1

SECTION 2:
MAJOR GOALS OF MACROECONOMICS

GOAL 1
PROMOTE ECONOMIC GROWTH

Increase output of goods and services

Output does not equal to GDP because of inflation
Boost output per capita.

HOW DO WE MEASURE TOTAL OUTPUT?

NOMINAL GROSS DOMESTIC PRODUCT (GDP)

The dollar value of final output of goods and services

produced in the United States.

The growth rate of NOMINAL GDP is a deceptive indicator

or economic growth.

Price doubled, GDP doubled, output doesn’t change

1
 2

1. IF OUTPUT INCREASED 10%:

This is economic growth

2. IF PRICES INCREASED 10%:

This is not economic growth
This is inflation

CALCULATION OF A GROWTH RATE:

Growth rate = (New – Old)/Old x 100%

Example:
New value = 2,200
Old value = 2,000
Growth rate = (2200 – 2000)/2000 x 100%
= .10 x 100% = 10%

2
 3

NOMINAL GDP:
Value of output calculated using prices that existed
during the year when the goods and services were
produced

Inflation is included

Value of output in 2005 using 2005 prices

TO GET NOMINAL GDP

The 2014 Economic Report of the President has 26 data
tables: See Table B-2
http://www.gpo.gov/fdsys/browse/collection.action?collection
Code=ERP&browsePath=2014&isCollapsed=false&leafLevel
Browse=false&isDocumentResults=true&ycord=0

Real GDP

take a base year, year 0, check the price

N years later, check the price again

Remove inflation from the number

3
4

4
5

5
 6

CREATION OF A CONSUMER PRICE INDEX

To create a price index, we first choose some year to be the

base year, say, Year 0.

Next we choose a representative set of quantities of items

Q0 that are purchased by consumers.

Next we determine how much those quantities cost using the

prices that existed during various years.

That is, we calculate, say, P0Q0, P1Q0, P2Q0, etc.

PRICE INDEX

The index for Year n is equal to:

(PnQ0/P0Q0) x 100

6
 7

Example:

Suppose an economy produced the following quantities of

items and sold them at the following prices during years 0, 1,
and 2.

Item P0 Q0 P1 Q1 P2 Q2
Shirts 30 10 35 12 37 14
Shoes 24 15 25 16 28 19
Coats 17 21 20 25 23 26

We obtain:

P0Q0 = 30x10 + 24x15 + 17 x 21 = 300 + 360 + 357 = 1,017

This tells us that the base year quantities had a value of

1,017 if sold during year 0.

P1Q0 = 35x10 + 25x15 + 20 x 21 = 350 + 375 + 420 = 1,145

This tells us that the base year quantities had a value of

1,017 if sold during year 1.

P2Q0 = 37x10 + 28x15 + 23 x 21 = 370 + 420 + 483 = 1,273

This tells us that the base year quantities had a value of

1,273 if sold during year 2.

We have held the items in the market basket constant and

we have changed the prices from year to year.

7
 8

We obtain the following values for the price index

Year 0: (P0Q0/ P0Q0) x 100 = (1017/1017) x 100 = 100

Year 1: (P1Q0/ P0Q0) x 100 = (1145/1017) x 100 = 112.59

Year 2: (P2Q0/ P0Q0) x 100 = (1273/1017) x 100 = 125.17

Interpretation of the price index:

Items which cost 100 during Year 0 cost 112.59 during Year
1 and 125.17 during Year 2.

Thus, the cost of the items has increased and we have had
inflation.

Prices are 12.59% higher during Year 1 than during Year 0.

Prices are 25.17% higher during Year 2 than during Year 0.

8
 9

Inflation rate between Year 1 and Year 2

During Year 1 the price index had a value of 112.59. During
Year 2 the price index had a value of 125.17.

The inflation rate is the rate of growth in prices. We obtain:

Inflation rate = [(125.17 – 112.59)/112.59] x 100% = 11.55%

9
 10

Suppose the base year was 1983. Thus the price index in
1983 would be 100.
Assume prices during 2005 are 75% higher than during 1983
Then the PRICE INDEX for 2005 would be 175

10
 11

REAL GDP:
Value of output during any year calculated using prices
that existed in some base year

CALCULATION OF REAL GDP GIVEN A SET OF PRICES

AND QUANTITIES
Suppose we are given a set of prices and a set of quantities
sold during various years. To calculate REAL GDP, we pick
a base year and use the prices during that year to determine
the value of output during any year using the base year
prices. As a result, the value of output during any year is not
affected by changes in prices.

11
 12

EXAMPLE:
Suppose an economy produced the following quantities of
items and sold them at the following prices during years 0, 1,
and 2. Let us use Year 0 as the base year. Thus, we
calculate the value of output each year based on the Year 0
prices.

