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Chapter 1 Introduction to Macroeconomics


Chapter 1 Introduction to Macroeconomics Session 1 What Macroeconomics is About Macroeconomics is the study of the structure and performance of national economies and ... – PowerPoint PPT presentation

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Title: Chapter 1 Introduction to Macroeconomics

Chapter 1Introduction to Macroeconomics
  • Session 1

What Macroeconomics is About
  • Macroeconomics is the study of the structure and
    performance of national economies and of the
    policies that governments use to try to affect
    economic performance.

What is macroeconomics? The study of the economy
as a whole, and the variables that control the
macro-economy. The study of government policy
meant to control and stabilize the economy over
time, that is, to reduce fluctuations in the
economy. The study of monetary policy, fiscal
policy, and supply-side economics.
Who introduced macroeconomics, and what was its
major objective? John Maynard Keynes, an English
economist, hence macroeconomics is also referred
to as Keynesianism. Keynes argued that by itself
the market is unable to generate enough savings
(capital) to sustain investment at full
employment levels and that this could be
achieved only with the periodic sharp increase in
government spending.
What is Macroeconomics
  • Macroeconomics examines economies at the
    aggregate (international, national, regional)
  • Some aspects of macroeconomics are about
    comparing two aggregate economies at the same

Why study the economy at the aggregate level?
  • Much of macroeconomics is concerned with policies
    such as money supply or tax policy which is
    national in scope.
  • Equilibrium effects means that outcomes are
    different when we consider the economy in
  • There are certain phenomenon like economic growth
    and business cycles which affect the aggregate
    economy equally.
  • .

  • Deals with the classic issues in economics
  • Unemployment
  • Inflation
  • National Output National Income
  • Population Growth
  • Economic Growth
  • Money Banking
  • Output
  • Business Cycle

Macro Economic Goals
  • The goal of economic growth
  • The Goal of Low Unemployment
  • The Goal of Low Inflation
  • Price Stability
  • Complementary and Conflicting Goals
  • A rise in average living standards
  • Sustainable position on the balance of payments
  • Sound government finances

2. Macroeconomic Goals Complementary and
Conflicting Goals
  • Complementary Goals
  • Low unemployment and high economic growth
  • Conflicting Goals
  • Low unemployment and low inflation

The Main Problems of Managing the Macroeconomy
  • Inaccurate economic data All of the main
    macroeconomic indicators are subject to a margin
    of error. They rely on statistical data collected
    from tax returns and surveys and data is often
    revised many months after its first release
  • Conflicting policy objectives  A policy of
    stimulating aggregate demand may reduce
    unemployment in the short term but initiate a
    period of higher inflation and exacerbate the
    current account of the balance of payments.
    Choices have to be made between objectives i.e.
    there exist trade-offs between them
  • Selecting the right policy instrument Each
    macroeconomic objective requires a separate
    policy instrument The usual rule of thumb is
    that one main policy instrument should be
    assigned to one policy objective. So, for
    example, interest rates might be assigned as the
    main instrument for keeping control of inflation,
    whilst fiscal policy instruments such as changes
    to the tax system might be allocated to achieving
    some supply-side objectives such as increasing
    the labour supply, boosting incentives, raising
    investment and increasing productivity. There are
    quite deep-rooted disagreements between some
    economists (who belong to different schools of
    thought) as to which policies are most effective
    to meet a certain objective

  • Uncertain time lags when running a
    policy Changes in economic policies are subject
    to uncertain time lags e.g. a change in interest
    rates is estimated to take some 18-24 months to
    work its way fully through the whole economy to
    filter through to a change in prices. The length
    of the time lags can change over the years as the
    reactions of consumers and businesses to policy
    measures alters
  • External shocks Unexpected external shocks to
    economy such as the events surrounding Sept 11th
    2001 or unexpected volatility in exchange rates
    and commodity prices can upset economic forecasts
    and take the economy some distance from the
    expected path. The Government might
    under-estimate or exaggerate the potential impact
    of an economic shock to either the demand or
    supply-side of the economy and therefore apply
    too little or too much of a policy response.

The main instruments of Macro Economic Policy
  • Fiscal Policy
  • Fiscal policy involves the use of government
    spending, taxation and borrowing to influence
    both the pattern of economic activity and also
    the level and growth of aggregate demand, output
    and employment.
  • Monetary Policy
  • Monetary policy involves the use of interest
    rates to control the level and rate of growth of
    aggregate demand in the economy.

