© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Chapter 18 Introduction to Macroeconomics

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Macroeconomics Macroeconomics deals with the economy as a whole. It studies the behavior of economic aggregates such as aggregate income, consumption, investment, and the overall level of prices.Macroeconomics deals with the economy as a whole. It studies the behavior of economic aggregates such as aggregate income, consumption, investment, and the overall level of prices. * Aggregate behavior refers to the behavior of all households and firms together.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair The Roots of Macroeconomics The Great Depression was a period of severe economic contraction and high unemployment that began in 1929 and continued throughout the 1930s in the US.The Great Depression was a period of severe economic contraction and high unemployment that began in 1929 and continued throughout the 1930s in the US. Before Great Depression, the Classical economists applied microeconomic models, or “market clearing” models, to economy-wide problems: as output falls, and demand for labor decreases, the wage rate will decline, thereby raising the quantity of labor demanded by firms; hence unemployment will not prevail.Before Great Depression, the Classical economists applied microeconomic models, or “market clearing” models, to economy-wide problems: as output falls, and demand for labor decreases, the wage rate will decline, thereby raising the quantity of labor demanded by firms; hence unemployment will not prevail. The failure of simple classical models to explain the prolonged existence of high unemployment during the Great Depression provided the impetus for the development of macroeconomics.The failure of simple classical models to explain the prolonged existence of high unemployment during the Great Depression provided the impetus for the development of macroeconomics.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair The Keynesian Revolution In 1936, John Maynard Keynes published The General Theory of Employment, Interest, and Money.In 1936, John Maynard Keynes published The General Theory of Employment, Interest, and Money. According to Keynes, it is not price and wage that determine the level of employment, as suggested by classical economists, but the level of aggregate demand for goods and services.According to Keynes, it is not price and wage that determine the level of employment, as suggested by classical economists, but the level of aggregate demand for goods and services. Hence, Keynes believed governments could intervene in the economy and affect the level of output and employment.Hence, Keynes believed governments could intervene in the economy and affect the level of output and employment.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Recent macroeconomic history Fine tuning- phrase used to refer to the role of government in regulating inflation and unemployment.Fine tuning- phrase used to refer to the role of government in regulating inflation and unemployment. Stagflation (Stagnation + Inflation)- it occurs when the overall price level rises rapidly (inflation) during periods of recession or high and persistent unemployment (stagnation).Stagflation (Stagnation + Inflation)- it occurs when the overall price level rises rapidly (inflation) during periods of recession or high and persistent unemployment (stagnation).

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Macroeconomic Concerns Three of the major concerns of macroeconomics are:Three of the major concerns of macroeconomics are: Inflation Inflation Output growth Output growth Unemployment Unemployment

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Inflation Inflation is an increase in the overall price level.Inflation is an increase in the overall price level. Hyperinflation is a period of very rapid increases in the overall price level. Hyperinflations are rare, but have been used to study the costs and consequences of even moderate inflation.Hyperinflation is a period of very rapid increases in the overall price level. Hyperinflations are rare, but have been used to study the costs and consequences of even moderate inflation. Deflation is a decrease in the overall price level. The goal of policymakers is to avoid prolonged periods of inflation as well as deflation for stability in economyDeflation is a decrease in the overall price level. The goal of policymakers is to avoid prolonged periods of inflation as well as deflation for stability in economy

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Output Growth: Short Run and Long Run The business cycle is the cycle of short-term ups and downs in the performance of an economy.The business cycle is the cycle of short-term ups and downs in the performance of an economy. The main measure of how an economy is doing is aggregate output:The main measure of how an economy is doing is aggregate output: Aggregate output is the total quantity of goods and services produced in an economy in a given period. Aggregate output is the total quantity of goods and services produced in an economy in a given period. When the aggregate output is less, the average standard of living declines When the aggregate output is less, the average standard of living declines Also unemployment increases when firms cut back on production leading to lay off of workers. Also unemployment increases when firms cut back on production leading to lay off of workers.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Output Growth: Short Run and Long Run A recession is a period during which aggregate output declines. Two consecutive quarters of decrease in output signal a recession.A recession is a period during which aggregate output declines. Two consecutive quarters of decrease in output signal a recession. A prolonged and deep recession becomes a depression.A prolonged and deep recession becomes a depression. The size of the growth rate of output over a long period is also a concern of macroeconomists and policy makers.The size of the growth rate of output over a long period is also a concern of macroeconomists and policy makers. If growth rate of output is greater than growth rate of population, so on an average people become better offIf growth rate of output is greater than growth rate of population, so on an average people become better off

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Unemployment The unemployment rate is the % of the labor force that is unemployed.The unemployment rate is the % of the labor force that is unemployed. The unemployment rate is a key indicator of the economy’s health.The unemployment rate is a key indicator of the economy’s health. Zero unemployment can never existZero unemployment can never exist The existence of unemployment seems to imply that the aggregate labor market is not in equilibrium.The existence of unemployment seems to imply that the aggregate labor market is not in equilibrium.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Government in the Macroeconomy There are three kinds of policy that governments use to influence the macroeconomy: There are three kinds of policy that governments use to influence the macroeconomy: 1. Fiscal policy 2. Monetary policy 3. Growth or supply-side policies

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Government in the Macroeconomy 1. Fiscal policy refers to government policies concerning taxes and expenditures. - Expansionary fiscal policy when government cuts taxes/ raises spending to get economy out of slump - Contractionary fiscal policy- when government raises taxes/ reduces spending to bring economy out of inflation 2. Monetary policy consists of tools used by the Central Bank of any country to control the money supply. It effects overall price levels, interest rates, exchange rates, level of output, etc.

© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Government in the Macroeconomy… 3. Growth policies are government policies that focus on stimulating aggregate supply – to stimulate growth of aggregate output and income, instead of aggregate demand.