1. An Introduction to Macroeconomics5
An Introduction to Macroeconomics
Where the telescope ends, the microscope begins. Which of the two has the grander view?
VICTOR HUGO

2. Contents Drawing a Line Between Macroeconomics and Microeconomics
Supply and Demand in Macroeconomics
Gross Domestic Product
The Economy on a Roller Coaster
The Problem of Macroeconomic Stabilization: A Sneak Preview
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3. Drawing a Line Between Macro and Microeconomics
In macroeconomics, we typically assume that most details of resource allocation and income distribution are of secondary importance to the study of the overall rates of inflation and unemployment.

4. Drawing a Line Between Macro and Microeconomics
Aggregation and Macroeconomics
An economic aggregate is nothing but an abstraction that people use to describe some important feature of economic life, such as total domestic product.

5. Drawing a Line Between Macro and Microeconomics
The Foundations of Aggregation
The composition of demand and supply in various markets is of little consequence for the economy-wide issues of growth, inflation, and unemployment.
During economic fluctuations, markets tend to move up or down together.

6. Supply and Demand in Macroeconomics
Moving to Macroeconomic Aggregates
Aggregate supply and aggregate demand relate domestic product (on the horizontal axis) to the price level (on the vertical axis).

7. Supply and Demand in Macroeconomics
Moving to Macroeconomic Aggregates
Aggregate demand (AD) = quantity of domestic product that is demanded at each possible price level
Aggregate supply (AS) = quantity of domestic product that is supplied at each possible price level

8. FIGURE 1: Two Interpretations of a Shift in the Demand Curve
Price
Price P P D 1 S S D D Q
Quantity
(a)
Quantity
(a)
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9. FIGURE 2: An Economy Slipping into a RecessionD0 S D 2 E
Price Level B D0 S D2
Domestic Product
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10. FIGURE 3: Economic GrowthS0 D 1 S 1 D0 C E
Price Level D 1 S0 S 1 D0 Q Q 1
Domestic Product
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11. Supply and Demand in Macroeconomics
Major concerns of macroeconomics
Inflation
Unemployment
Growth
 AD   price level

12. Supply and Demand in Macroeconomics
Recession and Unemployment
 AD/AS  unemployment
Recession = a period of time during which production falls and people lose jobs

13. Supply and Demand in Macroeconomics
Economic Growth
Economic growth =  GDP
 AD and/or AS  growth

14. Gross Domestic Product
Money as the Measuring Rod: Real Versus Nominal GDP
GDP = sum of the money values of all final goods and services produced in the domestic economy within the year
Nominal GDP (GDP in current dollars) values each good and service at the price at which it was actually sold during the year.

15. Gross Domestic Product
Drawback of Nominal GDP: it changes when prices change even if there is no change in actual production.
Solution: calculate real GDP or GDP in constant dollars.
Distinction between Nominal and Real GDP  a working definition of a recession as a period in which real GDP declines

16. GDP Example 2005 2006 Pounds Produced Price per lb. Beef 15 20 13
Corned Beef 5 10 2 12
Beef Jerky 3 8

17. GDP Example 2005 Nominal Output Pounds Produced Price per lb. Beef 15
Beef 15
Corned Beef 5 10
Beef Jerky 3 20
Nominal GDP =

18. GDP Example 2005 Nominal Output Pounds Produced Price per lb. Beef 15
Beef 15
225
Corned Beef 5 10 50
Beef Jerky 3 20 60
Nominal GDP =
335

19. GDP Example 2006 2005 Nominal Output Real Output in 2005 Dollars
Pounds Produced
Price per lb.
Beef 20 13 15
Corned Beef 2 12 10
Beef Jerky 8
 Nominal GDP =
 xxxxxxxxxxxxxxxx
Real GDP in 2005 Dollars =
xxxxxxxxxxxxxxxxxx 