Major Macroeconomic Variables Economic
output Short-run business fluctuations Long-run
economic growth Unemployment and Employment
Key Macroeconomic Variables Interest rates
Government budget balances and finance
International trade balances and finance
Macroeconomics Microeconomics
  • Microeconomics
  • Decisions of individual units
  • No matter how large
  • Macroeconomics
  • Behavior of entire economies
  • No matter how small
  • Economic aggregates

Macroeconomics Microeconomics
  • Aggregation
  • Combine many individual markets
  • Into one overall market
  • Composition of demand supply
  • In various markets
  • Important for microeconomics issues
  • Not important for macroeconomics issues
  • During economic fluctuations
  • Markets move up or down together

Macroeconomics Microeconomics
  • Macroeconomics
  • Assume most details
  • Resource allocation income distribution
  • Relatively unimportant
  • Microeconomics
  • Ignore macroeconomics issues
  • Focus individual markets
  • Allocate resources
  • Distribute income

Supply Demand in Macroeconomics
  • Aggregate demand curve
  • Quantity of domestic product demanded
  • Each possible value of price level
  • Aggregate supply curve
  • Quantity of domestic product supplied
  • Each possible value of price level

Figure 1
Two interpretations of a shift in the demand curve
Supply Demand in Macroeconomics
  • Inflation
  • Sustained increase in price level
  • Outward shift of aggregate demand curve
  • Recession period of time
  • Total output declines
  • Production falls
  • People lose jobs
  • Leftward shift of aggregate demand curve

Figure 2
An economy slipping into a recession
Supply Demand in Macroeconomics
  • Macroeconomists study
  • Inflation
  • Recession unemployment
  • Economic growth

Figure 3
Economic growth
Gross Domestic Product
  • Gross domestic product (GDP)
  • Sum money values
  • All final goods services
  • Produced - domestic economy
  • Sold organized markets
  • Specified period of time
  • Usually a year

Gross Domestic Product
  • Nominal GDP
  • GDP in current dollars
  • Value outputs current prices
  • Real GDP
  • Value outputs of different years
  • Common prices

Gross Domestic Product
  • GDP - particular year
  • Add up money value of things
  • Goods services
  • Produced within the year
  • Final goods services
  • Production geographic boundaries of U.S.
  • Organized markets

Gross Domestic Product
  • Final goods and services
  • Purchased by their ultimate users
  • Intermediate good - purchased
  • For resale
  • For use in producing another good

Gross Domestic Product
  • Limitations of GDP
  • Not measure nations economic well-being
  • Includes only market activity
  • Places no value on leisure
  • Ecological costs
  • Not deducted from GDP

microeconomics Examines the functioning of
individual industries and the behavior of
individual decision-making unitsfirms and
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.
aggregate behavior The behavior of all
households and firms together.
sticky prices Prices that do not always adjust
rapidly to maintain equality between quantity
supplied and quantity demanded.
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Macroeconomic Concerns
Output Growth
business cycle The cycle of short-term ups and
downs in the economy.
aggregate output The total quantity of goods and
services produced in an economy in a given
recession A period during which aggregate output
declines. Conventionally, a period in which
aggregate output declines for two consecutive
depression A prolonged and deep recession.
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Macroeconomic Concerns
Output Growth
expansion or boom The period in the business
cycle from a trough up to a peak during which
output and employment grow.
contraction, recession, or slump The period in
the business cycle from a peak down to a trough
during which output and employment fall.
30 of 24
Macroeconomic Concerns
Output Growth
? FIGURE 20.1 A Typical Business Cycle
In this business cycle, the economy is expanding
as it moves through point A from the trough to
the peak. When the economy moves from a peak
down to a trough, through point B, the economy is
in recession.
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Macroeconomic Concerns
Output Growth
? FIGURE 20.2 U.S. Aggregate Output (Real GDP),
The periods of the Great Depression and World
Wars I and II show the largest fluctuations in
aggregate output.
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Macroeconomic Concerns
unemployment rate The percentage of the labor
force that is unemployed.
Inflation and Deflation
inflation An increase in the overall price
hyperinflation A period of very rapid increases
in the overall price level.
deflation A decrease in the overall price level.
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The Components of the Macro economy
  • Macroeconomics focuses on four groups. To see
    the big picture, it is helpful to divide the
    participants in the economy into four broad
  • households,
  • firms,
  • the government, and
  • the rest of the world.

