Pakistan Economics

A Macro Economic Snapshot World Perspective Brush Up on Key Concepts By

Mohammad Ali Saeed

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Success in an (Any!) Economics Course

To do well in Economics, you need to be able to do 3 things well (in conjunction): Think Mathematically: Dont be afraid of equations! Think graphically! Abstract Logic! (Often the hardest part)

1. 2. 3.

Economics
One of the earliest and most famous definitions of economics was that of Thomas Carlyle, who in the early 19th century termed it the "dismal science." According to a muchrepeated (but erroneous) story, what Carlyle had noticed was the anti-utopian implications of economics. Many utopians, people who believe that a society of abundance without conflict is possible, believe that good results come from good motives and good motives lead to good results. Economists have always disputed this, and it was to the forceful statement of this disagreement by early economists such as Thomas Malthus and David Ricardo that Carlyle supposedly reacted.

Economics Definition
At the turn of the century, Alfred Marshall's Principles of Economics was the most influential textbook in economics. Marshall defined economics as"a study of mankind in the ordinary business of life; it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of wellbeing. Thus it is on one side a study of wealth; and on the other, and more important side, a part of the study of man."

1935 & Onwards

Most contemporary definitions of economics involve the notions of choice and scarcity. Perhaps the earliest of these is by Lionell Robbins in 1935: "Economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses." Virtually all textbooks have definitions that are derived from this definition. Though the exact wording differs from author to author, the standard definition is something like this:"Economics is the social science that examines how people choose to use limited or scarce resources in attempting to satisfy their unlimited wants."

Branches of Economics
Economics has two branches: microeconomics and macroeconomics. Microeconomics is the branch of economics that deals with the personal decisions of consumers and entrepreneurs. Its primary concern is to help consumers and investors make their lives better by increasing their earnings and satisfying their needs despite limited resources. Also included in its study are the consumers' decisions on what products to buy and how the cost of commodities is determined. Macroeconomics deals with the larger aspects of a nation's economy, such as the sectors of agriculture, industry, and service. It aims to (a) speed up the economy's growth rate and increase total production; (b) increase the rate of employment; (c) keep the prices of commodities stable so that they remain affordable; and (d) have sufficient reserves for foreign exchange for importing goods and paying off loans.
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A Definition of Economics

Economics is the study of the use of scarce resources to satisfy unlimited human wants

Microeconomics
Microeconomics is the study of the decisions of individual people and businesses and the interaction of those decisions in markets Studies: Prices and Quantities Effects of Regulation and Taxes

Macroeconomics
Macroeconomics is the study of the national economy and the global economy Studies: Average prices and total employment, income and production Effects of taxes, government spending, budget deficit on total jobs and incomes Effects of money and interest rates

Positive vs. Normative Statements

Positive statements are about what is Can be proven right or wrong Can be tested by comparing it to facts Normative Statements are about what ought to be Depends upon personal values and cannot be tested

Example: Global Warming Our planet is warming up because of increased C02 in the atmosphere We ought to cut back on our use of carbon-based fuels such as coal and oil

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Some Key Macroeconomic Questions

Will tomorrows world be more prosperous than today? Will jobs be plentiful? Will the cost of living be stable? Will the government and the nation go into deficit again?

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Origins and Issues of Macroeconomics

Economists began to study economic growth, inflation, and international payments during the 1750s

Modern macroeconomics dates from the Great Depression, a decade (1929-1939) of high unemployment and stagnant production throughout the world economy.

John Maynard Keynes book, The General Theory of Employment, Interest, and Money, began the subject.

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Origins and Issues of Macroeconomics

Short-Term Versus Long-Term Goals Keynes focused on the short-termon unemployment and lost production.

In the long run, said Keynes, were all dead.

During the 1970s and 1980s, macroeconomists became more concerned about the long-terminflation and economic growth.

