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Chapter 5 An Introduction to Macroeconomics Where the telescope ends, the microscope begins. Which of the two has the grander view? VICTOR HUGO.

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Presentation on theme: "Chapter 5 An Introduction to Macroeconomics Where the telescope ends, the microscope begins. Which of the two has the grander view? VICTOR HUGO."— Presentation transcript:

1 Chapter 5 An Introduction to Macroeconomics Where the telescope ends, the microscope begins. Which of the two has the grander view? VICTOR HUGO

2 Macroeconomics vs. Microeconomics Microeconomics individual –Decisions of individual units No matter how large Example: GE’s pricing policy Macroeconomics entire –Behavior of entire economies No matter how small Example: inflation in Monaco –Economic aggregates: aggregate output, inflation, unemployment, … 2

3 Macroeconomics & Aggregation Aggregation –Combine many individual markets into one overall market Why can we aggregate? –Composition of demand & supply In various markets Important for microeconomics issues Not important for macroeconomics issues –During economic fluctuations, markets move up or down together 3

4 Macroeconomics & Microeconomics Macroeconomics –Assume most details Resource allocation & income distribution Relatively unimportant Microeconomics –Ignore macroeconomics issues –Focus – individual markets Allocate resources Distribute income 4

5 Supply & Demand in Macroeconomics ADAggregate demand (AD) curve –Quantity of domestic product – demanded –Each possible value of price level ASAggregate supply (AS) curve –Quantity of domestic product – supplied –Each possible value of price level 5

6 Two interpretations of a shift in the demand curve Figure Quantity Price (a) D D 0 Quantity Price (b) Q0Q0 S S P0P0 E D0D0 D0D0 S S P0P0 D1D1 D1D1 P1P1 E A

7 Supply & Demand in Macroeconomics Inflation –Sustained increase in price level –Outward shift of aggregate demand curve Recession – period of time –Total output – declines Production falls People lose jobs –Inward shift of aggregate demand curve 7

8 An economy slipping into a recession Figure Domestic Product Price Level D0D0 D0D0 Q0Q0 S S P0P0 D2D2 D2D2 P2P2 Q2Q2 E B

9 Supply & Demand in Macroeconomics Macroeconomists study –Inflation –Recession & unemployment (Business Cycles) –Economic growth 9

10 Economic growth Figure Domestic Product Price Level D0D0 D0D0 Q0Q0 S0S0 S0S0 D1D1 D1D1 Q1Q1 E S1S1 S1S1 C

11 Gross Domestic Product Gross domestic product (GDP) money –Sum: money values final –All final goods & services Produced - domestic economy (Toyota car produced in the US vs. Ford pick-up produced in Japan) Sold – organized markets (gambling in Vegas vs. gambling in Chicago) –Specified period of time Usually a year 11

12 Gross Domestic Product Nominal GDP current –GDP in current dollars –Value outputs – current prices Real GDP –Value outputs of different years at common prices constant –GDP in constant dollars 12

13 What Gets Counted in GDP? GDP - particular year –Add up money value of things –Goods & services Produced within the year –Final goods & services –Production: geographic boundaries of U.S. –Organized markets 13

14 Gross Domestic Product FinalFinal goods and services –Purchased by their ultimate users IntermediateIntermediate good - purchased –For resale –For use in producing another good 14

15 Gross Domestic Product Limitations of GDP –Not measure: nation’s economic well-being –Includes only market activity Housework, yard work, … –Places no value on leisure –Counted: “Bads” and “Goods” Hurricane Katrina might increase GDP –Ecological costs Not deducted from GDP Green Needed: “Green GDP” 15

16 The Economy on a Roller Coaster U.S. economy –Growth – with fluctuations Macroeconomic fluctuations –Business cycles Real GDP per capita –Ratio: real GDP divided by population 16

17 Nominal GDP, real GDP, real GDP per capita since 1959 Figure 4 17

18 The growth rate of U.S. real GDP since 1870 Figure 5 18

19 The Economy on a Roller Coaster Inflation –Sustained increase –General price level Deflation –Sustained decrease –General price level 19

20 The inflation rate in the United States since 1870 Figure 6 20

21 The Economy on a Roller Coaster The Great Depression, –Decline in economic activity –Rapid deflation –Production – declined 30% –Unemployment rate Increased from 3% to 25% 21

