1. Intermediate Macroeconomics
Chapter 1
An Overview of Macroeconomics

2. An Overview of Macroeconomics
What is Macroeconomics
Macroeconomic Goals
Economic Theory in Practice
Intermediate Macroeconomics

3. 1. What Is Macroeconomics?
Microeconomics - study of behavior of individual economic agents.
Macroeconomics - study of aggregate measures of the economy
Forest vs. trees. Macroeconomics is study of the forest. Microeconomics is study of individual trees.
Aggregate - (n) a total, a mass or amount, brought together. (v) to collect or form into an aggregate.
Aggregate demand represents the total spending on all final goods and services in an economy by all consumers.
Problem with aggregation of preferences. Could add pro-con votes as in an election. But, how do you account for differences in intensity of preferences?
Intermediate Macroeconomics

4. Complementary and Conflicting Goals
2. Macroeconomic Goals
Low Unemployment
Price Stability
Economic Growth
Complementary and Conflicting Goals
Intermediate Macroeconomics

5. 2. Macroeconomic Goals Low Unemployment
Great Depression
( )
World War II
( )
recession
recession
recession
U.S.
Unemployment Rates:
U.S Virginia Fairfax Co.
Jun % % %
Jun % % %
Jun % % %
Jun % % %
Jun % % %
Lowest rates last 10 years:
U.S % Oct 2000
Virginia 1.9% Apr 2000
Fairfax Co 1.2% Apr 1998
Fairfax Co., VA.
Source: Bureau of Labor Statistics (
Intermediate Macroeconomics

6. 2. Macroeconomic Goals Price Stability
World War 1
Iranian
Revolution
and Oil Price
Increase
World War 2
Arab oil
Embargo
Great Depression
Source: Bureau of Labor Statistics (
Intermediate Macroeconomics

7. 2. Macroeconomic Goals Economic Growth
Annual change in U.S. GDP per capita
Nominal GDP
Real GDP (chained 1996 dollars)
Economic Growth
Distinction between short run and long run
Short run – described by business cycle models. Fluctuations in economic activity around a long-run trend.
Long-run – described by growth models. Long0run trend determined by factors such as savings, productivity, changes in technology.
Source: Bureau of Economic Analysis (
Intermediate Macroeconomics

8. 2. Macroeconomic Goals Economic Growth
Long term trend 2.4% per year
Intermediate Macroeconomics

9. 2. Macroeconomic Goals Complementary and Conflicting Goals
Complementary Goals
Low unemployment and high economic growth
Conflicting Goals
Low unemployment and low inflation
Are high economic growth and low inflation conflicting goals? Not necessarily if your policy action is to increase worker productivity then you could increase economic growth while maintaining low inflation.
Because of conflicting goals economics has been described as the “Dismal Science”
Intermediate Macroeconomics

10. 3. Economic Theory in Practice
Economic Theory and Models
Empirical Applications
A theory is like a map to a friends house. The map is necessarily incomplete and in many ways inaccurate. The map probably only shows the roads that will take you directly where you want to go. It may show a few landmarks like the gas station where you turn right. The map is useful precisely because it is a simplification. Showing every building and intersecting street won’t get you where you want to go any faster or with significantly greater confidence. Similarly, an economic theory tries to take you directly where you want to go without burdening you with the details.
But when the details of the map or a theory are left out it becomes less useful for other purposes. If we use one economic model to study economic growth it is likely unsuitable for studying short-term economic fluctuations.
Intermediate Macroeconomics

11. 3. Economic Theory in Practice Economic theory and models
What makes a good model?
Accurately explains history
Makes reasonable predictions about the future
John Maynard Keynes, General Theory of Employment Interest and Money, 1936 (p. 297):
“The object of our analysis is not to provide a machine or method of blind manipulation, which will furnish an infallible answer, but to provide ourselves with an organized and orderly method of thinking out particular problems; and, after we have reached a provisional conclusion by isolating the complicating factors one by one, we then have to go back on ourselves and allow, as well as we can, for the probable interactions of the factors amongst themselves. This is the nature of economic thinking.”
Intermediate Macroeconomics

12. 3. Economic Theory in Practice Economic theory and models
Keep models simple
Occam’s Razor - eliminate complicating details that don’t significantly contribute to the model
Ceteris Paribus - other things being equal
Intermediate Macroeconomics

13. Economic Theory in Practice Empirical time series applications
Use Real rather than Nominal values
Compare Per Capita rather than Totals
Compare Growth Rates rather than Levels
Empirical (Webster’s dictionary): relying or based solely on experiment or observation rather than theory.
Two types of empirical studies:
Longitudinal - time trends
Examining single sector at different points in time - use Real or Real per capita to eliminate effects of both inflation and population differences
Comparing sectors over a period of time use Real growth rates or Real per capita growth rates
Cross-sectional
Comparing different sectors at same point in time - either nominal or real OK
Comparing different geographic areas (e.g., countries) - use per Capita rather than aggregates
Purchasing power parity corrects for differences in average price levels
Indexes - not mentioned in text. Consumption as a share of total GDP. Eliminates problem of differences in population.
Intermediate Macroeconomics

14. 3. Economic Theory in Practice Compare real rather than nominal
Percent increase 1929 – 2003
Nominal GDP: 10,522 %
Real GDP: 1,100 %
Real GDP
Nominal GDP
Source: Bureau of Economic Analysis,
Intermediate Macroeconomics

15. 3. Economic Theory in Practice Compare per capita rather than aggregates
Percent increase 1929 – 2003
Total Real GDP: 1,100 %
Real GDP per capita: %
Real GDP
per capita
Total Real
GDP
The greatest problem with looking at a graph of levels is that a straight line does not imply constant growth and the slope does not indicate the growth rate. The trick is that an increase from $10,000 to $15,000 is much greater (50 percent) than growth from $30,000 to $35,000 (17 percent). Similarly, a 100 point increase in the stock market's Dow Jones Industrial Average today is not nearly as dramatic as it was twenty years ago.
Source: Bureau of Economic Analysis,
Intermediate Macroeconomics

16. 3. Economic Theory in Practice Compare growth rates rather than levels
Source: Bureau of Economic Analysis,
Intermediate Macroeconomics