1-1 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. CHAPTER 1 Introduction to Macroeconomics

1-2 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Questions How much richer are we than our parents were at our age? How much richer will our children be than our grandparents were? Will changing jobs be easy or hard in five years? How many of us will have jobs in five years?

1-3 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Questions Will the businesses we work for vanish as demand for the products they make dries up? Will inflation make us poor by destroying our savings or rich by eliminating our debts?

1-4 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Macroeconomics... is the subdiscipline of economics that tries to answer these six questions is the branch of economics related to the economy as a whole

1-5 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Macroeconomists... try to figure out why overall economic activity rises and falls try to understand what determines the level and rate of change of overall prices study other variables that play a major role in determining the overall levels of production, income, employment, and prices

1-6 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Why Macroeconomics Matters Cultural Literacy –ability to follow and participate in public debates and discussions –ability to understand news reports on changes in the economy

1-7 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Figure The Daily Flow of Economic News

1-8 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Why Macroeconomics Matters Self-Interest –effects of the macroeconomy on our daily lives –understanding of changing opportunities as the economy fluctuates

1-9 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Why Macroeconomics Matters Civic Responsibility –more informed voting –more responsible macroeconomic policy

1-10 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Macroeconomic Policy Growth Policy –policies to accelerate or decelerate long- run economic growth –most important policies for the long-run

1-11 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Figure Long-Run Economic Growth: Sweden and Argentina,

1-12 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Macroeconomic Policy Stabilization Policy –policies to smooth out the business cycle by diminishing the depth of recessions and depressions –business cycles are fluctuations in production and employment booms or expansions occur when production grows and unemployment falls recessions or depressions occur when production falls and unemployment rises

1-13 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Figure The American Business Cycle: Fluctuations in Total Production Relative to the Long-Run Growth Trend

1-14 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Macroeconomic Policy Business cycle fluctuations are also felt in the overall level of prices –booms usually bring inflation –recessions bring either disinflation or deflation Interest rates, the level of the stock market, and other economic variables also rise and fall with the business cycle

1-15 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Macroeconomics versus Microeconomics Macroeconomists –examine the economy as a whole –focus on the feedback from one component of the economy to another –study the total level of production and employment –believe that imbalances between supply and demand may be resolved by changes in quantities rather than prices

1-16 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Macroeconomics versus Microeconomics Microeconomists –study the markets for single commodities and the behavior of individual households and firms –focus on how competitive markets allocate resources to create consumer and producer surplus –assume that imbalances between demand and supply are resolved by changes in prices

1-17 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Economic Statistics and Economic Activity Economic activity is the pattern of transactions in which things of real, useful value are created, transformed, and exchanged Estimates of economic activity are contained in the National Income and Product Accounts (NIPA) –reported by the Commerce Department’s Bureau of Economic Analysis

1-18 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Six Key Economic Variables Real Gross Domestic Product (GDP) –is corrected for changes in the price level (real) –includes the replacement of worn-out and obsolete equipment and structures as well as new investment (gross) –counts economic activity that happens within the United States (domestic) –represents the production of final goods and services (product)

1-19 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Six Key Economic Variables Real Gross Domestic Product –often divided by the number of workers in the economy (real GDP per worker) –measures how well the economy produces goods and services that people find useful –does not indicate the relative distribution of the nation’s economic product –is an imperfect measure of economic well-being

1-20 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Figure Officially Measured Real GDP per Worker in the United States

1-21 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Six Key Economic Variables The Unemployment Rate –to be unemployed, a person must want to work and be actively looking for a job (but have not yet found one) –the labor force consists of those who are employed and those who are unemployed –the unemployment rate is equal to the number of unemployed people divided by the labor force

1-22 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Figure The U.S. Unemployment Rate

1-23 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Six Key Economic Variables The Unemployment Rate –frictional unemployment occurs because workers and firms spend time searching for the best match –cyclical unemployment occurs during recessions and depressions –the unemployment rate is the best indicator of how well the economy is doing relative to its productive potential

