1. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Robert J. Gordon, Macroeconomics, 10 th edition, 2006, Addison-Wesley Chapter 1 What Is Macroeconomics?

2. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University How Macroeconomics Affects our Everyday Lives  Macroeconomics is concerned with the big economic issues that determine our economic well-being.  Macroeconomic issues involves the overall economic performance of the nation.  There are three central concepts in macroeconomics; the unemployment rate, the inflation rate and productivity growth.  The basic task of macroeconomics is to study the behavior of each of these concepts, why they matter to individuals and what the government can do improve macroeconomic performance.

3. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University How Macroeconomics Affects our Everyday Lives 1. The unemployment rate  When unemployment rate is high, it is going to be harder for individuals who want to work to find a job.  Unemployed people will not be able to pay their bills. Crime, mental illness and suicide will increase.  Many economists consider unemployment as the single most important macroeconomic issue.  “Indolence is justly considered the mother of misery”, Robert Burton said (1621). 2. The Inflation Rate  A high inflation means that prices, on average are rising.  In inflationary periods, retired people lose the most, as their savings buy less as prices go up. While inflation harms savers, it helps borrowers, i.e inflation redistributes income.  Inflation increases uncertainty about the future

4. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University How Macroeconomics Affects our Everyday Lives 3. Productivity growth  Productivity is the average output per hour of work that a nation produces in total goods and services.  The faster average productivity grows, the easier is for individuals to raise their standards of living, i.e., there will be more houses, roads, cars, hospitals, schools..etc.  An economy with no productivity growth is called the “zero sum society” (the rate of growth is zero), any extra good or service enjoyed by one person requires that something else is taken from another. For example in order to build more houses, the economy has to sacrifice building fewer hospitals.

5. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Real GDP: Actual and Natural  The official measure of the economy is “the real GDP” includes all currently produced goods and services sold on the market within a given time period, i.e., reflects the quantity produced corrected for any changes in prices.  Actual real GDP is the amount an economy actually produces at any given time. Too much production of real GDP causes inflation, while too little causes a waste of resources. Neither are desirable.  Natural real GDP is the actual real GDP when inflation rate is constant with no tendency to accelerate or decelerate. (Figure 1-1)

6. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Figure 1-1 : The Relation Between Actual and Natural Real GDP and the Inflation Rate

7. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Real GDP: Actual and Natural  Note:  When real GDP equals natural GDP the inflation rate will be constant.  During periods of low actual real GDP, inflation slows down.  During periods of high actual real GDP, inflation accelerates (excessive actual real GDP is called overheating the economy).

8. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Unemployment: Actual and Natural  When actual real GDP is low, actual unemployment rate rises above its natural level (note that inflation slows down here).  When actual real GDP is high, actual unemployment rate falls below its natural level (inflation accelerates).  Whenever actual real GDP equals natural real GDP actual unemployment equals natural rate of unemployment NRU. (Figure 1-2)  NRU corresponds exactly to natural real GDP. A situation in which there is no tendency for inflation to change.

9. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Figure 1-2 The Behavior over Time of Actual and Natural Real GDP and the Actual and Natural Rates of Unemployment Inflation speeds up Inflation slows down

10. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University

11.  Note:  The NRU is not necessarily constant  The NRU is neither optimal nor immutable, and it can be reduced by the government policies that help the economy to function better.  To achieve a low inflation and unemployment at the same time is a dilemma. To lower inflation real GDP must be reduced which in turn increases actual unemployment and vice versa.

12. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University GDP and the three macro concepts  When actual real GDP is higher than its natural level, unemployment is low and vice versa  When actual GDP is higher than its natural level, inflation speeds up and vice versa  When actual real GDP is higher than its natural level, productivity is most likely to grow up.

13. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Macroeconomics in the short run and in the long run  Macroeconomic theories can be divided into 2 main groups the short run (concern) stability of the economy the long run (concern) growth of the economy In the short run we focus on two main concepts unemployment and inflation. Ups an downs in economic fluctuations are called the business cycles. In the long run we focus on productivity growth, or economic growth.  Short run business cycles The main concern of macroeconomists is to minimize fluctuations in unemployment and inflation rates. Fluctuations can be wide or small Figure 1-3

14. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Figure 1-3 Business Cycles in Volatilia and Stabilia

15. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University  Business cycle concepts Peak: the highest point reached by real output in each cycle Trough: the lowest point reached by real output in each cycle Recession: the interval in the business cycle between the peak and the trough Expansion: the period in the business cycle between the trough and the peak Figure 1-4

16. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Figure 1-4 Basic Business-Cycle Concepts

17. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University  The long run: Economic growth  To achieve an increasing standard of living, output per person must grow.  Look at Figure 1-5 of two hypothetical nations, stag nation and speed nation.  If population growth is the same in the two countries, GDP per capita in the speed nation is faster. i.e., people there can purchase more goods, have better schools, hospitals and other public services compared to the people of the stag nation.

18. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Figure 1-5 Economic Growth in Stag-Nation and Speed-Nation

19. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University  Taming the business cycles: Stabilization policy  In policy discussions the target variables are inflation, unemployment and long term productivity growth.  Alternative policy instruments are used when these targets are different from their desired values.  policy instruments are: Monetary policies (money supply and interest rates) Fiscal policies (changes in G and T) Miscellaneous group, to equip workers with skills they need to qualify for jobs  The goal of productivity growth is simple; just make productivity growth as fast as possible.  The goal of unemployment is not simple. If unemployment is set to be low, inflation accelerates. A compromise is to set it at its natural level (constant inflation)

20. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University  The role of stabilization policy  They are used to offset undesired changes in private spending.  But sometimes it may not be possible to control aggregate demand instantly and precisely.  The impact of different policies may also be highly uncertain.  Macroeconomic goals are incompatible, we cant have low unemployment rate and a stable price level.

21. Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University  The internationalization of macroeconomics