MACROECONOMICS

Macroeconomics studies the operation and development of a national economic system and aggregates such as industries, employment and prices. Economists and governments have given much attention to the careful numerical measurement of the concepts presented below. These ideas are central to macroeconomics and to this simulation. Graphs below are available from the US Bureau of Economic Analysis, Department of Commerce and the Federal Reserve Bank St. Louis.



GROSS DOMESTIC PRODUCT
The money value of the total output of goods and services in one year. An accounting system has been constructed so that different elements of the economy, e.g., wages, profits, rent and interest payments may be tracked and summed. Business cycles may be traced by following growth rates of GDP. A recession occurs when the overall economy does not grow for two consecutive quarters of the year (e.g. July through December). Note the darkened lines in the chart indicating recessionary periods.


INVESTMENT
Human populations grow, and people want higher levels of prosperity. More jobs and higher incomes have historically depended on a continuous flow of investment money into new firms with new ideas and techniques.


UNEMPLOYMENT
An economic condition where persons are willing and able to work but cannot find employment.


INFLATION
A process in which prices rise in many or all portions of the economy. Inflation is measured by a price index (usually the consumer price index) which weights the different price increases in various economic sectors according to their significance to a typical consumer's income.


INTEREST RATES
The prime rate is the interest rate which the best corporate customers pay for money loaned. The 10 Year US Treasury bond is an important longer term rate for the world monetary system. Note the similarity of the charts of the CPI (above) and the 10 year bond.

                                 Macroeconomic Relationships

The participant should know the relationships embedded in the simulation. Keep in mind that these relationships are strong tendencies which do not necessarily occur in lock step and have some lags - both in the simulation and reality. These ideas are to be found in any standard text on macroeconomics.

(1)  GDP growth varies with consumer expenditures, investment and government actions.

(2)  Business cycles include recessions which historically occur about once every five years.

(3)  Recessions may have multiple causes, but a frequent contributor is inventory build up - often described as a “market glut”.

(4)  Unemployment varies with GDP growth, increasing with recession or slower growth and declining in prosperous times.
        
(5)   Wages vary with unemployment, but rise more rapidly in long peiods of prosperity than they fall in recession.
        Manipulate the Macroeconomy: In the year 2000, major technical firms complained they could not find enough highly skilled technical computer people and pleaded for government action to allow major and immediate immigration of such personnel to the U.S. Simulate this situation by advancing to year 4 without adjustment and note the unemployment rate and wage rate for highly skilled labor.  Return to year 1 and increase the number of highly skilled workers shown in the supply box on the labor form.  Add  1000 workers by typing in the totaled. Compare the outcome in year 4 for unemployment and wage rates in this skill category. Write down the comparison answers.  

(6)  Interest rates vary with inflation rates.
         Manipulate the Macroeconomy: Advance the simulation to year 5. Push the chart button and choose macro stats in the drop down box.  How are inflation and the prime rate related?  Push on a few years - what happens when inflation falls below zero and prices fall (follow the blue line on the graph)?  Write down a complete sentence(s) answer.

