An Introduction to Macroeconomics

Macroeconomics vs. Microeconomics

Microeconomics
Decisions of individual units
No matter how large
Example: GEs pricing policy

Macroeconomics
Behavior of entire economies
No matter how small
Example: inflation in Monaco

Economic aggregates: aggregate output,

inflation, unemployment,

Macroeconomics & Aggregation

Aggregation
Combine many individual markets into
one overall market

Why can we aggregate?

Composition of demand & supply
In various markets
Important for microeconomics issues
Not important for macroeconomics issues

During economic fluctuations, markets

move up or down together

Macroeconomics & Microeconomics

Macroeconomics
Assume most details
Resource allocation & income distribution
Relatively unimportant

Microeconomics
Ignore macroeconomics issues
Focus individual markets
Allocate resources
Distribute income
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Supply & Demand in Macroeconomics

Aggregate demand (AD)
AD curve
Quantity of domestic product demanded
Each possible value of price level

Aggregate supply (AS)

AS curve
Quantity of domestic product supplied
Each possible value of price level

Figure 1

D1

Price

Price

Two interpretations of a shift in the demand curve

P1

D0

A
E

P0

P0

S
D
0

Q0
Quantity
(a)

D0

D1

0
Quantity
(b)

Supply & Demand in Macroeconomics

Inflation
Sustained increase in price level
Outward shift of aggregate demand curve

Recession period of time

Total output declines
Production falls
People lose jobs

Inward shift of aggregate demand curve

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Figure 2
An economy slipping into a recession
S

D0
D2
Price Level

E
P0
B

P2

S
0

D2
Q2

D0

Q0

Domestic Product
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Supply & Demand in Macroeconomics

Macroeconomists study
Inflation
Recession & unemployment (Business
Cycles)
Economic growth

Figure 3
Economic growth
D1

S0

D0

S1

Price Level

C
E

D1
S0
0

D0

S1
Q0

Q1

Domestic Product
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Gross Domestic Product

Gross domestic product (GDP)
Sum: money values
All final goods & services
Produced - domestic economy (Toyota car

produced in the US vs. Ford pick-up

produced in Japan)
Sold organized markets (gambling in Vegas
vs. gambling in Chicago)

Specified period of time

Usually a year
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Gross Domestic Product

Nominal GDP
GDP in current dollars
Value outputs current prices

Real GDP
Value outputs of different years at
common prices
GDP in constant dollars

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What Gets Counted in GDP?

GDP - particular year
Add up money value of things
Goods & services
Produced within the year

Final goods & services

Production: geographic boundaries of U.S.
Organized markets

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Gross Domestic Product

Final goods and services
Purchased by their ultimate users

Intermediate good - purchased

For resale
For use in producing another good

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Gross Domestic Product

Limitations of GDP
Not measure: nations economic well-being
Includes only market activity
Housework, yard work,

Places no value on leisure

Counted: Bads and Goods
Hurricane Katrina might increase GDP

Ecological costs
Not deducted from GDP
Needed: Green GDP

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The Economy on a Roller Coaster

U.S. economy
Growth with fluctuations

Macroeconomic fluctuations
Business cycles

Real GDP per capita

Ratio: real GDP divided by population

16

Figure 4
Nominal GDP, real GDP, real GDP per capita since 1959

17

Figure 5
The growth rate of U.S. real GDP since 1870

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The Economy on a Roller Coaster

Inflation
Sustained increase
General price level

Deflation
Sustained decrease
General price level

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Figure 6
The inflation rate in the United States since 1870

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The Economy on a Roller Coaster

The Great Depression, 1929-1933
Decline in economic activity
Rapid deflation
Production declined 30%
Unemployment rate
Increased from 3% to 25%

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The Economy on a Roller Coaster

The Great Depression, 1929-1933
Revolution in economic thought
Before: economy corrects itself
After: decrease in aggregate demand cannot

recover by themselves (J. M. Keynes)

Monetary & fiscal policy needed

Ended: early 1940s (due to WWII)

What caused it?
Stock bubbles
Contractionary monetary policy
Unregulated markets

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The Economy on a Roller Coaster

