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Chapter 1
Ch
Introduction to
Macroeconomics
Copyright © 2009 Pearson Education Canada
This Week
„
We’ll cover Chapters 1-3
„
Assignment #1 will be available on
the web in the next couple days. It
will be due next Friday May 15th at
3pm
„
Lee ((TA)) will hold regular
g
office hours
on Mondays 11:30-1pm (Dun 333),
except this week it will be held
Friday
id
11:30
30 - 1pm
Copyright © 2009 Pearson Education Canada
1-2
Why study macroeconomics
and why now?
„
The world economy, and with it
the Canadian economy, is now
going
i
th
through
h a once in
i severall
generations downturn.
„
But even without this, the subject
remains very
y important
p
– what
happens here affects everybody
Copyright © 2009 Pearson Education Canada
1-3
What Macroeconomics is
About
„
Macroeconomics
M
i is
i the
th study
t d off
the structure and performance of
national
ti
l economies
i and
d off th
the
policies that governments use to
t tto affect
try
ff t economic
i
performance. It is about how
markets
k t interact.
i t
t
„
Microeconomics more concerned
with individual markets.
Copyright © 2009 Pearson Education Canada
1-4
Issues Addressed by
Macroeconomists
„
The subject is empirical in nature.
It seeks to answer:
„
What determines a nation’s longrun economic growth?
„
What causes a nation’s
nation s economic
activity to fluctuate?
„
What causes unemployment?
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1-5
Issues Addressed by
Macroeconomists (continued)
„
What causes prices to rise?
„
How does being a part of a global
economic system affect nations’
economies?
„
Can government policies be used
to improve economic
performance?
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1-6
Relevance of the course
„
The models studied in this course
are at heart,
are,
heart those used by
professional economists to
address the issues raised above.
above
„
They are designed to try and
answer the questions just raised
as well as others.
Copyright © 2009 Pearson Education Canada
1-7
Reminder: What is a growth
rate?
„
G = [(Y(t) – Y(t
Y(t-1))/Y(t-1)]x100
1))/Y(t 1)]x100
Copyright © 2009 Pearson Education Canada
1-8
Long-Run Economic Growth
„ Rich
Ri h
nations
ti
h
have experienced
i
d
extended periods of rapid
economic
i growth.
th
„ Poor
nations either have never
experienced economic growth
growth was offset
or economic g
by economic decline.
Copyright © 2009 Pearson Education Canada
1-9
Output (Real GDP) for
Canada
1-10
Increased Output
„
Total output is increasing because
of increasing population, i.e. the
number of available workers.
„
IIncreasing
i
average labour
l b
productivity: the amount of
output
t t produced
d
d per unit
it off
labour input. This is key to
d t
determining
i i
li
living
i
standards
t d d
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1-11
Labor Productivity
1-12
Rates of Growth of Output
„
Rates of growth of output (or
output per worker) are
determined by:
„
rates
t off saving
i
and
d investment;
i
t
t
„
rates of technological change;
„
rates of change in other factors.
Copyright © 2009 Pearson Education Canada
1-13
Business Cycles
„
Business cycles are short-run
contractions and expansions of
economic activity.
„
The mostt volatile
Th
l til period
i d in
i the
th
history of Canadian output was
b t
between
1914 and
d 1945.
1945
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1-14
Business Cycles
1-15
Recessions
„
Recession is the downward phase
of a business cycle when national
output is falling or growing
slowly.
„
Hard times for many people
„
A major political concern
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1-16
Unemployment
„
Recessions are usually
accompanied by high
unemployment: the number of
people who are available for work
and are actively seeking it but
cannot find jobs.
Unemployed
Unemployme nt Rate =
× 100%
Labour Force
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1-17
The Unemployment Rate
„
The unemployment rate can stay
high even when the economy is
doing well.
„
After fifteen years of economic
growth, in 2006, the
unemployment rate in Canada
was near 6%.