20. GDP Example 2006 2005 Nominal Output Real Output in 2005 Dollars
Pounds Produced
Price per lb.
Beef 20 13 15
260
300
Corned Beef 2 12 10 24
Beef Jerky 8 64
160
 Nominal GDP =
348
Real GDP in 2005 Dollars =
480

21. FIGURE 4: Nominal GDP, Real GDP, and Real GDP per Capita
$40,000
Nominal GDP (right scale)
Real GDP per capita (left scale)
$11,000
35,000
Real GDP
(right scale)
$10,000
30,000
$9,000
8,000
25,000
7,000
20,000
6,000
Dollars per Year
Billions of Dollars per Year
5,000
15,000
4,000
Dollars per Year
10,000
3,000
2,000
Billions of Dollars per Year
5,000
1,000
2004
1955
1960
1965
1970
1975
1980
1985
1990
199 5
2000
Year
NOTE: Real GDP figures are in 2000 dollars.
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22. Gross Domestic Product
What Gets Counted in GDP?
Only goods and services produced within the year
Only final goods and services
Only production within the geographic boundaries of the United States

23. Gross Domestic Product
Limitations of the GDP: What GDP Is Not
Includes only market activities
Places no value on leisure
Counts “bads” as well as “goods”
Does not deduct ecological costs of economic activity

24. Well-Being?
If national income is a good measure of well-being, why is Switzerland's Gross Domestic Product so much lower than India's GDP or China's GDP?
What measures would better compare the well-being for residents of different countries?
How do you expect these direct measures to correlate with per capita GDP?

25. Well Being?
If national income is a good measure of well-being, why is Switzerland's Gross Domestic Product so much lower than India's GDP or China's GDP?
What measures would better compare the well-being for residents of different countries?
How do you expect these direct measures to correlate with per capita GDP?

26. The Economy on a Roller Coaster
Growth, but with Fluctuations
The U.S. has seen significant fluctuations in economic growth, unemployment, and inflation.
Before WWII, the business cycle was particularly strong, the worst episode being the Great Depression of the 1930s.

27. FIGURE 5: The Growth Rate of U.S. Real GDP, 1870-2004
Post–1950
Pre–1940
Rapid
industrialization
Railroad
prosperity
Depression
of 1890s
Panic
of 1907
Postwar
depression
Great
recession
World
War I
War II
Korean
War
Expansion of
1960s
1974–75
Recession
1982–83
Roaring
Twenties
1990–91
1980s
Boom
1990s 20 15 10 5 –5
–10
–15
Percentage Growth Rate of Real GDP
2004
–20 1 87 1 88 1 89 1 90 1 91 1 92 1 93 1 94 1 95 1 96 1 97 1 98 1 99
2000
Year
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28. FIGURE 6: The Inflation Rate in the United States, 1870-2004
Post–1950 Pr e
–1940
2004
Postwar
deflation
Post-Civil War
Great
Depression
World
War I
War II
adjustment
Inflation
of the 1970s
Vietnam War
inflation
Disinflation
of the 1980s 25 20 15 10 5
Percentage Inflation Rate –5
–10
–15 1 87 1 88 1 89 1 90 1 91 1 92 1 93 1 94 1 95 1 96 1 97 1 98 1 99
2000
Year
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29. The Economy on a Roller Coaster
The Great Depression
A worldwide event
Caused a much-needed revolution in economic thinking
Until the 1930s, the prevailing economic theory held that a capitalist economy could cure recessions or inflations by itself.

30. The Economy on a Roller Coaster
The Great Depression
The Great Depression led John Maynard Keynes, one of the world’s most renowned economists, to write The General Theory of Employment, Interest, and Money (1936).

31. The Economy on a Roller Coaster
The Great Depression
Keynes believed that:
The economy did not naturally gravitate toward smooth growth and high levels of employment
A pessimistic outlook could lead business firms and consumers to curtail their spending plans
The economy could then be condemned to years of stagnation

32. The Economy on a Roller Coaster
The Great Depression
In terms of the AD-AS framework, Keynes suggested that there were times when the AD curve shifted inward by large amounts.
The consequence would be declining output and deflation.