34 of 24
The Components of the Macroeconomy
The Circular Flow Diagram
circular flow A diagram showing the income
received and payments made by each sector of the
transfer payments Cash payments made by the
government to people who do not supply goods,
services, or labor in exchange for these
payments. They include Social Security benefits,
veterans benefits, and welfare payments.
35 of 24
The Components of the Macroeconomy
The Circular Flow Diagram
Households receive income from firms and the
government, purchase goods and services from
firms, and pay taxes to the government. They
also purchase foreign-made goods and services
(imports). Firms receive payments from
households and the government for goods and
services they pay wages, dividends, interest,
and rents to households and taxes to the
government. The government receives taxes from
firms and households, pays firms and households
for goods and servicesincluding wages to
government workersand pays interest and
transfers to households. Finally, people in
other countries purchase goods and services
produced domestically (exports).Note Although
not shown in this diagram, firms and governments
also purchase imports.
36 of 24
The Components of the Macroeconomy
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
  • the goods-and-services market,
  • the labor market, and
  • the money (financial) market.

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The Components of the Macroeconomy
The Three Market Arenas
Goods-and-Services Market
Firms supply to the goods-and-services market.
Households, the government, and firms demand from
this market.
Labor Market
In this market, households supply labor and firms
and the government demand labor.
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The Components of the Macroeconomy
The Three Market Arenas
Money 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.
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The Components of the Macroeconomy
The Three Market Arenas
Money Market
Treasury bonds, notes, and bills Promissory
notes issued by the federal government when it
borrows money.
corporate bonds Promissory notes issued by firms
when they borrow money.
shares of stock Financial instruments that give
to the holder a share in the firms ownership and
therefore the right to share in the firms
dividends The portion of a firms profits that
the firm pays out each period to its
40 of 24
The Components of the Macroeconomy
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.
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John Maynard Keynes
Much of the framework of modern macroeconomics
comes from the works of John Maynard Keynes,
whose General Theory of Employment, Interest and
Money was published in 1936.
42 of 24
Issues Addressed by Macroeconomists
  • What determines a nations long-run economic
  • What causes a nations economic activity to
  • What causes unemployment?

Issues Addressed by Macroeconomists (continued)
  • What causes prices to rise?
  • How does being a part of a global economic system
    affect nations economies?
  • Can government policies be used to improve
    economic performance?

Long-Run Economic Growth
  • Rich nations have experienced extended periods of
    rapid economic growth.
  • Poor nations either have never experienced them
    or economic growth was offset by economic decline.

Increased Output
  • Total output is increasing because of increasing
    population, i.e. the number of available workers.
  • Increasing average labour productivity the
    amount of output produced per unit of labour

Rates of Growth of Output
  • Rates of growth of output (or output per worker)
    are determined by
  • rates of saving and investment
  • rates of technological change
  • rates of change in other factors.

Business Cycles
  • Business cycles are short-run contractions and
    expansions of economic activity

  • Recession is the downward phase of a business
    cycle when national output is falling or growing
  • Hard times for many people
  • A major political concern

  • Recessions are usually accompanied by high
    unemployment the number of people who are
    available for work and are actively seeking it
    but cannot find jobs.

  • When prices of most goods and services are rising
    over time it is inflation. When they are falling
    it is deflation.
  • The inflation rate is the percentage increase in
    the average level of prices.

Effects of Inflation
  • When the inflation rate reaches an extremely high
    level the economy tends to function poorly. The
    purchasing power of money erodes quickly, which
    forces people to spend their money as soon as
    they receive it.

The International Economy
  • An economy which has extensive trading and
    financial relationships with other national
    economies is an open economy. An economy with no
    relationships is a closed economy.

The International Economy (continued)
  • International trade and borrowing relationships
    can transmit business cycles from country to

Exports and Imports
  • Indian exports are goods and services produced
    in India and consumed abroad.
  • Indian imports are goods and services produced
    abroad and consumed in India

Trade Imbalances
  • Trade imbalances (trade surplus and deficit)
    affect output and employment.
  • Trade surplus exports exceed imports.
  • Trade deficit imports exceed exports.

The Exchange Rate
  • The trade balance is affected by the exchange
    rate the amount of Indian Rupee that can be
    purchased with a unit of foreign currency.

Macroeconomic Policy
  • A nations economic performance depends on
  • natural and human resources
  • capital stock
  • technology
  • economic choices made by citizens
  • macroeconomic policies of the government.

Macroeconomic Policy (continued)
  • Macroeconomic policies
  • Fiscal policy government spending and taxation
    at different government levels.
  • Monetary policy the central banks control of
    short-term interest rates and the money supply.

Budget Deficits
  • The economy is affected when there are large
    budget deficits the excess of government
    spending over tax collection.

