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CHAPTER 5
INTRODUCTION TO MACROECONOMICS
In this chapter, you will find:
Learning Outcomes
Chapter Outline with PowerPoint Script
Chapter Summary
Teaching Points (as on Prep Card)
Solutions to Problems Appendix
Experiential Assignments
INTRODUCTION
To introduce students to macroeconomics in a natural and familiar way, the economy is compared to the
human body and parallels are drawn. The history of the U.S. economy is traced, using aggregate supply
and demand, and both demand-side economics and supply-side economics are discussed. The chapter also
conveys the difficulty of testing macroeconomic theories and includes a brief discussion of the twin
deficits.
LEARNING OUTCOMES
5-1 Explain what's special about a national economy compared to regional, state, or local economies.
The national economy has its own currency, its own system of government, its own laws, regulations,
customs, manners, and ways of doing business within its borders and across borders. Regional, state,
and local economies operate within the larger, national economy.
5-2 Describe the phases of the business cycle.
The economy fluctuates between two phases: periods of expansion and periods of contraction. See
the figures below for details. No two business cycles are the same. Before 1945, expansions averaged
29 months and contractions 21 months. Since 1945, expansions have averaged 57 months and
contractions 11 months. Despite the Great Depression and later recessions, the economy’s output has
grown more than fourteenfold since 1929 and jobs have grown faster than the population.
5-3 Explain the shapes of the aggregate demand curve and the aggregate supply curve, and how they
interact to determine real GDP and the price level for a nation.
The aggregate demand curve slopes downward, reflecting a negative, or inverse, relationship
between the price level and real GDP demanded. The aggregate supply curve slopes upward,
reflecting a positive, or direct, relationship between the price level and real GDP supplied. The
intersection of the two curves determines the economy’s real GDP and price level. See the figures
below.
5-4 Identify the five eras of the U.S economy, and describe briefly what went on during each.
1) The Great Depression and Before: The Great Depression and earlier depressions prompted John
Maynard Keynes to argue that the economy is unstable, largely because business investment is
erratic. Keynes did not believe that contractions were self- correcting. 2) The Age of Keynes: His
demand-side policies of increased government spending and decreased taxes dominated macro
economic thinking between World War II and the late 1960s. (3) Stagflation: During the 1970s,
higher oil prices and global crop failures reduced aggregate supply. The result was stagflation, the
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 5
Introduction to Macroeconomics
68
troublesome combination of declining real GDP and rising inflation. 4) Relatively Normal Times of
1980 until 2007: Output and employment also grew nicely during this era. The expanding economy
increased federal revenues enough to create a federal budget surplus by the end of the 1990s. But
after the longest expansion on record, the economy experienced an eight-month recession in 2001.
The economy started growing again, and that expansion lasted until the end of 2007. 5) The Great
Recession of 2007 to 2009 and Beyond: After peaking in December 2007, the economy entered a
recession because of falling home prices and rising foreclosure rates. The collapse of a Wall Street
bank in September 2008 panicked financial markets around the world, cutting investment and
consumption. Job losses during this Great Recession were the highest since the Great Depression.
Massive federal programs aimed at stabilizing the economy resulted in gigantic federal deficits.
Economic growth returned in the second half of 2009, but the unemployment rate remained
stubbornly high for years.
CHAPTER OUTLINE WITH POWERPOINT SCRIPT
USE POWERPOINT SLIDES 2-8 FOR THE FOLLOWING SECTION
The National Economy:
 Economy: the structure of economic life, or economic activity, in a community, a region, a country, a
group of countries, or the world.
 GDP (gross domestic product): The market value of all final goods and services produced in the U.S.
during a given period, usually a year.
What’s Special about the National Economy? Each country has its own “rules of the game” (laws,
regulations, customs, manners, and conventions).
The Human Body and the Economy: The economy, like the body: (1) consists of many parts, each
performing particular functions yet linked, (2) is continually renewing itself, and (3) involves circular flow
through the system.
Flow and Stock Variables
 Flow: A variable that measures an amount per unit of time.
 Stock: Amount measured at particular point in time.
Testing New Theories: There is no laboratory in which macroeconomic theories can be tested. Therefore,
economists examine historical and international evidence for clues about how the economy works.
Knowledge and Performance: We must know how a healthy economy works before we can consider
whether anything can be done about it.
USE POWERPOINT SLIDES 9-14 FOR THE FOLLOWING SECTION
Economic Fluctuations and Growth
Economic fluctuations (business cycles): The rise and fall of economic activity relative to the long-term
growth trend of the economy.
