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Introduction by Dr. R. JAYARAJ, M.A., PhD, Assistant Professor (SG), UPES
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Introduction
What is Macroeconomics?
WordReference.com state that "Macroeconomics is the branch of economics concernedwith aggregates, such as national income, consumption, and investment ".
The Economist's Dictionary of Economics defines Macroeconomics as the study of whole
economic systems aggregating over the functioning of individual economic units. It isprimarily concerned with variables which follow systematic and predictable paths of
behavior and can be analyzed independently of the decisions of the many agents whodetermine their level. More specifically, it is a study of national economies and the
determination of national income."
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Microeconomics examines the behavior ofindividual decision-making unitsbusinessfirms and households.
Macroeconomics deals with the economy as awhole; it examines the behavior of economicaggregates such as aggregate income,consumption, investment, and the overall
level of prices. Aggregate behaviorrefers to the behavior of all
households and firms together.
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Microeconomists generallyconclude that markets work well.
Macroeconomists, however,observe that some importantprices often seem sticky.
Sticky prices are prices that do notalways adjust rapidly to maintainthe equality between quantity
supplied and quantity demanded.
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Macroeconomists often reflect onthe microeconomic principles
underlying macroeconomicanalysis, or the microeconomic
foundations of macroeconomics.
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The Great Depressionwas a period of severeeconomic contractionand highunemployment thatbegan in 1929 andcontinued throughoutthe 1930s.
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Classical economists applied microeconomicmodels, or market clearing models, toeconomy-wide problems.
However, simple classical models failed toexplain the prolonged existence of highunemployment during the Great Depression.This provided the impetus for the
development of macroeconomics.
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In 1936, John Maynard Keynes published The General Theory
of Employment, Interest, and Money. Keynes believed governments could intervene in the
economy and affect the level of output and employment. During periods of low private demand, the government can
stimulate aggregate demand to lift the economy out of
recession.
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Fine-tuning was the phrase used by Walter
Heller to refer to the governments role in
regulating inflation and unemployment. The use of Keynesian policy to fine-tune the
economy in the 1960s, led to disillusionment(free from illusion) in the 1970s and early1980s.
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Stagflation occurs when the overall price
level rises rapidly (inflation) during periods of
recession or high and persistentunemployment (stagnation).
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Three of the major concerns of
macroeconomics are:
Inflation Output growth
Unemployment
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Inflation is an increase in the overall pricelevel.
Hyperinflation is a period of very rapid
increases in the overall price level.Hyperinflations are rare, but have been usedto study the costs and consequences of evenmoderate inflation.
Deflation is a decrease in the overall pricelevel. Prolonged periods of deflation can bejust as damaging for the economy assustained inflation.
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The business cycle is the cycle ofshort-term ups and downs in the
economy. The main measure of how an
economy is doing is aggregateoutput:
Aggregate outputis the totalquantity of goods and servicesproduced in an economy in a givenperiod.
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A recession is a period during whichaggregate output declines. Two consecutivequarters of decrease in output signal a
recession. A prolonged and deep recession becomes a
depression.
Policy makers attempt not only to smooth
fluctuations in output during a business cyclebut also to increase the growth rate of outputin the long-run.
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The unemployment rate is the percentage ofthe labor force that is unemployed.
The unemployment rate is a key indicator ofthe economys health. The existence of unemployment seems to
imply that the aggregate labor market is not
in equilibrium. Why do labor markets notclear when other markets do?
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There are three kinds of policy thatthe government has used to
influence the macroeconomy:1. Fiscal policy
2. Monetary policy
3. Growth or supply-side policies
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Fiscal policyrefers to government policiesconcerning taxes and spending.
Monetary policyconsists of tools used by the
Federal Reserve to control the quantity ofmoney in the economy.
Growth policies are government policies thatfocus on stimulating aggregate supply instead
of aggregate demand.
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The circular flowdiagram shows the
income received and
payments made byeach sector of the
economy.
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Everyonesexpenditure issomeone elses
receipt. Everytransaction musthave two sides.
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Transfer payments are paymentsmade by the government to people
who do not supply goods, services, orlabor in exchange for these payments.
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Households, firms, thegovernment, and the rest of the
world all interact in three differentmarket arenas:
1. Goods-and-services market
2. Labor market3. Money (financial) market
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Households and the government purchase goods and
services (demand) from firms in thegoods-and servicesmarket, and firms supplyto the goods and services market.
In the labor market, firms and government purchase(demand) labor from households (supply).
The total supply of labor in the economy depends on the sum ofdecisions made by households.
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In the money marketsometimes called thefinancial
markethouseholds purchase stocks and bonds from firms.
Households supplyfunds to this market in the expectation of earning
income, and also demand(borrow) funds from this market. Firms, government, and the rest of the world also engage in
borrowing and lending, coordinated by financial institutions.
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Treasury bonds, notes, and billsare promissory notes issued by the
federal government when itborrows money.
Corporate bonds are promissory
notes issued by corporations whenthey borrow money.
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Shares of stockare financialinstruments that give to the
holder a share in the firmsownership and therefore the rightto share in the firms profits.
Dividends are the portion of acorporations profits that the firmpays out each period to itsshareholders.
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Connections to microeconomics:
Macroeconomic behavior is the sum
of all the microeconomic decisionsmade by individual households andfirms. We cannot understand theformer without some knowledge of
the factors that influence the latter.
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Aggregate demandis thetotal demand for goods andservices in an economy.
Aggregate supplyis the total
supply of goods and services in an
economy.
Aggregate supply and demand
curves are more complex thansimple market supply and demand
curves.
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An expansion, or boom, isthe period in the businesscycle from a trough up to a
peak, during which outputand employment rise.
A contraction, recession, or slump
is the period in the business cycle
from a peak down to a trough, during
which output and employment fall.
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aggregate behavioraggregate behavior
aggregate demandaggregate demand
aggregate outputaggregate output
aggregate supplyaggregate supply
business cyclebusiness cycle
circular flowcircular flow
contraction, recession, orcontraction, recession, orslumpslump
corporate bondscorporate bonds
deflationdeflation
depressiondepression
microeconomicsmicroeconomics
monetary policymonetary policy
recessionrecession
shares of stockshares of stock
stagflationstagflation
sticky pricessticky prices
supplysupply--side policiesside policiestransfer paymentstransfer payments
Treasury bonds, notes,Treasury bonds, notes,billsbills
unemployment rateunemployment rate
dividendsdividends
expansion or boomexpansion or boom
fine tuningfine tuning
fiscal policyfiscal policy
Great DepressionGreat Depression
hyperinflationhyperinflation
inflationinflationmacroeconomicsmacroeconomics
microeconomicmicroeconomicfoundations offoundations ofmacroeconomicsmacroeconomics
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Macroeconomics.flv