Macroeconomics: Crash Course Economics #5

Summary

This Crash Course Economics episode explores macroeconomics, focusing on its significance in understanding economic booms and busts, job prospects, and government policies. It introduces key economic indicators such as GDP, unemployment rate, and inflation rate, explaining their impact on the economy. The script also discusses the business cycle, the role of government in economic stability, and the limitations and importance of economic measurements like GDP in assessing a nation's economic health.

Takeaways

• 📚 Economics is divided into microeconomics and macroeconomics, with macroeconomics focusing on the overall economy, including economic output, unemployment, inflation, interest rates, and government policies.
• 💡 Macroeconomics emerged as a distinct field during the Great Depression, highlighting the need for systematic measurement and policy guidance in response to economic downturns.
• 📈 The Gross Domestic Product (GDP) is a primary measure of an economy's health, representing the value of all final goods and services produced within a country's borders over a specific period.
• 🔍 GDP has limitations, such as not accounting for transactions involving used goods, illegal activities, or non-traditional economic activities like household production.
• 🌐 Real GDP adjusts for inflation, providing a more accurate reflection of economic health by comparing the value of goods and services over time.
• 📉 Greece's economy exemplifies the use of Real GDP, showing a significant decrease from 2010 to 2013, indicating a severe and prolonged recession.
• 👥 Unemployment is a critical macroeconomic concern, measured by the unemployment rate, which represents the percentage of the labor force actively seeking employment but unable to find it.
• 🔄 The unemployment rate does not account for discouraged workers or underemployed individuals, potentially underestimating labor market issues.
• 🔄 There are three types of unemployment: frictional, structural, and cyclical, with the goal of economic policy being to minimize cyclical unemployment.
• 💰 Inflation and deflation are monitored through the inflation rate, which tracks the percent change in the price of a market basket of commonly purchased items over time.
• 🔄 The business cycle, characterized by periods of expansion and contraction, is influenced by the interplay of consumer spending, business investment, government spending, and net exports.
• 🚗 Government policies, such as increased spending or tax cuts, can act as 'cruise control' for the economy, aiming to stabilize it during recessions but potentially leading to debt.

Q & A

What is the primary distinction between microeconomics and macroeconomics?

Microeconomics focuses on the behavior of individual consumers and firms, while macroeconomics studies the economy as a whole, including factors like economic output, unemployment, inflation, and government policies.

Why did the field of macroeconomics emerge as a distinct area of study?

Macroeconomics emerged during the Great Depression in the 1930s when economists recognized the need for a systematic way to measure the overall economy and develop theories to guide policies and address potential economic problems.

What are the three main economic goals that policy makers aim to achieve?

The three main economic goals are to promote economic growth over time, to limit unemployment, and to maintain price stability.

What is the Gross Domestic Product (GDP) and why is it significant?

GDP is the total value of all final goods and services produced within a country's borders in a given time period, usually a year. It is significant as it serves as the primary measure of a country's economic performance and size.

Why is Real GDP a more accurate measure of economic health than nominal GDP?

Real GDP is adjusted for inflation, which means it provides a more accurate reflection of the economy's health by accounting for changes in the price level over time, unlike nominal GDP which does not adjust for inflation.

How does the unemployment rate in Greece compare to the concept of full employment?

In Greece, the unemployment rate is over 25%, which is significantly higher than the natural rate of unemployment, indicating a state of underemployment and economic struggle compared to full employment where only frictional and structural unemployment exist.

What are the three types of unemployment recognized by economists?

The three types of unemployment are frictional, structural, and cyclical. Frictional unemployment occurs when people are between jobs, structural unemployment is due to a lack of demand for specific types of labor, and cyclical unemployment results from a recession, causing businesses to lay off workers.

Why is deflation, or falling prices, considered problematic for an economy?

Deflation is problematic because it discourages spending as consumers may delay purchases expecting further price drops. This reduction in spending can lead to decreased GDP and increased unemployment, creating a negative cycle.

