1. Ch 4: What Macroeconomics Tries to Explain
Microeconomic deals with behavior of individual decision makers and individual markets
Macroeconomic deals with broad outlines of the economy
Which view is better?
Depends on what we’re trying to do
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2. Macroeconomic Goals
Economists—and society at large—agree on three important macroeconomic goals
Economic growth
Full employment
Stable prices
Why is there such universal agreement on these three goals?
Because achieving them gives us opportunity to make all of our citizens better off
There are some disagreement among economists about how to make the macro-economy perform well
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3. Economic Growth
- the increase in our production of goods and services that occurs over long period of time.
- in most developed economies, the annual output of goods and services has risen over time and risen faster than population (therefore…?????)
Economists monitor economic growth
By keeping track of real gross domestic product (real GDP)
- The total quantity of goods and services produced in a country over a year
Real GDP has actually increased faster than the population
During this period (1929 to 2004), while U.S. population did not quite triple
Quantity of goods and services produced each year has increased more than tenfold
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4. Economic Growth
Part of the reason for the rise in real GDP is an increase in population(why?)… therefore..
Although output has grown, rate of growth has varied over the decades
Over long periods of time small differences in growth rates can cause huge differences in living standards
Economists and government officials are very concerned when economic growth slows down- growth increases the size of the economic pie (for every citizen to have a larger slice?)
- growth doesn’t benefit everyone. example?)
- some people believe that in the long run everyone will benefit from growth
- others see role for the government (in ?)
Macroeconomics helps us understand a number of issues surrounding economic growth.
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5. Figure 1: U.S. Real Gross Domestic Product, 1929-2002
Real GDP
(Billions of 1998 dollars)
1000
2000
3000
4000
5000
6000
7000
8000
9000
1950
1960
1940
1930
1970
1990
2002
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6. High Employment (or Low Unemployment)
Unemployment affects distribution of economic well being among our citizens
People who cannot find jobs suffer a loss of income
Joblessness affects all of us—even those who have jobs
- A high unemployment rate means economy is not achieving its full economic potential
Average standard of living falls
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7. High Employment (or Low Unemployment)
Unemployment rate
Percentage of the workforce that would like to work, but cannot find jobs (unemployment rate is never zero, even though the economy is doing well)
Used to keep track of employment
The nation’s commitment to high employment has twice been written into law
With memory of Great Depression still fresh, Congress passed Employment Act of 1946
Required federal government to “promote maximum employment, production, and purchasing power”
A numerical target was added in 1978, when Congress passed Full Employment and Balanced Growth Act
Called for an unemployment rate of 4%
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8. In the 1990s, we came closer and closer and finally—in December 1999—we reached the target again for the first time since the 1960s
In 2001 unemployment rate began to creep up again, and fluctuated between 5.2 and 6.3 percent though the first half of 2005
All these facts are critically examined under the subject Macroeconomics.
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9. Figure 2: U.S. Unemployment Rate, 1920-2003
(Percent) 25
1950
1960
1940
1930
1970
1980
1990
2000 20 15 10 5
200 3
1920
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10. Employment and the Business Cycle
When firms produce more output, they hire more workers—when they produce less output, they tend to lay off workers
We would thus expect real GDP and employment to be closely related, and indeed they are
Business cycles
Periodic fluctuations in GDP around its long-term growth trend- the bumps in the figure
Expansion
A period of increasing real GDP
Contraction
A period of declining real GDP
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11. Employment and the Business Cycle
Recession
A contraction of significant depth, breadth and duration
Depression
An unusually severe recession
In the twentieth century, United States experienced one decline in output serious enough to be considered a depression—the worldwide Great Depression of the 1930s
From 1929 to 1933, the first four years of Great Depression, U.S. output dropped by more than 25%
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12. Figure 3: The Business Cycle
Time
Real
GDP
Long-run upward trend of real GDP
The business cycle fluctuation of actual output around its long-run trend.
Expansion
Recession
Expansion
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13. Stable Prices
With very few exceptions, inflation rate has been positive
During 1990s, inflation rate averaged less than 3% per year
During the 2000s (through June 2005) inflation rate averaged about 2.5%
Other countries have not been so lucky
An extreme case was the new nation of Serbia—prices rose by 1,880% in August 1993
Why are stable prices—a low inflation rate—an important macroeconomic goal?
Because inflation is costly to society
With annual inflation rates in the thousands of percent, the costs are easy to see
Purchasing power of currency declines so rapidly that people are no longer willing to hold it
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14. Economists regard some inflation as good
Price stabilization requires not only preventing inflation rate from rising too high
But also preventing it from falling too low, where it would be dangerously close to turning negative
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15. Figure 4: U.S. Annual Inflation Rate, 1922-2003
Inflation Rate (Percent) -5
-10 5 15
2000
1940
1950
1960
1970
1980
1990 10
1930
2003
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16. The Macroeconomic Approach
In macroeconomics, we want to understand how the entire economy behaves
Thus, we apply the steps to all markets simultaneously
How can we possibly hope to deal with all these markets at the same time?
The answer is aggregation—process of combining different things into a single category and treating them as a whole
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17. Aggregation in Macroeconomics
Aggregation plays a key role in both micro- and macro-economics
In macroeconomics, we take aggregation to the extreme
Because we want to consider the entire economy at once, and yet keep our model as simple as possible
Must aggregate all markets into broadest possible categories
By aggregating in this way, can create workable and reasonably accurate models that teach us a great deal about how overall economy operates
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18. Macroeconomic Controversies
Macroeconomics is full of disputes and disagreements
Modern macroeconomics began with publication of The General Theory of Employment, Interest, and Money by British economist John Maynard Keynes in 1936
Keynes was taking on conventional wisdom of his time
Which held that the macroeconomy worked very well on its own, and the best policy for the government to follow was laissez faire – ‘leave it alone’.
This new school of thought held that the economy does not do well on its own and needed guidance from an activists and well-intentioned government.
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19. Macroeconomic Controversies
While some of the early disagreements have been resolved, others have arisen to take their place
For example—the controversy over the Bush administration’s $330-billion ten-year tax cut
Because of such political battles, people who follow the news often think that there is little agreement among economists about how the macroeconomy works
In fact, the profession has come to a consensus on many basic principles, and we will stress these as we go
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