U.S. Economic Fluctuations: Two phases: periods of expansion and contraction
 Depression: A severe contraction or reduction in the nation’s total production lasting more than a
year and accompanied by high unemployment.
 Recession: A mild contraction, a decline in total output lasting at least two consecutive quarters.
 Periods of expansion: Begin when economic activity starts to increase and continues until the
economy reaches a peak.
USE POWERPOINT SLIDE 15 FOR THE FOLLOWING SECTION
Leading Economic Indicators: Foreshadow a turning point in economic activity
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 5
Introduction to Macroeconomics
69
USE POWERPOINT SLIDES 16-17 FOR THE FOLLOWING SECTION
Aggregate Demand and Aggregate Supply
Aggregate Output and the Price Level
 Aggregate output: Total amount of final goods and services produced in the economy during a given
period, real GDP.
 Price level: The average price of aggregate output (CPI or GDP price index.)
USE POWERPOINT SLIDES 18-23 FOR THE FOLLOWING SECTION
Aggregate Demand Curve: Shows the relationship between the economy’s price level and real GDP
demanded
Aggregate Supply Curve: Shows how much producers in an economy are willing and able to supply at
each price level.
 Factors held constant along an aggregate supply curve:
1) Resource prices
2) State of technology
3) “Rules of the Game” that provide production incentives
Equilibrium: Determined by the intersection of the aggregate supply and the aggregate demand curves.
USE POWERPOINT SLIDES 24-28 FOR THE FOLLOWING SECTION
A Short History of the U.S. Economy
The Great Depression and Before: Due to the 1929 stock market crash, aggregate demand declined so
severely that one of the deepest contractions of the economy was created. Prior to that time,
macroeconomic policy was based on the “laissez-faire” philosophy of Adam Smith.
USE POWERPOINT SLIDES 29-34 FOR THE FOLLOWING SECTION
The Age of Keynes: After the Great Depression to the Early 1970s
 Demand-side economics: Focused on how changes in aggregate demand could promote full
employment.
USE POWERPOINT SLIDES 35-37 FOR THE FOLLOWING SECTION
Stagflation: 1973 to 1980
 Stagflation: A contraction in the economy’s aggregate output, along with inflation, or a rise in the
economy’s price level.
USE POWERPOINT SLIDES 38-42 FOR THE FOLLOWING SECTION
Relatively Normal Times: 1980 to 2007
 Supply-side economics: Theorizes that lowering federal tax rates would increase after-tax wages,
which would provide an incentive to increase the supply of labor and other resources.
 Output and employment grew nicely during the 1990s. The expanding economy increased federal
revenues enough to create a federal budget surplus by the end of the decade. After achieving the
longest expansion on record, the U.S. economy slipped into recession aggravated by the terrorist
attacks of September 2001. The subsequent expansion lasted until 2007.
USE POWERPOINT SLIDES 43-49 FOR THE FOLLOWING SECTIONS
The Recession of 2008-2009 and Beyond
 The economy went in recession in early 2008 because of falling home prices and rising foreclosure
rates. The collapse of a Wall Street bank in September 2008 panicked financial markets around the
world, cutting investment and consumption. Job losses were the worst since the Great Depression.
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 5
Introduction to Macroeconomics
70
 Massive federal programs aimed at stabilizing the economy resulted in gigantic federal deficits.
Economic growth returned in the second half of 2009.
USE POWERPOINT SLIDES 50-52 FOR THE FOLLOWING SECTION
Eight Decades of Real GDP and Price Levels
CHAPTER SUMMARY
Macroeconomics focuses on the national economy. A standard measure of performance is the growth of
real gross domestic product, or real GDP, the value of all final goods and services produced in the nation
during the year.
The economy has two phases: periods of expansion and periods of contraction. No two business cycles are
the same. Before 1945, expansions averaged 29 months, and contractions 21 months. Since 1945,
expansions have averaged 57 months and contractions 11 months. Despite the Great Depression and later
recessions, the economy’s output has grown more than thirteenfold since 1929 and jobs have grown faster
than the population.
The aggregate demand curve slopes downward, reflecting a negative, or inverse, relationship between the
price level and real GDP demanded. The aggregate supply curve slopes upward, reflecting a positive, or
direct, relationship between the price level and real GDP supplied. The intersection of the two curves
determines the economy’s real GDP and price level.
The Great Depression and earlier depressions prompted John Maynard Keynes to argue that the economy
is unstable, largely because business investment is erratic. Keynes did not believe that contractions were
self-correcting. He argued that whenever aggregate demand sagged, the federal government should spend
more or tax less to stimulate aggregate demand. His demand-side policies dominated macroeconomic
thinking between World War II and the later 1960s.
