Chapter 22 an introduction to macroeconomics

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Eastern Illinois University1© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as

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An Introduction to Macroeconomics

Where the telescope ends, the microscope begins. Which of the two has the grander view?

VICTOR HUGO

Drawing a Line• Drawing a line between macroeconomics

and microeconomics• Microeconomics

– Decisions of individual units• No matter how large

• Macroeconomics– Behavior of entire economies

• No matter how small– Economic aggregates

2© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Drawing a Line• Aggregation

– Combine many individual markets into one overall market

• Composition of demand and supply– In various markets– Important for microeconomics issues– Not important for macroeconomics issues

• During economic fluctuations– Markets – move up or down together


Drawing a Line• Macroeconomics

– Assume most details• Resource allocation and income distribution• Relatively unimportant

• Microeconomics– Ignore macroeconomics issues– Focus on individual markets

• Allocate resources• Distribute income


Macroeconomics

• Aggregate demand curve– Quantity of domestic product that is

demanded at each possible value of the price level

• Aggregate supply curve– Quantity of domestic product that is

supplied at each possible value of the price level


Figure 1Two interpretations of a shift in the demand curve

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A

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Macroeconomics• Inflation

– Sustained increase in the general price level

• Recession – A period of time during which the total

output of the economy declines • Production falls• People lose jobs

– Leftward shift of aggregate demand curve


Figure 2An Economy Slipping into a Recession

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Domestic Product

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vel

D0

D0

Q0

S

S

P0

D2

D2

P2

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B


Macroeconomics

• Macroeconomists study– Inflation– Recession and unemployment– Economic growth


Figure 3Economic Growth

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Domestic Product

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Gross Domestic Product

• Gross domestic product (GDP)– Sum of the money values of all final

goods and services– Produced in the domestic economy and

sold on organized markets – During a specified period of time, usually

a year



• Nominal GDP– GDP in current dollars– Calculated by valuing all outputs at

current prices• Real GDP

– Calculated by valuing outputs of different years at common prices

– Better measure than nominal GDP of changes in total production



• GDP - particular year– Add up money value of things– Goods and services

• Produced within the year– Final goods and services– Production: geographic boundaries of U.S.– Organized markets



• Final goods and services– Purchased by their ultimate users

• Intermediate good - purchased– For resale– For use in producing another good



• Limitations of GDP– Not a measure of the nation’s economic

well-being– Includes only market activity– Places no value on leisure– Counted: “Bads” and “Goods”– Ecological costs are not netted out of the

GDP


The Economy on a Roller Coaster

• U.S. economy– Growth – with fluctuations

• Macroeconomic fluctuations– Business cycles

• Real GDP per capita– Ratio of real GDP divided by population


Figure 4Nominal GDP, Real GDP, and Real GDP per Capita since 1959


Figure 5The Growth Rate of U.S. Real Gross Domestic Product since 1870



• Inflation– Sustained increase in the general price

level• Deflation

– Sustained decrease in the general price level


Figure 6The Inflation Rate in the United States since 1870



• The Great Depression, 1929-1933– Decline in economic activity– Rapid deflation– Production declined 30%– Business investment ceased – Unemployment rate

• Increased from 3% to 25%– World-wide event



• The Great Depression, 1929-1933– Revolution in economic thought

• Before: economy corrects itself• After: decrease in aggregate demand

– Monetary & fiscal policy

– Ended: early 1940s



• From WWII to 1973– Increased government spending

• Increased aggregate demand• Accidental fiscal policy• Price controls• Shortage: consumer goods

– 1960s – strong growth– Vietnam war – increased spending

• Inflation and high unemployment– Wage and price controls



• Fiscal policy– Government spending and taxation– Used to steer aggregate demand

• Stagflation– Inflation– While economy

• Growing slowly (“stagnating”)• Or recession



• The Great Stagflation, 1973-1980– OPEC – 1973 oil prices quadrupled– Poor harvests– Recession

• Inflation rate: 12%• High unemployment

– Stagflation– Inward shift of aggregate supply



• The Great Stagflation, 1973-1980– Economy recovered

• Government actions• Natural economic forces

– 1979 – OPEC soaring oil prices• Stagflation • Inflation: 16%


Figure 7The Effects of an Adverse Supply Shift

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Real GDP

Pric

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vel

D

D

S0

S0

E

S1

S1

A



• Reaganomics and its aftermath– Recovery underway– High inflation– Federal Reserve

• Monetary policy, High interest rate

• Monetary policy– Actions – Federal Reserve

• Change interest rates• Influence aggregate demand



• Reaganomics and its aftermath– 1981-1982 recession– Large budget deficits– Recovery started 1982-1983– President Bush

• Inflation• Deficit-reduction package• Spike in oil prices• 1990-1991 recession



• Clintonomics: deficit reduction and the “New Economy”– Deficit-reduction package, 1993 & 1997

• Tax increase & spending cuts– Large surplus– Economy boomed– Lower inflation– Aggregate supply curves

• Pushed outward – rapid pace, 1996 – 1998


Figure 8The Effects of a Favorable Supply Shift

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0Real GDP

Pric

e Le

vel

D0

D0

S0

S0

D1

D1

E

S1

S1

C

S2

S2

B



• Tax cuts and the Bush economy– 2001 recession, the 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



• Obamanomics and the Great Recession– January 2009, economy was sinking

• Jobs - disappearing at a rapid pace– More tax cuts– A burst of federal spending– Large-scale aid to state and local

governments



• Obamanomics and the Great Recession– Bush, Obama administrations, the Fed

• Variety of unprecedented emergency measures - to rescue the collapsing financial system

– Summer 2009, the Great Recession was over

– Economy started growing again– High unemployment


Macroeconomic Stabilization

• Stabilization policy – Government programs designed to

prevent or shorten recessions– And to counteract inflation

• To stabilize prices



• Combating unemployment– Increase aggregate demand

• Government - Fiscal policy– Increase spending and / or cut taxes

• Federal Reserve - Monetary policy– Lower interest rates

– Increase output– Reduce unemployment– Raise prices


Figure 9Stabilization Policy to Fight Unemployment

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0Real GDP

Pric

e Le

vel

D0

D0

S0

S0

D1

D1

E

A

Increase in output



• Combating inflation– Decrease aggregate demand

• Government - Fiscal policy– Cut spending and / or increase taxes

• Federal Reserve - Monetary policy– Increase interest rates

– Decrease inflation (decrease prices)– Decrease output– Increase unemployment


Figure 10Stabilization Policy to Fight Inflation

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0Real GDP

Pric

e Le

vel

D0

D0S

SD2

D2

E

Decrease in prices


B

Stabilization policy

• Prewar data– Fluctuations – unmanaged economy

• Booms & recessions– “Natural” economic reasons

• Little government intervention


Stabilization policy

• Postwar data– Economy - managed by government

policy• Successfully or unsuccessfully

– Recessions - less severe– More inflation-prone


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Chapter 22 an introduction to macroeconomics

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