Download intro to macroeconomics

INTRODUCTION TO
MACROECONOMICS
Notes and Summary of Readings
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Topics Covered
What
macroeconomics
is about
What
macroeconomists
do
Why
macroeconomists
disagree
Definition of
macroeconomics
Macroeconomic
forecasting
Positive analysis
and normative
analysis
Difference
between micro
and
macroeconomics
Data collection
and analysis
The classical
approach
Basic issues in
macroeconomics
Macroeconomic
research
The Keynesian
approach
References


Macroeconomics by Abel, Bernanke and Croushore
–Chapter 1* (main reference)
Macroeconomics by Dornbusch and Fischer –
Chapter 1* (for supplementary reading)
* These chapters are available online for free reading.
What Macroeconomics is about
Let us start by reading about some news topics that
generated debate and discussion in the world of
economics...
1)
FDI in multi-brand retail (India, Sep 2012)
2)
Debt crisis (Eurozone)
3)
Fiscal cliff (USA, Dec 2012 / Jan 2013)
4)
Direct cash transfer program (India, Jan 2013)
5)
Record high unemployment rate (Eurozone, Jan
2013)
While reading the above articles, you would have come
across terms like growth, unemployment, inflation,
depression, debt, deficit, interest rate, savings,
exchange rate, economic policy etc. The branch of
economics that deals with all these issues, and much
more, is called macroeconomics.
Formally, macroeconomics is defined as the field
concerned with the structure and performance of
national economies and the policies governments use
to try to affect economic performance.
Structure
refers to the relationship between input-output accounts, levels of
consumption and investment, sectors of the economy, relationships between different
sectors, degree of independence of the economy etc.
Performance
the values of macroeconomic variables, such as inflation rate,
unemployment rate, GDP etc., and how they are related to one another.
Difference between microeconomics and macroeconomics
The difference between the two fields is primarily one of
approach and emphasis.
 Diff. in approach:
Microeconomics
Macroeconomics
Focuses on the choices
made by the individual
decision-making units of the
society-typically the
consumers and firms- and
the impact of those choices
on individual markets
Concerns itself with choices
made by the ‘macro’
players of the economysuch as the government, the
central bank etc. – and the
impact of those choices on
the economy as a whole
Bottoms-up approach
Top-down approach

Diff. in emphasis
Microeconomics
Macroeconomics
Studies the demand and supply in
individual markets, each of which is
too small to have an impact on the
national economy
Emphasizes on aggregate quantities
such as aggregate consumption,
aggregate investment and
aggregate output; fine distinctions
among different kinds of goods,
firms and markets are usually
ignored
Phenomena affecting the economy as Phenomena such as inflation and
a whole, like inflation or
unemployment are among the key
unemployment, are either not
variables studied
mentioned or are taken as given, as
these are not variables that
individual buyers or sellers can
change
Some basic issues in Macroeconomics
What determines a nation’s long-run economic growth?
What causes a nation’s economic activity to fluctuate?
What causes unemployment?
What causes prices to rise?
How is a nation’s economy affected by being part of the
international economy?
Can (and should) the government do anything to improve
economic performance?
Long-run economic growth
Economic growth is the increase in the amount of the goods
and services produced by an economy over time. i.e. the
quantitative changes taking place in an economy.
Economic growth is measured in terms of real Gross National
Product (GNP) or Gross Domestic Product (GDP). It is
different from economic development because the latter
also takes into account qualitative changes taking place in
the economy, such as improvement in socio-cultural relations,
health care, literacy etc.
Rich nations: Experienced periods of rapid economic growth
at some point in their history.
Developing nations: Never experienced sustained growth /
Periods of growth offset by periods of economic decline.
1.
Factors important for long-term economic growth:
Availability of resources:
Exploitation of natural resources, increase in
workforce & capital stock contribute to greater output
Efficiency of labour force:
Education, training & experience increase average
labour productivity**
Efficiency of capital:
Improvement in knowledge & technological change
increase productivity of land, machines & buildings
Rates of investment and saving in the economy
** Output per unit of employed labour
2. Business cycles
As said earlier, an increase in the availability of
resources and improvements in efficiency help a
country to register an upward trend in long-run
economic growth. But it has been observed that at
any given point of time, the rate of economic growth
is greater than, smaller than, or sometimes equal to,
the general trend.