From WWII to 1973
WWII: increased government spending
Increased aggregate demand
Accidental fiscal policy
Price controls
Shortage: consumer goods

1960s strong growth

Vietnam war increased spending
Inflation (5-6%) & high unemployment

Wage & price controls by Nixon

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The Economy on a Roller Coaster

The Great Stagflation,
Stagflation 1973-1980
OPEC 1973 oil prices quadrupled (1 st
Oil Shock)
Poor harvests in 1973 rose food prices
Stagflation
Inflation rate: 12%
High unemployment (9% in 1st quarter 1975)

Inward shift of aggregate supply

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The Economy on a Roller Coaster

The Great Stagflation,
Stagflation 1973-1980
Economy recovered
Government actions
Natural economic forces

1979 OPEC soaring oil prices (2 nd Oil

Shock)
Stagflation again
Inflation: 16%

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Figure 7
The effects of an adverse supply shift
D
S1

S0

Price Level

A
E

S1

S0

0
Real GDP
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The Economy on a Roller Coaster

Reaganomics and its aftermath
High inflation
Federal Reserve
Monetary policy (Paul Volcker)
High interest rate to fight inflation
Result: high unemployment rate (11% in 1982)

Fiscal policy
large tax cut
Laffer Curve
Help recovery beginning in the winter of 19821983
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The Economy on a Roller Coaster

Reaganomics and its aftermath
Large budget deficits
Recovery started 1982-1983
President Bush continues Regans
policies
Inflation
Deficit-reduction package
Spike in oil prices triggers 1990-1991

recession
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The Economy on a Roller Coaster

Clintonomics: deficit reduction
Deficit-reduction package, 1993 & 1997
Tax increase & spending cuts

Large fiscal surplus

Economy boomed (might due to
globalization and computerization)
Lower inflation
Aggregate supply curves
Pushed outward rapid pace, 1996 1998
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Figure 8
The effects of a favorable supply shift
D1

S0

D0

S1

S2

Price Level

C
B

D1
S0

S1

S2

D0

0
Real GDP

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The Economy on a Roller Coaster

Tax cuts and the Bush economy
2001 recession
First in 10 years

Tax cut 2001

Budget deficit
Burst of government spending
War on terror

Aggregate demand shift outward

Federal Reserve
Lowered interest rate

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The Economy on a Roller Coaster

The Great Recession (Dec. 2007
now)
Output falls hard
10% unemployment rate
Inflation is modest
Triggered by subprime crisis

Problem of Macroeconomic Stabilization

Historical record shows
US economy has not generally produced
steady growth w/o inflation
Short-run trade-off b/w unemployment
and inflation, sometimes both increase
(1970s)
Gov policy might contribute to this
performance

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Problem of Macroeconomic Stabilization

Stabilization policy
Government programs
Prevent or shorten recessions
Counteract inflation, stabilize prices

Problem of Macroeconomic Stabilization

Fight unemployment
Increase aggregate demand
Government - Fiscal policy
Increase spending
Cut taxes
Federal Reserve - Monetary policy
Lower interest rates

Increase output
Reduce unemployment
Raise prices
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Figure 9
Stabilization policy to fight unemployment
D1

S0

D0

Price Level

D1
S0

D0
Increase in output

0
Real GDP
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Problem of Macroeconomic Stabilization

Fight inflation
Decrease aggregate demand
Government - Fiscal policy
Cut spending
Increase taxes
Federal Reserve - Monetary policy
Increase interest rates

Decrease inflation (decrease prices)

Decrease output
Increase unemployment
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Figure 10
Stabilization policy to fight inflation
S

D0
D2
Price Level

E
B
Decrease
in prices
S

D2

D0

0
Real GDP
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Stabilization policy
Prewar data
Fluctuations unmanaged economy
Booms & recessions
Natural economic reasons
Little government intervention

Postwar data
Economy - managed by government policy
Successfully (60s and 90s) or unsuccessfully (70s)

Recessions - less severe

More inflation-prone
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Summary

Macro vs. Micro

Macro is all about Aggregation
AD-AS curve
GDP
Business Cycles vs. Economic Growth
Brief Macroeconomic History of US
Stabilization Policy