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CHAPTER 1
Introduction to Macroeconomics
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Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
Questions
• How much richer are we than our
parents were at our age?
• How much richer will our children be
than our grandparents were?
• Will changing jobs be easy or hard in
five years?
• How many of us will have jobs in five
years?
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Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
Questions
• Will the businesses we work for
vanish as demand for the products
they make dries up?
• Will inflation make us poor by
destroying our savings or rich by
eliminating our debts?
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Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
Macroeconomics...
• is the subdiscipline of economics
that tries to answer these six
questions
• is the branch of economics related
to the economy as a whole
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Macroeconomists...
• try to figure out why overall economic
activity rises and falls
• try to understand what determines
the level and rate of change of overall
prices
• study other variables that play a
major role in determining the overall
levels of production, income,
employment, and prices
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Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
Why Macroeconomics Matters
• Cultural Literacy
– ability to follow and participate in public
debates and discussions
– ability to understand news reports on
changes in the economy
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Figure 1.1 - The Daily Flow of Economic News
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Why Macroeconomics Matters
• Self-Interest
– effects of the macroeconomy on our
daily lives
– understanding of changing opportunities
as the economy fluctuates
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Why Macroeconomics Matters
• Civic Responsibility
– more informed voting
– more responsible macroeconomic policy
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Macroeconomic Policy
• Growth Policy
– policies to accelerate or decelerate longrun economic growth
– most important policies for the long-run
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Figure 1.2 - Long-Run Economic Growth:
Sweden and Argentina, 1900-2004
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Macroeconomic Policy
• Stabilization Policy
– policies to smooth out the business cycle
by diminishing the depth of recessions
and depressions
– business cycles are fluctuations in
production and employment
• booms or expansions occur when
production grows and unemployment falls
• recessions or depressions occur when
production falls and unemployment rises
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Figure 1.3 - The American Business
Cycle: Fluctuations in Total Production
Relative to the Long-Run Growth Trend
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Macroeconomic Policy
• Business cycle fluctuations are also
felt in the overall level of prices
– booms usually bring inflation
– recessions bring either disinflation or
deflation
• Interest rates, the level of the stock
market, and other economic variables
also rise and fall with the business
cycle
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Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
Macroeconomics versus
Microeconomics
• Macroeconomists
– examine the economy as a whole
– focus on the feedback from one
component of the economy to another
– study the total level of production and
employment
– believe that imbalances between supply
and demand may be resolved by changes
in quantities rather than prices
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Macroeconomics versus
Microeconomics
• Microeconomists
– study the markets for single commodities
and the behavior of individual households
and firms
– focus on how competitive markets allocate
resources to create consumer and producer
surplus
– assume that imbalances between demand
and supply are resolved by changes in
prices
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Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
Economic Statistics and
Economic Activity
• Economic activity is the pattern of
transactions in which things of real,
useful value are created, transformed,
and exchanged
• Estimates of economic activity are
contained in the National Income
and Product Accounts (NIPA)
– reported by the Commerce Department’s
Bureau of Economic Analysis
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Six Key Economic Variables
• Real Gross Domestic Product (GDP)
– is corrected for changes in the price level
(real)
– includes the replacement of worn-out
and obsolete equipment and structures
as well as new investment (gross)
– counts economic activity that happens
within the United States (domestic)
– represents the production of final goods
and services (product)
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Six Key Economic Variables
• Real Gross Domestic Product
– often divided by the number of workers
in the economy (real GDP per worker)
– measures how well the economy
produces goods and services that people
find useful
– does not indicate the relative distribution
of the nation’s economic product
– is an imperfect measure of economic
well-being
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Figure 1.4 - Officially Measured Real GDP
per Worker in the United States
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Six Key Economic Variables
• The Unemployment Rate
– to be unemployed, a person must want
to work and be actively looking for a job
(but have not yet found one)
– the labor force consists of those who
are employed and those who are
unemployed
– the unemployment rate is equal to the
number of unemployed people divided by
the labor force
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Figure 1.5 - The U.S. Unemployment Rate
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Six Key Economic Variables
• The Unemployment Rate
– frictional unemployment occurs because