                       SIMULATED MACROECONOMIC  POLICY


        The automatic adjustment mechanisms in a market economy with workable competition would seem to leave government policy makers with a minimum of decisions.  Yet there are a wide range of public policy decisions which have an economic dimension and significant economic effects.  The following exercise allows you to operate the Strategy and Scarcity model to understand some of the complexity of the interactions of policy choices.  
        Assumed here is a competitive model with minimal government consumption or taxation but with a determination to achieve the highest living standards possible over a 20 year period.  Policy choices are confined to specific years, when you must decide whatever merits apply.   As with many decisions which must pass into law through legislation, there are critical times when passage is possible. Miss your chance and take the consequences. Your goal is to achieve the highest possible economic proficiency score (EPS) - push the score button on the main screen to see the criteria for scoring.
         The economic proficiency score was designed for use in this simulation to address the problem of evaluating a business cycle over time. It is an attempt to equally weight the growth of the national economy as shown in GDP and the situation of the individual wage earner indicated by the wage index. Note that both the GDP index and the wage index in the EPS are “real” meaning that adjustments for inflation are made yearly. The misery index is  widely used in economics to give a numerical clarification to the twin troubles of unemployment and inflation.  Subtraction of the misery index from the GDP and wage indexes is a surprisingly efficient way to simplify the complex problem of evaluation over a 20 year time frame.
        Competitive contests to achieve the highest economic proficiency score are possible in at least two forms - individual and collective.  Individuals may run the simulation repeatedly to improve their personal score.  The numbered challenges below offer a choice of which policy decisions will be enacted at various times. Some students may be assigned  another individual to compete with.   The highest EPS score wins.  These scores may be compared to determine a winner whether group size is two or twenty. It is expected that the challenges are repeated and reworked to find the best score. Use the print button on the main control screen (the main screen, EPS table and a chart will all be printed at once) to have a written record of your final score .
         Groups may compete with diverse assignments.  One group versus another on managing and directing the best economic choices in a scenario as shown by the EPS - with decisions made by majority vote.  Alternatively, with two or more groups the instructor may assign various industries to individuals (who may choose to alter either price or output levels ) and are ranked on the profitability of their firm.  Then an individual or the entire group may undertake responsibility for Federal Reserve policy.   Admittedly, it may be difficult for an instructor to grade such a competitive undertaking involving industries assigned to individuals (some industries are more profitable than others). Therefore use of a pass/fail system based on participation or participation time may be appropriate.

                                 Policy Choice Examples

        Immigration:
Adds to the growth rate of your economy, especially when labor is in short supply. However, as the supply curve of labor increases (moves to the right) , wages currently paid to labor decline. This happens most often among less skilled workers.  Therefore, allowing immigration is usually quite politically unpopular.

        Price Controls:
(1) Clicking the ceiling price controls button and entering a value in the ceiling price column may allow the consumer to buy a product for less money than the market price set by supply and demand.   The actual plan for the level of prices and the length of time price ceilings are enforced is important to judging the effects on the economy.
(2) Clicking the support price controls button and entering a value in the support price column sets a base under which prices cannot fall.  However, the industry will generally supply more of the product at this higher price.  Support price controls can be quite politically popular, but the resulting surplus can be problematic for government.
(3) A set price may be established by clicking the ceiling and support buttons to remove both check marks. This will allow the participant to establish a set price at which goods are sold every year.

        Central Bank (Federal Reserve) actions:
(1) No action -  requires no adjustments to the simulation.
(2) Raise interest rates -  is done by checking the box of the same name on the main form. The prime rate will rise in the next year, and a number of businesses will fail. Higher interest rates will be impossible for some to pay, and the banking system will also make credit very hard to get.  Unprofitable industries will see more bankruptcies and the number of firms will decline.   Energy and construction firms are often especially dependent on borrowing, so they will have a more difficult time staying in business.  
(3) Lower interest rates - by checking the box on the main form.   Easier monetary policy means lower rates, better terms, and greater availability of credit.  Firms in the energy and construction industries will grow in number because of reliance on borrowing when money is available.  Firms from profitable industries will enter the market, but companies losing money will borrow little.

        Monetary policy:
Has more impact on the business cycle when rates are raised than when rates are lowered because struggling firms do not wish to expand.  This situation has given rise to the saying that “You can pull on the string (raising rates is rather effective in slowing an economy), but you can’t push it” (lowering rates is often not very effective in accelerating an economy).

        Minimum wage:
What at first glance seems a fairly simple policy to help the least paid workers generates controversy because it has complex effects. Higher minimum wages cause incomes to rise among those employed at the minimum , and some jobs to be lost because some weak businesses cannot bear the higher costs for labor.  The debate over how much the workers are helped and how many jobs are lost has been going on for decades.  Many economists have observed that a minimum wage has ripple effects on many lower paid workers, because the entire wage schedule tends to move up - creating cost problems for businesses greater than just paying the cheapest help a bit more.  Immigration is also affected.. Since immigrants are often paid the minimum wage, increases will tend to encourage both legal and illegal immigration.