12
 13

Item P0 Q0 P1 Q1 P2 Q2
Shirts 30 10 35 12 37 14
Shoes 24 15 25 16 28 19
Coats 17 21 20 25 23 26

We obtain the following values for REAL GDP:

Year 0:
P0Q0 = 30x10 + 24x15 + 17 x 21 = 300 + 360 + 357 = 1,017

Year 1:
P0Q1 = 30x12 + 24x16 + 17 x 25 = 360 + 384 + 425 = 1,169

Year 2:
P0Q2 = 30x14 + 24x19 + 17 x 26 = 420 + 456 + 442 = 1,318

We obtain the following values for NOMINAL GDP:

Year 0:
P0Q0 = 30x10 + 24x15 + 17 x 21 = 300 + 360 + 357 = 1,017

Year 1:
P1Q1 = 35x12 + 25x16 + 20 x 25 = 420 + 400 + 500 = 1,320

Year 2:
P2Q2 = 37x14 + 28x19 + 23 x 26 = 518 + 532 + 598 = 1,648

13
 14

1. Nominal GDP increased each year. This is because

BOTH quantities increased AND prices increased each year.

2. Real GDP increased each year. This is because

quantities increased. We have held prices constant, so none
of the increase is caused by price increases.

Growth rate of NOMINAL GDP between Year 1 and Year 2

[(1648 – 1320)/1320] x 100% = 24.85%

Growth rate of REAL GDP between Year 1 and Year 2

[(1318 – 1169)/1169] x 100% = 12.75%

14
 15

CALCULATION OF REAL GDP GIVEN A PRICE INDEX

Suppose we have data showing nominal GDP for each year

and we have a price index using, say, 1983 as the base
year. Real GDP for, say, Year 1993 is calculated by valuing
the things produced during 1993 using 1983 (base year)
prices.

FORMULA FOR REAL GDP during Year i:

Real GDPi = (Nominal GDPi/Price indexi) x 100

15
 16

CALCULATION OF REAL GDP

USING A PRICE INDEX

A PRICE INDEX enables us to compare prices during any

given year to the level of prices in an arbitrary BASE YEAR.

Example: Suppose we choose 1983 as the BASE YEAR.

The value of the price index during the base year is
ALWAYS equal to 100.

EXAMPLE 1:
Suppose that prices during, say, 1993 are 44.5% higher than
during 1983. Then the value of the price index for 1993
would be 44.5% higher than during 1983.
Price index during 1993 = 144.5 (based on 1983 = 100)

EXAMPLE 2:
Suppose the price index during 1994 is 148.2.
This means that prices are 48.2% higher during 1994 than
they were during 1983.

EXAMPLE 3:
Suppose the price index during 2010 is 218.1.
This means that prices are 118.1% higher during 2010 than
they were during 1983.

16
 17

CALCULATION OF REAL GDP

USING A PRICE INDEX

Real GDPi = (Nominal GDPi/Price indexi) x 100

Nominal GDP during 1993 = $6,343.3 billion

Price index during 1993 = 144.5 (based on 1983 = 100)
Real GDP during 1993 = ($6,343.3 / 144.5) x 100
= $4,389.80 billion

EXPLANATION:
This means that items which sold for $6,343.3 billion during
1993 would have sold for $4,389.80 billion if 1983 prices had
been used.

Nominal GDP during 1994 = $6,738.4 billion

Price index during 1994 = 148.2
Real GDP during 1994 = ($6,738.4 / 148.2) x 100
= $4,546.80 billion

EXPLANATION:
This means that items which sold for $6,738.4 billion during
1994 would have sold for $4,546.80 billion if 1983 prices had
been used.

17
 18

GROWTH RATE OF NOMINAL GDP BETWEEN 1993 AND

1994

GROWTH RATE = (NEW – OLD)/OLD x 100%

= (6738.4 – 6343.3)/6343.3 x 100% = .0623 x 100%
= 6.23%

GROWTH RATE OF REAL GDP BETWEEN 1993 AND

1994

= (4546.8 – 4389.8)/4389.8 x 100% = .0357 x 100%

= 3.58%

GROWTH RATE OF PRICES BETWEEN 1993 AND 1994

= (148.2 – 144.5) / 144.5 X 100% = .0256 X 100% = 2.56%
This is called the INFLATION RATE

18
 19

TO GET INFLATION RATES FROM ECONOMIC REPORT

OF THE PRESIDENT

The 2014 Economic Report of the President has 26 data

tables: See Table B-10
http://www.gpo.gov/fdsys/browse/collection.action?collection
Code=ERP&browsePath=2014&isCollapsed=false&leafLevel
Browse=false&isDocumentResults=true&ycord=0

