INTRODUCTION TO MACROECONOMICS
AGGREGATE OUTPUT – a composite measure of all final goods and
Microeconomics
◦ Examines the functioning of individual industries and the
behavior of individual decision-making units—firms and
households.
Macroeconomics
◦ Deals with the economy as a whole. Macroeconomics
focuses on the determinants of total national income,
deals with aggregates such as aggregate consumption and
investment, and looks at the overall level of prices instead
of individual prices.
Three of the major concerns of macroeconomics are:
◦ Output growth
◦ Unemployment
◦ Inflation and deflation
ECONOMIC FLUCTUATIONS AND GROWTH
Hypothetical Business Cycle
ECONOMIC FLUCTUATIONS
◦ the rise and fall of economic activity relative to the long –
term growth trend of the economy; also called business
cycles. The ups and downs usually involve the entire nation
and often many economies around the world.
2 PHASES OF ECONOMY:
◦ EXPANSION – a period during which the economy’s output
increases.
◦ CONTRACTION – a period during which economy’s output
declines.
DEPRESSION – a sharp reduction in an economy’s total output
accompanied by high unemployment lasting more than a year.
RECESSION – a sustained decline in the economy’s total output
lasting at least two consecutive quarters, or six months; an economic
contraction.
INFLATION – an increase in the economy’s average price level.
DEFLATION – a decrease in the economy’s average price level
AGGREGATE DEMAND AND AGGREGATE SUPPLY
services produced in an economy during a given period; real GDP
AGGREGATE DEMAND – the relationship between the economy’s
price level and aggregate output demanded, with other things
constant.
Aggregate demand sums demands of the four economic decision
makers.
◦ Household demand
◦ Firm demand
◦ Government demand
◦ + World demand
◦ Aggregate demand
THE COMPONENTS OF THE MACROECONOMY
Macroeconomics focuses on four groups. To see the big picture, it is
helpful to divide the participants in the economy into four broad
groups:
(1) households,
(2) firms,
(3) the government, and
(4) the rest of the world.
THE THREE MARKET ARENAS
◦ Another way of looking at the ways households, firms, the
government, and the rest of the world relate to each other
is to consider the markets in which they interact.
We divide the markets into three broad arenas:
(1) Goods and Services Market
◦ Firms supply to the goods-and-services market.
Households, the government, and firms
demand from this market.
(2) Labor Market
◦ In this market, households supply labor and
firms and the government demand labor.
(3) Money Market or Financial Market
◦ Households supply funds to this market in the
expectation of earning income in the form of
dividends on stocks and interest on bonds.
◦ Firms, the government, and the rest of the
world also engage in borrowing and lending
which is coordinated by financial institutions.
THE ROLE OF THE GOVERNMENT IN THE MACROECONOMY
Fiscal Policy
◦ Government policies concerning taxes and spending.
Monetary Policy
◦ The tools used by the Federal Reserve to control the
quantity of money, which in turn affects interest rates.
Growth or supply – side policies
◦ Government policies that focus on stimulating aggregates
supply – to promote potential growth of aggregate output
and income, instead of aggregate demand.
SHORT HISTORY OF THE US ECONOMY
4 ECONOMIC ERAS
1. before and during the Great Depression
2. after the Great Depression to the early 1970s
3. from the early 1970s to the early 1980s
4. since the early 1980s
THE GREAT DEPRESSION AND BEFORE
THE AGE OF KEYNES: AFTER THE GREAT DEPRESSION TO THE EARLY
1970S
John Maynard Keynes argued that aggregate demand was inherently
unstable, in part because investment decisions were often guided by
the unpredictable “animal spirits” of business expectations. If
businesses grew pessimistic about the economy, they would invest
less, which would reduce aggregate demand, output and
employment.
◦ Keynes proposed that the government jolt the economy out
of its depression by increasing aggregate demand. He
recommended an expansionary fiscal policy to offset
contractions. The government could achieve this stimulus
either directly by increasing its own spending or indirectly
by cutting taxes to stimulate consumption and investment.
