Download LECTURE 1 INTRODUCTION

1. Introduction to Macroeconomics
Economics is the study of how economic agents make decisions what to produce, how to
produce, and for whom to produce
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Microeconomics – studies how economic agents make decisions what, how and for
whom to produce from the point of view of individual households and firms
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Macroeconomics - studies how economic agents make decisions what, how and for
whom to produce from the perspective of the impact of these decisions on the national
economy as a whole.
The most aggregate impact of our decisions on the national economy as a whole is
presented by the output - goods and services that the national economy produces. (Later, we
will specify the concept of gross domestic product – GDP). The greater the potential of the
economy and the more efficient the economic activity, the greater the value of the output. The
potential of the economy and the efficiency of economic activity depend on the levels and the
rates of employment and unemployment. Another major determinant of economic activity and
welfare is definitely the price level.
1.1. Major Macroeconomic Issues
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Output
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Employment and Unemployment
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Price Level
Macroeconomic objectives are determined by the major macroeconomic issues.
1.2. Major Macroeconomic Objectives
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High level and rapid growth of output
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High level of employment and low level of involuntary unemployment
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Price level stability
1.3. Institutional production possibilities frontier and potential GDP
The value and growth of output depend on the availability of resources. From your
previous course in economics (ABSE 101) you know, that the potential of an economy to
produce is determined by its production possibilities frontier (PPF). On the other hand, the
ability of an economy to use efficiently its resources depends on the rules and norms of
economic activity, or, in other words, on economic institutions. Institutions are norms, rules
of conduct, and generally accepted ways of doing things. Economic institutions are formal
and informal “rules of the economic game”. If, for example, businesses will incur greater cost
of hiring more workers, or their profitability will fall, they will be reluctant to hire more
workers. If it is very difficult to fire young workers (the French example), businesses would
be reluctant to hire them. Thus, the rules of economic activity put a second constraint to the
potential of the economy to produce. Aside from the Physical production possibilities frontier,
there is another frontier – an Institutional production possibilities frontier.
The Physical PPF – indicates the potential of the economy to produce, constrained by the
physical availability of resources.
The Institutional PPF – indicates the potential of the economy to produce, constrained by
the physical availability of resources and by the rules and traditions followed by the decision
makers. (Fug. 1.1.)
The maximum sustainable level of output that the economy can produce, given the
productive capacity, the economy’s technological efficiency, and the rules and traditions,
followed in the economy is its Potential Output (indicated by the institutional PPF)
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When actual output exceeds potential output, price inflation tends to rise
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When actual output falls below the potential, unemployment tend to increase
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Physical PPF
Institutional PPF
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Fig. 1.1. Physical and institutional PPF.
1.4. The Rate of Employment and the rate of Unemployment
The second macroeconomic objective is to achieve a high level of employment and
low level of involuntary unemployment. These levels are measured by the rate of
employment and the rate of unemployment.
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Employment Rate – reflects the fraction of working population over 16 and below 64
years
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Unemployment rate – reflects the percentage of unemployed in the labor force
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Labor force = employed + unemployed
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Unemployment rate = [unemployed : (employed + unemployed)] x 100%
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Natural Rate of Unemployment – the rate of unemployment, determined by the
institutional PPF and potential output.
If the society is operating on its institutional production possibilities frontier, there is still
involuntary unemployment. These people want to work, but they cannot find jobs, because
businesses are not interested in hiring more workers. The rules of economic behavior in
the country (institutions) determine the level of such unemployment. Its rate is the natural
rate of unemployment. It is different in different countries and in different periods. In the
1990s the natural rate of unemployment in Spain was very high. Spain introduced
economic reforms, changed the rules for the labor market, taxes, etc. and encouraged
Spanish businesses to increase production and employment. As a result, the natural rate of
unemployment fell significantly. In the U.S. and in the U.K. the natural rate of
unemployment is much lower, than in Greece, or in France, or in Germany.