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Economic Growth and Fluctuations

Real GDP

Source: Bureau of Economic Analysis

Economic Growth in the United States

Figure 1 above shows real GDP in the United States from 1960 to 2010.
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Economic Growth and Fluctuations

Potential GDP

Real GDP

Source: Bureau of Economic Analysis

The figure highlights:

Fluctuations of real GDP Smoother growth of potential GDP
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Economic Growth and Fluctuations

The long term growth rate is
3.1 percent per year

Potential GDP

Real GDP

4.4 percent per year

2.8 percent per year 2.9 percent per year

Source: Bureau of Economic Analysis

During the 1970s and early 1980s, real GDP growth sloweda productivity growth slowdown. 16

Economic Growth and Fluctuations

The long term growth rate is
3.1 percent per year

Potential GDP

Real GDP

4.4 percent per year

2.8 percent per year 2.9 percent per year

Source: Bureau of Economic Analysis

Real GDP fluctuates around potential GDP in a business cycle

a periodic but irregular up-and-down movement in 17 production.

Economic Growth and Fluctuations

Every business cycle has two phases:
1. A recession 2. An expansion

and two turning points:

1. A peak 2. A trough

A recession is a period during which real GDP decreases for at least two successive quarters. An expansion is a period during which real GDP increases.
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Economic Growth and Fluctuations

This figure shows the most recent U.S. cycles.
Recession

Peak

Potential GDP
Peak Expansion Expansion Trough

Real GDP

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Economic Growth and Fluctuations

Decomposing output into a trend and cyclical component, we get:
Recession (1990 1991) 1st OPEC Recession (1973 1975) Recession (2001)

Korean War

Recession (2007 - 2009)

Roaring Twenties World War 1 (1917 1918)

World War II (1939 1945)

Recession 2nd OPEC Recession (1981 1982) 1979

Postwar Recession 1960's Expansion Great Depression (1929 1939)

1907 Banking Panic

1890's Depression Rapid Industrialization

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A Global Recession
The most recent recession began during December 2007. The US economy technically exited the recession during June of 2009 (although the end of the recession has yet to be declared by the NBER). Several other countries around the world, including most of the G7 countries also experienced a recession, e.g. Japan, the UK, France, Germany and several European countries.

Most countries appear to have exited their respective recessions during 2009.
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Economic Conditions in United States: 2010Q2

Key Statistics
GDP: +1.6% Inflation: -0.1% Unemployment: 9.5% Interest Rates: 0% 0.25%
Source: Bureau of Economic Analysis

Although the end of the recession has not been officially announced by the NBER, the United States joined France, Germany and Japan in achieving a positive growth rate since the second quarter of 2009. However, the recovery has been weak and unemployment rates 22 are expected to be high until 2012.

Quick Exercise
For the real GDP numbers to the right, calculate the percentage change in real GDP between the current year and the prior year. Is there any indication of a recession for any of these years?
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Year
1988 1989 1990 1991 1992 1993 1994

Real GDP
6742.7 6981.4 7112.5 7100.5 7336.6 7532.7 7835.5

Percentage Change

3.54 1.88 - 0.17 3.33 2.67 4.02

Economic Growth and Fluctuations

Economic Growth Around the World Figure 3(b) compares the growth rate of real GDP in the United States with those of other countries and regions. The economies of Asia have grown persistently faster than those of the rest of the world. Industrialized countries are growing relatively slower than developing countries
Source: IMF World Economic Outlook Database, October 2008

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Economic Growth and Fluctuations

The Lucas Wedge The Lucas wedge is the accumulated loss of output from a slowdown in the growth rate of real GDP per person. Figure 4(a) shows that the U.S. Lucas wedge is some $50 trillion or five years GDP.

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Economic Growth and Fluctuations

The Okun Gap The Okun gap is the gap between potential GDP and actual real GDP and is another name for the output gap. Figure 4(b) shows that the Okun gaps since 1973 are $2.7 trillion or about 3 months real GDP.

