Central problem of macroeconomics

1. Central problem of macroeconomics • „Welfare of citizens” • Looking at „welfare” and different policies affecting it • However, the problem is: how to define „welfare”?

2. The problem of relative and total welfare • Which is more important? Relative or total? • How much „society has” or how much individuals have? • The example of Marx and historical laws connected to increasing poverty of labour

3. Mainstream proposition - GDP • Gross Domestic Product – the amount of goods produced within society • One immediate problem – „society” cannot sell its own GDP, but it is measured in… money • Doesn’t matter what is the distribution of GDP • Simon Kuznets (Nobel Laureate 1971) "for his empirically founded interpretation of economic growth which has led to new and deepened insight into the economic and social structure and process of development"

4. The first method (Expenditures) • Consumption • Investment • Government • Net Export (E-I) • Y=C+I+G+N

5. Second method (value added) • Value added as the difference between the value of expenses and value of that what is sold

6. Third method (incomes) • The sum of all incomes (profits, wages, rents) in the economy • All methods are supposed to give the same results (… although it does not happen)

7. Inflate GDP by inflation money supply • The problem of purchasing power and increasing monetary value • Solution: real GDP versus nominal GDP • Measure nominal and deflate it • Question of deflating becomes problematic (recent case in United States) • Opportunity for manipulations

8. Other problems • Black market is not included • Product not sold on the market is not taken into account (charities, Linux etc.) • Local differences in prices are hidden (e.g. Norway vs. United States) • Distribution is not the issue • Malinvestment also increase GDP (housing bubble)

9. Problems with GDP (continued) • Imperial wars and destructions increase GDP (and does not decrease it in other place) • Increase in Government Debt is not a problem (the crowding out effect) • Free time is not included • Social values are not part of the equation (e.g. number of divorces, crimes) • Waste of environment is excluded

10. Hayek’s point • "The first fact which emerges is that the amount of money spent on producers' goods during any period of time may be far greater than the amount spent for consumers' goods during the same period. It has been computed, indeed, that in the United States, payments for consumers' goods amount only to about one-twelfth of the payments made for producers' goods of all kinds.‘Nevertheless, this fact has not only very often been overlooked, it was even expressly denied by no less an authority than Adam Smith. According toSmith : " The value of goods circulated between the different dealers never can exceed the value of those circulated between dealers and consumers ; whatever is bought by the dealer being ultimately - destined to be sold to the consumers." This proposition- clearly rests upon a mistaken inference from the fact that the total expenditure made in production must be covered by the return from the sale of the ultimate products ; but it remained unrefuted, and  quite recently in our own day it has formed the foundation of some very erroneous doctrines.' '

11. The solution of the difficulty is, of course, that most goods are exchanged several times against money before they are sold to the consumer, and on the average exactly as many times as often as the total amount spent for producers' goods is larger than the amount spent for consumers' goods. Another point which is of great importance for what follows, and which, while often overlooked in current discussion,' is quite obvious if we look at our diagram, is the fact that what is generally called the capital equipment of society-the total of intermediate products in our diagram-is not a magnitude which, once it is brought into existence, will necessarily last for ever independently of human decisions. Quite the contrary : whether the structure of production remains the same depends entirely upon whether entrepreneurs find it profitable to re-invest the usual proportion of the return from the sale of the product of their respective stages of production in turning out intermediate goods of the same sort. (...)"

12. Alternatives to GDP • NEW (Net Economic Welfare) – Nordhaus and Samuelson • HDI (Human Development Index) – UNO (life expectancy, education etc.) • PPP (Purchasing Power Parity) • Big Mac Index (The Economist) • Gross National Output (GNO) more related to fluctuations

13. Price inflation • Different goods are priced and their prices are inflating at different speeds • Each one of them is a different part in individual „baskets” • How to measure the „general movement of prices”?

14. Consumer Price Index • Assign different weights to goods bought by consumers • Average them out and create CPI • Changes are supposed to reflect the measurement of price inflation • Again: the possibility of manipulation

15. Example of United States

16. Macroeconomics at dead end? • Macroeconomics as a „science of indexes” • Differences of opinion as differences in… indexes? • Example: lower taxes cause increase in „welfare”. Whose „welfare”? In which „run”? • If you cannot measure, measure anyway?

17. Circular flow • Households and firms • Financial markets, the government, foreign trade • „Stocks” and „flows”

18. Unemployment and macroeconomics • 1929, Great Crash and great problems • The central problem related to wealth is employment • During recession people are unemployment • Where macroeconomics meets sociology

19. Unemployment rate • All the people that are capable to work (labor force) • Numbers of unemployed divided by labor force • Different ways of measuring labor force • Open unemployment versus hidden one

20. Types of unemployment • Frictional unemployment (market process) • Structural unemployment (dynamic changes in the economy) • Classical unemployment (real wage rate is too high) – 1929

21. Unemployment: voluntary of involuntary? • Voluntary is obviously used in cases of personal decision to change the job • Involuntary – when the decision is set by socio-economic environment, not made by the person

22. Classical attitude • Voluntary – decision to adapt, or not adapt • If the prospering firm goes bankrupt, one can find another job, for example by lowering wage rate • I prefer to work at Harvard • Is it voluntary or involuntary unemployment?

23. Keynesian definition of involuntary unemployment • „Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relative to the money wage, both the aggregate supply of labor willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment” • Translated into English – people are unemployed if we can’t print some money and hire them

24. Costs of unemployment • Private costs: lack of funds, for credit payment, for health-care, in extreme cases for food etc; mental problems • Social costs: lower production, resources are not employment to „full” extent, costs of social programs etc. • In Keynesian model – „spillover” effects

25. Unemployment and business cycle • During recession unemployment usually rises • Downward phase of the cycle is associated with unemployment • Cyclical unemployment – is usually considered as involuntary • Because it could be reduced with certain policies • Which ones? It depends…

26. Unemployment and equilibrium • „Natural rate of unemployment” (Phelps, Friedman) – there is some necessary amount of unemployment in the economy • NAIRU (Keynesian model) – Non Accelerating Inflation Rate of Unemployment (Phillips curve) • Okun’s law

27. Unemployment and taxes • On the supply side of labor market – more decisive element is net income • Lowered taxes increase disposable income • Increased prices cause the seller of a good to increase supply • The same mechanism in the labor market