What is the business cycle and how does it relate to economic growth and contraction?

The business cycle refers to the periodic expansions and contractions of economic activity. It is characterized by phases of economic growth (booms) and slowdowns (busts), driven by changes in consumer spending, business investment, government spending, and net exports.

How can the government intervene to stabilize the economy during a recession?

The government can intervene by increasing spending or cutting taxes to inject money into the economy, which can stimulate demand, encourage business activity, and help to reduce unemployment.

What is the significance of the four components of GDP in driving the economy?

The four components of GDP—consumer spending, business investment, government spending, and net exports—are significant as they represent the different groups that contribute to economic activity. Changes in these components can accelerate or decelerate the economy.

Outlines

00:00

📚 Introduction to Macroeconomics

Adriene Hill introduces the topic of macroeconomics, contrasting it with microeconomics and emphasizing its relevance to major economic events and policy decisions. Macroeconomics encompasses the study of economic output, unemployment, inflation, interest rates, and government policies. The field emerged as a distinct discipline during the Great Depression, highlighting the need for systematic economic measurement and policy guidance. Adriene clarifies that macroeconomics is not just about numbers but about understanding the broader economic trends that affect society, including the unpredictability inherent in human behavior and economic systems.

05:04

📈 Economic Indicators: GDP, Unemployment, and Inflation

This paragraph delves into the three key economic indicators used by macroeconomists to assess a country's economic health: Gross Domestic Product (GDP), the unemployment rate, and the inflation rate. GDP measures the total value of goods and services produced within a country, but it has limitations, such as not accounting for transactions involving used goods or illegal activities. The unemployment rate is a measure of joblessness among the labor force, yet it has its own shortcomings, such as not including discouraged workers or underemployed individuals. Inflation, the rate at which the general price level of goods and services falls or rises, is also discussed, with the paragraph explaining the negative impacts of both high inflation and deflation on the economy.

10:04

🔄 The Business Cycle and Economic Fluctuations

The final paragraph explores the concept of the business cycle, which includes periods of economic expansion and contraction. It uses the analogy of a car to explain how an economy can overheat with too much spending, leading to inflation, and then slow down as production costs rise and demand decreases. The paragraph also discusses the four components of GDP—consumer spending, business investment, government spending, and net exports—and how changes in these areas can affect economic growth. The role of government in managing the economy through fiscal policy is introduced, along with a brief mention of the potential drawbacks, such as increasing debt. The paragraph concludes with a reminder of the importance of understanding economic indicators and the impact of the economy on individual lives.

Keywords

💡Macroeconomics

Macroeconomics is the branch of economics that studies an economy as a whole, focusing on large-scale economic phenomena such as economic output, unemployment, inflation, interest rates, and government policies. In the video, macroeconomics is introduced as a relatively new field of study that became essential during the Great Depression, and it is central to understanding the overall health and functioning of an economy.

💡Economic Aggregates

Economic aggregates refer to the collective measures of economic activity, such as total production, total income, and total spending in an economy. The script mentions that macroeconomics studies these aggregates through national income accounting, which helps in understanding the broader economic trends and patterns.

💡Gross Domestic Product (GDP)

GDP is the monetary value of all final goods and services produced within a country's borders in a given period, typically a year. It is a primary measure of a country's economic performance. The video explains that GDP does not include transactions involving used goods or financial assets, and it distinguishes between nominal GDP, which is not adjusted for inflation, and real GDP, which is.

💡Unemployment Rate

The unemployment rate is the percentage of the labor force that is actively seeking employment but is unable to find work. The video clarifies that the unemployment rate only counts those who are actively looking for work, excluding discouraged workers and underemployed individuals, thus sometimes underestimating the true extent of unemployment.

💡Inflation Rate

The inflation rate measures the percent change in the price of a market basket of commonly purchased items over time. It is a key indicator of the economy's health, as too much inflation erodes purchasing power, while deflation can discourage spending and lead to a decrease in economic activity. The video discusses the negative aspects of both high inflation and deflation.