FEDERAL BUDGET DEFICIT – a flow variable measuring the amount by
which federal government outlays exceed federal government
revenues in a particular period, usually a year.
DEMAND – SIDE ECONOMICS – macroeconomic policy that focuses
on shifting the aggregate demand curve as a way of promoting full
employment and price stability.
◦ Keynes argued that government stimulus could shock the
economy out of its depression. Once investment returned
to normal levels, and the economy started growing on its
own, the government’s shock treatment would no longer be
necessary.
STAGFLATION: 1973 TO 1980
STAGFLATION – a contraction, or stagnation, of a nation’s output
accompanied by inflation in the price level.
◦ During the late 1960s, federal spending increased.
◦ In 1968, inflation rate climbed to 4.4 percent from 2.0
percent for two decades. In 1969, it increased to 4.7 percent
and to 5.3 percent in 1970.
◦ In 1971, Pres. Richard Nixon imposed ceilings on prices and
wages.
SINCE 1980
◦ Increasing aggregate supply seemed an appropriate way to
combat stagflation, for such a move would both lower the
price level and increase output and employment.
◦ SUPPLY-SIDE ECONOMICS – macroeconomic policy that
focuses on a rightward shift of the aggregate supply curve
through tax cuts or other changes to increase production
incentives.
◦ FEDERAL DEBT – a stock variable that measures the net
accumulation of annual federal deficits.
SUMMARY OF THE HISTORY OF THE U.S. ECONOMY
◦ 1970s – Presidents Richard Nixon, Gerald Ford, and Jimmy
Carter all wrestled with a rising rate of inflation.
◦ 1980s – Inflation subsided, but Presidents Ronald Reagan
and George Bush presided over large federal budget
deficits.
◦ 1990s – With President Bill Clinton, the economy and stock
market enjoyed a remarkable boom and the federal budget
turned from deficit to surplus. As Clinton left office, the
stock market was in retreat and the economy was heading
into recession.
◦ 2001 – President George W. Bush reduced taxes to help end
the recession but the tax cuts contributed to reemergence
of budget deficits.
◦ 2009 – President Barack Obama moved into the White
House in a period of heightened economic turbulence. The
economy was reeling from a financial crisis driven by a large
chop in housing prices and a steep rise in mortgage default.
UNEMPLOYMENT, INFLATION AND LONG – TERM GROWTH
EMPLOYED - Any person 16 years old or older
(1) who works for pay, either for someone else or in his or her
own business for 1 or more hours per week
(2) who works without pay for 15 or more hours per week in a
family enterprise
(3) who has a job but has been temporarily absent with or
without pay.
UNEMPLOYED - A person 16 years old or older who is not working, is
available for work, and has made specific efforts to find work during
the previous 4 weeks
NOT IN THE LABOR FORCE - A person who is not looking for work
because he or she does not want a job or has given up looking.
LABOR FORCE - The number of people employed plus the number of
unemployed
labor force = employed + unemployed
population = labor force + not in labor force
UNEMPLOYMENT RATE - The ratio of the number of people
unemployed to the total number of people in the labor force
unemployed
unemployment rate =
employed + unemployed
LABOR FORCE PARTICIPATION RATE - The ratio of the labor force to
the total population 16 years old or older.
labor force
labor force participation rate =
population
DISCOURAGED – WORKER EFFECT - The decline in the measured Four Causes of Structural Unemployment:
unemployment rate that results when people who want to work but 1. Lack of Education
cannot find jobs grow discouraged and stop looking, thus dropping out of 2. Changes in Consumer Demand
the ranks of the unemployed and the labor force. 3. Technological Advances
Job Search – the process by which workers find appropriate jobs given 4. Globalization
their tasters and skills. Outsourcing – the practice of a company having its work done by another
Union – a worker association that bargains with employers over wages, company in another country.
benefits, and working conditions. Offshoring – the practice of having work for a company performed by the
Collective Bargaining – the process by which unions and firms agree on company’s employees located in another country.
the terms of employment.
Efficiency Wages – above equilibrium wages paid by firms to increase INFLATION
worker productivity. INFLATION – an increase in the general (average) price level of goods
and services in the economy.