  • Macroeconomists ignore distinctions between
    individual product markets and focus on national
  • The process of summing individual economic
    variables to obtain economywide totals is called

What Macroeconomists Do
  • Macroeconomic forecasting
  • Macroeconomic analysis
  • Macroeconomic research
  • Data development

Macroeconomic Forecasting
  • Macroeconomic forecasting prediction of future
    economic trends - has some success in the short
    run. In the long run too many factors are highly

Macroeconomic Analysis
  • Macroeconomic analysis - analyzing and
    interpreting events as they happen helps both
    private sector and public policymaking.

Macroeconomic Research
  • Macroeconomic research - trying to understand the
    structure of the economy in general forms the
    basis for macroeconomic analysis and forecasting.

Economic Theory
  • Economic theory a set of ideas about the economy
    to be organized in a logical framework.
  • Economic model a simplified description of some
    aspects of the economy.

Developing and Testing a Theory
  • State the research question.
  • Make provisional assumptions.
  • Work out the implications of the theory.
  • Conduct an empirical analysis.
  • Evaluate the results.

Data Development
  • Macroeconomists use data to assess the state of
    the economy, make forecasts, analyze policy
    alternatives, and test theories.

Data Development (continued)
  • Providers of data must
  • Decide what types of data should be collected
    based on who is expected to use the data and how.
  • Ensure the measures of economic activity
    correspond to economic concepts.
  • Guarantee the confidentiality of data.

Why Macroeconomists Disagree
  • A positive analysis examines the economic
    consequences of an economic policy, but it does
    not address its desirability.
  • A normative analysis tries to determine whether a
    certain economic policy should be used.

Why Macroeconomists Disagree (continued)
  • Economists can disagree on normative issues
    because of differences in values.
  • Economists disagree on positive issues because of
    different schools of thought.

The Classical Approach
  • The invisible hand of Economics General welfare
    will be maximized (not the distribution of
    wealth) if
  • there are free markets
  • individuals act in their own best interest.

The Classical Approach (continued)
  • To maintain markets equilibrium the quantities
    demanded and supplied are equal
  • Markets must function without impediments.
  • Wages and prices should be flexible.

The Classical Approach (continued)
  • Thus, according to the classical approach, the
    government should have a limited role in the

The Keynesian Approach
  • Keynes (1936) assumed that wages and prices
    adjust slowly.
  • Thus, markets could be out of equilibrium for
    long periods of time and unemployment can

The Keynesian Approach (continued)
  • Therefore, according to the Keynesian approach,
    governments can take actions to alleviate

The Keynesian Approach (continued)
  • The government can purchase goods and services,
    thus increasing the demand for output and
    reducing unemployment.
  • Newly generated incomes would be spent and would
    raise employment even further.

Evolution of the Classical-Keynesian Debate
  • After stagflation high unemployment and high
    inflation of the 1970s, a modernized classical
    approach reappeared.
  • Substantial communication and cross-pollination
    is taking place between the classical and the
    Keynesian approaches.

Unified Approach to Macroeconomics
  • Individuals, firms and the government interact in
    goods, asset and labour markets.
  • The macroeconomic analysis is based on the
    analysis of individual behaviour.

The Unified Approach (continued)
  • Keynesian and classical economists agree that in
    the long run prices and wages adjust to
    equilibrium levels.
  • The basic model will be used either with
    classical or Keynesian assumptions about
    flexibility of wages and prices in the short run.

Importance of Macro Economics
  • Growing importance of macro economic issues
  • Persistence of Macroeconomic Problems
  • Growing Complexity of economic system
  • Need for Govt. intervention with the market
  • Use of Macro Economics in Business Management

  • It ignores structural Changes
  • Aggregate are nor reality but a picture or
    approximation of reality
  • Some Economist consider macroeconomics only as an
    intellectual attraction without much of practical
    use. Such as J.R.Hicks.

Global Economy Global Economy Global Economy Global Economy Global Economy Global Economy
US UK Euro Japan China
GDP 1.6Q2-2013 1.3Q2-2013 -0.5Q2-2013 1.2Q2-2013 7.5Q2-2013
CPI 1.5Aug2013 2.7Aug2013 1.1Sept2013 0.9Aug2013 2.6Aug2013
IIP 2.7Aug2013 -1.5July2013 -2.1July2013 -0.2Aug2013 10.4Aug2013
Emp 7.3Aug2013 7.7June2013 12.0Aug2013 4.1Aug2013 4.1  Q2-2013
Updated on 07 October, 2013 Updated on 07 October, 2013 Updated on 07 October, 2013 Updated on 07 October, 2013 Updated on 07 October, 2013 Updated on 07 October, 2013
Emp Unemployment Rate
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