For example, the trend in the USA over the last century
has been one of rising economic growth. However, the
growth hasn’t been smooth and has numerous ‘hills’
and ‘valleys’. During the 1960s, national output
nearly doubled, but during 1973-75, 1981-82, and
1990-91, output declined from one year to the next.
These short-run fluctuations, called ‘business cycles’, exist
not only for economic growth, but also for other
macroeconomic variables such as inflation and
unemployment.
Formally, a business cycle is defined as the more or less
regular pattern of expansion and contraction in
economic activity around the path of trend growth.
It is important to note that business cycles do not include
fluctuations that last only for a few months, such as the
spurts in economic activity that occur around major
festivals.
In the past few years, we often came across the term “recession” in newspaper articles.
Recession simply refers to the downward phase of a business cycle, during which
national output may be falling or growing very slowly.
3. Unemployment
Unemployment (joblessness) occurs when people are without
work and actively seeking work.
The prevalence of unemployment in an economy is measured by
the unemployment rate, which is calculated as a percentage
by dividing the number of unemployed individuals by all
individuals currently in the labour force.
An economy usually experiences a relatively high unemployment
rate during periods of recession. But even if the economy on
the whole is doing very well, the unemployment rate can
remain fairly high.
Example:
1933 USA: Great Depression era. Unemployment rate 24.9%
1944 USA: Peak of war time boom. National output doubles. Unemployment
rate significantly small, 1.2%
2000 USA: 4% even after prolonged economic growth with no recession.
4. Inflation
When the prices of most goods and services are rising over
time, the economy is said to be experiencing inflation.
The percentage increase in the average level of prices
over a year is called the inflation rate. If the inflation
rate in consumer prices is 10%, then on an average the
prices of items that consumers buy are rising by 10% per
year.
In contrast, deflation is the fall in the average level of
prices. The last major deflation in the USA was seen
during the Great Depression. After that, rising prices
have been the normal state of affairs.
High inflation is a major issue because it greatly reduces
the purchasing power of consumers. When inflation rates
are extremely high, the economy tends to function poorly.
A deflation too, is nothing to be excited about, as falling
prices reduce the incentive of producers to sell goods.
5. The international economy
Today, every major economy is an open economy, which
means that it has extensive trading and financial
relationships with other national economies. (This is in
contrast to a closed economy, which doesn’t interact
economically with the rest of the world.)
A macroeconomist studying the international economy would
be interested in knowing how economic links among
nations, such as international trade and borrowing, affect
the performance of individual economies and the world
economy as a whole.
Some major issues related to the international economy are:
1)
How are business cycles transmitted from one country to
another?
2)
Why do trade imbalances take place? Are they good or
bad for the economy? Exports are goods and services
produced within the nation and sold to other countries.
Imports are goods and services produced abroad and
purchased by people within the country. An excess of
exports over imports is called trade surplus, while an
excess of imports over exports is called trade deficit.
3)
How does the foreign exchange rate (value of one
country’s currency in terms of another currency) affect
international trade?
4)
How do immigration and outsourcing affect an economy?
Related articles: Immigration in Canada, Outsourcing in
the USA
6) Macroeconomic policy
An extremely important factor
affecting economic performance is
the set of macroeconomic policies
pursued by the government.
The two major types of policies are:
Fiscal policy
• concerns government spending and
taxation
• determined at the national, state
and local levels
Monetary policy
• determines the rate of growth of
money supply in the country
• under the control of the central
bank
What are federal budget surpluses
and deficits? Do governments usually
run a surplus or a deficit?
Which is the central bank in
India? In the USA?
What macroeconomists do
Teach economics at the college or school level
Engage in macroeconomic forecasting
Work as analysts in govt/pvt organizations
Enter the research arena in macroeconomics
Collect data related to macroeconomic
variables
Macroeconomic forecasting
An economist trying to forecast (predict) the performance of
the economy will be concerned with questions such as: How
will a severe drought in agricultural regions affect food
quantities and prices? Will productivity rise as rapidly in the
future as it did during the tech boom of the early 2000s?
How will a crisis in the middle east affect fuel prices?
Owing to the complexity of the economic system, answering
such questions with a high degree of accuracy is close to
impossible. So, a macroeconomic forecaster will usually talk
in terms of “most likely” forecasts, while offering “optimistic”
and “pessimistic” alternative scenarios. In this sense, he/she
is very similar to a meteorologist – both can only talk about
the probability of an event taking place.