workers and firms spend time searching
for the best match
– cyclical unemployment occurs during
recessions and depressions
– the unemployment rate is the best
indicator of how well the economy is
doing relative to its productive potential
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Six Key Economic Variables
• The Inflation Rate
– is a measure of how fast the overall price
level is rising
– hyperinflation occurs when the price
level is rising by more than 20% per
month
• can cause massive economic destruction
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Figure 1.6 - Inflation in the United States
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Six Key Economic Variables
• The Interest Rate
– is important because it governs the
redistribution of purchasing power across
time
– there are many different interest rates in
the economy that vary by duration and
degree of risk
• they often move up and down together
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Six Key Economic Variables
• The Interest Rate
– the nominal interest rate is the interest
rate in terms of money
• does not take into account the effects of
inflation
– the real interest rate is the interest rate
in terms of goods and services
• does take into account the effects of inflation
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Six Key Economic Variables
• The Interest Rate
– when interest rates are low, investment
tends to be high
– when interest rates are high, investment
tends to be low
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Figure 1.7 - U.S. Real Interest Rates,
1960-2004
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Six Key Economic Variables
• The Stock Market
– is heard about most often (every day)
– is an index of expectations for the future
• a high value means that investors expect
economic growth to be rapid, profits to be
high, and unemployment to be low
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Figure 1.8 - Real Stock Index Prices
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Six Key Economic Variables
• The Exchange Rate
– governs the terms on which international
trade and investment take place
– the nominal exchange rate is the rate at
which monies of different countries can
be exchanged for one another
– the real exchange rate is the rate at
which the goods and services produced in
different countries can be exchanged for
one another
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Six Key Economic Variables
• The Exchange Rate
– if domestic currency appreciates
• its value in terms of other currencies
increases
• foreign-produced goods are relatively cheap
for domestic buyers
– imports are likely to be high
• domestic-made goods are relatively
expensive for foreigners
– exports are likely to be low
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Six Key Economic Variables
• The Exchange Rate
– if domestic currency depreciates
• its value in terms of other currencies declines
• domestic-produced goods are relatively cheap
for foreign buyers
– exports are likely to be high
• foreign-made goods are relatively expensive
for domestic buyers
– imports are likely to be low
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Figure 1.9 - The U.S. Real Exchange Rate:
The Dollar against a Composite Index
of Foreign Currencies
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The Current
Macroeconomic Situation
• The United States – recent past
– the collapse of the stock market bubble
and the September 11 terrorist act
triggered a recession
• the U.S. economy lost 0.9 million jobs
– in response, the Federal Reserve reduced
interest rates and the federal government
lowered taxes
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The Current
Macroeconomic Situation
• The United States – recent past
– slowly in 2002 and more rapidly in 2003
the economy began to recover
• demand and production grew
• employment did not expand much
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The Current
Macroeconomic Situation
• The United States - 2004
– there are renewed worries among
economists
• tax cuts and extra defense spending have led
to large budget deficits
• fear that foreign exchange speculators will
lose confidence in the dollar
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The Current
Macroeconomic Situation
• Europe
– in the early 2000s, 11 Western European
nations adopted the euro as their
common currency
– the adoption of the euro was followed by
stagnation and recession
• unemployment rates of close to 10%
• real GDP growth at less than 2% per year
• consumer prices rising at 2% per year
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The Current
Macroeconomic Situation
• Japan
– interest rates are very low (0.03% in the
three-month money market)
– still undergoing deflation
– six straight quarters of positive growth in
real GDP
– unemployment is still above 5%, but
steady
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The Current
Macroeconomic Situation
• Emerging Markets
– China and India are experiencing
enormous growth
• their economies are expected to grow at 8%
and 6% in 2005
– foreign investors have appeared to have
regained confidences in East Asian
economies
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The Current
Macroeconomic Situation
• Emerging Markets
– the Argentinean economy crashed at the
end of 2001
• problems are still unresolved
– elsewhere in Latin America, growth rates
continued to be positive but small
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Chapter Summary
• Macroeconomics is the study of the
overall economy
• There are three key reasons to
study macroeconomics
– to gain cultural literacy
– to understand how economic trends
affect you personally
– to exercise your responsibility as a
voter and citizen
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Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Summary
• The key indicators in macroeconomics
are
– real GDP
– the unemployment rate
– the inflation rate
– the interest rate
– the level of the stock market
– the exchange rate
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Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.