5 5 an introduction to macroeconomics where the telescope ends, the microscope begins. which of the...

5

An Introduction to Macroeconomics

Where the telescope ends, the microscope begins. Which of the two has the grander view?

VICTOR HUGO

● Drawing a Line Between Macroeconomics and Microeconomics

● Supply and Demand in Macroeconomics

● Gross Domestic Product

● The Economy on a Roller Coaster

● The Problem of Macroeconomic Stabilization: A Sneak Preview

● Drawing a Line Between Macroeconomics and Microeconomics

● Supply and Demand in Macroeconomics

● Gross Domestic Product

● The Economy on a Roller Coaster

● The Problem of Macroeconomic Stabilization: A Sneak Preview

ContentsContents

Copyright © 2006 South-Western/Thomson Learning. All rights reserved.

Copyright© 2006 Southwestern/Thomson Learning All rights reserved.

Drawing a Line Between Macro and MicroeconomicsDrawing a Line Between Macro and Microeconomics

● In macroeconomics, we typically assume that most details of resource allocation and income distribution are of secondary importance to the study of the overall rates of inflation and unemployment.

● In macroeconomics, we typically assume that most details of resource allocation and income distribution are of secondary importance to the study of the overall rates of inflation and unemployment.



● Aggregation and Macroeconomics♦ An economic aggregate is nothing but an

abstraction that people use to describe some important feature of economic life, such as total domestic product.

● Aggregation and Macroeconomics♦ An economic aggregate is nothing but an

abstraction that people use to describe some important feature of economic life, such as total domestic product.



● The Foundations of Aggregation♦ The composition of demand and supply in

various markets is of little consequence for the economy-wide issues of growth, inflation, and unemployment.

♦ During economic fluctuations, markets tend to move up or down together.

● The Foundations of Aggregation♦ The composition of demand and supply in

various markets is of little consequence for the economy-wide issues of growth, inflation, and unemployment.

♦ During economic fluctuations, markets tend to move up or down together.


Supply and Demand in MacroeconomicsSupply and Demand in Macroeconomics

● Moving to Macroeconomic Aggregates♦ Aggregate supply and aggregate demand relate

domestic product (on the horizontal axis) to the price level (on the vertical axis).

● Moving to Macroeconomic Aggregates♦ Aggregate supply and aggregate demand relate

domestic product (on the horizontal axis) to the price level (on the vertical axis).



● Moving to Macroeconomic Aggregates♦ Aggregate demand (AD) = quantity of

domestic product that is demanded at each possible price level

♦ Aggregate supply (AS) = quantity of domestic product that is supplied at each possible price level

● Moving to Macroeconomic Aggregates♦ Aggregate demand (AD) = quantity of

domestic product that is demanded at each possible price level

♦ Aggregate supply (AS) = quantity of domestic product that is supplied at each possible price level

FIGURE 1: Two Interpretations of a Shift in the Demand Curve

FIGURE 1: Two Interpretations of a Shift in the Demand Curve


Q0

Pri

ce

P0

D1

A

S

D

D

S

E

Quantity(a)

Pri

ce

P0

S

D

D

S

E

Quantity(a)

D1

FIGURE 2: An Economy Slipping into a Recession

FIGURE 2: An Economy Slipping into a Recession


D2

B

Pri

ce L

evel

S

D0

D0

S

E

Domestic Product

D2

FIGURE 3: Economic GrowthFIGURE 3: Economic Growth


D1

C

Pri

ce L

evel

S0

D0

D0

S0

E

Domestic Product

D1

S1

S1

Q0 Q1


● Major concerns of macroeconomics■Inflation■Unemployment■Growth

AD price level

● Major concerns of macroeconomics■Inflation■Unemployment■Growth

AD price level



● Recession and Unemployment AD/AS unemployment

♦ Recession = a period of time during which production falls and people lose jobs

● Recession and Unemployment AD/AS unemployment

♦ Recession = a period of time during which production falls and people lose jobs



● Economic Growth♦ Economic growth = GDP AD and/or AS growth

● Economic Growth♦ Economic growth = GDP AD and/or AS growth



● Money as the Measuring Rod: Real Versus Nominal GDP♦ GDP = sum of the money values of all final

goods and services produced in the domestic economy within the year

♦ Nominal GDP (GDP in current dollars) values each good and service at the price at which it was actually sold during the year.

