The Study of Macroeconomics
•Micro vs. Macro •Microeconomics –the study of how individual households and firms make decisions and how they interact with one another in markets. •Macroeconomics –the study of the economy as a whole. –Its goal is to explain the economic changes that affect many households, firms, and markets at once. •The Two Groups of Economists •Macroeconomists •Focus on the economy as a whole. •Spend much time analyzing how total income changes and how changes in income cause changes in other modes of economic behavior. •Microeconomists •Focus on the markets for individual commodities and on the decisions of single economic agents. Hold total income constant. •The Two Groups of Economists •Macroeconomists •Spend a great deal of time and energy investigating how people form their expectations and change them over time. •Consider the possibility that decision makers might change the quantities they produce before they change the prices they charge. •Microeconomists •Don’t worry much about how decision makers form their expectations. •Assume that economic adjustment occurs first through prices that change to balance supply and demand and that only afterward do producers and consumers react to the changed prices by changing the quantities they make, buy or sell. Why Macroeconomics Matters… •Cultural Literacy –“If you want to follow and participate in public debates and discussions, you need to know about macroeconomics. ” –Self-interest –“the macro economy matters to you personally” •Civic Responsibility –“working together, we can improve the macro economy. ” •Macroeconomic Questions •Why do output and employment sometimes fall and how can unemployment be reduced? •What are the sources of price inflation and how can it be kept under control? •How can a nation increase its rate of economic growth? •Objectives of Macroeconomics OUTPUT •high level and rapid growth of output to provide goods and services that the population desires •most comprehensive measure of total output in an economy is the gross domestic product / gross national product •potential output is determined by the economy’s productive capacity which depends on inputs available and the economy’s technological efficiency •Objectives of Macroeconomics EMPLOYMENT •high employment and low unemployment •unemployment rate is the percentage of the labor force that is unemployed •When output is falling, the demand for labor falls and the unemployment rate rises •Objectives of Macroeconomics STABLE PRICES rate of inflation denotes the rate of growth or decline in the price level from one year to the next •consumer price index (CPI) measures the cost of a basket of goods bought by the average urban consumer •price stability is important because a smoothly functioning market system requires that prices accurately and easily convey information about relative scarcities •SIX KEY VARIABLES •Real gross domestic product •The unemployment rate •The inflation rate •The interest rate •The level of the stock market •The exchange rate •Tools of Macroeconomics FISCAL POLICY •Denotes the use of taxes and government expenditures MONETARY POLICY through managing the country’s money, credit and banking system ? restricting money supply leads to higher interest rates and reduced investments which cause a decline in GDP and lower inflation •MACROECONOMIC POLICY •Growth policy – aims to accelerate or decelerate long-run economic growth •Stabilization policy -aims to avoid recessions and undue inflation by keeping total aggregate demand growing smoothly and unemployment near its NAIRU*. *Nonaccelerating inflation rate of unemployment (natural rate of unemployment) •SOME CONCEPTS… •Business cycle – a short-run fluctuation in the output, income and employment of an economy. Expansion – a period when real GDP is growing •Recession – a fall in the level of real GDP for at least six months, or two quarters of the year •Depression – a very severe recession •The Major Macroeconomic Issues •Economic growth and living standards •Productivity •Recessions and expansions •Unemployment •Inflation •Economic interdependence among nations •ROOTS OF MACROECONOMICS •Most economists and policy makers accepted the highs and lows of business cycles as being inevitable, which left them hopeless during the Great Depression in the 1930s. •The Great Depression in the 1930s “America’s “Great Depression” began with the dramatic crash of the stock market on “Black Thursday”, October 24, 1929 when 16 million shares of stock were quickly sold by panicking investors who had lost faith in the American economy. At the height of the Depression in 1933, nearly 25% of the Nation’s total work force, 12,830,000 people, were unemployed. ” •“Wage income for workers who were lucky enough to have kept their jobs fell almost 43% between 1929 and 1933. It was the worst economic disaster in American history. Farm prices fell so drastically that many farmers lost their homes and land.
