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MacroeconomicsCHAPTER 6

Macroeconomics: The BigPicture

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What you will learn in this chapter:

An overview of macroeconomics, the study of the economy asa whole, and how it differs from microeconomics

The importance of the business cycle and why policy-makers seek to diminish the severity of business cycles

What long-run growth is and how it determines a country’sstandard of living

The meaning of inflation and deflation and why pricestability is preferred

What is special about the macroeconomics of an openeconomy, an economy that trades goods, services andassets with other countries

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Macroeconomics vs. MicroeconomicsTo understand the scope and sweep of macroeconomics, let’sbegin by looking more carefully at the difference betweenmicroeconomic and macroeconomic questions.

What determines the overallsalary levels paid to workersin a given year?

What determines the salaryoffered by Citibank to CherieCamajo, a new Columbia MBA?

How many people areemployed in the economy as awhole?

Go to business school or takea job?

MACROECONOMICQUESTION

MICROECONOMICQUESTION

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Macroeconomics vs. Microeconomics

What determines the overalltrade in goods, services andfinancial assets between theUS and the rest of the world?

What determines whetherCitibank opens a new office inShanghai?

What government policiesshould be adopted to promotefull employment and growthin the economy as a whole?

What government policiesshould be adopted to make iteasier for low-income studentsto attend college?

What determines the overalllevel of prices in the economyas a whole?

What determines the cost to auniversity or college of offeringa new course?

MACROECONOMICQUESTION

MICROECONOMICQUESTION

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Microeconomics focuses on how decisions are made byindividuals and firms and the consequences of those decisions.

Ex.: How much it would cost for a university or college tooffer a new course _ the cost of the instructor’s salary, theclassroom facilities, the class materials, and so on.

Having determined the cost, the school can then decidewhether or not to offer the course by weighing the costs andbenefits.

Macroeconomics vs. Microeconomics

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Macroeconomics examines the aggregate behavior of theeconomy (i.e. how the actions of all the individuals and firms inthe economy interact to produce a particular level of economicperformance as a whole).

Ex.: Overall level of prices in the economy (how high or howlow they are relative to prices last year) rather than the priceof a particular good or service.

Macroeconomics vs. Microeconomics

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Four Principal Ways that MacroeconomicsDiffers from Microeconomics:1.In macroeconomics, the behavior of the whole

macroeconomy is, indeed, greater than thesum of individual actions and market outcomes.

2.Macroeconomics is widely viewed as providinga rationale for continual governmentintervention to manage short-termfluctuations and adverse events in the economy.

monetary policy

fiscal policy

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Four Principal Ways that MacroeconomicsDiffers from Microeconomics (cont.):

3.Macroeconomics is the study of long-rungrowth: What factors lead to a higher long-run growth rate? And are there governmentpolicies capable of increasing the long-rungrowth rate?

4.The theory and policy implementation focus oneconomic aggregates -- economic measuresthat summarize data across many differentmarkets for goods, services, workers, andassets.

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The Great DepressionThe Great Depression precipitated a thorough rethinking ofmacroeconomics which gave rise to modern macroeconomics.

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The Business CycleThe business cycle is the short-run alternation betweeneconomic downturns and economic upturns.

A depression is a very deep and prolonged downturn.

Recessions are periods of economic downturns when outputand employment are falling.

Expansions, sometimes called recoveries, are periods ofeconomic upturns when output and employment are rising.

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The Unemployment Rate and RecessionsSince 1948

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FOR INQUIRING MINDS: DefiningRecessions and Expansions

In many countries, economists adopt the rule that a recession isa period of at least 6 months, or two quarters, during whichaggregate output falls.

sometimes too strictIn the United States, the task of determining when a recessionbegins and ends is assigned to an independent panel of experts atthe National Bureau of Economic Research (NBER). This panellooks at a number of economic indicators, with the main focus onemployment and production, but ultimately the panel makes ajudgment call.

sometimes controversial

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What happens during a business cycle, and what can be doneabout it?

the effects of recessions and expansions on unemployment;

the effects on aggregate output; and

the possible role of government policy.