● Money as the Measuring Rod: Real Versus Nominal GDP♦ GDP = sum of the money values of all final

goods and services produced in the domestic economy within the year

♦ Nominal GDP (GDP in current dollars) values each good and service at the price at which it was actually sold during the year.

Gross Domestic ProductGross Domestic Product


♦ Drawback of Nominal GDP: it changes when prices change even if there is no change in actual production.

♦ Solution: calculate real GDP or GDP in constant dollars.

♦ Distinction between Nominal and Real GDP a working definition of a recession as a period in which real GDP declines

♦ Drawback of Nominal GDP: it changes when prices change even if there is no change in actual production.

♦ Solution: calculate real GDP or GDP in constant dollars.

♦ Distinction between Nominal and Real GDP a working definition of a recession as a period in which real GDP declines



GDP ExampleGDP Example

2005 2006

Pounds Produced Price per lb. Pounds Produced Price per lb.

Beef 15 15 20 13

Corned Beef 5 10 2 12

Beef Jerky 3 20 8 8



2005 Nominal Output

Pounds Produced Price per lb.

Beef 15 15

Corned Beef 5 10

Beef Jerky 3 20

Nominal GDP =



2005 Nominal Output

Pounds Produced Price per lb.

Beef 15 15 225

Corned Beef 5 10 50

Beef Jerky 3 20 60

Nominal GDP = 335



2006 2006 2005 Nominal OutputReal Output in 2005 Dollars

Pounds Produced Price per lb. Price per lb.

Beef 20 13 15

Corned Beef 2 12 10

Beef Jerky 8 8 20

Nominal GDP = xxxxxxxxxxxxxxxx

Real GDP in 2005 Dollars = xxxxxxxxxxxxxxxxxx



2006 2006 2005 Nominal OutputReal Output in 2005 Dollars

Pounds Produced Price per lb. Price per lb.

Beef 20 13 15 260 300

Corned Beef 2 12 10 24 20

Beef Jerky 8 8 20 64 160

Nominal GDP = 348

Real GDP in 2005 Dollars = 480

FIGURE 4: Nominal GDP, Real GDP, and Real GDP per Capita

FIGURE 4: Nominal GDP, Real GDP, and Real GDP per Capita


0

10,000

5,000

20,000

30,000

15,000

25,000

35,000

$40,000

0

2,000

1,000

4,000

6,000

8,000

3,000

5,000

7,000

$9,000

$10,000

Real GDP(right scale)

$11,000

Year1995 2000

2004

19901985198019751970196519601955

Nominal GDP (right scale)

NOTE: Real GDP figures are in 2000 dollars.

Do

llars

pe

r Y

ea

rB

illion

s of D

olla

rs pe

r Ye

ar

Real GDP per capita (left scale)



● What Gets Counted in GDP?♦ Only goods and services produced within the

year

♦ Only final goods and services

♦ Only production within the geographic boundaries of the United States

● What Gets Counted in GDP?♦ Only goods and services produced within the

year

♦ Only final goods and services

♦ Only production within the geographic boundaries of the United States


● Limitations of the GDP: What GDP Is Not♦ Includes only market activities

♦ Places no value on leisure

♦ Counts “bads” as well as “goods”

♦ Does not deduct ecological costs of economic activity

● Limitations of the GDP: What GDP Is Not♦ Includes only market activities

♦ Places no value on leisure

♦ Counts “bads” as well as “goods”

♦ Does not deduct ecological costs of economic activity



Well-Being?Well-Being?

● If national income is a good measure of well-being, why is Switzerland's Gross Domestic Product so much lower than India's GDP or China's GDP?

● What measures would better compare the well-being for residents of different countries?

● How do you expect these direct measures to correlate with per capita GDP?





Well Being?Well Being?








The Economy on a Roller CoasterThe Economy on a Roller Coaster

● Growth, but with Fluctuations♦ The U.S. has seen significant fluctuations in

economic growth, unemployment, and inflation.

♦ Before WWII, the business cycle was particularly strong, the worst episode being the Great Depression of the 1930s.

● Growth, but with Fluctuations♦ The U.S. has seen significant fluctuations in

economic growth, unemployment, and inflation.

♦ Before WWII, the business cycle was particularly strong, the worst episode being the Great Depression of the 1930s.

