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PART II CONCEPTS AND PROBLEMS IN MACROECONOMICS Introduction to Macroeconomics 5 CHAPTER OUTLINE Macroeconomic Concerns Output Growth Unemployment Inflation and Deflation PART II Concepts and Problems in Macroeconomics The Components of the Macroeconomy © 2012 Pearson Education, Inc. Publishing as Prentice Hall The Circular Flow Diagram The Three Market Arenas The Role of the Government in the Macroeconomy A Brief History of Macroeconomics The U.S. Economy Since 1970 1 of 38 Macroeconomic Concerns Three of the major concerns of macroeconomics are Output growth Unemployment PART II Concepts and Problems in Macroeconomics Inflation and deflation © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2 of 38 Macroeconomic Concerns Output Growth business cycle The cycle of short-term ups and downs in the economy. PART II Concepts and Problems in Macroeconomics aggregate output The total quantity of goods and services produced in an economy in a given period. recession A period during which aggregate output declines. Conventionally, a period in which aggregate output declines for two consecutive quarters. depression A prolonged and deep recession. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 3 of 38 PART II Concepts and Problems in Macroeconomics For economists, the main measure of how an economy is doing is: a. Aggregate output. b. Aggregate employment. c. The aggregate price level. d. The growth rate of the population. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 4 of 38 PART II Concepts and Problems in Macroeconomics For economists, the main measure of how an economy is doing is: a. Aggregate output. b. Aggregate employment. c. The aggregate price level. d. The growth rate of the population. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 5 of 38 Macroeconomic Concerns Output Growth expansion or boom The period in the business cycle from a trough up to a peak during which output and employment grow. PART II Concepts and Problems in Macroeconomics contraction, recession, or slump The period in the business cycle from a peak down to a trough during which output and employment fall. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 6 of 38 Macroeconomic Concerns Output Growth PART II Concepts and Problems in Macroeconomics FIGURE 5.1 A Typical Business Cycle In this business cycle, the economy is expanding as it moves through point A from the trough to the peak. When the economy moves from a peak down to a trough, through point B, the economy is in recession. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 7 of 38 Macroeconomic Concerns PART II Concepts and Problems in Macroeconomics Output Growth FIGURE 5.2 U.S. Aggregate Output (Real GDP), 1900–2009 The periods of the Great Depression and World Wars I and II show the largest fluctuations in aggregate output. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 8 of 38 Macroeconomic Concerns Unemployment unemployment rate The percentage of the labor force that is unemployed. PART II Concepts and Problems in Macroeconomics Unemployment rate = (No. of unemployed people / Labor force )*100 © 2012 Pearson Education, Inc. Publishing as Prentice Hall 9 of 38 PART II Concepts and Problems in Macroeconomics In microeconomic theory, which of the following happens as the labor market eliminates unemployment and restores its equilibrium? a. The equilibrium wage rises above the wage that prevailed when there was unemployment. b. As it moves toward equilibrium, the market experiences an increase in the quantity of labor demanded and a decrease in the quantity supplied. c. The market will turn a shortage into a surplus. d. Supply and demand will shift, but equilibrium price remain the same in the end. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 10 of 38 PART II Concepts and Problems in Macroeconomics In microeconomic theory, which of the following happens as the labor market eliminates unemployment and restores its equilibrium? a. The equilibrium wage rises above the wage that prevailed when there was unemployment. b. As it moves toward equilibrium, the market experiences an increase in the quantity of labor demanded and a decrease in the quantity supplied. c. The market will turn a shortage into a surplus. d. Supply and demand will shift, but equilibrium price remain the same in the end. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 11 of 38 Macroeconomic Concerns Inflation and Deflation inflation An increase in the overall price level. PART II Concepts and Problems in Macroeconomics hyperinflation A period of very rapid increases in the overall price level. deflation A decrease in the overall price level. Negative inflation © 2012 Pearson Education, Inc. Publishing as Prentice Hall 12 of 38 The Components of the Macroeconomy Understanding how the macroeconomy works can be challenging because a great deal is going on at one time. Everything seems to affect everything else. To see the big picture, it is helpful to divide the participants in the economy into four broad groups: PART II Concepts and Problems in Macroeconomics (1) Households. (2) Firms. (3) The government. (4) The rest of the world. