. We measure every new good or service produced during the year, at its market price. If Ford Motor Company sold $753 million in vehicles in 2020, that’s what we will add in the GDP—and on and on until we have added everything! We measure it quarterly, but the big important number is “how much did we produce this year?” It is important because most of the income from domestic production winds up in the hands of our workers and managers. Foreign owners get “profits” when firms are headquartered in other nations but have production facilities in the US. But that is not a large number, and US firms get profits from US production facilities located in other nations. Generally when GDP goes up it is a good thing! GDP measure how much new “stuff” private firms and government (all 3 levels of government) are producing every year. The “stuff” consists of goods and services, such as vehicles, food, entertainment, legal services, clothing, and on and on. In addition to what is produced for the private market, government produces mostly services that it might charge a fee or pay for from collecting taxes. These would be things such as education, local police, drivers’ license services, passports, defense services, testing of food and drugs, and on and on. In other words, it is consumer goods & services, capital goods, government goods and services, and exports—in short, total production. This is macro economics in a nutshell: we use resources hired or purchased by firms to produce goods and services that benefit our society. Economic Goods and Services Resources Production  Consumer goods &  Natural resources Process services  Human Resources  Capital goods  Capital Resources  Government goods &  Entrepreneurship services Sometimes we need to measure and look at “real GDP.” We will actually do this calculation a little later in the course. For now, just know that real GDP is an artificial number that we calculate from (nominal) GDP. One of the major reasons for calculating GDP is to compare it to the previous year’s GDP so we can see how we are doing. Think about it. What happens when most nearly all prices go up? Then each item sells for more. So even if total production did not increase, the calculated GDP number would increase. There is a problem when we want to compare. Measuring real GDP “removes” price level changes such as inflation from GDP so we can compare year to year. One thing is very important to understand: There is a very important distinction between economic “performance” which is an increase in production during some short time period, and economic “growth” which is an increase in the “capacity to produce.” Remember the PPC? When the curve shifts out there is an increase in the capacity to produce. That doesn’t mean actual production increases! Why not? Because often the economy is not performing up to its capacity due to unemployment or a lack of spending. We will be going over this a lot! Your text mentions the “business cycle” but does not actually define it until chapter 9. It represents short run fluctuations in real GDP, generally every quarter. Notice, an expansion is a short run increase in real GDP, while a recession is a short run decrease in real GDP. Anyway it does show the difference between performance and growth. I am borrowing a diagram from chapter 9 that explains the difference between economic growth and economic performance. The diagram below is one we will discuss in class. It is out of date—there is a new one, but every time I try to copy and paste it. One interesting tidbit is how the growth rate of the economy is related to how large it can growth during some time period. To understand this relationship, economists use a little calculation called the rule of 70. If you divide 70 by the yearly growth rate, it will tell you the number of years it will take for GDP to double. For instance, if the yearly growth rate is 7% it will take 10 years for GDP to double. You can use the same formula to see how much it will shrink with a negative growth rate. Your text discusses the miracle of economic growth. Since the growth rate is exponential in that 2% yearly over time is compounded into larger levels of real GDP, the earlier that economies entered the industrial revolution, the better off the population is compared to late comers. Much of the growth of the U.S. economy since 1950 has been due to increases in technology which fostered increases in labor productivity, and shifted out the PPC. Labor productivity is defined as total real output per person hour. Something like 3 TVs per hour. It is really not quantifiable in dollars, and we will refer to it throughout the course. Another thing chapter 6 introduces is the concept of savings and investment. They are important to economic growth. For now, however, we shall just define them: Looking at overall data from the economy, personal savings is household income not spent. Banks are one way to “buy” financial assets by opening a savings account. There are also bonds, and stocks. Or options. Lots of choices. The idea is that instead of spending money on consumer goods, you purchase a financial asset or hold money to be able to purchase more during a future income period. Savings is related to enables some of the production to be shifted from consumer goods and services to economic investment—we will explore that in chapter 7! Economic investment is the purchase of NEW capital goods by firms (usually as they increase their productive capacity.) On a “macro” level, when firms borrow money from the credit markets to purchase new capital goods, we say the capital stock of the nation increased. This is very important because it means that production facilities have more machines, computers, space, etc. to work with and it increases our capacity to produce—and that is real economic growth! Now—once you have read down to “Uncertainty, Expectations, and Shocks,” DO NOT READ further—go straight to Chapter 8. If you are wondering why, just try reading that stuff—those are graduate school topics. So we will stick to our plan of basics first! Chapter 8: I like to distinguish the difference between long-run growth and short-run performance. Therefore, I think your textbook’s definition of growth is a little misleading. Traditionally, growth is a measure of an increase in the “capacity to produce,” or “potential real GDP.” At this time, as the US recovers from a pandemic, economic performance has decreased, but actual growth has increased! If you look at the stock market’s value of firms, it has skyrocketed even during the pandemic. Elon Musk is building an electric car, shooting rockets into space, and at the same time several other firms are ordering new machines and production