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  • 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?

  • It's the study of economic aggregates revealed through national

  • income accounting, which is then...

  • Okay okay, when you define it like that,

  • macroeconomic sounds boring

  • but it is not boring!

  • It is exciting!

  • Macro is about booms and busts,

  • will you get a job when you graduate,

  • should the government cut taxes.

  • In theory, lowering marginal tax rates would actually increase the...

  • 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.

  • So, macroeconomics is the study of the entire economy.

  • Macroeconomists tell you 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.

  • I challenge all of you to a tournament of champions in Flappy Bird!

  • 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?"

  • 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 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.

  • 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%.

  • 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.

  • 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?

  • 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 get 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.

  • 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 too 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.