macroeconomics –introduction and goals lecture 1

8/4/2019 Macroeconomics Introduction and Goals Lecture 1

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Macroeconomics

Introduction and Goals


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Introduction toMacroeconomics Microeconomics examines the

behavior of individual decision-making unitsbusiness firms andhouseholds.

Macroeconomics deals with theeconomy as a whole; it examines thebehavior of economic aggregates

such as aggregate income,consumption, investment, and theoverall level of prices.

Aggregate behavior refers to the


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Introduction toMacroeconomics

Microeconomists generally concludethat markets work well.Macroeconomists, however, observe

that some prices often seem sticky.

Sticky prices are prices that do notalways adjust rapidly to maintain the

equality between quantity suppliedand quantity demanded.


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The Roots ofMacroeconomics

The Great Depression was a periodof severe economic contraction andhigh unemployment that began in

1929 and continued throughout the1930s.


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Classical economists appliedmicroeconomic models, or marketclearing models, to economy-wide

problems.

However, simple classical modelsfailed to explain the prolonged

existence of high unemploymentduring the Great Depression. Thisprovided the impetus for the

development of macroeconomics.


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In 1936, John Maynard Keynespublished The General Theory ofEmployment, Interest, and Money.

Keynes believed governments couldintervene in the economy and affectthe level of output and employment.

During periods of low privatedemand, the government canstimulate aggregate demand to lift

the economy out of recession.


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Says Law and KeynesianRevolution

Classical Economist assumes fullemployment of labor and otherresources.

Free market economy automaticallyrestore full employment in case ofany deviation.

This belief was based on Says Law ofMarkets

Supply creates its own demand


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Keynes contested this classical viewpoint.

He explained equilibrium level ofnational income and employmentwas determined by aggregatedemand and aggregate supply

So equilibrium is established far fromfull employment in free marketcapitalist economy.

This cause involuntar


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Macroeconomic Goals

Three of the major goals ofmacroeconomics are:

A Stable and Gently Rising Price i.e. Lowand Stable Inflation Rate

A High and Growing Level of nationalIncome i.e. Economic Growth

High Employment with LowUnemployment


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Inflation and Deflation

Inflation is an increase in the overallprice level.

Hyperinflation is a period of veryrapid increases in the overall pricelevel. Hyperinflations are rare, buthave been used to study the costs

and consequences of even moderateinflation.

Deflation is a decrease in the

overall price level. Prolonged periods


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Price Stability Government track price by

constructing price indexes. For e.g. Consumer Price index which

measures the trend in the average

price of goods and services boughtby consumers. Overall price leveldenoted by P

Economist measure price stability bylooking at inflation or rate ofinflation.

Inflation is the percentage change in


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CPI 201.6 in 2006 and CPI 207.3 in2007

Rate of Inflation in year t = Pt-

Pt-1/

Pt-1

= 2.8% per year

Price stability is important becausesmoothly functioning market systemrequires that prices accurately conveyinformation about relative scarcities.

Deflation is also costly so slow rising


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Output Growth:Short Run and Long Run

A recession is a period during whichaggregate output declines. Twoconsecutive quarters of decrease in

output signal a recession. A prolonged and deep recession

becomes a depression.

Policy makers attempt not only tosmooth fluctuations in output duringa business cycle but also to increase

the growth rate of output in the long-


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Output and EconomicGrowth

Ultimate goal of economic activity isto provide the goods and servicesthat the population desires.

The most comprehensive measure oftotal output in the economy is grossdomestic product (GDP).

GDP is the market value of all finalgoods and services produced in acountry during a year


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Nominal GDP is the measure of

actual market prices. Real GDP iscalculated in constant or invariantprices.

Real GDP is most closely watchedmeasure of output.

The growth rate is defined as :

% growth rate of real GDP in year t =100x GDPt- GDPt-1/ GDPt-1

Despite the short term fluctuations seen in

business cycles ,if economies generally


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Theory of Economic growth has

gained great deal of importance. Economic growth is a long run

phenomenon and Keynes did not

deal with it as he said in thelong run we all are dead.

Harrod and Domar talked aboutgrowth with stability.

Emphasized dual role of

investment: income generating


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Unemployment

The unemployment rate is thepercentage of the labor force that isunemployed.

The unemployment rate is a keyindicator of the economys health.

The existence of unemployment

seems to imply that the aggregatelabor market is not in equilibrium.


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The unemployment rate tends toreflect the state of the business cyclewhen output is falling , the demand

for labor falls and the unemploymentrate rises.


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Government in theMacroeconomy

There are three kinds of policy thatthe government has used toinfluence the macroeconomy:

1. Fiscal policy

2. Monetary policy

3. Growth or supply-side policies


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Government in theMacroeconomy

Fiscal policyrefers to governmentpolicies concerning taxes andspending.

Monetary policyconsists of toolsused by the Federal Reserve tocontrol the quantity of money in the

economy. Growth policies are government

policies that focus on stimulating

aggregate supply instead of

os eynes an


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os eynes anDevelopment in

Macroeconomics Monetarism Supply side Economy

Rational expectation theory


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The Components ofthe Macro economy

The circular flow diagram showsthe income received and paymentsmade by each sector of the economy.

Money is the medium of Exchange


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The Components ofthe Macroeconomy

Transfer payments are paymentsmade by the government to peoplewho do not supply goods, services,

or labor in exchange for thesepayments.


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The Three Market Arenas

Households, firms, the government,and the rest of the world all interactin three different market arenas:

1. Goods-and-services market

2. Labor market

3. Money (financial) market


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Households and the government purchasegoods and services (demand) from firms inthe goods-and services market, and

firms supply to the goods and servicesmarket.

In the labor market, firms andgovernment purchase (demand) labor

from households (supply). The total supply of labor in the economy

depends on the sum of decisions madeby households.


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In the money marketsometimes calledthe financial markethouseholdspurchase stocks and bonds from firms.

Households supply funds to this marketin the expectation of earning income,and also demand (borrow) funds fromthis market.

Firms, government, and the rest of theworld also engage in borrowing andlending, coordinated by financial

institutions.


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Financial Instruments

Treasury bonds, notes, and billsare promissory notes issued by thefederal government when it borrows

money. Corporate bonds are promissory

notes issued by corporations when

they borrow money.


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Shares of stockare financialinstruments that give to the holder ashare in the firms ownership and

therefore the right to share in thefirms profits.

Dividends are the portion of a

corporations profits that the firm paysout each period to its shareholders.


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The Methodology ofMacroeconomics

Connections to microeconomics:

Macroeconomic behavior is the sum ofall the microeconomic decisions made

by individual households and firms. Wecannot understand the former withoutsome knowledge of the factors thatinfluence the latter.


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Aggregate Supply andAggregate Demand

Aggregate demandis the totaldemand for goods and services in aneconomy.

Aggregate supplyis the total supply ofgoods and services in an economy.

Aggregate supply and demand curves aremore complex than simple market supplyand demand curves.


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Expansion and Contraction:The Business Cycle

An expansion, or boom, is theperiod in the business cycle from atrough up to a peak, during which

output and employment rise. A contraction, recession, or slump is the

period in the business cycle from a peak

down to a trough, during which output andemployment fall.

macroeconomics –introduction and goals lecture 1

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