facilities adding to their capacity to produce (investment) even as economic performance lagged. Economists understand that you only measure growth after the fact—it “grows” slowly as firms become bigger and add to their capacity. That enables a nation to produce more and so it is possible to produce a lot more in 2018 than it was in 1998. And, unless there is an asteroid hitting the earth, growth may slow or stop but it never becomes negative. Production fluctuates around that long run trend as in the diagram above. In fact, economists define a “business cycle” mentioned at the beginning of chapter 6, and explained in chapter 9, which shows SHORT RUN fluctuations in “real” GDP. All that means is that we have removed the effects of inflation. When real GDP goes up, it means that MORE stuff was produced. Your text discusses the benefits of economic growth that have been bestowed on the high income nations: better products, less physical labor, more leisure, more and better “social” products such as education, entertainment, sports, the arts. One negative consequence: increases in income and wealth inequality. So what causes increases in economic growth? Remember, right now, we are not talking about performance—only growth. Also, over time, we can measure the increases in the standard of living as the trend line of production gets higher. Chapter 8 discusses economic growth in a number of ways. During the past 150 years, economic growth has dazzled economists and historians. Before that time, people lived the same lives as their parents and grandparents—overall not much was happening. There are many ideas, and your ideas are valid as well, about what happened. Of course everyone realizes there has been a huge boom in technology. Technology has changed agriculture, transportation, education, entertainment, manufacturing, financial services, scientific research, medicine, and communication. Many point to capitalist economies that allow entrepreneurs freedom to accumulate wealth through innovation and investment. Human resources are able to use computers to solve problems, more women entering the workplace, the birth control pill, the fight against discrimination in the workplace, and more access to higher education—all these factors have been catalysts for higher and higher growth. Many point out to democracies that impose restrictions on monopolies, family dynasties, and improper influence on lawmakers—these tend to spread the wealth and allow new entrepreneurs to compete with established firms. Of course, we measure growth using that artificial indicator, real GDP. Increases in prices are not growth! International comparisons of the standard of living are done by calculating real GDP per capita. In many nations, their real GDP growth rate is actually lower than their population growth rate. This causes a decline in their standard of living. It is difficult for these nations to get in the game, because their labor force may be under-educated and often malnourished. Many of these nations do not have resources that are valuable such as oil or copper. Your text also discusses “leader” nations that innovate and invent new products and processes, and “follower” nations who can often adapt these new ideas to their own economic system and sort of leap- frog ahead. It seems to work for Asian nations, but many of these have highly developed education systems and an economic system that favors business. Even though that is a popular idea, it certainly hasn’t helped the poorest nations. Your text mentions factors that promote growth—we’ve seen these before in chapter 1. Think about how they might work: Property rights Patents and Copyrights Efficient financial institutions Literacy and widespread education Free trade—allows a nation to sell its high priced products and buy low priced products from other nations Competition—we do not allow the governor’s brother to get no-bid contracts with the state. Inexpensive and available transportation: good roads, mass transit Communications technology IN BLUE—not on the next quiz We have already talked about “supply” factors that favor growth. An increase in the quantity and quality of economic resources. Technology is also important in making the resources more productive. We will focus later in this course on the demand factors—just means if people won’t spend their money, firms won’t increase capacity! Efficiency is important—but remember, competitive firms are constantly striving to improve their efficiency in production. Other factors that are important: Worker productivity: output (real GDP) per person hour. It may not surprise you to learn that the higher the growth rate of technology, the higher the growth rate of worker productivity. Labor force participation rate: are all the eligible workers in the labor force? Human capital: An increase in the productivity of people because they have invested in training, education, practice, research—whatever makes them more productive. Firms can also invest in human capital rather than investing in physical capital. There are many more areas of discussion that your text presents. We have briefly mentioned most of them, so don’t worry about any new topics starting with “Recent Fluctuations in the Average Rate of Productivity Growth.” But we do want to look at economic growth in an era of resource depletion, pollution of the atmosphere and the oceans, animal species decline, climate change, and inequality. Most observers believe all of these concerns are important and signal some degradation of our standard of living. There is another idea that we are using up resources which would rightfully belong to future generations. The anti-growth movement believes we can be just as happy with only one of everything instead of the proliferation of consumer goods and wasteful packaging (often not recyclable.) Proponents of growth say that growth does not have to degrade the environment or cause inequality. We know better now, and we will be using production methods that are kind to the environment. Further, there are new products coming online which do not accelerate degradation. Solar energy is becoming less expensive and this does not pollute at all. Also, there are new jobs in these “green” industries. And, as we use more oil or timber, or other minerals, they will become scarce and their price tag will rise. This will force us to conserve. Let the market make these decisions, not government. Finally, many of the anti-pollution forces make our economy worse by reducing the standard of living, raising prices, and stifling growth. People who feel deprived may not support the new laws and restrictions, and since we cannot police the entire nation, pollution may actually get worse.