Intermediate Macroeconomics Chapter 1 An Overview of Macroeconomics

An Overview of Macroeconomics What is Macroeconomics Macroeconomic Goals Economic Theory in Practice Intermediate Macroeconomics

1. What Is Macroeconomics? Microeconomics - study of behavior of individual economic agents. Macroeconomics - study of aggregate measures of the economy Forest vs. trees. Macroeconomics is study of the forest. Microeconomics is study of individual trees. Aggregate - (n) a total, a mass or amount, brought together. (v) to collect or form into an aggregate. Aggregate demand represents the total spending on all final goods and services in an economy by all consumers. Problem with aggregation of preferences. Could add pro-con votes as in an election. But, how do you account for differences in intensity of preferences? Intermediate Macroeconomics

Complementary and Conflicting Goals 2. Macroeconomic Goals Low Unemployment Price Stability Economic Growth Complementary and Conflicting Goals Intermediate Macroeconomics

2. Macroeconomic Goals Low Unemployment Great Depression (1929 - 1933) World War II (1941 - 1945) 1981 - 1982 recession 1973 - 1975 recession 1990 - 1991 recession U.S. Unemployment Rates: U.S. Virginia Fairfax Co. Jun 2005 5.2% 3.8% 2.9% Jun 2004 5.8% 4.0% 3.0% Jun 2003 6.5% 4.5% 3.6% Jun 2002 6.0% 4.4% 3.7% Jun 2001 4.7% 3.2% 2.6% Lowest rates last 10 years: U.S. 3.6% Oct 2000 Virginia 1.9% Apr 2000 Fairfax Co 1.2% Apr 1998 Fairfax Co., VA. Source: Bureau of Labor Statistics (www.bls.gov) Intermediate Macroeconomics

2. Macroeconomic Goals Price Stability World War 1 1917 - 1918 Iranian Revolution and Oil Price Increase World War 2 1941 - 1945 Arab oil Embargo 1973 - 1974 Great Depression 1929 - 1933 Source: Bureau of Labor Statistics (www.bls.gov) Intermediate Macroeconomics

2. Macroeconomic Goals Economic Growth Annual change in U.S. GDP per capita Nominal GDP Real GDP (chained 1996 dollars) Economic Growth Distinction between short run and long run Short run – described by business cycle models. Fluctuations in economic activity around a long-run trend. Long-run – described by growth models. Long0run trend determined by factors such as savings, productivity, changes in technology. Source: Bureau of Economic Analysis (www.bea.gov) Intermediate Macroeconomics

2. Macroeconomic Goals Economic Growth Long term trend 2.4% per year Intermediate Macroeconomics

2. Macroeconomic Goals Complementary and Conflicting Goals Complementary Goals Low unemployment and high economic growth Conflicting Goals Low unemployment and low inflation Are high economic growth and low inflation conflicting goals? Not necessarily if your policy action is to increase worker productivity then you could increase economic growth while maintaining low inflation. Because of conflicting goals economics has been described as the “Dismal Science” Intermediate Macroeconomics

3. Economic Theory in Practice Economic Theory and Models Empirical Applications A theory is like a map to a friends house. The map is necessarily incomplete and in many ways inaccurate. The map probably only shows the roads that will take you directly where you want to go. It may show a few landmarks like the gas station where you turn right. The map is useful precisely because it is a simplification. Showing every building and intersecting street won’t get you where you want to go any faster or with significantly greater confidence. Similarly, an economic theory tries to take you directly where you want to go without burdening you with the details. But when the details of the map or a theory are left out it becomes less useful for other purposes. If we use one economic model to study economic growth it is likely unsuitable for studying short-term economic fluctuations. Intermediate Macroeconomics

3. Economic Theory in Practice Economic theory and models What makes a good model? Accurately explains history Makes reasonable predictions about the future John Maynard Keynes, General Theory of Employment Interest and Money, 1936 (p. 297): “The object of our analysis is not to provide a machine or method of blind manipulation, which will furnish an infallible answer, but to provide ourselves with an organized and orderly method of thinking out particular problems; and, after we have reached a provisional conclusion by isolating the complicating factors one by one, we then have to go back on ourselves and allow, as well as we can, for the probable interactions of the factors amongst themselves. This is the nature of economic thinking.” Intermediate Macroeconomics

3. Economic Theory in Practice Economic theory and models Keep models simple Occam’s Razor - eliminate complicating details that don’t significantly contribute to the model Ceteris Paribus - other things being equal Intermediate Macroeconomics

Economic Theory in Practice Empirical time series applications Use Real rather than Nominal values Compare Per Capita rather than Totals Compare Growth Rates rather than Levels Empirical (Webster’s dictionary): relying or based solely on experiment or observation rather than theory. Two types of empirical studies: Longitudinal - time trends Examining single sector at different points in time - use Real or Real per capita to eliminate effects of both inflation and population differences Comparing sectors over a period of time use Real growth rates or Real per capita growth rates Cross-sectional Comparing different sectors at same point in time - either nominal or real OK Comparing different geographic areas (e.g., countries) - use per Capita rather than aggregates Purchasing power parity corrects for differences in average price levels Indexes - not mentioned in text. Consumption as a share of total GDP. Eliminates problem of differences in population. Intermediate Macroeconomics

3. Economic Theory in Practice Compare real rather than nominal Percent increase 1929 – 2003 Nominal GDP: 10,522 % Real GDP: 1,100 % Real GDP Nominal GDP Source: Bureau of Economic Analysis, www.bea.gov Intermediate Macroeconomics

3. Economic Theory in Practice Compare per capita rather than aggregates Percent increase 1929 – 2003 Total Real GDP: 1,100 % Real GDP per capita: 402% Real GDP per capita Total Real GDP The greatest problem with looking at a graph of levels is that a straight line does not imply constant growth and the slope does not indicate the growth rate. The trick is that an increase from $10,000 to $15,000 is much greater (50 percent) than growth from $30,000 to $35,000 (17 percent). Similarly, a 100 point increase in the stock market's Dow Jones Industrial Average today is not nearly as dramatic as it was twenty years ago. Source: Bureau of Economic Analysis, www.bea.gov Intermediate Macroeconomics

3. Economic Theory in Practice Compare growth rates rather than levels Source: Bureau of Economic Analysis, www.bea.gov Intermediate Macroeconomics