Measuring the Macroeconomic Objectives: Economic Growth, Unemployment and Inflation

Macroeconomics provides government policymakers with a set of tools that can be employed to help achieve certain macroeconomic objectives deemed desirable for a nation. For an economy to be considered healthy, three objectives must be met:

  • Economic growth: defined as an increase in the nation’s output of goods and services over time
  • Low unemployment: meaning that nearly everyone who is willing and able to work should be able to find a job, and
  • Low inflation: meaning that the average price level of the nation’s goods and services should not increase too rapidly over time.

Measuring these three objectives requires the use of some simple mathematical formulas. Once they are known, we can use the basic production possibilities curve diagram to illustrate their effect on a nation’s potential output and its current equilibrium level of output.

This lesson will define the three macroeconomic objectives, show how it can be determined whether or not they are being achieved, and use a PPC model to illustrate them.

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Money Creation in a Fractional Reserve Banking System

In this video we illustrate the process by which money is created in a fractional reserve banking system. Due to the fact that at any given time a bank must only keep a certain percentage of its total deposits on reserve, an initial deposit of a certain amount of money will be multiplied as the bank loans out any excess reserves, whose spending leads to further new deposits and even further loans in the economy.

Through this process money is actually multiplied and created. This gives monetary policy makers the ability to stimulate or contract the overall level of spending in an economy through its buying and selling of government bonds from the private sector on the open market.

 

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The Tools of Monetary Policy

This video lesson graphically presents the three tools Central Banks have at their disposal for managing the level of aggregate demand in the economy. Through increasing or decreasing the money supply, a central bank has influence over the interest rates in a nation, and therefore over the level of investment and consumption among firms and households. To accomplish this, three tools are employed: The reserve requirement, the open market purchase or sale of government bonds, and the discount rate.

This lesson illustrates these three tools and explains the relative importance of each to monetary policy makers.

After watching this video, consider reading and responding to the discussion questions for the following blog posts:

 

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Introduction to the Money Market

Macroeconomics policymakers have two general tools in their kit to manage the level of aggregate demand in an economy. The first is fiscal policy, which involves government changing the levels of taxes and government spending to manage demand. Central banks engage in the second type of demand-management, known as monetary policy. By changing the supply of money available in a nation, central banks can raise and lower interest rates and thereby stimulate or contract the level of aggregate demand in the nation.

This video lesson introduces the money market, a model essential to understanding the workings of monetary policy. The supply and demand for money are introduced, and the basic effect of monetary policies are modeled in the simple money market diagram. In later videos, the various tools available to monetary policy makers will be explained and evaluated using the money market model.

After watching this video, consider reading and responding to the discussion questions for the following blog posts:

 

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The Long-run Phillips Curve

In the second lesson on the Phillips Curve model we will further explore the relationship between unemployment and inflation in an economy, this time examining what happens in the long-run, or the flexible-wage period, following a change in aggregate demand in an economy. Will the tradeoff between inflation and unemployment exist even once wages and prices have had time to adjust to the level of demand for a nation’s output?

We will find that, in fact, as an economy self-corrects from changes to aggregate demand and output returns to its full employment level, the unemployment rate will always return to its natural rate, even as inflation rises and falls with demand in the economy.

 

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The Short-run Phillips Curve

This video lesson introduces a basic Macroeconomic model showing the short-run tradeoff that exists between inflation and unemployment in nation’s economy. By examining the effect that a shift in Aggregate Demand has on the average price level and the level of output and employment, we observe a simple tradeoff: lower unemployment generally comes at the cost of higher inflation, while lower inflation may require higher unemployment.

The following blog posts provide some real world applications of the Phillips Curve theory:

 

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Fiscal Policy – another interpretation of the Crowding-out Effect

In our first lesson on the crowding-out effect we examined the impact that deficit-financed government spending may have on the demand for private loanable funds in the economy. A government’s need to borrow to pay for a fiscal policy drives up private interest rates and could, therefore, crowd-out private investment and consumption, making the fiscal policy less effective at stimulating economic activity.