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Production (Real GDP) as a Benchmark

In Macroeconomics, we compare what happens to different variables in terms of how it relates to production in the economy (i.e. how does inflation, or unemployment relate to real GDP?) Definition: Procyclical: the variable moves with the business cycle (i.e. it increases when production increases and vice versa) Countercyclical: the variable moves in the opposite direction of the business cycle (i.e. it increases when production decreases and vice versa) Acyclical: does not move with the business cycle
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Introduction to Key Macro Concepts

Economic Growth and Fluctuations Jobs and Unemployment Inflation Surpluses and Deficits

Macroeconomic Policy Tools

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US Unemployment Rates During Last Recession

During the last recession, the unemployment rate hit 10.1%.
The figure to the right shows how the unemployment rate has changed over the most recent cycle.
Recession

Source: Bureau of Labor Statistics

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Jobs and Unemployment

Unemployment Around the World Figure 6 compares the unemployment rate in the United States with those in Western Europe, Japan, Canada and the United Kingdom. In the 1960s 1970s, U.S. unemployment, on the average, was higher than the other countries shown. More recently, US unemployment has declined relative to the other countries.

Source: IMFs World Economic Outlook Database

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Inflation
Inflation is a process of rising prices.

We measure the inflation rate as the percentage change in the average level of prices or the price level. The Consumer Price Index the CPI is a common measure of the price level used to calculate inflation. An alternative measure of inflation, called core inflation uses the CPI in its construction, except the price index used to construct core inflation does not include any food or energy prices (which tend to be fairly volatile).
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Inflation
The inflation rate fluctuates, but it is always positive the price level has not fallen during the years shown in the figure.
Second OPEC price hike

CPI Inflation
Volcker Disinflation (interest rate hike)

First OPEC price hike

Vietnam War

1990 1991 Recession

2008 Recession

A falling price level a negative inflation rate is called deflation.

2001 Recession

Core Inflation

Source: FRED - St. Louis Fed Economic Data

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Inflation
Inflation Around the World Figure 9 shows the inflation rate in the United States compared with other countries. U.S. inflation has been similar to that in other industrial countries U.S. inflation has been much lower than that in developing countries

Source: IMFs World Economic Outlook Database

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Inflation
Is Inflation a Problem? Answer: Not in and of itself. Moderate inflation (between 1% 2% annual increase) is good for the economy since it contributes towards job and wage growth. However: out of control inflation is not good since it erodes the purchasing power of money. In addition, deflation is not good either since it typically leads to declining salaries.

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Surpluses and Deficits

Figure 10(a) shows the changing surplus and deficit of the federal and provincial governments in the United States since 1971. Persistent federal deficit during the 1970s through 1990s.
2002 2007 expansion

1990s expansion

1980s expansion

Surplus from 1998 to 2001

More deficits following.
OPEC Recession 2001 2002 Recession

1982 Recession

1991 Recession

Source: Congressional Budget Office

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Surpluses and Deficits

International Surplus and Deficit If a nation imports more than it exports, it has an international (trade) deficit. If a nation exports more than it imports, it has an international (trade) surplus.

The current account deficit or surplus is the balance of exports minus imports plus net interest paid to and received from the rest of the world.

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Surpluses and Deficits

Figure 10(b) shows The U.S. current account balance since 1960. Persistent current account deficit since 1983
1980s Expansion OPEC Recession 1981-82 Recession

1991 Recession

2001 2002 Recession

2008 Recession

The deficit has swollen during the past few years

1990s Expansion

Source: Bureau of Economic Analysis

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Macroeconomic Policy Challenges and Tools

1. 2. 3. 4. 5.

Five widely agreed policy challenges for macroeconomics are to: Boost economic growth Keep inflation low Stabilize the business cycle Reduce unemployment Reduce government and international deficits

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Review Questions:
1. What is Economic Growth and how is the long term growth rate measured? 2. What is the difference between real and potential GDP? 3. What is a Business Cycle and what are its phases? 4. What is a recession? 5. What is unemployment?
6. What are the main costs of unemployment? 7. What is inflation and how does it influence the value of money? 7. How is inflation measured? 8. What determines a countrys budget deficit? What determines its international deficit? 8. How do the unemployment rate, inflation rate, and the deficits move with regards to the Business Cycle?
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