💡Business Cycle

The business cycle refers to the periodic expansions and contractions of economic activity. The video uses the analogy of a car to explain the phases of the business cycle, including periods of growth, peak, recession, and trough, and how these fluctuations can be influenced by various economic factors.

💡Consumer Spending

Consumer spending is the amount of money spent by households on goods and services. It is a significant component of GDP, as illustrated in the video where it is compared to the engine of a car, driving the economy. Changes in consumer spending can greatly affect the overall economic growth or contraction.

💡Investment

In the context of macroeconomics, investment refers to the spending by businesses on new capital goods, such as machinery, buildings, and equipment, which contribute to economic growth. The video mentions investment as one of the four components of GDP, highlighting its importance in driving the economy.

💡Government Spending

Government spending is the expenditure by the government on various projects and services. The video discusses how government spending can be used as a tool to stimulate the economy during recessions by increasing overall demand.

💡Net Exports

Net exports represent the value of a country's exports minus its imports. It is one of the components of GDP and can significantly impact a country's economic growth, especially for countries that rely heavily on international trade, as mentioned in the video.

💡Natural Rate of Unemployment

The natural rate of unemployment refers to the rate of unemployment that is consistent with full employment in an economy, accounting for frictional and structural unemployment. The video explains that this rate is considered normal and differs slightly between countries, usually ranging between 4 to 6 percent in the United States.

Highlights

Economics is divided into microeconomics and macroeconomics, with macroeconomics focusing on large-scale economic phenomena.

Macroeconomics studies economic aggregates, such as booms and busts, job prospects, and government tax policies.

Economists use national income accounting to measure the overall economy, a necessity realized during the Great Depression.

Economic data is abundant today, but economists may not agree on the economy's status or policies to address it.

Economics is not a traditional science due to the difficulty in controlling variables when studying human behavior.

Macroeconomists analyze Greece's economy, noting its prolonged recession and comparison to the U.S. Great Depression.

GDP is the primary measure of an economy, representing the value of all final goods and services produced within a country.

GDP does not account for transactions involving used goods or financial assets, nor illegal activities.

Real GDP adjusts for inflation, providing a more accurate reflection of economic health.

Unemployment rate is a critical measure, calculated by the number of actively seeking jobs divided by the labor force.

The unemployment rate does not include discouraged workers or those underemployed, thus potentially underestimating labor market issues.

Economists recognize three types of unemployment: frictional, structural, and cyclical, with the latter being the target for policy.

Inflation and deflation are measured by the change in prices of a market basket, with both extremes posing economic challenges.

The business cycle, characterized by expansions and contractions, is influenced by the four components of GDP: consumer spending, investment, government spending, and net exports.

Government policies, such as increased spending or tax cuts, can influence the economy's speed, aiming to achieve full employment.

Economic policy debates, including the role of government and debt, will be explored in future videos.

Understanding macroeconomics is crucial for everyone's livelihood and future, as it shapes economic conditions globally.

Transcripts

Adriene: Hi I'm Adriene Hill, welcome back to Crash Course Economics. As you may remember

from our first video, economics can be divided into two parts: microeconomics and macroeconomics.

Since macroeconomics is the one that's most often in the news, that's where we're gonna

start. We'll get to microeconomics, which is also super important in future episodes,

but what is macroeconomics again?

Mr. Clifford: (monotone) It's the study of economic aggregates revealed through national

income accounting, which is then-

Adriene: Okay okay, when you explain it like that it sounds boring but it is not boring!

Macro is about booms and busts, will you get a job when you graduate, should the government cut taxes?

Mr. Clifford: In theory, lowering marginal tax rates would actually increase-

Adriene: No no no! Remember, the goal of learning economics is to become a better decision maker,

and part of that is learning how the whole economy works. So let's learn about the whole economy.