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1-18
Unemployment Rate
1-19
Inflation
„
When prices of most goods and
services are rising over time it is
inflation. When they are falling it
is deflation.
„
The inflation rate is the
percentage
t
iincrease iin th
the
average level of prices.
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1-20
CPI and Inflation
1-21
Effects of Inflation
„
When the
Wh
th inflation
i fl ti
rate
t reaches
h
an extremely high level the
economy tends
t d tto function
f
ti
poorly. The purchasing power of
money erodes
d quickly,
i kl which
hi h
forces people to spend their
money as soon as they
th
receive
i
it.
it
„
It can also damage
g investment.
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1-22
The International Economy
„
An economy which has extensive
trading and financial relationships
with other national economies is
an open economy.
economy An economy
with no relationships is a closed
economy.
economy
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1-23
The International Economy
(continued)
„
International trade and
borrowing relationships can
transmit business cycles from
country to country.
country
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1-24
Exports and Imports
„
Canadian exports are goods and
services produced in Canada and
consumed abroad.
„
Canadian imports are goods and
services produced abroad and
consumed in Canada.
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1-25
Imports and Exports
1-26
Trade Imbalances
„
Trade imbalances (trade surplus
and deficit) affect output and
employment.
„
„
Trade surplus: exports exceed
imports.
Trade
T
d d
deficit:
fi it imports
i
t exceed
d
exports.
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1-27
The Exchange Rate
„
The trade balance is affected by
the exchange rate: the amount of
Canadian dollars that can be
purchased with a unit of foreign
currency.
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1-28
Exchange Rates
1-29
Macroeconomic Policy
„
A nation’s economic performance
depends on:
natural and human resources;
„ capital stock;
„ technology
„ economic choices made by citizens;
„ macroeconomic policies of the
government.
„
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1-30
Macroeconomic Policy
(continued)
„
Macroeconomic policies:
„
„
Fiscall policy:
Fi
li
government spending
di
and taxation.
Monetary policy: the central bank’s
control of short-term interest rates
and the money supply.
supply
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1-31
Budget Deficits
„
The economy is affected when
there are large budget deficits:
the excess of government
spending over tax collection.
collection
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1-32
Budget Deficits (continued)
„
The large budget deficits of the
1980s and early 1990s were
unusual.
„
„
Borrowing from the public might
divert funds from more productive
uses.
Federal budget deficits might be
linked to the decline in productivity
growth
growth.
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1-33
Fiscal Policies
1-34
Aggregation
„
Macroeconomists ignore
distinctions between individual
product markets and focus on
national totals.
totals
„
The process of summing
individual economic variables to
obtain economy wide totals is
called aggregation.
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1-35
What Macroeconomists Do
„
Macroeconomic forecasting
„
Macroeconomic analysis
„
Macroeconomic research
„
Data development
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1-36
Macroeconomic Forecasting
„
Macroeconomic forecasting –
prediction of future economic
trends - has some success in the
short run. In the long run too
many factors are highly
uncertain.
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1-37
Macroeconomic Analysis
„
Macroeconomic analysis analyzing and interpreting events
as they happen – helps both
private sector and public
policymaking.
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1-38
Macroeconomic Research
„
Macroeconomic research - trying
to understand the structure of
the economy in general – forms
the basis for macroeconomic
analysis and forecasting.
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1-39
Economic Theory
„
Economic theory: a set of ideas
about the economy to be
organized in a logical framework.
„
Economic
E
i model:
d l a simplified
i
lifi d
description of some aspects of the
economy.
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1-40
Developing and Testing a
Theory
„
State the research question.
„
„
Is this an interesting and useful line
of enquiry?
Make provisional assumptions.
assumptions
„
Are the assumptions reasonable and
realistic?
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1-41
Developing and Testing a
Theory (continued)
„
Work out the implications of the
theory.
y
„
Does the theory have implications
that can be tested by looking at the
real world?
„
Conduct an empirical analysis.
„
Evaluate the results.
