Download Chapter 11 - Introduction to Macroeconomics

Chapter 11
Introduction To
Macroeconomics
INTRODUCTION TO ECONOMICS 2e / LIEBERMAN & HALL
CHAPTER 11 / INTRODUCTION TO MACROECONOMICS
©2005, South-Western/Thomson Learning
Slides by John F. Hall
Animations by Anthony Zambelli
What Macroeconomics Tries to Explain
Microeconomic deals with behavior of
individual decision makers and individual
markets
 Macroeconomic deals with broad outlines of
the economy
 Which view is better?
 Depends on what we’re trying to do

Lieberman & Hall; Introduction to Economics, 2005
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Macroeconomic Goals


Economists—and society at large—agree on three
important macroeconomic goals
 Economic growth
 Full employment
 Stable prices
Why is there such universal agreement on these
three goals?
 Because achieving them gives us opportunity to make all
of our citizens better off
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Economic Growth

Economists monitor economic growth
 By keeping track of real gross domestic product (real GDP)

• Total quantity of goods and services produced in a country over a year
Real GDP has actually increased faster than the population
 During this period (1929 to 2002), while U.S. population did not quite triple
• Quantity of goods and services produced each year has increased more than
tenfold




Although output has grown, rate of growth has varied over the decades
Over long periods of time small differences in growth rates can cause
huge differences in living standards
Economists and government officials are very concerned when
economic growth slows down
Macroeconomics helps us understand a number of issues surrounding
economic growth
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Figure 1: U.S. Real Gross Domestic
Product, 1929-2002
Real GDP
(Billions of 1998 dollars)
9000
8000
7000
6000
5000
4000
3000
2000
1000
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High Employment (or Low
Unemployment)

Unemployment affects distribution of
economic well being among our citizens
 People who cannot find jobs suffer a loss of
income

Joblessness affects all of us—even those
who have jobs
 A high unemployment rate means economy is
not achieving its full economic potential
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High Employment (or Low
Unemployment)

Unemployment rate
 Percentage of the workforce that would like to work, but cannot find jobs
 Used to keep track of employment

The nation’s commitment to high employment has twice been written
into law
 With memory of Great Depression still fresh, Congress passed Employment
Act of 1946
• Required federal government to “promote maximum employment, production, and
purchasing power”

A numerical target was added in 1978, when Congress passed Full
Employment and Balanced Growth Act
 Called for an unemployment rate of 4%

In the 1990s, we came closer and closer and finally—in December
1999—we reached the target again for the first time since the 1960s
 In 2001 unemployment rate began to creep up again, and continued rising
through the first half of 2003, when it averaged 6%
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Figure 2: U.S. Unemployment Rate,
1920-2003
Unemployment
Rate
(Percent)
25
20
15
10
5
0
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Employment and the Business Cycle

When firms produce more output, they hire more
workers—when they produce less output, they tend
to lay off workers
 We would thus expect real GDP and employment to be
closely related, and indeed they are

Business cycles
 Fluctuations in real GDP around its long-term growth
trend


Expansion
 A period of increasing real GDP
Contraction
 A period of declining real GDP
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Employment and the Business Cycle



Recession
 A contraction of significant depth and duration
Depression
 An unusually severe recession
In the twentieth century, United States experienced
one decline in output serious enough to be
considered a depression—the worldwide Great
Depression of the 1930s
 From 1929 to 1933, the first four years of Great
Depression, U.S. output dropped by more than 25%
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Figure 3: The Business Cycle
Real
GDP
Long-run upward
trend of real GDP
The business cycle
fluctuation of actual
output around its
long-run trend.
Expansion
Recession
Expansion
Time
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Stable Prices



With very few exceptions, inflation rate has been positive
During 1990s, inflation rate averaged less than 3% per year
Other countries have not been so lucky
 An extreme case was the new nation of Serbia—prices rose by 1,880% in August
1993

Why are stable prices—a low inflation rate—an important macroeconomic goal?
 Because inflation is costly to society
 With annual inflation rates in the thousands of percent, the costs are easy to see
• Purchasing power of currency declines so rapidly that people are no longer willing to hold it


Economists regard some inflation as good
Price stabilization requires not only preventing inflation rate from rising too high
 But also preventing it from falling too low, where it would be dangerously close to
turning negative
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Figure 4: U.S. Annual Inflation Rate,
1922-2003
Inflation Rate (Percent)
15
10
5
0
-5
-10
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The Macroeconomic Approach

In macroeconomics, we want to understand
how the entire economy behaves
 Thus, we apply the steps to all markets
simultaneously
How can we possibly hope to deal with all
these markets at the same time?
 The answer is aggregation—process of
combining different things into a single
category and treating them as a whole

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Aggregation in Macroeconomics


Aggregation plays a key role in both micro- and
macro-economics
In macroeconomics, we take aggregation to the
extreme
 Because we want to consider the entire economy at
once, and yet keep our model as simple as possible
• Must aggregate all markets into broadest possible categories

By aggregating in this way, can create workable
and reasonably accurate models that teach us a
great deal about how overall economy operates
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Macroeconomic Controversies

Macroeconomics is full of disputes and
disagreements
 Modern macroeconomics began with publication of The
General Theory of Employment, Interest, and Money by
British economist John Maynard Keynes in 1936

Keynes was taking on conventional wisdom of his
time
 Which held that the macroeconomy worked very well on
its own
• Best policy for the government to follow was laissez faire

This new school of thought held that the economy
does not do well on its own and needed guidance
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Macroeconomic Controversies



While some of the early disagreements have been
resolved, others have arisen to take their place
For example—the controversy over the Bush
administration’s $330-billion ten-year tax cut
Because of such political battles, people who follow
the news often think that there is little agreement
among economists about how the macroeconomy
works
 In fact, the profession has come to a consensus on many
basic principles, and we will stress these as we go
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