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An Introduction to Macroeconomics

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1 An Introduction to Macroeconomics
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
Decisions of individual units No matter how large Example: GE’s pricing policy Macroeconomics Behavior of entire economies No matter how small Example: inflation in Monaco Economic aggregates: aggregate output, inflation, unemployment, …

3 Macroeconomics & 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

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

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

6 Figure 1 Two interpretations of a shift in the demand curve D1 Price
Q0 Quantity Quantity (a) (b)

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

8 Figure 2 An economy slipping into a recession S E P0 Price Level B P2
D0 Price Level D2 E P0 Q0 B P2 Q2 Domestic Product

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

10 Figure 3 Economic growth S0 S1 C Price Level E D1 D0 Q0 Q1
Domestic Product

11 Gross Domestic Product
Gross domestic product (GDP) Sum: money values 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

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

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

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

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 Needed: “Green GDP”

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

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

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

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

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

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%

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

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

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

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

26 Figure 7 The effects of an adverse supply shift S1 S0 A Price Level E
Real GDP

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

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 – 1998

30 Figure 8 The effects of a favorable supply shift S0 S1 S2 C B
D1 S0 S1 Price Level D0 S2 C B E Real GDP

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

32 The Economy on a Roller Coaster
The 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

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

36 Figure 9 Stabilization policy to fight unemployment S0 A Price Level E
D1 S0 Price Level D0 A E Increase in output Real GDP

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

38 Figure 10 Stabilization policy to fight inflation S E Price Level B
D0 Price Level D2 E Decrease in prices B Real GDP

39 Stabilization policy Prewar data Postwar 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

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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