1. Macroeconomics Macroeconomic theories try to explain the business cycle, economic policies try to control it. Business cycles are alternating periods of economic growth and contraction.

2. The Business Cycle 20 15 10 5 5 3 0 3 0 –5 –10 193019351940194519501955196019651970197519801985199019952000 15 20 15 10 –5 –10 –15 Long-term average growth (3%) Korean War World War II Recession Vietnam War Great Depression Growth recession

3. The Business Cycle Trough Peak REAL GDP (units per time period) TIME Growth trend Peak Trough

4. The Unemployment Record Rate of Unemployment (Percent) 19101920193019401950196019701980 0 5 10 15 20 25 19902000

5. The Historical Record

6. Evolution of Macro Theory Classical economics Based on the concept of laissez faire, the doctrine of “leave it alone,” of nonintervention by government in the market mechanism The Great Depression was a stunning blow to classical economists. Keynes developed an alternate view of the macro economy. market forces and changing prices did not solve high unemployment, required government intervention

7. Evolution of Macro Theory cont. Keynesian policy suggests government stimulate economy when high unemployment Contract economy when inflationary Monetarist Policy, expansionary policies lead to inflation Supply-Side Policy, stimulate economy’s ability to produce Current policy combination of Keynesian and supply-side

8. Macroeconomic Model Aggregate Demand and Supply Examines forces that effect macroeconomy Provides avenues for government policy fiscal policy monetary policy

9. Aggregate Demand Aggregate demand is the total quantity of output demanded at alternative price levels in a given time period, ceteris paribus. It is used to refer to the collective behavior of all buyers in the marketplace.

10. Aggregate Demand Three separate reasons explain the downward slope of the aggregate demand curve: – The real-balances effect. – The foreign-trade effect. – The interest-rate effect.

11. Aggregate Supply Aggregate supply is the total quantity of output producers are willing and able to supply at alternative price levels in a given time period, ceteris paribus.

12. Aggregate Supply Two reasons explain the upward slope of the aggregate supply curve: – The profit effect. – The cost effect.

13. Macro Equilibrium Aggregate supply and demand curves summarize the market activity of the whole (macro) economy. Equilibrium occurs at intersection of aggregate demand and supply It is the only price-output combination that is mutually compatible with aggregate supply and demand.

14. Macro Equilibrium PRICE LEVEL (average price) REAL OUTPUT (quantity per year) D1D1 S1S1 QEQE PEPE Aggregate demand Aggregate supply P1P1 E

15. Demand-Side Theories

16. Supply-Side Theories AD 0 Q3Q3 P3P3 QFQF E0E0 AS 0 REAL OUTPUT (quantity per year) PRICE LEVEL (average price) P0P0 AS 1 E3E3

17. Long-Run Self Adjustment Some economists argue that short-run theories are pointless. In their view, short-run fluctuations in real output or prices are just statistical noise. This argument is based on Classical and monetarist views of long-run stability.

18. The “Natural” Rate of Output REAL OUTPUT(quantity per year) PRICE LEVEL (average price) QNQN AS AD 2 AD 1 P2P2 P1P1

19. Three Basic Policy Strategies Shift aggregate demand curve - find and use policy tools that stimulate or restrain total spending. Shift the aggregate supply curve - find and implement policy levers that reduce the costs of production or otherwise stimulate more output at every price level. Laissez-faire - if we can’t identify or control the determinants of aggregate supply and demand, then we shouldn’t interfere with the market.

20. Specific Policy Options All the following policy strategies have been tried at one time or another: l Classical approaches. l Fiscal policy. l Monetary policy. l Supply-side policy. l Trade policy. l Eclecticism.