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Macroeconomics Instructor : Dr. Jack Zhang Date: 2007.9.5 Lecture 1 : Introduction to Macroeconomics Issues covered Objective Contents Issues covered What is the subject matter of macroeconomics?

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Instructor: Dr. Jack Zhang

Date: 2007.9.5

lecture 1 introduction to macroeconomics
Lecture 1: Introduction to Macroeconomics
  • Issues covered
  • Objective
  • Contents
issues covered
Issues covered
  • What is the subject matter of macroeconomics?
  • What methods and simplifying assumptions do macroeconomists use in their efforts to explain how the economy works?

Explain the philosophy underlying macroeconomics, especially why we have divided the main body of macroeconomics into two parts: one concerned with the long run, and the other dealing with the short run.

  • What is Macroeconomics?
  • Macroeconomic Theory for the Short Run;
  • Macroeconomic Theory for the Long Run;
  • Long-Run versus Short-Run Economic Policies。
1 what is macroeconomics
1.What is Macroeconomics?

Gary Becker:Economics is the study of the allocation of scarce resources to satisfy competing ends.

This definition generally applies to microeconomics, but not macroeconomics, because some parts of macroeconomics are concerned with situations where resources are not scarce, e.g., the available supplies of labor and capital are not fully utilized.

Generally accepted definition: Macroeconomics is that part of economics focuses which is concerned with the economics as a whole.

This definition is inaccurate, since important parts of macroeconomics are not (directly) concerned with the whole economy, but rather with understanding particular markets such as the labor market or the credit market

1 a definition of macroeconomics by subject
(1)A definition of macroeconomics by subject

The basic questions in macroeconomics:

  • What creates growth in aggregate output and income per capita in the long run?
  • What causes the fluctuations in economic activity that we observe in the short run?
  • What explains the level of long-run unemployment?
  • What explains the short-run variations in unemployment?
1 a definition of macroeconomics by subject continue
(1)A definition of macroeconomics by subject(continue)

Definition by subject: Macroeconomics is the study of economic growth and business cycles.

To explain the movements in total output, we must also understand the movements in:

  • total consumption;
  • total investment;
  • the rate of unemployment;
  • the interaction of the above real variables with nominal variables such as the general level of wages, prices, nominal interest rates, exchange rates, etc.
2 a definition of macroeconomics by method
(2)A definition of macroeconomics by method

Another definition, known as the empiricist view, reflects the view that a scientific discipline should be in terms of data macroeconomics seeks to explain: Macroeconomics is concerned with explaining observed time series for economic variables like GDP, consumption, investment, prices and wages, the rate of unemployment, etc.

Basic belief: theories should be evaluated by holding them up against the facts, and new theory should ideally be justified and accompanied by illustrative empirical material.

To sum up, in macroeconomics we follow in three steps:
  • the phenomena we want to understand;
  • the fundamental characteristics of the models we use;
  • the policies we analyze .
2 macroeconomic theory for the short run
2、Macroeconomic Theory for the Short Run

Macroeconomic theory for the short run intends to

explain the economic fluctuations from year to year or from

Quarter to quarter, which typically includes the following

Three modeling features:

(1)exogenous shocks;

(2)short-run rigidity;

(3)expectational errors.

1 exogenous shocks
(1) exogenous shocks

i.e., sudden abrupt influences on the economy coming from changes in preferences, technology, or economic policies.

Supply shock: Examples like

- a sudden increase in the productivity of resources

- a sudden increase in oil prices

Demand shock: Examples like

- a sudden rise in domestic consumption or investment rooted in more optimistic expectations concerning the future, or in a more expansionary fiscal or monetary policy, or in a sudden increase in the demand for exports.

2 short run rigidity
(2)short-run rigidity

i.e., some period after the occurrence of a shock during which some prices and/or wages are sticky.

Short-run nominal wage rigidity:

Nominal wage rates are fixed for a certain period of time.

Short-run nominal price rigidity:

The nominal prices of most goods and services are only adjusted with certain time intervals.

3 expectational errors
(3)expectational errors

i.e., a period after the occurrence of a shock during which some prices are different from what was expected before the shock.

Misperceptions by workers: since (most) wages had to be set before the shock, and since the shock was not perfectly foreseen, the negotiated wage had to be based on the expected price level which did not include the full inflationary effect of the shock.

Misperceptions by firms: when firms pre-set their prices for a certain period, they will base their pricing decisions on their expected costs which will be influenced by the expected general price level.

3 macroeconomic theory for the long run
3、Macroeconomic Theory for the Long Run

Macroeconomic theory for the long runintends to

explain the trend-wise movements of main economic

variables around which the year-to-year fluctuations occur,

which portrays the economy as if:

  • exogenous shocks do not occur, i.e., the economic fundamentals like preferences and technology develop in a smooth and foreseeable way over time;
  • prices are fully adjusted in all periods in accordance with the economy’s full long-run price flexibility
  • expectations are correct all the time
Supply side:
  • the long –run growth performance
  • the long-run gravity level of unemployment

Modeling feature:

static: a macroeconomic model for the long run can be a single-period static model: models of long-run structural unemployment

dynamic: dynamic models for the long run describe the process of capital accumulation and technological improvement: growth models

4 long run versus short run economic policies
4、Long-Run versus Short-Run Economic Policies

A main motivation for studying economic phenomena is the need to improve the basis for economic policy advice.

Long-run policies:aimed at promoting growth and long-run prosperity and at reducing long-run unemployment.

Structural: long-run policies must affect one or several structural characteristics of the economics such as the long-run prosperities to save and invest, to engage in education and R&D, etc.

Short-run policies: aimed at mitigating economic fluctuations and their harmful consequences coming, say, from sudden increases in unemployment.

Demand management:short-run policies can affect the rate of unemployment even if they do not influence the basic structures and incentives in the economy.