The Business Cycle

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Employment and Unemployment

Employment is the number of people working in the economy.

Unemployment is the number of people who are activelylooking for work but aren’t currently employed.

The labor force is equal to the sum of employment andunemployment.

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Employment and Unemployment

Discouraged workers are non-working people who arecapable of working but are not actively looking for a job.Underemployment is the number of people who work duringa recession but receive lower wages than they would during anexpansion due to smaller number of hours worked, lower-payingjobs, or both.The unemployment rate is the ratio of the number of peopleunemployed to the total number of people in the labor force,either currently working or looking for jobs.

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Underemployment

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The Effects of Recessions and Expansionson Unemployment and Aggregate Output:

In general, the unemployment rate rises during recessions andfalls during expansions. It moves in the direction opposite toaggregate output, which falls during recessions and rises duringexpansions.

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Growth in Aggregate Output, 1948–2004

Real GDP is a measure of aggregate output, the output of theeconomy as a whole.

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Growth in Aggregate Output, 1948–2004

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Taming the Business Cycle

Policy efforts undertaken to reduce the severity of recessions arecalled stabilization policy.

One type of stabilization policy is monetary policy,changes in the quantity of money or the interest rate.

The second type of stabilization policy is fiscal policy,changes in tax policy or government spending, or both.

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ECONOMICS IN ACTION: Has the BusinessCycle Been Tamed?

Has progress in macroeconomics made the economy more stable?

Answer: “Sort of”

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Long-Run Economic Growth

Secular long-run growth, or long-run growth, is thesustained upward trend in aggregate output per person overseveral decades.

A country can achieve a permanent increase in the standard ofliving of its citizens only through long-run growth. So a centralconcern of macroeconomics is what determines long-run growth.

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U.S. real gross domestic product per personfrom 1900 to 2004

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Aggregate Price LevelA nominal measure is a measure that has not been adjustedfor changes in prices over time.

A real measure is a measure that has been adjusted forchanges in prices over time.The aggregate price level is the overall level of prices in theeconomy.

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Consumer price index from 1913 to 2004

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Inflation and Deflation

A rising aggregate price level is inflation.A falling aggregate price level is deflation.The inflation rate is the annual percent change in theaggregate price level.The economy has price stability when the aggregate pricelevel is changing only slowly.

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Inflation and deflation since 1929

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ECONOMICS IN ACTION: A Fast (Food)Measure of Inflation

_McDonald’s opened in 1954: Hamburgers cost only 0.15 cents-25cents with fries._Today a hamburger at a typical McDonald’s costs five times asmuch-between $0.70 and $0.80._Too expensive?_No-in fact, a burger is, compared with other consumer goods, abetter bargain than it was in 1954. Burger prices have risen about400%, from $0.15 to about $0.75, over the last half century. Butthe overall consumer price index has increased more than 600%._If McDonald’s had matched the overall price level increase, ahamburger would now cost between 90 cents and $1.00.

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The Open Economy

A closed economy is an economy that does not trade goods,services, and assets.

Open-economy macroeconomics is the study of thoseaspects of macroeconomics that are affected by movements ofgoods, services, and assets across national boundaries.

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The Open Economy

One of the main concerns introduced by open-economymacroeconomics is the exchange rate, the price of one currencyin terms of another.

Exchange rates can affect the aggregate price level.

They can also affect aggregate output through their effecton the trade balance, the difference between the value ofthe goods and services a country sells to other countries andthe value of the goods and services it buys in return.

Economists are also concerned about capital flows,movements of financial assets across borders.

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Movements of the exchange ratebetween the U.S. dollar and the euro

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The End of Chapter 6

coming attraction:Chapter 7:

Tracking the Macroeconomy