TO GET INFLATION RATES FROM BLS

Type in: www.bls.gov

Click on: Data tools

Click on: Series report
Inside the Series ID formats box insert the following code
number:
CUUR0000SA0 (This is the code number for CPI-U)

Click on: Next

Choose 12 month percent change
Choose annual change
Select the years you want
Choose HTML table
Click on retrieve data

19
 20

NOMINAL GDP VS. REAL GDP

During 1994, nominal GDP increased by 6.23%
This takes into account the increases in output AND the
increases in prices

During 1994, real GDP increased by 3.58%

This takes into account ONLY increases in quantity of output
because prices have been held fixed

CALCULATING REAL GDP

YEAR NOMINAL PRICE REAL = (GDP/P) X 100

GDP INDEX GDP
1983=100
1970 1,038.3 38.8 2,676.0
1979 2,562.2 72.6 3,529.2
1980 2,788.1 82.4 3,383.6
1982 3,253.2 96.5 3,371.2
1983 3,534.6 100 3,534.6
1990 5,800.5 130.7 4,438.0
2000 9,951.5 172.2 5,779.0
2010 14,498.9 218.1 6,647.8

GROWTH RATE OF NOMINAL GDP (1980 – 82)

(3,253.2 – 2,788.1)/2,788.1 X 100% = 16.68%

GROWTH RATE OF PRICES (1980 – 82)

(96.5 – 82.4)/82.4 X 100% = 17.1 %

GROWTH RATE OF REAL GDP (1980 – 82)

(3,371.2 – 3,383.6)/3,383.6 X 100% = -0.4%

GROWTH RATE OF NOMINAL GDP (1970 – 2010)

(14,498.9 – 1,038.3)/1,038.3 X 100% = 1,296.4%

GROWTH RATE OF PRICES (1970 – 2010)

(218.1 – 38.8)/38.8 X 100% = 462.1%

GROWTH RATE OF REAL GDP (1970 – 2010)

(6,647.8 – 2,676.0)/2,676.0 X 100% = 148.4%

20
 21

TO GET REAL GDP FROM ECONOMIC REPORT OF THE PRESIDENT

The 2014 Economic Report of the President has 26 data

tables: see Table B-1 for growth rates of Real GDP
http://www.gpo.gov/fdsys/browse/collection.action?collection
Code=ERP&browsePath=2014&isCollapsed=false&leafLevel
Browse=false&isDocumentResults=true&ycord=0

GROWTH OF GDP

Nominal GDP has increased every year since at least 1950.

This does NOT mean that the economy has grown every
year.

It is possible that the quantity of output contracted, but prices

increased by enough to cause nominal GDP to increase
from year to year.

To determine if the QUANTITY of output increased or

decreased, we need to compare REAL GDP from year to
year.

21
 22

Real GDP decreased during the following years

1954
1958
1974
1975
1980
1982
1991
First 3 quarters of 2001; (but entire year was positive)
12/2007 to 6/2009

REAL OUTPUT PER CAPITA

= REAL GDP/POPULATION

If population grows 4%, we need a 4% increase in real

GDP to maintain our standard of living.

Real output per hour worked = Real GDP / Hours

worked

22
 23

TO PROMOTE GROWTH:

INCREASE AND IMPROVE PHYSICAL CAPITAL:

PLANT AND EQUIPMENT = factories, buildings, tools,
machinery, computers, technology, etc.

FULL UTILIZATION of plant and equipment

No excess capacity

IMPROVE HUMAN CAPITAL

The skills of the workforce

Better education
Better job training

REDUCE UNEMPLOYMENT

23
24

24
25

25
 26

RULE OF 72

If some quantity grows at an annual growth rate of g% per

year, how long will it take for the quantity to double in size?

Let g = annual growth rate (expressed as an integer)

I.e.: 5.4% per year growth is expressed as 5.4

FORMULA: (Approximate)
Years Required to Double = 72 / g

26
 27

EXAMPLE: PRICES
Assume inflation rate = 6% per year.
Prices will double in 72/6 = 12 years.

EXAMPLE: OUTPUT
Assume Real Output grows 4% per year.
Real Output will double in 72/4 = 18 years.

EXAMPLE: INVESTMENT
Assume you earn 8% interest per year.
Your amount invested doubles in 72/8 = 9 years.

27
 28

POLICY GOAL 2:

MAINTAIN STABLE PRICES

MAINTAIN THE PURCHASING POWER OF THE DOLLAR

MAINTAIN A LOW INFLATION RATE

28
29

29
30

30
31

31
 32

Inflation causes problems when it is high and/or when it is

unanticipated.

High inflation hurts people on fixed incomes

Standard of living decreases

Unanticipated inflation causes disruptions because what

economic agents expected to happen did not happen.