1-24 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Six Key Economic Variables The Inflation Rate –is a measure of how fast the overall price level is rising –hyperinflation occurs when the price level is rising by more than 20% per month can cause massive economic destruction

1-25 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Figure Inflation in the United States

1-26 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Six Key Economic Variables The Interest Rate –is important because it governs the redistribution of purchasing power across time –there are many different interest rates in the economy that vary by duration and degree of risk they often move up and down together

1-27 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Six Key Economic Variables The Interest Rate –the nominal interest rate is the interest rate in terms of money does not take into account the effects of inflation –the real interest rate is the interest rate in terms of goods and services does take into account the effects of inflation

1-28 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Six Key Economic Variables The Interest Rate –when interest rates are low, investment tends to be high –when interest rates are high, investment tends to be low

1-29 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Figure U.S. Real Interest Rates,

1-30 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Six Key Economic Variables The Stock Market –is heard about most often (every day) –is an index of expectations for the future a high value means that investors expect economic growth to be rapid, profits to be high, and unemployment to be low

1-31 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Figure Real Stock Index Prices

1-32 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Six Key Economic Variables The Exchange Rate –governs the terms on which international trade and investment take place –the nominal exchange rate is the rate at which monies of different countries can be exchanged for one another –the real exchange rate is the rate at which the goods and services produced in different countries can be exchanged for one another

1-33 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Six Key Economic Variables The Exchange Rate –if domestic currency appreciates its value in terms of other currencies increases foreign-produced goods are relatively cheap for domestic buyers –imports are likely to be high domestic-made goods are relatively expensive for foreigners –exports are likely to be low

1-34 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Six Key Economic Variables The Exchange Rate –if domestic currency depreciates its value in terms of other currencies declines domestic-produced goods are relatively cheap for foreign buyers –exports are likely to be high foreign-made goods are relatively expensive for domestic buyers –imports are likely to be low

1-35 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Figure The U.S. Real Exchange Rate: The Dollar against a Composite Index of Foreign Currencies

1-36 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. The Current Macroeconomic Situation The United States – recent past –the collapse of the stock market bubble and the September 11 terrorist act triggered a recession the U.S. economy lost 0.9 million jobs –in response, the Federal Reserve reduced interest rates and the federal government lowered taxes

1-37 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. The Current Macroeconomic Situation The United States – recent past –slowly in 2002 and more rapidly in 2003 the economy began to recover demand and production grew employment did not expand much

1-38 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. The Current Macroeconomic Situation The United States –there are renewed worries among economists tax cuts and extra defense spending have led to large budget deficits fear that foreign exchange speculators will lose confidence in the dollar

1-39 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. The Current Macroeconomic Situation Europe –in the early 2000s, 11 Western European nations adopted the euro as their common currency –the adoption of the euro was followed by stagnation and recession unemployment rates of close to 10% real GDP growth at less than 2% per year consumer prices rising at 2% per year

1-40 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. The Current Macroeconomic Situation Japan –interest rates are very low (0.03% in the three-month money market) –still undergoing deflation –six straight quarters of positive growth in real GDP –unemployment is still above 5%, but steady

1-41 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. The Current Macroeconomic Situation Emerging Markets –China and India are experiencing enormous growth their economies are expected to grow at 8% and 6% in 2005 –foreign investors have appeared to have regained confidences in East Asian economies

1-42 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. The Current Macroeconomic Situation Emerging Markets –the Argentinean economy crashed at the end of 2001 problems are still unresolved –elsewhere in Latin America, growth rates continued to be positive but small

1-43 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Summary Macroeconomics is the study of the overall economy There are three key reasons to study macroeconomics –to gain cultural literacy –to understand how economic trends affect you personally –to exercise your responsibility as a voter and citizen

1-44 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Summary The key indicators in macroeconomics are –real GDP –the unemployment rate –the inflation rate –the interest rate –the level of the stock market –the exchange rate