In this lesson we’ll examine another interpretation of the crowding-out effect, which says the supply of funds available in the private sector will decrease when a government deficit spends, due to the fact that government must offer higher interest rates on its debt, making saving in the private banking system less attractive to households. The supply of loanable funds will therefore decrease, driving up private interest rates and reducing the quantity of investment and consumption among households. The end result is the same: government spending is “crowded-out” by a decline in private spending, rendering the fiscal policy less effective than desired.

 

Once you’ve watched this video, learn more about the crowding-out effect by reading one of the following blog posts and responding to the discussion questions included:

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Fiscal Policy – the Crowding-out Effect

Previous lessons on fiscal policy have explored the multiplier effects resulting from increases in government spending and decreases in taxes. This video will examine the possibility that expansionary fiscal policy, when financed by a budget deficit, will actually result in less private sector spending, i.e. “crowding-out” of the private sector. When governments borrow to pay for a stimulus, this drives up borrowing costs for households and firms, reducing the amount of consumption and investment. The crowding-out effect reduces the effectiveness of expansionary policies aimed at increasing the total demand for a nation’s output.

Once you’ve watched this video, learn more about the crowding-out effect by reading one of the following blog posts and responding to the discussion questions included:

 

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Fiscal Policy – the Tax Multiplier

This is part two of the lessons on the multiplier effects of fiscal policy. The first lesson explained how the Keynesian Spending Multiplier could be found using the marginal propensities to consume and save. Watch that video here before watching the one below.

This lesson illustrates how a tax cut of a particular amount will ultimately affect aggregate demand in the economy and therefore total output. Tax cuts are an indirect injection into the macro-economy, meaning that they put money into the pockets of households, but who then get to decide how much of it to spend on goods and services. For this reason, the tax multiplier is generally thought to be smaller than the spending multiplier. What does this mean for fiscal policy-makers? When considering the possible expansionary effects of a particular tax cut or government spending package, it should be acknowledged that tax cuts, may not provide the level of stimulus as government spending, since some of a tax cut will be saved rather than spent.

 

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Fiscal Policy – the Government Spending Multiplier

This video will introduce and explain the effect of an expansionary fiscal policy on aggregate demand, specifically an increase in government spending. When government spending increases, household incomes rise and therefore consumption increases, further adding to the expansionary effect on Aggregate Demand. If we know the marginal propensity to consume among a nation’s households, we can calculate the size of the spending multiplier, and thereby determine how much of a stimulus would be needed to increase AD by a particular desired amount.

Once you’ve watched the video, read and respond to the discussion questions for one of the following blog posts:

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Introduction to Fiscal Policy – Expansionary vs. Contractionary Policies

This video lesson will introduce the use of fiscal policies by a government aimed at expanding or contracting the level of economic activity in the nation. Changing the amount of government spanding and taxation can influence several macroeconomic variables, such as employment, price levels and the level of output.

When should a government alter the level of taxes and spending it engages in? This lesson will introduce two circumstances under which fiscal policy may be used to promote the achievement of various macroeconomics objectives.

 

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An Introduction to Aggregate Demand

This lesson introduces the macroeconomic concept of Aggregate demand. AD is defined, and its components are explained individually, focusing on the factors that can lead to a change in the overall demand for a nation’s goods and services in a particular period of time at a range of price levels.

 

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The Income Approach and the Expenditure Approach to Measuring the GDP of a Nation

GDP is generally understood to represent the health of a nation’s economy, and most people realize that if GDP is growing, things are going well, while if it’s falling things have turned sour in the economy. But what, precisely, does GDP measures? There are two primary methods for measuring GDP, which should yield the same result even though they measure completely different factors.
  • The income approach: measures the total incomes earned by households in a nation in a year.
  • The expenditure approach: measures the total amount spent on the goods produced by a country in a year.
By examining the circular flow model of a nation’s economy, we can demonstrate why every dollar earned by a household in a nation’s resource market will ultimately be spent in the product market, or leaked through taxes, savings, and import spending, leading to injections in the form of government spending, investment and export sales.
In the video lecture below, the two methods for measuring GDP are introduced, and the various components it includes are explained in detail. Watch the video and then download and attempt the activity: 

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