[Theme Music]

So, macroeconomics is the study of the entire economy. Macroeconomists study the big stuff,

like economic output, unemployment, inflation, interest rates, and government policies.

Now when it comes to fields of study, macroeconomics is a relatively new subject. It wasn't until

the Great Depression in the 1930's that economists fully appreciated the need for a systematic way to

measure the overall economy, and that we might need theories to guide policies and fix potential problems.

A hundred years ago there was no comprehensive data on economic activity, so there was no

macroeconomics. Today, economic data is plentiful, but that doesn't mean that economists agree

about where the economy is, where it's going, or what should be done to help. Macroeconomists

make predictions based on data, theoretical models and historical trends, but in the end they're just predictions.

If you ask three economists the same question, you're likely to get three different answers,

but how, you ask, can the dismal "science" be so subjective? Well, economics is not a

traditional science because it is nearly impossible to control all the different variables. Like

all the social sciences, economics is studying people, and it turns out that sometimes people are unpredictable.

Stan Muller: I challenge all of you to a tournament of champions in Flappy Bird!

Adriene: Who saw that coming?

That doesn't mean that economics is all guesswork. For example, right now in early 2015, the

economy of Greece is, well it's not, it's not good. But how can we tell, and is it gonna

get better? Is it gonna get worse? What should be done about it?

These are all questions that macroeconomists try to answer, but for this video, we're gonna

focus on the question "How can we tell?"

Mr. Clifford: Well in general, policy makers have three economic goals: they want to keep

the economy growing over time, they want to limit unemployment, and they want to keep

prices stable. Now for the most part when these three things happen, the citizens are

happy, politicians get reelected, and economists get raises.

There are three specific measurements that economists analyze to see if a country is

achieving each goal. They're the Gross Domestic Product, unemployment rate, and the inflation rate.

The most important measure of an economy is Gross Domestic Product or GDP. GDP is the

value of all final goods and services produced within a country's border in a

specific period of time, usually a year.

Now there are some details worth mentioning. GDP doesn't include every transaction that's

in the economy. For example, if you buy a used domestic car, it doesn't count towards

GDP because nothing new was produced. Now that same logic applies to buying financial

assets like stocks, or when one company buys another company, for example when Google bought

YouTube. Those don't count towards GDP because no new good or service was produced.

Also, GDP often doesn't include illegal activity, since drug dealers don't usually report their

sales to the government, or non-traditional economic activity like household production.

For example, if a plumber charges someone $100 to fix their hot water heater, that counts

towards GDP, when he fixes his own water heater, that doesn't count towards GDP.

Here's a list of countries organized by GDP. Notice that GDP is measured in dollars, not

in the raw number of things produced. If we analyzed just the raw number, then a country

that produced five million thumbtacks would look like they're doing just as well as a

country that produced five million cars, but there's also a problem with using the dollar

value of stuff produced: it's inflation.

If two countries produce the same amount of cars, but one has higher prices, then that

country's going to have a higher nominal GDP, or GDP not adjusted for inflation. To get

a more accurate idea of the health of the economy, economists look at Real GDP, which

is GDP adjusted for inflation. Just what "adjusted for inflation" means is really important,

but too big of a topic to discuss right now. We'll get to it.

Adriene: So what does the Real GDP in Greece tell us about its economy? In 2013, the Greek

Real GDP was around 242 billion dollars, but that number doesn't really mean anything until

you compare it to previous years.

In 2012, it was 250 billion dollars, in 2011, it was 288 billion, and in 2010 it was 300

billion. In fact, starting in 2008, Greece has had six years of decreasing GDP, and the

data reveals that this recession is just as deep and prolonged as the Great Depression

in the United States in the 1930's.

Now, I just used the term recession, which a lot of people use incorrectly. A recession

is not just when the economy's bad, officially it's when two successive quarters or six months

show a decrease in Real GDP. Even though the economy in Greece is still struggling, it

climbed out of its recession in 2014, experiencing a slight increase in GDP.