33. The Economy on a Roller Coaster
The Great Depression
Keynes showed how governments can manage their economies so that recessions will not turn into depressions and depressions will not last as long as the Great Depression.

34. The Economy on a Roller Coaster
From World War II to 1973
During this period, the economy experienced some fairly mild business cycles, but grew considerably.
By the end of the period, inflation was rising.

35. The Economy on a Roller Coaster
The Great Stagflation,
The international price of oil was raised sharply in 1973 and again in 1979.
For that reason and some others, the period saw the emergence of stagflation, both unemployment and inflation increasing together.

36. FIGURE 7: The Effects of an Adverse Supply Shift1 D S A
Price Level E
Real GDP
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37. The Economy on a Roller Coaster
Reaganomics and its Aftermath
When Reagan assumed office in 1981, the economy went into a sharp tailspin, and soon the rate of inflation fell.
This was followed by a period of steady, non-inflationary growth during most of the 1980s. In , recession hit.

38. The Economy on a Roller Coaster
Clintonomics: Deficit Reduction and “The Best Economy in 30 Years”
Clinton’s initial objectives were spurring growth and increasing public investment.
Soon, however, the overriding goal in Washington became deficit reduction.

39. FIGURE 8: The Effects of a Favorable Supply ShiftD 1 S 1 S 2 D C B E
Price Level
Real GDP
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40. The Economy on a Roller Coaster
Clintonomics: Deficit Reduction and “The Best Economy in 30 Years”
A variety of transitory factors pushed the economy’s AS curve outward at an unusually rapid pace between 1996 and 1999.
Strong economic growth continued through the late 1990s.
Inflation remained low.

41. The Economy on a Roller Coaster
The Bush Economy and the 2004 Election
Real GDP grew very slowly then declined slightly in 2nd half of 2001
1st recession in 10 years
Recession ended November 2001

42. The Economy on a Roller Coaster
The Bush Economy and the 2004 Election
Policies that helped shift AD curve, mitigating recession
tax cuts
war of terrorism, burst of government spending
consumers spending remained strong, despite 9/11
low interest rates encouraged spending

43. The Problem of Macroeconomic Stabilization
Combating Unemployment
When recessions are caused by too low aggregate demand, governments can try to stimulate demand.

44. FIGURE 9 Stabilization Policy to Fight UnemploymentD 1 S D A E
Price Level
Increase in
output
Real GDP
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45. The Problem of Macroeconomic Stabilization
Combating Inflation
When inflation is caused by too high aggregate demand, governments can try to restrain aggregate demand.

46. FIGURE 10: Stabilization Policy to Fight InflationD D 2 E
Price Level
Decrease
in prices B
Real GDP
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47. The Problem of Macroeconomic Stabilization
Does It Really Work?
Before 1940, the economy endured pronounced business fluctuations and inflation was rare.
Since World War II the business fluctuations have been much less severe, but inflation has been a common occurrence.
How successful government policy can be is a question to be explored throughout the text.

48. FIGURE 5: The Growth Rate of U.S. Real GDP, 1870-2004
Post–1950
Pre–1940
Rapid
industrialization
Railroad
prosperity
Depression
of 1890s
Panic
of 1907
Postwar
depression
Great
recession
World
War I
War II
Korean
War
Expansion of
1960s
1974–75
Recession
1982–83
Roaring
Twenties
1990–91
1980s
Boom
1990s 20 15 10 5 –5
–10
–15
Percentage Growth Rate of Real GDP
2004
–20 1 87 1 88 1 89 1 90 1 91 1 92 1 93 1 94 1 95 1 96 1 97 1 98 1 99
2000
Year
Copyright © 2006 South-Western/Thomson Learning. All rights reserved.