Introduction to Macroeconomics

Lesson 1.2

What is Macroeconomics?

• Macroeconomics is the study and application of managing the overall economy for everyone.– Managing business cycles to reduce, mitigate, or eliminate

recessions or depressions.– Maintain a stable currency– Promote employment and a “fair” distribution of societies

goods and services

Business Cycles• Macroeconomics is primarily concerned with the

Business Cycle.– The business cycle is the time from a peak in the

economy to the next peak.– The business cycle is Peak - Recession –Trough -

Expansion – Peak• Recession - GDP is falling• Expansion - at some point the economy (hopefully)

recovers and begins to grow again• Business cycles can vary wildly from 18 months to over

ten years

– A Recession is a period of two consecutive quarters (3 months each) of contraction or downturn in the economy

– A Depression is an unusually long and severe recession (no actual definition)

Employment, Unemployment and the Business Cycle

• One of the principle effects of a recession is a loss of employment of many people, from the hundreds of thousands to millions of jobs lost.– Employment is the number of people currently working– Unemployment is people looking for work– The Labor Force is the aggregate of Employed people and Unemployed

people• The Unemployment Rate is the percentage of the Labor Force that

unemployed• What is a “good” unemployment rate?

Aggregate Output and the Business Cycle

• While employment and unemployment are central concerns during contractions and expansions, another crucial factor is Output– Output is the goods and services

created– Aggregate Output is the combined

total of all goods and services– Aggregate output normally falls

during recession and increases during expansion

– How do Aggregate Output and Unemployment relate to each other?

Inflation, Deflation, and Price Stability

• Inflation is the rise in prices over time– In 1972, a candy bar was $0.25, today the same bar would cost $1.25. This

means that even though wages are rising, the price of goods is also rising. Are wages keeping up?

• Deflation is the drop in prices over time– While this may seem desirable, what are the consequences?

• Rising or falling prices influence people to save or to spend. How does this effect the economy?

• Price Stability is a goal because it provides a more stable economy. Why? (Think future spending decisions)

Economic Growth

• Economic Growth is the long term rise in aggregate output.– This means that more goods and services are produced,

generating better living conditions.• Imagine what it would be like with no electricity. The state of

Tennessee did not have electricity for most of its population until after WWII. Economic growth means access to autos, washing machines, computers, cell phones, etc.

Use of Models in Economics• Economics is so complex with so many variables that it is

literally (at this time) impossible to Model directly. Therefore Economics uses approximations, and simplified Models to try to understand what is happening.

• The use of Models is necessary, but at the same time it introduces Assumptions about the economy and the world. Assumptions are guesses that allow us to ignore many variables to simplify the Model.

• For example, if you were a economist tasked by the Governor of California to determine if a new Tax would benefit or hurt the economy, you would have to make certain assumptions about peoples behavior with regards to the tax in order to create a Model.

• One form of assumption that is regularly used it Ceteris Paribus, which means (loosely) “all other things being equal” (or we are changing one variable, but we think everything else will remain the same.)

The Rational Actor in Economic Theory (1)• Homo economicus is a term used for an approximation or model

of Homo sapiens that acts to obtain the highest possible well-being for himself given available information about opportunities and other constraints, both natural and institutional, on his ability to achieve his predetermined goals. This approach has been formalized in certain social science models, particularly in economics.

The Rational Actor in Economic Theory (2)• Homo economicus is seen as "rational" in the sense that

well-being as defined by the utility function is optimized given perceived opportunities. That is, the individual seeks to attain very specific and predetermined goals to the greatest extent with the least possible cost.

The Rational Actor in Economic Theory (3)• Note that this kind of "rationality" does not say that the

individual's actual goals are "rational" in some larger ethical, social, or human sense, only that he tries to attain them at minimal cost. Only naïve applications of the Homo economicus model assume that this hypothetical individual knows what is best for his long-term physical and mental health and can be relied upon to always make the right decision for himself.