Efficiency – wage theory – states that such a constraint on firms is DEFLATION – a decrease in the general (average) price level of goods
unnecessary in many cases because firms may be better off keeping and services in the economy.
wages above the equilibrium level TWO BASIC TYPES OF INFLATION:
Several Types of Efficiency – wage theory: 1. Demand-pull inflation – a rise in the general price level
◦ Worker Health resulting from an excess of total spending (demand)
◦ Worker Turnover 2. Cost-push inflation – an increase in the general price level
◦ Worker Quality resulting from an increase in the cost of production
◦ Worker Effort
THE COSTS OF INFLATION
Inflation Changes the Distribution of Incomes
WORKER HEALTH
◦ If your incomes are fixed and prices rise, your ability to
◦ It emphasizes the link between wages and worker health.
purchase goods and services falls proportionately.
Better paid workers eat a more nutritious diet, and workers
Effects on Debtors and Creditors
who eat better diet are healthier and more productive.
◦ Inflation that is higher than expected benefits debtors;
WORKER TURNOVER
inflators that is lower than expected benefits creditors.
◦ It emphasizes the link between wages and worker turn over.
Workers quit jobs for many reasons: to take jobs in other firms,
PRODUCTION AND GROWTH
to move to other parts of the country, to leave the labor force,
PRODUCTIVITY – the quantity of goods and service produced from each
and so on. The frequency with which they quit depends of the
unit of labor input.
entire set of incentives they face, including the benefits of
PHYSICAL CAPITAL – the stock of equipment and structures that are
leaving and benefits of staying.
used to produce goods and services.
WORKER QUALITY
HUMAN CAPITAL – the knowledge and skills that workers acquire
◦ It emphasizes the link between wages and worker quality. All
through education, training and experience.
firms want workers who are talented, and they try to pick the
NATURAL RESOURCES – the inputs into the production of goods and
best applicants to fill job openings. When a firm pays a high
services that are provided by nature, such as land, rivers, and mineral
wage, it attracts a better pool of workers to apply for its jobs
deposits.
and thereby increases the quality of its workforce.
TECHNOLOGICAL KNOWLEDGE – society’s understanding of the best
WORKER EFFORT
ways to produce goods and services.
◦ It emphasizes the link between wages and worker effort. In
many jobs, workers have some discretion over how hard to
LONG – RUN GROWTH
work. As a result, firm monitor the efforts of their workers and
◦ Add more workers
those who are caught shirking their responsibilities are fired.
- If, for example, 12 workers are added, 2 extra per
But monitoring is costly and imperfect.
machine, then more output can be produced per
◦ One solution is paying wages above the equilibrium level. High
machine per hour worked because there are more
wages make workers more eager to keep their jobs and give
workers helping out on each machine.
workers an incentive to put forward their best effort.
◦ Add more machines
- If 4 machines are added, then the 60 workers have a
THREE TYPES OF UNEMPLOYMENT
total of 10 machines to work with instead of 6, and more
1. FRICTIONAL UNEMPLOYMENT – temporary unemployment
output can be produced per worker per hour worked.
caused by the time required of workers to move from one job
◦ Increase the length of the workweek
to another.
- For example, from 40 hours to 45 hours. With workers
2. STRUCTURAL UNEMPLOYMENT – unemployment caused by a
and machines working more hours, more output can be
mismatch of the skills of workers out of work and the skills
produced.
required for existing job opportunities.
◦ Increase the quality of the workers
3. CYCLICAL UNEMPLOYMENT - The increase in unemployment
- If the education of the workers increases, this may add
that occurs during recessions and depressions.
to their skills and may increase their ability to work on
4. SEASONAL UNEMPLOTMENT – (santa claus, construction
the machines.
worker)
◦ Increase the quality of the machines
- New machines that replace old machines may allow
NATURAL RATE OF UNEMPLOYMENT - The unemployment that occurs as
more output to be produced per hour with the same
a normal part of the functioning of the economy. Sometimes taken as the
number of workers.
sum of frictional unemployment and structural unemployment.