Copyright Copyright © 2009 Pearson Education
Canada
1-42
Data Development
„
Macroeconomists use data to
assess the state of the economy,
make forecasts, analyze policy
alternatives, and test theories.
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1-43
Data Development
(continued)
„
Providers of data must:
„
„
„
Decide what types of data should be
collected based on who is expected
to use the data and how.
Ensure the measures of economic
activity correspond to economic
concepts.
Guarantee the confidentiality of
d
data.
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1-44
Why Macroeconomists
Disagree
„
A positive analysis examines the
economic consequences of an
economic policy, but it does not
address its desirability.
„
A normative analysis tries to
d t
determine
i
whether
h th a certain
t i
economic policy should be used.
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1-45
Why Macroeconomists
Disagree (continued)
„
Economists can disagree on
normative issues because of
differences in values.
„
Economists disagree on positive
issues because of different
schools of thought.
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1-46
The Classical Approach
„
The invisible hand of Economics:
General welfare will be
maximized (not the distribution of
wealth) if:
„
„
there are free markets, with no
impediments to adjustments;
individuals act in their own best
interest.
Copyright © 2009 Pearson Education Canada
1-47
The Classical Approach
(continued)
„
To maintain markets’ equilibrium
– the quantities demanded and
supplied are equal:
„
„
Markets
M
k t mustt function
f
ti
without
ith t
impediments.
Wages and prices should be flexible.
Copyright © 2009 Pearson Education Canada
1-48
The Classical Approach
(continued)
„
Thus, according to the classical
approach the government should
approach,
have a limited role in the
economy – largely because there
is no need for them to do
anything.
anything
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1-49
The Keynesian Approach
„
Keynes (1936) assumed that
wages and prices adjust slowly.
„
Thus, markets could be out of
equilibrium
ilib i
ffor llong periods
i d off
time and unemployment can
persist.
i t
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1-50
The Keynesian Approach
(continued)
„
Therefore, according to the
Keynesian approach
approach, it may be
useful for governments to take
actions to alleviate
unemployment.
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1-51
The Keynesian Approach
(continued)
„
The government can purchase
goods and services
services, thus
increasing the demand for output
and reducing unemployment.
unemployment
„
Newly generated incomes would
be spent and would raise
employment even further.
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1-52
Evolution of the ClassicalKeynesian Debate
„
After stagflation – high unemployment
and high
g inflation – of the 1970s,, a
modernized classical approach
reappeared.
„
New Classical Approach (Lucas,
Prescott, Sargent, Wallace) attacked
Keynesian theoretical foundations and
insisted on microfoundations of
macroeconomic theory
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1-53
The New Classical Approach
(continued)
„
Introduced
d
d the
h rational-expectations
l
hypothesis: what people are modelled
to expect is what the model itself
predicts
„
“Lucas Critique”
„
„
The decision problems of individuals
change as a result of policy
Aggregate macro relationships
a ge/s
with shifts
s
s in policy
po y
change/shift
Copyright © 2009 Pearson Education Canada
1-54
Where Is Macroeconomics
Now?
„
Microfoundations
f
d
adopted
d
d by
b nearly
l
all mainstream economists
„
Sticky prices and wages were needed
for models to match empirical
fluctuations
„
Substantial communication and crosspollination
lli ti
iis ttaking
ki
place
l
b
between
t
th
the
New Classical and the New Keynesian
approaches
Copyright © 2009 Pearson Education Canada
1-55
Unified Approach to
Macroeconomics
„
Individuals, firms and the
government interact in goods,
goods
asset and labour markets.
„
Macroeconomic
M
i analysis
l i iis b
based
d
on the analysis of individual
behaviour.
behaviour
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1-56
The Unified Approach
(continued)
„
Keynesian and classical
economists agree that in the long
run prices and wages adjust to
equilibrium levels.
„
The basic model will be used
either with classical or Keynesian
y
assumptions about flexibility of
wages and prices in the short
run.
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