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 13 of 38 The Components of the Macroeconomy PART II Concepts and Problems in Macroeconomics The Circular Flow Diagram circular flow A diagram showing the income received and payments made by each sector of the economy. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 14 of 38 The Circular Flow Income ($) PART II Concepts and Problems in Macroeconomics Labor Firms Households © 2012 Pearson Education, Inc. Publishing as Prentice Hall Goods Expenditure ($) 15 of 38 The Components of the Macroeconomy The Circular Flow Diagram PART II Concepts and Problems in Macroeconomics FIGURE 5.3 The Circular Flow of Payments Households receive income from firms and the government, purchase goods and services from firms, and pay taxes to the government. They also purchase foreign-made goods and services (imports). Firms receive payments from households and the government for goods and services; they pay wages, dividends, interest, and rents to households and taxes to the government. The government receives taxes from firms and households, pays firms and households for goods and services—including wages to government workers—and pays interest and transfers to households. Finally, people in other countries purchase goods and services produced domestically (exports). Note: Although not shown in this diagram, firms and governments also purchase imports. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 16 of 38 The Components of the Macroeconomy The Three Market Arenas Another way of looking at the ways households, firms, the government, and the rest of the world relate to one another is to consider the markets in which they interact. PART II Concepts and Problems in Macroeconomics We divide the markets into three broad arenas: (1) The goods-and-services market. (2) The labor market. (3) The money (financial) market. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 17 of 38 The Components of the Macroeconomy The Three Market Arenas Goods-and-Services Market PART II Concepts and Problems in Macroeconomics Firms supply to the goods-and-services market. Households, the government, and firms demand from this market. Labor Market In this market, households supply labor and firms and the government demand labor. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 18 of 38 The Components of the Macroeconomy The Three Market Arenas Money Market PART II Concepts and Problems in Macroeconomics Households supply funds to this market in the expectation of earning income in the form of dividends on stocks and interest on bonds. Much of the borrowing and lending of households, firms, the government, and the rest of the world are coordinated by financial institutions. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 19 of 38 The Components of the Macroeconomy The Three Market Arenas Money Market PART II Concepts and Problems in Macroeconomics Treasury bonds, notes, and bills Promissory notes issued by the federal government when it borrows money. corporate bonds Promissory notes issued by firms when they borrow money. shares of stock Financial instruments that give to the holder a share in the firm’s ownership and therefore the right to share in the firm’s profits. dividends The portion of a firm’s profits that the firm pays out each period to its shareholders. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 20 of 38 PART II Concepts and Problems in Macroeconomics All of the following are debt instruments, or promissory notes issued by a borrower, except one. Which one? a. Treasury bonds. b. Treasury notes. c. Treasury bills. d. Corporate Stocks. e. Corporate bonds. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 21 of 38 PART II Concepts and Problems in Macroeconomics All of the following are debt instruments, or promissory notes issued by a borrower, except one. Which one? a. Treasury bonds. b. Treasury notes. c. Treasury bills. d. Corporate Stocks. e. Corporate bonds. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 22 of 38 The Components of the Macroeconomy The Role of the Government in the Macroeconomy fiscal policy Government policies concerning taxes and spending. PART II Concepts and Problems in Macroeconomics monetary policy The tools used by the Federal Reserve to control the quantity of money, which in turn affects interest rates. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 23 of 38 PART II Concepts and Problems in Macroeconomics The Great Depression Year 1929 1930 1931 1932 1933 Real GDP 8.813 8.054 7.537 6.557 6.473 (billion dollars) Real GDP Growth © 2012 Pearson Education, Inc. Publishing as Prentice Hall -8.61% -6.42% -13.00% -1.28% Unemployment rate 3.90% 9.60% 16.60% 24.30% 25.60% Inflation rate -3.88% -9.98% -11.46% -2.62% 25 of 38