CHAPTER 1

1. CHAPTER 1 Introduction to Macroeconomics

2. Definition MACROECONOMICS is the study of … the structure and performance of national economies and the policies that governments use to try to affect economic performance. Aggregation … is the process of summing individual economic variables to obtain economy wide totals i.e. aggregate consumption aggregate investment aggregate output.

3. Macroeconomic Issues What determines a nation’s long-run economic growth? What causes a nation’s economic activity to fluctuate? What causes unemployment? What causes prices to rise? How does being part of a global economic system affect nation’s economies? Can government policies be used to improve a nation’s economic performance?

4. Issue 1:Long-run Economic Growth FIGURE 1.1 Rich nations have had periods of rapid economic growth. Poor nations have not had sustained growth or have suffered periods of economic decline. US: since 1869, annual output ↑ by >100 times and influenced by military, social and cultural implications. Output (US) 

5. Issue 1: Long-run Economic Growth FIGURE 1.2 Long-term economic growth is the US is attributable to: Rising population ↑ Average labor productivity Example: Output per worker ↑ by: 2.5% per year 1949-1973 1.0% per year 1973-1995 1.9% per year 1995-2002 Average labor productivity 

6. Issue 2: Business Cycles FIGURE 1.1 Describes short-run contractions and expansions in economic activity. Recession: the period of time during which aggregate economic activity is falling (the downward phase of a business cycle). Output (US) 

7. Issue 3: Unemployment FIGURE 1.3 Unemployment = the number of people who are available for work and are actively seeking work but cannot find jobs. Unemployment rate = the number of unemployed / the total labor force. Unemployment rate 

8. Issue 4: Inflation FIGURE 1.4 Inflation: when prices of most goods and services are rising over time. Deflation: when prices of most goods and services fall over time. Inflation rate: the percentage increase in the average level of prices over a year. Inflation rate 

9. Issue 5:The International Economy FIGURE 1.5 Open economy: when one country practices extensive trading and financial relationships with other national economies. Closed economy: when one country doesn’t interact economically with the rest of the world. Trade imbalance i.e. trade surplus, trade deficit. US Exports and Imports 

10. Issue 6:Macroeconomic Policy FIGURE 1.6 Fiscal policy: concerns government spending (G) and taxation (T) at the national, state, and local levels. Monetary policy: determines the rate of growth of the nation’s money supply, under the control of the central bank. US government spending and tax collections 

11. Macroeconomic activities Macroeconomic Forecasting It is impossible to forecast with accuracy since there are too many factors that need to be considered but it helps to understand past and present situations in macroeconomics. Macroeconomic Analysis Analyzes current economic situations and issues to assist in decision-making by the government and private sectors. Macroeconomic Research Pulls resources to gather more information on specific matter including studying results from previous research done by others. Data Development Economic data are collected and analyzed to assess the current economy, make forecasts, analyze policy alternatives, and test macroeconomic theories.

12. Macroeconomic activities Economic Theory Set of ideas about the economy that has been organized in a logical framework, developed in terms of an economic model which is usually expressed in mathematical form based on specified assumptions, empirical analysis and policy implication. STEP 1. State the research question. STEP 2. Identify provisional assumptions. STEP 3. Work out the implications. STEP 4. Conduct an empirical analysis. STEP 5. Evaluate the results for consistency.

13. Macroeconomics: The Classical Approach Based on the “invisible hand” and “free-market economy” concepts by Adam Smith (1776). Markets and individuals interact freely to maximize own self-interest and the economy will self-adjust to maximize general welfare. Key assumption: prices adjust quickly in all markets including financial, labor and product markets. Prices must react to demand and supply to maintain equilibrium.

14. Macroeconomics: The Keynesian Approach Based the assumption of price and wage rigidity by John Maynard Keynes (1936). Wages and prices adjust very slowly and market ends up in disequilibrium for longer periods of time. Keynes’ proposed solution to high unemployment is for the government to increase government spending to boost economic activities [government intervention].

15. Macroeconomics: The Classical-Keynesian Approach In effort to explain the 1970s stagflation: high unemployment + high inflation. Integration of both approaches to key macroeconomic issues: Classical economists works to improve explanations on business cycles and unemployment. Keynesians works to develop theoretical foundations to explain slow adjustment of wages and prices.

16. Abel: A Single Economic Model Joins both Classical and Keynesian school of thoughts in a single model with these characteristics: 1. Individuals, firms and the government interact in goods markets, asset markets, and labor markets. 2. The macroeconomic analysis is based on the analysis of individual behavior in maximizing own satisfaction, given their needs, opportunities and resources. 3. Prices and wages fully adjust in the long-run and achieve market equilibrium. [Long-term economic behavior Chapters 3-7, Short-term Chapters 8-13]. 4. This model may be used with either the classical or the Keynesian assumptions.

17. End of Chapter 1 Definition Macroeconomic Issues Macroeconomic activities Classical, Keynesian, Classical-Keynesian A Single Economic Model