During the 1970s, higher oil prices and global crop failures reduced aggregate supply. The result was
stagflation, the troublesome combination of declining real GDP and rising inflation. Demand-side policies
appeared less effective in an economy suffering from a reduction in aggregate supply because stimulating
aggregate demand would worsen inflation.
Supply-side tax cuts in the early 1980s were aimed at increasing aggregate supply, thereby increasing
output while dampening inflation. Some hoped that the added tax revenue from a stronger economy would
offset the loss in tax revenue from cuts in tax rates. But federal spending increased faster than federal tax
revenue, resulting in budget deficits that grew into the 1990s. Tax increases, a slower growth in
government spending, and an expanding economy all helped erase budget deficits by 1998, creating a
federal budget surplus. But after the longest expansion on record, the economy experienced an eightmonth recession. The recession ended in late 2001, but unemployment continued to rise into 2003. Tax
cuts and a sluggish recovery boosted the federal deficit. Jobs began growing once again in late 2003, and
by 2007 the economy added more than 8 million jobs. This growth cut the federal deficit to about $160
billion. After spikes in the price of oil and other commodities and the collapse of the housing market, the
U.S. economy lost 2.5 million jobs in 2008. The federal budget deficit swelled to $450 billion in 2008.
With lower tax revenues and increased stimulus spending, the deficit was sharply higher in 2012.
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 5
Introduction to Macroeconomics
71
TEACHING POINTS
1. It may be useful to point out to students here that the reasons for the negative and positive slopes
of the demand and supply curves of individual goods do not apply in dealing with the AS and AD
curves. For example, holding “other prices” and “money income” constant is not appropriate in
construction of the AD curve, and aggregate suppliers may be neither willing nor able to offer more
output when the aggregate price level increases.
2. A short time series (projected roughly on the screen) will show that the U.S. economy did not
really have a serious fall in income until 1931. The low point was reached in 1933 during a period of
terrific monetary contraction. Many people mistakenly believe that the economy rose continually
after that point in time (owing to FDR’s New Deal). However, the economy turned down again in
1938, although the drop was not as deep as the one that occurred in 1933. After 1938 the economy
rose steadily as a result of the military spending required to fight World War II. 3.Some students may
think that study of the Great Depression is akin to the study of dinosaurs. However, many have noted
parallels between the Great Recession and the Great Depression, especially as they relate to the
dramatic rises and falls in the stock market and the global recession of 2007–2009.
4. The purpose of introducing AS-AD in this chapter is to provide the student with a sense of the two
sides to macroeconomics: supply and demand. It capsulizes national income determination and the
determination of the price level in a heuristic way. Nevertheless, it can be troublesome explaining
why a lower price level increases the quantity of aggregate output demanded. A drop in the price
level, holding all else constant, makes money balances more valuable, thus giving rise to greater
demand for output. A drop in the U.S. price level also makes domestic goods cheaper than foreign
goods.
5. You may wish to ask the students how the AS and AD curves would shift in each of the following
situations: (1) government spending increases, (2) consumer confidence improves, and (3) personal
tax rates are cut.
SOLUTIONS TO PROBLEMS APPENDIX
1.
(The National Economy) Why do economists pay more attention to national economies (for
example, the U.S. or Canadian economies) than to state or provincial economies (such as
California or Ontario)?
Each national economy has its own “rules of the game,” that is, its own laws, regulations,
customs, and conventions for conducting economic activity. U.S. gross domestic product
provides a measure of the performance of the national economy and of how it interacts with the
rest of the world.
2.
(Economic Fluctuations) Describe the various components of fluctuations in economy activity
over time. Because economic activity fluctuates, how is long-term growth possible?
The economy moves through periods of expansion and periods of contraction. Contractions
include recessions in which total output and employment decline over a six-month period and
more serious depressions in which sharp reductions occur in output and employment that last
more than a year. The end of a contraction is marked by the trough, or lowest point. After the
trough, the economy enters an expansion period in which total output increases until the
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 5
Introduction to Macroeconomics
72
economy reaches its peak.
The economy grows over time. This is possible because the growth during expansions more
than offsets the decline during recessions. Economic fluctuations reflect movements around the
long-term growth trend.
3.
(Aggregate Demand and Supply) Review the information on demand and supply curves in
Chapter 4. How do the aggregate demand and aggregate supply curves presented in this chapter
differ from the market curves of Chapter 4?