Certain people will benefit and others will lose.

32
 33

Variable inflation affects long run planning

Increases future risk

Long term investments are avoided

High inflation hurts lenders.

They get repaid with devalued dollars.

33
 34

ANTICIPATED VS. UNANTICIPATED INFLATION

Unanticipated inflation hurts lenders

When lenders are repaid, the dollars will buy less than
was expected

Lenders include owners of bonds, banks, etc.

Unanticipated inflation helps borrowers

Major borrowers: Governments, students, home buyers

34
 35

GOAL 3
PROMOTE FULL EMPLOYMENT

WHO ARE THE UNEMPLOYED?

1. NEW ENTRANTS

2. RE-ENTRANTS

3. JOB LEAVERS

4. JOB LOSERS

TO GET UNEMPLOYMENT DATA FROM ECONOMIC

REPORT OF THE PRESIDENT

The 2014 Economic Report of the President has 26 data

tables: See Table B-11
http://www.gpo.gov/fdsys/browse/collection.action?collection
Code=ERP&browsePath=2014&isCollapsed=false&leafLevel
Browse=false&isDocumentResults=true&ycord=0

35
 36

MAJOR ECONOMIC GOAL

Reduce the unemployment of JOB LOSERS

Reduce the unemployment caused by RECESSIONS

and LACK OF AGGREGATE DEMAND

36
37

37
38

38
 39

GOAL 4
SMOOTH OUT THE BUSINESS CYCLE

EXPANSION
Period when REAL GDP is growing

PEAK:
Turning point when REAL GDP peaks and begins
falling

CONTRACTION (RECESSION)
Period when REAL GDP is falling

TROUGH
Turning point when REAL GDP stops falling and
begins rising

39
40

40
 41

RECESSION AND DEPRESSION

RECESSION (unofficial definition)

Two consecutive quarters of declining REAL GDP

The unofficial beginning and ending dates of national

recessions are defined by a nonprofit research organization
known as the National Bureau of Economic Research
(NBER). The NBER defines a recession as “a significant
decline in economic activity spread across the economy,
lasting more than a few months, normally visible in real
gross domestic product (GDP), real income, employment,
industrial production, and wholesale retail sales.”

DEPRESSION: A severe recession

41
 42

RECENT RECESSIONS
12-69 to 11-70 11 months
11-73 to 3-75 16 months
1-80 to 7-80 6 months
7-81 to 11-82 16 months
7-90 to 3-1991 8 months
3-2001 to 11-2001 8 months
12-2007 to 6-2009 18 months

1945 – 2009: (11 CYCLES)

Average expansion: 58.4 months
Average recession: 11.1 months

To see the NBER website list of expansions and recessions:

NBER LIST OF RECESSIONS AND EXPANSIONS
http://www.nber.org/cycles/cyclesmain.html

42
 43

RECENT EXPANSIONS:
2-61 to 12-69 106 months
11-70 to 11-73 36 months
3-75 to 1-80 58 months
7-80 to 7-81 12 months
11-82 to 7-90 92 months
3-1991 to 3-2001 120 months
11-2001 to 12-2007 73 months
6-2009 to Present
1945 – 2009: (11 CYCLES)
Average expansion: 58.4 months
Average recession: 11.1 months

To see the NBER website list of expansions and recessions:

NBER LIST OF RECESSIONS AND EXPANSIONS
http://www.nber.org/cycles/cyclesmain.html

43
 44

GROWTH RATE AS A PROPORTION

g = (new – old)/old = new/old - 1

GROWTH RATE AS A PERCENTAGE

Multiply proportion by 100 and attach % sign

KEY FORMULAS
1. g = NEW/OLD -1 = (NEW – OLD)/OLD

new/old = 1 + g
2. NEW = (1 + g) OLD

3. OLD = NEW/(1 + g)

EXAMPLE:
CPI in 1981 = 90.9 CPI in 1980 = 82.4
Inflation rate = 90.9/82.4 – 1 = 1.103 – 1 = .103, or 10.3%

Minimum wage in 1980 = $3.10

Minimum wage in 1981 = $3.35
g = 3.35/3.10 – 1 = .081, or 8.1%

If minimum wage grew at inflation rate

New = (1 +.103) x $3.10 = 1.103 x $3.10 = $3.42

CPI in 1974 = 49.3 CPI in 2012 = 229.6

Inflation rate = 229.6/49.3 - 1 = 4.657 – 1 = 3.657, or 365.7%

Minimum wage in 1974 = $2.00

Minimum wage in 2012 = $7.35
If minimum wage grew at the inflation rate
New minimum wage in 2012 would be = (1 + 3.657) x $2.00
= $9.31

44