1. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-1 CHAPTER 1 Introduction to Macroeconomics

2. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-2 Questions How much richer are we than our parents? How much richer will our children be than our grandparents were? Will changing jobs be easy or hard in five years? How many of us will have jobs in five years?

3. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-3 Questions Will the businesses we work for vanish as demand for the products they make dries up? Will inflation make us poor by destroying our savings or rich by eliminating our debts?

4. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-4 Macroeconomics... is the subdiscipline of economics that tries to answer these six questions is the branch of economics related to the economy as a whole

5. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-5 Macroeconomists... try to figure out why overall economic activity rises and falls try to understand what determines the level and rate of change of the price level study other variables that play a major role in determining the overall levels of production, income, employment, and prices

6. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-6 Why Macroeconomics Matters Cultural Literacy –ability to follow and participate in public debates and discussions –understanding of news reports on changes in the economy

7. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-7 Figure 1.1 - The Daily Flow of Economic News

8. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-8 Why Macroeconomics Matters Self-Interest –effects of macroeconomy on our daily lives –understanding of changing opportunities as the economy fluctuates

9. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-9 Why Macroeconomics Matters Civic Responsibility –more informed voting –more responsible macroeconomic policy

10. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-10 Macroeconomic Policy Growth Policy –policies to accelerate or decelerate long- run economic growth –most important policies for the long-run

11. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-11 Figure 1.2 - Long-Run Economic Growth: Sweden and Argentina, 1900-2000

12. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-12 Macroeconomic Policy Stabilization Policy –policies to smooth out the business cycle by diminishing the depth of recessions and depressions –business cycles are fluctuations in production and employment booms or expansions occur when production grows and unemployment falls recessions or depressions occur when production falls and unemployment rises

13. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-13 Figure 1.3 - The American Business Cycle: Fluctuations in Total Production Relative to the Long-Run Growth Trend

14. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-14 Macroeconomics versus Microeconomics Macroeconomists –examine the economy as a whole –focus on the feedback from one component of the economy to another –study the total level of production and employment –believe that imbalances between supply and demand may be resolved by changes in quantities rather than prices

15. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-15 Macroeconomics versus Microeconomics Microeconomists –study the markets for single commodities and the behavior of individual households and firms –focus on how competitive markets allocate resources to create consumer and producer surplus –assume that imbalances between demand and supply are resolved by changes in prices

16. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-16 Economic Statistics and Economic Activity Economic activity is the pattern of transactions in which things of real, useful value are created, transformed, and exchanged. National Income and Product Accounts (NIPA) –reported by the U.S. Commerce Department’s Bureau of Economic Analysis

17. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-17 Table 1.2 - The Flow of Economic Data, 2000-2001

18. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-18 Six Key Economic Variables Real Gross Domestic Product (GDP) –is corrected for changes in the price level (real) –includes the replacement of worn-out and obsolete equipment and structures as well as new investment (gross) –counts economic activity that happens in the United States (domestic) –represents the production of final goods and services (product)

19. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-19 Six Key Economic Variables Real Gross Domestic Product –often divided by the number of workers in the economy –measures how well the economy produces goods and services that people find useful –does not indicate the relative distribution of the nation’s economic product –is an imperfect measure of economic well-being

20. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-20 Figure 1.4 - Officially Measured Real GDP per Worker in the United States

21. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-21 Six Key Economic Variables The Unemployment Rate –to be unemployed, a person must want to work and be actively looking for a job (but have not yet found one) –the labor force consists of those who are employed and those who are unemployed –the unemployment rate is equal to the number of unemployed people divided by the labor force

22. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-22 Figure 1.5 - The U.S. Unemployment Rate

23. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-23 Six Key Economic Variables The Unemployment Rate –frictional unemployment occurs because workers and firms spend time searching for the best match –cyclical unemployment occurs during recessions and depressions –the unemployment rate is the best indicator of how well the economy is doing relative to its productive potential

24. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-24 Six Key Economic Variables The Inflation Rate –is a measure of how fast the overall price level is rising –hyperinflation occurs when the price level is rising by more than 20% per month

25. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-25 Figure 1.6 - Inflation in the United States

26. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-26 Six Key Economic Variables The Interest Rate –is important because it governs the redistribution of purchasing power across time –the many different interest rates in the economy vary by duration and degree of risk often move up and down together

27. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-27 Six Key Economic Variables The Interest Rate –nominal interest rate is the interest rate in terms of money does not take into account the effects of inflation –real interest rate is the interest rate in terms of goods and services does take into account the effects of inflation

28. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-28 Figure 1.7 - U.S. Real Interest Rates, 1960-1999

29. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-29 Six Key Economic Variables The Stock Market –is heard about most often (every day) –is an index of expectations for the future a high value means that investors expect economic growth to be rapid, profits to be high, and unemployment to be low

30. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-30 Figure 1.8 - Real Stock Index Prices

31. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-31 Six Key Economic Variables The Exchange Rate –governs the terms on which international trade and investment take place –nominal exchange rate is the rate at which monies of different countries can be exchanged for one another –real exchange rate is the rate at which the goods and services produced in different countries can be exchanged for one another

32. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-32 Six Key Economic Variables The Exchange Rate –if domestic currency appreciates its value in terms of other currencies increases foreign-produced goods are relatively cheap for domestic buyers –imports are likely to be high domestic-made goods are relatively expensive for foreigners –exports are likely to be low

33. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-33 Six Key Economic Variables The Exchange Rate –if domestic currency depreciates its value in terms of other currencies declines domestic-produced goods are relatively cheap for foreign buyers –exports are likely to be high foreign-made goods are relatively expensive for domestic buyers –imports are likely to be low

34. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-34 Figure 1.9 - The U.S. Real Exchange Rate: The Dollar against a Composite Index of Foreign Currencies

35. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-35 The Current Macroeconomic Situation The United States - 2001 –economic growth has slowed to a very weak pace forecast for 2001 is that real GDP will grow by no more than 1.8% –interest rates lowered through Fed policy due to lags, effects of lower interest rates will not be felt until end of 2001 (at the earliest) –inflation continues to be low

36. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-36 The Current Macroeconomic Situation The United States - recent past –from early 1990s to 2000, there was an economic boom –unemployment fell during the 1990s lowest unemployment rate in two decades (4%) –real wages increased only slightly helped to keep inflation low

37. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-37 The Current Macroeconomic Situation Europe –economic growth in countries belonging to the European Monetary Union slowing –low inflation less than 2% per year –relatively high unemployment near 10%

38. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-38 The Current Macroeconomic Situation Japan –slow growth rate real GDP grew only 1.8% in 2000 real GDP is expected to grow only by 1.4% in 2001 –deflation is occurring the overall price level fell by 0.7% in 2000

39. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-39 Chapter Summary Macroeconomics is the study of the overall economy. There are three key reasons to study macroeconomics –to gain cultural literacy –to understand how economic trends affect you personally –to exercise your responsibility as a voter and citizen

40. Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 1-40 Chapter Summary The key indicators in macroeconomics are –real GDP –the unemployment rate –the inflation rate –the interest rate –the level of the stock market –the exchange rate