A depression, on the other hand, doesn't have a technical definition, but it's a severe

recession, when the economy's really really bad. It's worth noting though that GDP can

be a little problematic. I mean not all countries measure GDP in the same way, and in recent

years some European Union countries have started experimenting with counting underground markets,

like the sex trade and drug trade as part of the total.

In fact, GDP isn't even that old an idea. According to Robert Froyen, during the Great

Depression, economic decisions were made "on the basis of such sketchy data as stock price

indices, freight car loadings, and incomplete indices of industrial production. The fact

was that comprehensive measures of national income and output did not exist at the time.

The depression, and with it the growing role of government in the economy, emphasized the

need for such measures and led to the development of a comprehensive set of national income accounts."

So GDP was invented to account for national income, and it may not necessarily provide

a complete picture of a country's economy, but for the moment it's what we've got.

So that's economic growth, or at least one way to look at economic growth. now, for the

next big issue for macroeconomists: unemployment. Anyway, the major goal of unemployment policy

is to limit unemployment, and that's measured by - you guessed it - the unemployment rate.

In Greece, unemployment is over 25%.

Mr Clifford: The unemployment rate is calculated by taking the number of people that are unemployed

and dividing by the number of people in the labor force, times 100. Now this percentage

represents the number of people that are actively looking for a job but just can't find one.

First, the labor force only includes people that are of legal working age and working

or actively looking for work, so little kids don't count and neither do people who aren't

able to work or who just choose not to work. So what about someone who's been looking for

a job but just gives up? Well, they're no longer part of the labor force, and they're

no longer considered unemployed. These are called discouraged workers.

The unemployment rate also doesn't take into account people that are underemployed. A worker

with a five hour a week part time job is considered fully employed even if they're looking for a better

job. In both of these cases, the official unemployment rate underestimates the problems in the labor market.

A common misconception is that the goal is to have 0% unemployment, but it turns out

there's types of unemployment that'll exist even when the economy's going strong. Economists would

point out that there's three types of unemployment, or three reasons why people would be unemployed.

First is frictional unemployment. This is when people are temporarily unemployed or

between jobs. So if you quit your job and look for a new one, or if you're just entering

the labor force, then you're frictionally unemployed.

The second is called structural unemployment. Workers are out of work because there's no

demand for that specific type of labor. This would be like a VCR repair person, but it

also includes technological unemployment, where workers are replaced by machines.

Now both frictional and structural unemployment will always exist; the goal is not to have

0% unemployment. I mean, 0% is not even possible. We're always going to have people between

jobs or people fired because machines do it better.

So the goal is to have no cyclical unemployment. This is unemployment due to a recession. It's

when people stop buying stuff, so businesses lay off their workers and since workers have

lower incomes, they stop buying stuff which means more people lose their jobs.

An economy is considered to be at full employment when there's only frictional and structural

unemployment. This is called the natural rate of unemployment. This natural rate differs

slightly between countries, in the United States it's usually between 4 to 6 percent unemployment.

Now as you might expect the GDP growth rate and the unemployment rate are inversely related.

That means that when GDP is rising, the unemployment rate is falling, when GDP is falling, the unemployment rate is rising.

Adriene: And that's exactly what happened in the United States during the Great Depression.

in the 1930's, droughts, bank failures, and counterproductive policies caused GDP to fall,

and unemployment peaked at 25 percent.

Let's move on to the third economic goal: stable prices. While I might like the idea

of the stuff I buy getting cheaper across the board, falling prices are not really a

good thing. Average prices in Greece have fallen about two percent recently, and during

the 1930's, the inflation rate in the US was negative ten percent, but how can cheaper

stuff be bad for the economy?

Mr. Clifford: Well the goal is to keep prices stable, mainly to avoid rapid inflation, or

rising prices, but we also want to avoid excessive deflation which is falling prices. Inflation

is measured by tracking the prices of a set amount of commonly purchased items, or what

economists call a market basket. The inflation rate is the percent change in the price of that basket over time.