The demand and supply curves in Chapter 4 describe the relationship between the price of an
individual product or product category, such as textbooks or food, and the quantities of that
individual item demanded and supplied. Aggregate demand and aggregate supply describe the
relationship between the average price level of all goods and services and the total quantities of
goods and services demanded and supplied throughout the entire economy.
4.
(Aggregate Demand and Supply) Determine whether each of the following would cause a shift
of the aggregate demand curve, a shift of the aggregate supply curve, neither, or both. Which
curve shifts, and in which direction? What happens to aggregate output and the price level in
each case?
a. The price level changes.
b. Consumer confidence declines.
c. The supply of resources increases.
d. The wage rate increases.
a. Neither curve would shift. A change in the price level would cause a movement along the
curves.
b. Aggregate Demand shifts left because less consumer confidence reduces the aggregate
output demanded at each price level. Therefore, both aggregate output and the price level
fall.
c. Aggregate Supply shifts right. There is an increase in the aggregate output supplied at each
price level. Therefore, aggregate output increases and the price level falls.
d. Aggregate Supply shifts left as the costs of production have risen. Therefore, aggregate
output falls and the price level rises.
5.
(Five Eras of U.S. Economy) Identify the five eras of the U.S. economy beginning with the
great Depression and before.
1) The Great Depression and Before: The Great Depression and earlier depressions
prompted John Maynard Keynes to argue that the economy is unstable, largely because
business investment is erratic. Keynes did not believe that contractions were self- correcting.
2) The Age of Keynes: His demand-side policies of increased government spending and
decreased taxes dominated macro economic thinking between World War II and the late
1960s. (3) Stagflation: During the 1970s, higher oil prices and global crop failures reduced
aggregate supply. The result was stagflation, the troublesome combination of declining real
GDP and rising inflation. 4) Relatively Normal Times of 1980 until 2007: Output and
employment also grew nicely during this era. The expanding economy increased federal
revenues enough to create a federal budget surplus by the end of the 1990s. But after the
longest expansion on record, the economy experienced an eight-month recession in 2001.
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 5
Introduction to Macroeconomics
73
The economy started growing again, and that expansion lasted until the end of 2007. 5) The
Great Recession of 2007 to 2009 and Beyond: After peaking in December 2007, the economy
entered a recession because of falling home prices and rising foreclosure rates. The collapse
of a Wall Street bank in September 2008 panicked financial markets around the world,
cutting investment and consumption. Job losses during this Great Recession were the highest
since the Great Depression. Massive federal programs aimed at stabilizing the economy
resulted in gigantic federal deficits. Economic growth returned in the second half of 2009,
but the unemployment rate remained stubbornly high for years.
6.
(Supply-Side Economics) One supply-side measure introduced by the Reagan administration
was a cut in income tax rates. Use an aggregate demand/aggregate supply diagram to show
what effect was intended. What might happen if such a tax cut also shifted the aggregate
demand curve?
Lower tax rates were intended to increase after-tax earnings and thus increase incentives for
resource owners to provide labor and capital. The resulting rightward shift in Aggregate
Supply would increase aggregate output and lower the price level. The increase in after-tax
earnings would also increase Aggregate Demand, which would increase aggregate output
and raise the price level. The overall impact on the price level would depend on the relative
sizes of the shifts in the aggregate supply and the aggregate demand.
Experiential Assignments
1. The National Bureau of Economic Research maintains a Web page devoted to business cycle
expansions and contractions at http://www.nber.org/cycles.html. Have students take a look at this
page to see if they can determine how the business cycle has been changing in recent decades. Has
the overall length of cycles been changing? Have recessions been getting longer or shorter?
2. Ask students to review the Summary of Commentary on Current Economic Conditions by Federal
Reserve District (Beige Book), available through the Federal Reserve System at
http://www.federalreserve.gov/monetarypolicy/beigebook/default.htm. Have them a. Summarize the
national economic conditions for the most recent period covered in the report. Overall, is the
economy healthy? If not, what problems is it experiencing? b. Go to the summary applicable to their
district. Summarize the economic conditions for the last reporting period. Is the economy in their
district healthy? If not, what problems is it experiencing?
3. This chapter introduced the tools of aggregate demand and supply. Test your students’
understanding by having them find an article in today’s Wall Street Journal describing an event that
may affect the U.S. price level and real GDP. They can look under “Economy” or “International” in
the first section of the newspaper. Students should then draw an initial set of AD and AS curves and
determine which curve will be affected and in which direction it will shift. Ask them to predict what
will happen to the price level and real GDP.
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.