FIGURE 5: The Growth Rate of U.S. Real GDP, 1870-2004



–20

–15

–10

–5

5

10

15

20

1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

2004

Year

0

Post–1950

Pre–1940

Rapidindustrialization

Railroadprosperity

Depressionof 1890s

Panicof 1907

Postwardepression

GreatDepression

Postwarrecession

WorldWar I

WorldWar II Korean

WarExpansion

of1960s

1974–75Recession

1982–83Recession

RoaringTwenties

1990–91Recession

Expansionof

1980s

Boomof

1990s

FIGURE 6: The Inflation Rate in the United States, 1870-2004

FIGURE 6: The Inflation Rate in the United States, 1870-2004


–15

–10

0

5

10

15

20

25

1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Year

–5Post–1950

Pre–1940

2004Postwardeflation

Post-Civil Wardeflation Great

Depression

WorldWar I

WorldWar II

Postwaradjustment

Inflationof the 1970s

Vietnam Warinflation

Disinflationof the 1980s



● The Great Depression♦ A worldwide event

♦ Caused a much-needed revolution in economic thinking

♦ Until the 1930s, the prevailing economic theory held that a capitalist economy could cure recessions or inflations by itself.

● The Great Depression♦ A worldwide event

♦ Caused a much-needed revolution in economic thinking

♦ Until the 1930s, the prevailing economic theory held that a capitalist economy could cure recessions or inflations by itself.



● The Great Depression♦ The Great Depression led John Maynard

Keynes, one of the world’s most renowned economists, to write The General Theory of Employment, Interest, and Money (1936).

● The Great Depression♦ The Great Depression led John Maynard

Keynes, one of the world’s most renowned economists, to write The General Theory of Employment, Interest, and Money (1936).



● The Great Depression♦ Keynes believed that:

■The economy did not naturally gravitate toward smooth growth and high levels of employment

■A pessimistic outlook could lead business firms and consumers to curtail their spending plans

■The economy could then be condemned to years of stagnation

● The Great Depression♦ Keynes believed that:

■The economy did not naturally gravitate toward smooth growth and high levels of employment

■A pessimistic outlook could lead business firms and consumers to curtail their spending plans

■The economy could then be condemned to years of stagnation



● The Great Depression♦ In terms of the AD-AS framework, Keynes

suggested that there were times when the AD curve shifted inward by large amounts.

♦ The consequence would be declining output and deflation.

● The Great Depression♦ In terms of the AD-AS framework, Keynes

suggested that there were times when the AD curve shifted inward by large amounts.

♦ The consequence would be declining output and deflation.


● The Great Depression♦ Keynes showed how governments can manage

their economies so that recessions will not turn into depressions and depressions will not last as long as the Great Depression.

● The Great Depression♦ Keynes showed how governments can manage

their economies so that recessions will not turn into depressions and depressions will not last as long as the Great Depression.




● From World War II to 1973♦ During this period, the economy experienced

some fairly mild business cycles, but grew considerably.

♦ By the end of the period, inflation was rising.

● From World War II to 1973♦ During this period, the economy experienced

some fairly mild business cycles, but grew considerably.

♦ By the end of the period, inflation was rising.



● The Great Stagflation, 1973-1980♦ The international price of oil was raised

sharply in 1973 and again in 1979.

♦ For that reason and some others, the period saw the emergence of stagflation, both unemployment and inflation increasing together.

● The Great Stagflation, 1973-1980♦ The international price of oil was raised

sharply in 1973 and again in 1979.

♦ For that reason and some others, the period saw the emergence of stagflation, both unemployment and inflation increasing together.

FIGURE 7: The Effects of an Adverse Supply Shift

FIGURE 7: The Effects of an Adverse Supply Shift


S1

S1 D

D S0

S0

Pri

ce L

evel

Real GDP

A

E



● Reaganomics and its Aftermath♦ When Reagan assumed office in 1981, the

economy went into a sharp tailspin, and soon the rate of inflation fell.

♦ This was followed by a period of steady, non-inflationary growth during most of the 1980s. In 1990-91, recession hit.

● Reaganomics and its Aftermath♦ When Reagan assumed office in 1981, the

economy went into a sharp tailspin, and soon the rate of inflation fell.

♦ This was followed by a period of steady, non-inflationary growth during most of the 1980s. In 1990-91, recession hit.