Too much inflation is bad because it decreases the purchasing power of money; it means you

can buy less stuff with the same amount of money, which has all sorts of negative effects

on the economy. Business costs increase as workers demand higher wages and interest rates

increase, so it's harder to buy loans, so people buy less cars and houses.

Deflation on the other hand, seems like it would be a good thing but most economists

see falling prices as a bad thing. Falling prices actually discourage people from spending

since they might expect prices to fall more in the future. Less spending in the economy

means GDP is gonna decrease and unemployment's gonna increase, and that just becomes a vicious

cycle. So severe recessions are often accompanied by deflation because the demand for goods

and services falls, but when the economy starts to improve again, we often see an increase in prices.

Adriene: Throughout history, economies have expanded and contracted. It's called the business

cycle. Let's go to the Thought Bubble.

If we imagine the economy as a car, then GDP, employment and inflation are the gauges. A

car can cruise along at 65 miles per hour without overheating. Safe cruising speed is

like full employment; unemployment is low, prices are stable and people are happy.

But if we drive that car too fast for too long, it'll overheat, and in the economy,

significant spending increases GDP causing an expansion. Unemployment falls and factories

start producing at full capacity to keep up with demand. Since the amount of products

that can be produced is limited, people start to outbid each other, resulting in inflation.

Eventually, production costs increase as workers demand higher wages and the economy starts

to slow down. Businesses lay off a few workers, those unemployed workers spend less causing

the businesses that produce the good that they would otherwise be buying to lay off more workers.

This is a contraction, the economy is going to slow. Eventually things stabilize, production

costs fall since resources are sitting idle, and the economy starts to expand again. This

process of booms and busts is called the business cycle.

To understand why these fluctuations might occur, let's take this car analogy just a

little further and look at the engine. Much like the four cylinder engine that powers

the Volkswagen of growth, an economy has four components that make up GDP. Each represents

a different group that can purchase things in the economy. They're consumer spending,

business spending which is called investment, government spending, and net exports which

is basically spending by other countries.

If any one of these components loses power, the economy will slow down, but not all of

them are created equal. Most economies rely heavily on consumer spending. For example,

in the US, consumers account for about 70% of GDP, but other countries might rely more

heavily on exports. The point is, changes in these four components change the speed of the economy.

Thanks Thought Bubble. So when I'm driving my car on the highway, I use cruise control

to regulate my speed. So why don't we have cruise control for the economy? Well many

economists think that the government should play a role in speeding up or slowing down

the economy. For example, when there's a recession, the government can increase spending or cut

taxes so consumers have more money to spend.

Proponents of this policy argue that it would get the economy back to full employment, but

it has its drawback: debt, which some economists hate while others argue isn't very much of

a drawback at all. Stupid economic policy, always resisting simplistic explanations.

We're gonna save the debate over how to fix the economy for future videos, but for now

it's important for you to have a general understanding of how the economy works and how it's measured.

After all, whether you're driving a Namco in Greece, a Kia in Korea or a Ford in the

US, your livelihood and your future will be shaped by what happens in the economy. So

wear your seat belt. By which I mean try to save a little once in a while, OK?

So we've really just touched on these three major indicators of economic health, and while

they can be useful in providing a broad overview of a nation's economy, reality is, as usual,

a little more nuanced than that.

Mr. Clifford: Next week, we're gonna go under the hood and look at the greasy, dirty details

of how economists calculate growth, and tune up thee economy, and rev up their economic

engines and drive around the drag racing tr--

Adriene: OK, I think that's enough with the cars, Thanks for watching, we'll see you next week.

Mr. Clifford: Thanks for watching Crash Course Economics. It was made with the help of all

of these nice people. Now, if you want to help keep Crash Course free for everyone forever,

please consider subscribing over at Patreon. It's a voluntary subscription platform that

allows you to pay whatever you want per month to make Crash Course exist, and it also increases

GDP. Thanks for watching, DFTBA.