Related news article
Macroeconomic analysis
Macroeconomic analysts monitor the economy and think
about the implications of current economic events.
In private sector organizations (like banks and large
corporations), the job of an analyst is to try to determine
how general economic trends will affect their employers’
financial investments, their opportunities for expansion,
the demand for their products, and so on.
In public sector agencies (such as the government, the
World Bank and the International Monetary Fund) the
main function of analysts is to assist in policymaking. The
ultimate decisions regarding economic policy are taken
by politicians, who may or may not heed the advice of
macroeconomists in the face of numerous political
considerations.
Macroeconomic research
The role of a macroeconomist engaged in research is to make
general statements about how the economy works. Research
can take a variety of forms, from abstract mathematical
analyses to psychological experimentation to simulation
experiments representing the randomness of day-to-day
economic activity.
Like many other fields, macroeconomic research proceeds
primarily through the formulation and testing of theories. An
economic theory is a set of ideas about the economy
organized in a logical framework. Most economic theories
are developed in terms of an economic model, which is a
simplified description of some aspect of the economy,
usually expressed in mathematical form.
A useful economic theory has the following characteristics:
1.
It is based on reasonable and realistic assumptions
2.
It is easy to use
3.
It is consistent with data obtained from the real world
Data development
Several macroeconomists are involved in the process of
collecting data on macroeconomic variables such as
the price level, measures of output etc. This economic
data is used to assess the current state of the
economy, make forecasts, analyze policy alternatives,
and test macroeconomic theories.
In the USA, most economic data is collected by agencies
such as the Bureau of the Census, the Bureau of
Labour Statistics, and the Bureau of Economic Analysis.
Why macroeconomists disagree
A positive analysis of an
economic policy examines the
economic consequences of a
policy but doesn’t address
the question of whether those
consequences are desirable.
A normative analysis of an
economic policy tries to
examine the desirability of
an economic policy
Disagreements between macroeconomists may arise due to differences in
normative conclusions, and because of differences in the positive analysis of
a policy proposal.
There have always been many schools of thought in macroeconomics, but the
most important and enduring disagreements on positive issues involve the
two schools of thought called the classical approach and the Keynesian
approach.
The classical approach
Origin: Can be traced back to as early as 1776, when Scottish economist
Adam Smith published “The Wealth of Nations”.
Main idea:
Free markets are guided by the “invisible hand”, which operates through
the price mechanism. Economic agents-typically firms and households-look
at the prices in the market, and use the available information to make
rational decisions that maximize their self-interest in the given
circumstances. If they could increase their welfare by adjusting their wages
or prices, there is no reason why they would not do so. As a result, wages
and prices in an economy adjust reasonably quickly to equate supply and
demand in all markets. A major implication of these assumptions is that
there is no possibility for involuntary unemployment in the economy.
Proponents of the classical approach believe that the invisible hand works
well to ensure the economic welfare of the whole society, so that there is
only a limited scope for government intervention.
Well-known ‘classicals’: Robert Lucas, Thomas Sargent, Robert Barro, Edward
Prescott and Neil Wallace, all of whom were influenced by the ideas of
Adam Smith and Milton Friedman.
The Keynesian approach
Origin: Relatively recent, during the Great Depression of the 1930s.
Introduced by John Maynard Keynes in his book “General Theory of
Employment, Interest, and Money” (1936)
Main idea: The unprecedentedly high rates of unemployment of the 1930s
could not be explained by the classical theory. The thoery appeared to
be inconsistent with the data collected from the real world, and the
invisible hand seemed completely ineffective. This led Keynes to suggest
an alternative explanation for unemployment: There are problems of
asymmetric information, and high costs related to frequent price changes,
due to which prices and wages do not adjust rapidly enough to maintain
market equilibrium at all times. Slow price and wage adjustment means
that the supply of labour may exceed the demand for long periods of
time-leading to high and persistent unemployment.
Proponents of this approach tend to be sceptical about the invisible hand
and thus are more willing to advocate a role for government in improving
macroeconomic performance.
Influential Keynesians: Franco Modigliani and James Tobin were among the
early Keynesians. The new generation of Keynesians includes George
Akerlof, Janet Yellen, David Romer, Olivier Blanchard, Gregory Mankiw,
Larry Summers and Ben Bernanke.
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