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Many went hungry. ” •JOHN MAYNARD KEYNES The General Theory of Employment, Interest and Money ?argued that it is possible for high unemployment and underutilized capacity to persist in market economies ? argued that government fiscal and monetary policies can affect output and thereby reduce unemployment and shorten economic downturns •Measuring a Nation’s Income •Measuring a Nation’s Income •Microeconomics •Microeconomics is the study of how individual households and firms make decisions and how they interact with one another in markets. •Macroeconomics •Macroeconomics is the study of the economy as a whole. Its goal is to explain the economic changes that affect many households, firms, and markets at once. •Measuring a Nation’s Income •Macroeconomics answers questions like the following: •Why is average income high in some countries and low in others? •Why do prices rise rapidly in some time periods while they are more stable in others? •Why do production and employment expand in some years and contract in others? •THE ECONOMY’S INCOME AND EXPENDITURE •When judging whether the economy is doing well or poorly, it is natural to look at the total income that everyone in the economy is earning. THE ECONOMY’S INCOME AND EXPENDITURE •For an economy as a whole, income must equal expenditure because: •Every transaction has a buyer and a seller. •Every dollar of spending by some buyer is a dollar of income for some seller. •THE MEASUREMENT OF GROSS DOMESTIC PRODUCT •Gross domestic product (GDP) is a measure of the income and expenditures of an economy. •It is the total market value of all final goods and services produced within a country in a given period of time. •THE MEASUREMENT OF GROSS DOMESTIC PRODUCT •The equality of income and expenditure can be illustrated with the circular-flow diagram. Figure 1 The Circular-Flow Diagram •THE MEASUREMENT OF GROSS DOMESTIC PRODUCT •GDP is the market value of all final goods and services produced within a country in a given period of time. •THE MEASUREMENT OF GROSS DOMESTIC PRODUCT •“GDP is the Market Value . . . ” •Output is valued at market prices. •“. . . Of All Final . . . ” •It records only the value of final goods, not intermediate goods (the value is counted only once). •“. . . Goods and Services . . . “ •It includes both tangible goods (food, clothing, cars) and intangible services (haircuts, housecleaning, doctor visits). THE MEASUREMENT OF GROSS DOMESTIC PRODUCT •“. . . Produced . . . ” •It includes goods and services currently produced, not transactions involving goods produced in the past. •“ . . . Within a Country . . . ” •It measures the value of production within the geographic confines of a country. •THE MEASUREMENT OF GROSS DOMESTIC PRODUCT •“. . . In a Given Period of Time. ” •It measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months). •THE COMPONENTS OF GDP GDP includes all items produced in the economy and sold legally in markets. •THE COMPONENTS OF GDP •What Is Not Counted in GDP? •GDP excludes most items that are produced and consumed at home and that never enter the marketplace. •It excludes items produced and sold illicitly, such as illegal drugs. •Does GDP count intermediate goods? •Intermediate goods are goods used to produce other goods. •No, to avoid double counting, GDP only measures final goods and services. •Solving the Problem of Double Counting •What is gross national product (GNP)? GNP measures the market value of all final goods and services produced by a nation’s residents, no matter where they are located •What are the two approaches we use to measure GDP? •Flow of Product Approach / Expenditure Approach ? includes only final goods ultimately bought and used by consumers ? sum of annual flow of final goods and services (P x Q) ? upper loop of the circular flow of economic activity •THE COMPONENTS OF GDP •GDP (Y) is the sum of the following: •Consumption (C) • Investment (I) • Government Purchases (G) • Net Exports (NX) Y = C + I + G + NX •THE COMPONENTS OF GDP Consumption (C): •The spending by households on goods and services, with the exception of purchases of new housing. •Investment (I): •The spending on capital equipment, inventories, and structures, including new housing. •THE COMPONENTS OF GDP •Government Purchases (G): •The spending on goods and services by local, state, and federal governments. •Does not include transfer payments because they are not made in exchange for currently produced goods or services. •Net Exports (NX): •Exports minus imports. •Table 1 GDP and Its Components •GDP and Its Components (2001) •Flow of Product / Expenditure Approach