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An Introduction to Macroeconomics
Chapter 5 An Introduction to Macroeconomics Where the telescope ends, the microscope begins. Which of the two has the grander view? VICTOR HUGO
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Macroeconomics vs. Microeconomics
Decisions of individual units No matter how large Example: GE’s pricing policy Macroeconomics Behavior of entire economies No matter how small Example: inflation in Monaco Economic aggregates: aggregate output, inflation, unemployment, …
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Macroeconomics & Aggregation
Combine many individual markets into one overall market Why can we aggregate? 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
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Macroeconomics & Microeconomics
Assume most details Resource allocation & income distribution Relatively unimportant Microeconomics Ignore macroeconomics issues Focus – individual markets Allocate resources Distribute income
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Supply & Demand in Macroeconomics
Aggregate demand (AD) curve Quantity of domestic product – demanded Each possible value of price level Aggregate supply (AS) curve Quantity of domestic product – supplied
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Figure 1 Two interpretations of a shift in the demand curve D1 Price
Q0 Quantity Quantity (a) (b)
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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 Inward shift of aggregate demand curve
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Figure 2 An economy slipping into a recession S E P0 Price Level B P2
D0 Price Level D2 E P0 Q0 B P2 Q2 Domestic Product
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Supply & Demand in Macroeconomics
Macroeconomists study Inflation Recession & unemployment (Business Cycles) Economic growth
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Figure 3 Economic growth S0 S1 C Price Level E D1 D0 Q0 Q1
Domestic Product
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Gross Domestic Product
Gross domestic product (GDP) Sum: money values All final goods & services Produced - domestic economy (Toyota car produced in the US vs. Ford pick-up produced in Japan) Sold – organized markets (gambling in Vegas vs. gambling in Chicago) Specified period of time Usually a year
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Gross Domestic Product
Nominal GDP GDP in current dollars Value outputs – current prices Real GDP Value outputs of different years at common prices GDP in constant dollars
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What Gets Counted in GDP?
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
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Gross Domestic Product
Final goods and services Purchased by their ultimate users Intermediate good - purchased For resale For use in producing another good
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Gross Domestic Product
Limitations of GDP Not measure: nation’s economic well-being Includes only market activity Housework, yard work, … Places no value on leisure Counted: “Bads” and “Goods” Hurricane Katrina might increase GDP Ecological costs Not deducted from GDP Needed: “Green GDP”
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The Economy on a Roller Coaster
U.S. economy Growth – with fluctuations Macroeconomic fluctuations Business cycles Real GDP per capita Ratio: real GDP divided by population
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Figure 4 Nominal GDP, real GDP, real GDP per capita since 1959
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Figure 5 The growth rate of U.S. real GDP since 1870
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The Economy on a Roller Coaster
Inflation Sustained increase General price level Deflation Sustained decrease
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Figure 6 The inflation rate in the United States since 1870
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The Economy on a Roller Coaster
The Great Depression, Decline in economic activity Rapid deflation Production – declined 30% Unemployment rate Increased from 3% to 25%
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The Economy on a Roller Coaster
The Great Depression, Revolution in economic thought Before: economy corrects itself After: decrease in aggregate demand cannot recover by themselves (J. M. Keynes) Monetary & fiscal policy needed Ended: early 1940s (due to WWII) What caused it? Stock bubbles Contractionary monetary policy Unregulated markets
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The Economy on a Roller Coaster
From WWII to 1973 WWII: increased government spending Increased aggregate demand Accidental fiscal policy Price controls Shortage: consumer goods 1960s – strong growth Vietnam war – increased spending Inflation (5-6%) & high unemployment Wage & price controls by Nixon
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The Economy on a Roller Coaster
The Great Stagflation, OPEC – 1973 oil prices quadrupled (1st Oil Shock) Poor harvests in 1973 rose food prices Stagflation Inflation rate: 12% High unemployment (9% in 1st quarter 1975) Inward shift of aggregate supply
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The Economy on a Roller Coaster
The Great Stagflation, Economy recovered Government actions Natural economic forces 1979 – OPEC soaring oil prices (2nd Oil Shock) Stagflation again Inflation: 16%
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Figure 7 The effects of an adverse supply shift S1 S0 A Price Level E
Real GDP
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The Economy on a Roller Coaster
Reaganomics and its aftermath High inflation Federal Reserve Monetary policy (Paul Volcker) High interest rate to fight inflation Result: high unemployment rate (11% in 1982) Fiscal policy large tax cut Laffer Curve Help recovery beginning in the winter of
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The Economy on a Roller Coaster
Reaganomics and its aftermath Large budget deficits Recovery started President Bush continues Regan’s policies Inflation Deficit-reduction package Spike in oil prices triggers recession
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The Economy on a Roller Coaster
Clintonomics: deficit reduction Deficit-reduction package, 1993 & 1997 Tax increase & spending cuts Large fiscal surplus Economy boomed (might due to globalization and computerization) Lower inflation Aggregate supply curves Pushed outward – rapid pace, 1996 – 1998
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Figure 8 The effects of a favorable supply shift S0 S1 S2 C B
D1 S0 S1 Price Level D0 S2 C B E Real GDP
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The Economy on a Roller Coaster
Tax cuts and the Bush economy 2001 recession First in 10 years Tax cut 2001 Budget deficit Burst of government spending War on terror Aggregate demand – shift outward Federal Reserve Lowered interest rate
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The Economy on a Roller Coaster
The Great Recession (Dec – now) Output falls hard 10% unemployment rate Inflation is modest Triggered by subprime crisis
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Problem of Macroeconomic Stabilization
Historical record shows US economy has not generally produced steady growth w/o inflation Short-run trade-off b/w unemployment and inflation, sometimes both increase (1970s) Gov policy might contribute to this performance
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Problem of Macroeconomic Stabilization
Stabilization policy Government programs Prevent or shorten recessions Counteract inflation, stabilize prices
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Problem of Macroeconomic Stabilization
Fight unemployment Increase aggregate demand Government - Fiscal policy Increase spending Cut taxes Federal Reserve - Monetary policy Lower interest rates Increase output Reduce unemployment Raise prices
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Figure 9 Stabilization policy to fight unemployment S0 A Price Level E
D1 S0 Price Level D0 A E Increase in output Real GDP
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Problem of Macroeconomic Stabilization
Fight inflation Decrease aggregate demand Government - Fiscal policy Cut spending Increase taxes Federal Reserve - Monetary policy Increase interest rates Decrease inflation (decrease prices) Decrease output Increase unemployment
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Figure 10 Stabilization policy to fight inflation S E Price Level B
D0 Price Level D2 E Decrease in prices B Real GDP
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Stabilization policy Prewar data Postwar data
Fluctuations – unmanaged economy Booms & recessions “Natural” economic reasons Little government intervention Postwar data Economy - managed by government policy Successfully (60s and 90s) or unsuccessfully (70s) Recessions - less severe More inflation-prone
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Summary Macro vs. Micro Macro is all about Aggregation AD-AS curve GDP
Business Cycles vs. Economic Growth Brief Macroeconomic History of US Stabilization Policy
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