● Clintonomics: Deficit Reduction and “The Best Economy in 30 Years”♦ Clinton’s initial objectives were spurring

growth and increasing public investment.

♦ Soon, however, the overriding goal in Washington became deficit reduction.

● Clintonomics: Deficit Reduction and “The Best Economy in 30 Years”♦ Clinton’s initial objectives were spurring

growth and increasing public investment.

♦ Soon, however, the overriding goal in Washington became deficit reduction.

FIGURE 8: The Effects of a Favorable Supply Shift

FIGURE 8: The Effects of a Favorable Supply Shift


Real GDP

Pri

ce L

evel

D0

D0

S0

S0

S1

S1

D1

D1

S2

S2

C

B E



● Clintonomics: Deficit Reduction and “The Best Economy in 30 Years”♦ A variety of transitory factors pushed the

economy’s AS curve outward at an unusually rapid pace between 1996 and 1999.

♦ Strong economic growth continued through the late 1990s.

♦ Inflation remained low.

● Clintonomics: Deficit Reduction and “The Best Economy in 30 Years”♦ A variety of transitory factors pushed the

economy’s AS curve outward at an unusually rapid pace between 1996 and 1999.

♦ Strong economic growth continued through the late 1990s.

♦ Inflation remained low.



● The Bush Economy and the 2004 Election♦ Real GDP grew very slowly then declined

slightly in 2nd half of 2001■1st recession in 10 years■Recession ended November 2001

● The Bush Economy and the 2004 Election♦ Real GDP grew very slowly then declined

slightly in 2nd half of 2001■1st recession in 10 years■Recession ended November 2001



● The Bush Economy and the 2004 Election♦ Policies that helped shift AD curve, mitigating

recession■2001-2003 tax cuts■war of terrorism, burst of government spending■consumers spending remained strong, despite 9/11■low interest rates encouraged spending

● The Bush Economy and the 2004 Election♦ Policies that helped shift AD curve, mitigating

recession■2001-2003 tax cuts■war of terrorism, burst of government spending■consumers spending remained strong, despite 9/11■low interest rates encouraged spending


● Combating Unemployment♦ When recessions are caused by too low

aggregate demand, governments can try to stimulate demand.

● Combating Unemployment♦ When recessions are caused by too low

aggregate demand, governments can try to stimulate demand.

The Problem of Macroeconomic StabilizationThe Problem of Macroeconomic Stabilization

FIGURE 9 Stabilization Policy to Fight Unemployment

FIGURE 9 Stabilization Policy to Fight Unemployment


Increase in output

Pri

ce

Le

ve

l

Real GDP

S

S D0

D0

E

D1

D1

A


● Combating Inflation♦ When inflation is caused by too high aggregate

demand, governments can try to restrain aggregate demand.

● Combating Inflation♦ When inflation is caused by too high aggregate

demand, governments can try to restrain aggregate demand.


FIGURE 10: Stabilization Policy to Fight Inflation

FIGURE 10: Stabilization Policy to Fight Inflation


Decrease in prices

Pri

ce L

evel

Real GDP

S

S

D0

D0

E

D2

D2

B



● Does It Really Work?♦ Before 1940, the economy endured

pronounced business fluctuations and inflation was rare.

♦ Since World War II the business fluctuations have been much less severe, but inflation has been a common occurrence.

♦ How successful government policy can be is a question to be explored throughout the text.

● Does It Really Work?♦ Before 1940, the economy endured

pronounced business fluctuations and inflation was rare.

♦ Since World War II the business fluctuations have been much less severe, but inflation has been a common occurrence.

♦ How successful government policy can be is a question to be explored throughout the text.





–20

–15

–10

–5

5

10

15

20

1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

2004

Year

0

Post–1950

Pre–1940

Rapidindustrialization

Railroadprosperity

Depressionof 1890s

Panicof 1907

Postwardepression

GreatDepression

Postwarrecession

WorldWar I

WorldWar II Korean

WarExpansion

of1960s

1974–75Recession

1982–83Recession

RoaringTwenties

1990–91Recession

Expansionof

1980s

Boomof

1990s

5 5 an introduction to macroeconomics where the telescope ends, the microscope begins. which of the...

Documents

quantity of domestic

microeconomics supply

total domestic product

composition of demand

microeconomics aggregation

economic fluctuations

victor hugo slide

foundations of aggregation