1. Module Introduction to Macroeconomics2
Module Introduction to Macroeconomics
KRUGMAN'S
MACROECONOMICS for AP*
Margaret Ray and David Anderson

2. What you will learn in this Module:
What a business cycle is and why policy makers seek to diminish the severity of business cycles
How employment and unemployment are measured and how they change over the business cycle
The definition of aggregate output and how it changes over the business cycle
The meaning of inflation and deflation and why price stability is preferred
How economic growth determines a country's standard of living
Why models - simplified representations of reality- play a crucial role in economics

3. The Business Cycle Business Cycle Depression Recession Expansion
Business cycle: The alternation between economic downturns and upturns in the macroeconomy.
The instructor may wish to show a slide of the actual business cycle (figure 2-1 shows the unemployment rate on the vertical axis) or hand-draw a smoothed out version similar to the graph below. The important point is to describe the phases.
peak
Phases of the business cycle over a several‑year period  :
recession
Upward trend
time
Business activity
recovery
trough
   
1. A peak is when business activity reaches a temporary maximum with full employment and near capacity output. The unemployment rate is at its lowest level.
2. A recession is a decline in total output, income, employment, and trade lasting six months or more. The unemployment rate is beginning to rise.
3. The trough is the bottom of the recession period. The unemployment rate is at its highest level.
4. Recovery is when output and employment are expanding toward full‑employment level. The unemployment rate is beginning to fall.
5. The entire business cycle is measured by the elapsed time between peaks in the cycle.

4. Employment, Unemployment, and the Business Cycles
Labor force
Unemployment rate
The unemployment rate is calculated by random survey of 60,000 households nationwide. The sample is selected so as to be representative of the entire population of the United States.
Survey asks a series of questions and employment status is based upon the responses. The interviewer does not classify the interviewee and the interviewee is not allowed to define her/his own employment status.
Employed persons:
All who did any work for pay or profit during the survey week.
All who did at least 15 hours of unpaid work in a family-operated enterprise.
All who were temporarily absent from their regular jobs because of illness, vacation, bad weather, industrial dispute, or various personal reasons.
E: basically those who work at a job with pay for at least one hour or without pay for at least 15 hours (family business or farm).
Unemployed Persons:
All who did not have a job at all during the survey week, made specific active efforts to find a job during the prior 4 weeks, and were available for work (unless temporarily ill).
All who were not working and were waiting to be called back to a job from which they had been temporarily laid off.
U: basically has no job, or is temporarily laid off but is actively looking for work in the 4-week period prior to the reference week.
Labor Force LF = E + U
Unemployment rate UR% = 100*(#U)/(#LF)
The unemployment rate is defined as the percentage of the labor force that is not employed.
Example computations
A country has the following labor statistics:
Military Personnel …………………………………………………………… million
Population under 16 years old who are working part time …………………… million
Population over 16 years old who are working part time …………………… million
Population over 16 years old who are working full time …………………… million
Those without jobs and who are actively seeking jobs ……………………… million
Calculate the size of the civilian work force and the unemployment rate.
LF = million = 20 million. The military personnel are not counted and citizens younger than 16 are not counted.
UR% = 100*(2/20) = 10%

5. Aggregate Output and the Business Cycle
Aggregate output: the economy’s total production of goods and services for a given time period, usually a year.
Aggregate output is closely related to employment. When the economy is strong, near the peak of the business cycle, many goods and services are being produced, firms need to hire workers, employment is high, and the unemployment rate is low.
When the economy is weak, during a recession of the business cycle, fewer goods and services are being produced, firms need to lay off workers, employment is low, and the unemployment rate is high.

6. Inflation, Deflation, and Price Stability
Nominal income v. Real income
Inflation
Deflation
Price Stability
Inflation, a rise in the overall price level.
Inflation is bad because it reduces our ability to purchase goods and services. A dollar of our hard-earned income doesn’t go as far if the prices of most goods and services are rising. If inflation is rapid, our wages could become useless for  consumption .
Deflation, a fall in the overall price level.
Deflation is bad too. When overall prices are falling, consumers will hold onto their dollars and continue to wait for lower and lower prices. This waiting creates a problem as producers find they can’t sell goods and services. Producers respond by lower prices and consumers respond by waiting even longer to make a purchase.
Be sure to stress that changes to the prices of a few goods changes the opportunity cost of purchasing those goods, but does not constitute inflation or deflation.
Inflation and deflation are terms are reserved for more general changes in the prices of goods and services throughout the economy.

7. Economic Growth Standards of living Economic growth
Here’s an analogy that might work to demonstrate long-term economic growth as different from short-term economic recovery from a recession.
Example: Imagine a talented athlete who is good, but not great enough to be an All-Star in his/her sport. Suppose this athlete suffers an injury. Because of the industry, his/her performance is significantly reduced, but after some rehabilitation and time, his/her performance returns to the original level of good, but not great.
Now suppose that the athlete undertakes a more diligent approach to his/her sport. He/she works harder in the off-season, improves his/her nutrition, gets stronger, faster, smarter about the game. He/she studies film to learn where gains can be made, and mistakes can be avoided. These efforts fundamentally increase the athlete’s performance level and turn a good athlete into a great athlete who is now an All Star.
The first situation does not represent growth, simply recovery back to the original level of output. The second situation does represent growth because the level of output has been increased.

8. The Use of Models in Economics
Other things equal assumption
Ceteris Paribus
Economists use the scientific method to establish theories, laws, and principles.
1. The scientific method consists of:
a. Facts/Data. The observation of facts (real data).
b. Hypotheses. The formulations of explanations of cause and effect relationships based upon the facts.
Example: A convenience store owner notices that when the temperature rises, she sells more fountain soft drinks and fewer coffees. The reverse tends to occur when the temperature falls. A hypothesis is born out of this data. “Soft drink sales are positively related, and coffee sales are negatively related, to the outside temperature.”
c. Testing. The testing of the hypotheses.
Months of data is collected on the outside temperature and the quantity of soft drinks and coffee drinks sold at the store.
d. The acceptance, reject, or modification of the hypotheses.
If the data seems to confirm our hypothesis, we might be able to confirm that most of the time, this trend holds.
Note: The instructor could draw a crude scatter-plot with soft-drink sales on the y-axis and temperature on the x-axis. Show the scatter plot with a fairly obvious upward trend.
The determination of a theory, law, principle, or model.
2. Theoretical economics: The systematic arranging of facts, interpretation of the facts, making generalizations.
Theories evolve after hypotheses have been repeatedly tested and favorable results have been accumulated.
After weeks of gathering data on temperature and sales, and with the use of a few statistical tools, we publish a landmark article called “The effect of global warming on beverage choice: a theory of soft drink consumption.”
3. Laws/Principles are very well tested and widely accepted theories. Principles are used to explain and/or predict the behavior of individuals and institutions.
Model: a simplified representation of reality that is used to better understand real-life situations.
On some days our theory holds, on others it doesn’t, but on average we can count on it.
“Other things equal” or ceteris paribus assumption: In order to judge the effect one variable has upon another it is necessary to hold other contributing factors constant. Natural scientists can test with much greater precision than can economists. They have the advantage of a controlled laboratory experiment. Economists must test their theories using the real world as their laboratory.
What factors are we holding constant in our theoretical model? Consumer incomes? Price? Price of other drink options? Price of related goods (the gasoline)?