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Chapter 1
What Is
Macroeconomics?
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The “Big Three” Concepts of
Macroeconomics
• Unemployment Rate
U = (# of Unemployed) / Labor Force
• Inflation Rate
∏ = %ΔP = (P1 – P0) / P0
• Productivity Growth
– “Productivity” is the average output per hour
of work that a nation produces in goods and
services.
– Productivity in 2010 = $61 per worker-hour
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The Global Economic Crisis
and the 3 Big Concepts
• The global economic crisis started in 2008
• Results:
– High sustained level of unemployment
• U = 10% in 2009-2010
• Not expected to fall to 5% until 2015 or 2016
– But inflation has remained low
– Productivity growth has also been robust
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Macroeconomics vs.
Microeconomics
• Macroeconomics deals with the totals, or
aggregates, of the economy such as:
– The unemployment rate (of all U.S. workers)
– Inflation (i.e. the rise of all prices in the U.S.)
• Microeconomics deals with parts of the economy
like:
– The unemployment rate of low-skilled workers in a certain
state
– The price of cars
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Gross Domestic Product (GDP)
• Definition: (Nominal) GDP is the value of all
currently produced goods and services sold on the
market during a particular time interval.
– Real GDP adjusts the value of total output to correct for
changes in prices.
• Sometimes referred to as Actual Real GDP
– Natural Real GDP is the level of real GDP in which
there is no tendency for inflation to rise or fall.
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Figure 1-1 The Relation Between Actual and
Natural Real GDP and the Inflation Rate
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Unemployment: Actual and Natural
• Actual Unemployment (U) is the
unemployment rate observed in the economy.
• The Natural Rate of Unemployment (U*) is
the rate of unemployment at which there is no
tendency for inflation to rise or fall.
– If U > U*  ∏ rises
– If U < U*  ∏ falls
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Figure 1-2 The Behavior Over Time of Actual and
Natural Real GDP and the Actual and Natural Rates
of Unemployment
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Short Run vs. Long Run
• The “short run” lasts from 1-5 years and the
main issue is the stability of the economy.
– The ups and downs (or “economic fluctuations”) of
an economy are part of the business cycle. The
business cycle has the following phases:
• Expansion
• Contraction
• The “long run” ranges from one to several
decades and is concerned with economic growth.
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Figure 1-3 Business Cycles in Volatilia
and Stabilia
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Figure 1-4 Basic Business-Cycle
Concepts
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Figure 1-5 Economic Growth
in Stag-Nation and Speed-Nation
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Figure 1-6 Actual and Natural GDP and
Unemployment, 1900–2010 (1 of 2)
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Figure 1-6 Actual and Natural GDP and
Unemployment, 1900–2010 (2 of 2)
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Sources: See Appendix A-1 and C-4.
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Macroeconomics at the Extremes
• Three examples of the breakdown of
normal macroeconomic mechanisms:
– The Great Depression of the 1930s
– The German hyperinflation of 1922-23
– South Korea vs. Philippines economic growth in
the last 50 years
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Figure 1-7 The Unemployment Rate
from 1929–41 Compared with 1998–2010
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Source: Bureau of Labor Statistics. See Appendix C-4.
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Figure 1-8 The German Price Level,
1920–23
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Source: Groningen Growth and Development Center.
See Appendix C-4.
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Figure 1-9 Per-Capita Real GDP, South
Korea and the Philippines, 1960–2010
Source: Groningen Growth and Development Center. See Appendix C-4.
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Taming Business Cycles
• Macroeconomic analysts have two main tasks:
– Analyze the causes of changes in macroeconomic
variables
– Predict the consequences of alternative policy changes
• Macroeconomic target variables important to
analysts and policy makers include:
– Inflation
– Unemployment
– Long-term growth of productivity
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The Role of Stabilization Policy
• A Stabilization Policy is any policy that seeks to
influence the level of aggregate demand.
– Monetary policy tries to influence aggregate
demand by changing the money supply and/or
interest rates.
– Fiscal policy tries to influence aggregate demand
by changing government spending and/or tax
rates.
• New Challenges: The global economic crisis has
brought forth novel and controversial strategies in
both monetary and fiscal policy (see Chapters 5
and 6).
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Economic Performance of the U.S.
vs. Europe
• Europe outperformed the U.S. from 1960 – 1985.
• But the U.S. has grown much more quickly than Europe since
1995.
• Puzzle #1: Why has European unemployment risen so much?
• Puzzle #2: Why has Europe not benefited from the adoption
of computer and internet technology like the U.S?
– During the current crisis, US productivity soared while EU
productivity lagged because European workers were protected
from layoffs even as EU output slumped.
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The “Internationalization” of
Macroeconomics
• A closed economy has no trade in goods, services or financial
assets with any other nations.
– In the 1940s and 50s, the U.S. was relatively closed:
• Trade was 5% of the U.S. economy
• Exchange rates were fixed
• Financial flows to and from the U.S. were restricted
• An open economy exports and imports goods and services to
and from other nations, and has financial flows to and from
foreign nations.
– Today the U.S. is increasingly open:
• Imports equal 17% of U.S. GDP
• Since 1973, the exchange rate of the $ has been flexible
• International financial flows are massive and almost instantaneous
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