22 The Economy on a Roller Coaster The Great Depression, –Revolution in economic thought Before: economy corrects itself After: decrease in aggregate demand cannot recover by themselves (J. M. Keynes) –Monetary & fiscal policy needed –Ended: early 1940s (due to WWII) –What caused it? Stock bubbles Contractionary monetary policy Unregulated markets 22

23 The Economy on a Roller Coaster From WWII to 1973 –WWII: increased government spending Increased aggregate demand Accidental fiscal policy Price controls Shortage: consumer goods –1960s – strong growth –Vietnam war – increased spending Inflation (5-6%) & high unemployment –Wage & price controls by Nixon 23

24 The Economy on a Roller Coaster Great StagflationThe Great Stagflation, –OPEC – 1973 oil prices quadrupled (1 st Oil Shock) –Poor harvests in 1973 rose food prices –Stagflation Inflation rate: 12% High unemployment (9% in 1 st quarter 1975) –Inward shift of aggregate supply 24

25 The Economy on a Roller Coaster Great StagflationThe Great Stagflation, –Economy recovered Government actions Natural economic forces –1979 – OPEC soaring oil prices (2 nd Oil Shock) Stagflation again Inflation: 16% 25

26 The effects of an adverse supply shift Figure Real GDP Price Level D D S0S0 S0S0 E S1S1 S1S1 A

27 The Economy on a Roller Coaster Reaganomics and its aftermath –High inflation –Federal Reserve Monetary policy (Paul Volcker) –High interest rate to fight inflation –Result: high unemployment rate (11% in 1982) Fiscal policy –large tax cut –Laffer Curve –Help recovery beginning in the winter of

28 The Economy on a Roller Coaster Reaganomics and its aftermath –Large budget deficits –Recovery started –President Bush continues Regan’s policies Inflation Deficit-reduction package Spike in oil prices triggers recession 28

29 The Economy on a Roller Coaster Clintonomics: deficit reduction –Deficit-reduction package, 1993 & 1997 Tax increase & spending cuts –Large fiscal surplus –Economy boomed (might due to globalization and computerization) –Lower inflation –Aggregate supply curves Pushed outward – rapid pace, 1996 –

30 The effects of a favorable supply shift Figure Real GDP Price Level D0D0 D0D0 S0S0 S0S0 D1D1 D1D1 E S1S1 S1S1 C S2S2 S2S2 B

31 The Economy on a Roller Coaster Tax cuts and the Bush economy –2001 recession First in 10 years –Tax cut 2001 –Budget deficit –Burst of government spending War on terror –Aggregate demand – shift outward –Federal Reserve Lowered interest rate 31

32 The Economy on a Roller Coaster Great RecessionThe Great Recession (Dec – now) –Output falls hard –10% unemployment rate –Inflation is modest –Triggered by subprime crisis

33 Problem of Macroeconomic Stabilization Historical record shows –US economy has not generally produced steady growth w/o inflation –Short-run trade-off b/w unemployment and inflation, sometimes both increase (1970s) –Gov policy might contribute to this performance 33

34 Problem of Macroeconomic Stabilization Stabilization policy –Government programs –Prevent or shorten recessions –Counteract inflation, stabilize prices

35 Problem of Macroeconomic Stabilization Fight unemployment –Increase aggregate demand Government - Fiscal policy –Increase spending –Cut taxes Federal Reserve - Monetary policy –Lower interest rates –Increase output –Reduce unemployment –Raise prices 35

36 Stabilization policy to fight unemployment Figure Real GDP Price Level D0D0 D0D0 S0S0 S0S0 D1D1 D1D1 E A Increase in output

37 Problem of Macroeconomic Stabilization Fight inflation –Decrease aggregate demand Government - Fiscal policy –Cut spending –Increase taxes Federal Reserve - Monetary policy –Increase interest rates –Decrease inflation (decrease prices) –Decrease output –Increase unemployment 37

38 Stabilization policy to fight inflation Figure Real GDP Price Level D0D0 D0D0 S S D2D2 D2D2 E B Decrease in prices

39 Stabilization policy Prewar data –Fluctuations – unmanaged economy Booms & recessions –“Natural” economic reasons Little government intervention Postwar data –Economy - managed by government policy Successfully (60s and 90s) or unsuccessfully (70s) –Recessions - less severe –More inflation-prone 39

40 Summary Macro vs. Micro Macro is all about Aggregation AD-AS curve GDP Business Cycles vs. Economic Growth Brief Macroeconomic History of US Stabilization Policy


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