Introduction to

Macroeconomics

Introduction to Macroeconomics
Microeconomics examines the behavior of individual
decision-making unitsbusiness firms and households.
Macroeconomics deals with the economy as a whole; it
examines the behavior of economic aggregates such as
aggregate income, consumption, investment, and the
overall level of prices.
Aggregate behavior refers to the behavior of all households
and firms together.

The Scope of Economics

Examples of microeconomic and macroeconomic concerns

Microeconomics

Macroeconomics

Production

Prices

Income

Employment

Production/Output
in Individual
Industries and
Businesses

Price of Individual
Goods and
Services

Distribution of
Income and Wealth
Wages in the auto
industry
Minimum wages
Executive salaries
Poverty

Employment by
Individual
Businesses &
Industries
Jobs in the steel
industry
Number of
employees in a firm

National Income
Total wages and
salaries

Employment and
Unemployment in
the Economy

Total corporate
profits

Total number of
jobs
Unemployment rate

How much steel

How many offices
How many cars

Price of medical
care
Price of gasoline
Food prices
Apartment rents

National
Production/Output

Aggregate Price
Level

Total Industrial
Output
Gross Domestic
Product
Growth of Output

Consumer prices
Producer Prices
Rate of Inflation

Introduction to Macroeconomics
Microeconomists generally conclude that
markets work well. Macroeconomists,
however, observe that some important
prices often seem sticky.
Sticky prices are prices that do not
always adjust rapidly to maintain the
equality between quantity supplied and
quantity demanded.
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Introduction to Macroeconomics
Macroeconomists often reflect on the
microeconomic principles underlying
macroeconomic analysis, or the
microeconomic foundations of
macroeconomics.

The Roots of Macroeconomics

Classical economists applied microeconomic
models, or market clearing models, to
economy-wide problems.
However, simple classical models failed to
explain the prolonged existence of high
unemployment during the Great Depression.
This provided the impetus for the development
of macroeconomics.
In 1936, John Maynard Keynes published The
General Theory of Employment, Interest, and
Money.
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The Roots of Macroeconomics

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.
The use of Keynesian policy to fine-tune the economy in
the 1960s, led to disillusionment in the 1970s and early
1980s.
Stagflation occurs when the overall price level rises
rapidly (inflation) during periods of recession or high and
persistent unemployment (stagnation).
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Stagflation 70s
During 1970s, oil price shocks led to rapid
price rises and low production levels
called stagflation.
In many countrys, inflationary
expectations led to wage-price spirals and
historically high inflation rates.
Developed economies begin 20 year
slowdown in productivity growth rates.

International Economics
In early 1970s, US abandons Bretton Woods,
and exchange rates start to float. After a few
years of relative stability, exchange rates
become one of the most volatile variables.
International trade increases.
Oil price rises damaging to developing countries,
a problem partly solved when OPEC oil
revenues are recycled as loans to 3rd World.

Eighties
U.S. central bank cuts the money supply to
counter-act inflation. Deep recession in USA and
elsewhere.
Latin American countries default on their debts
leading to persistent financial crisis.
Most developing economies begin long period of
stagnation and even shrinking income levels.
Only East Asia continues to grow. China reforms
agricultural system and India institutes structural
reforms that spark growth.

1990s
Globalization: Big expansion in international
trade, internatioal lending and direct investment.
Productivity Takeoff: After 20 years of slow
growth, in 1995 productivity growth takes off
again.
Financial crisis in a number of developing
economies in Latin American and East Asia.
Rise of Unemployment in Europe, Inequality in
USA, Economic Stagnation in Japan
Central Banks Choose Monetary Policies meant
to lead to steady inflation: Inflation Targeting.

Macroeconomic Concerns
Major concerns of macroeconomics are:
Inflation
Output growth
Unemployment
Reduction of economic inequality
Steady foreign exchange position

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Inflation and Deflation

Inflation is an increase in the overall price level.
Hyperinflation is a period of very rapid
increases in the overall price level.
Hyperinflations are rare, but have been used to
study the costs and consequences of even
moderate inflation.
Deflation is a decrease in the overall price level.
Prolonged periods of deflation can be just as
damaging for the economy as sustained inflation.
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Inflation and Deflation in China

CN: Consum er Price Index: PY=100
PY = 100
125

120

115

110

105

100

95
1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

Output Growth
The business cycle is the cycle of short-term ups and
downs in the economy.
A recession is a period during which aggregate output
declines. Two consecutive quarters 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 cycle but also to increase the
growth rate of output in the long-run.
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Unemployment
The unemployment rate is the
percentage of the labor force that is
unemployed.
The unemployment rate is a key indicator
of the economys health.
The existence of unemployment seems to
imply that the aggregate labor market is
not in equilibrium. Why do labor markets
not clear when other markets do?
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Government in the
Macroeconomy
There are three kinds of policy that the government has
used to influence the macro-economy:
1. Fiscal policy: refers to government policies
concerning taxes and spending.
2. Monetary policy: consists of tools used by the
Federal Reserve to control the quantity of money in
the economy.
3. Growth or supply-side policies: that focus on
stimulating aggregate supply instead of aggregate
demand.
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The Components of
the Macroeconomy
The circular flow diagram
shows the income received
and payments made by each
sector of the economy.

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The Components of
the Macroeconomy
Everyones
expenditure is
someone elses
receipt. Every
transaction must
have two sides.

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The Three Market Arenas

Households and the government purchase goods
and services (demand) from firms in the goodsand services market, and firms supply to the
goods and services market.
In the labor market, firms and government
purchase (demand) labor from households
(supply).
In the money marketsometimes called the
financial markethouseholds purchase stocks
and bonds from firms.
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Economic policy
Criteria for judging economic outcomes:
Efficiency
Equity
Growth
Stability

Diagnosing Health of the Economy

National Product and Domestic Product

Aggregate Consumption
Gross Domestic Savings
Gross Domestic Capital Formation
Wholesale Prices, Consumer Prices and
Inflation
Employment
Balance of Payments
Rate of Growth
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The Circulation Flow of Income

Two Sector Economy
Closed Economy
Open Economy

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Two-Sector Economy
(When All Income is Consumed)
Wages and Profits (i.e.
income (Y)
Rs.1000

AtEquilibrium :
Household Sector
Productive Sector

Y AD
AD C
Y C

Private Consumption (C)

Rs.1000

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Closed Economy
Wages and Profits
(i.e. income (Y)
Rs.1000

Household
Sector

Productive
Sector

AtEquilibrium :
Y AD
AD C S C I
InEquilibrium
SI

Private
Consumption
(C) Rs.800
Investment
Rs.200

Savings (S)
Rs.200

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Open Economy
Wages and Profits (i.e.
income (Y) Rs.1000

AtEquilibrium :
Household Sector

Productive Sector

Y AD
Y C I G X
C J

Private Consumption
(C) Rs.800

Investment (I) Rs.80

Exports (E) Rs.60
Government
Expenditure (G)
Rs.60
[Injections (J)
Rs.200]

Savings (S) Rs.100

Imports (M) Rs.50
Taxes (T) Rs.50
[Withdrawals (W)
Rs.200]
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