Chapter 1 notes

Average labor productivity amount of output produced per unit of

labor input
-average worker produces more now than before
Business Cycles describes short run contractions and expansions in
economic activity
-recession output falling/growing slowly
Unemployment people available to work but cannot find jobs
-highest and most prolonged period of unemployment during
Great Depression
Inflation when price of goods and services rise over time
-inflation primarily occurred during wartime
-periods of inflation followed by periods of deflation
-deflation prices of goods and servies fell
-inflation and deflation offset each other and prices remain fairly
constant in long run
inflation rate percentage increase in average level of prices over
the year
International Economy
-open economy economy that has extensive trading and financial
relationships with other national economies
-closed economy doesn't interact economically with rest of
world
-trade surplus when exports exceed imports
-trade deficit when imports exceed exports
Macroeconomic Policy
-two major types of macroeconomic policies:
-fiscal policy determined at national state and local levels
concerns govt spending and taxation
-monetary policy determined rate of growth of nations
money supply and under control of govt institution known as
central bank
-in US, central bank = Federal Reserve System or Fed
-main macroeconomic policies in recent years is in fiscal
-fed had large budget deficits during wartime, but deficits started
emerging in 1980s outside of war time
-during 1980s fed had large trade and budget deficits
Aggregation
-macroeconomics ignore find distinctions among goods, firms and
markets
-instead focus on national totals

-Aggregation process of summing individual economic

variables to obtain economy wide totals
1.2 What Macroeconomists Do
Macroeconomic Forecasting
-minor part of what macroeconomists do
-difficult to incorporate all variables and don't have complete
understanding of economy
Macroeconomic Analysis
-due to complexity of economy, macroeconomic policies will always be
uncertain regardless of amount of qualified macroeconomic analysts
-politicians not economics often make economic policies
-poliicians less concerned with abstract desirability of policy than
immediate effect on its constituents
Macroeconomic Research
-goal of macroeconomic research to make general statements of how
economy works
-macroeconomists able to offer advice by looking at historical cases
and working out theories
-research takes place primarily in colleges and universities and non
profitsand public sector
-in public sector line is more fuzzy between macro and economic
research
-many have to jump around between issues
Economic Theory
-economic theory set of ideas about economy that has been
organized in a logical framework
-economic model simplified description of some aspect of the
economy, usually expressed in mathematical form
-economic theories developed in terms of a mathematical model
-economic models evaluated by applying four criteria
1) are its assumptions reasonable and realistic?
2) is it understandable and manageable enough to be used in
studying real problems
3) does it have implications that can be tested by empirical
analysis?
-can its implications be evaluated by comparing them with
data obtained in real world?
4) when the implications and the data are compared, are the
implications of
the theory consistent with the data?
-for theory or model to be useful, answer to all questions must be yes

Developing and Testing an Economic Theory

1) state the research question
2) make provisional assumptions that describe the economic setting
and behavior of the economic actors
-these ssumptions should be simple yet capture the most
important aspect of the problem
3) work out the implications of the theory
4) conduct an empirical analysis to compare the implications of the
theory with the data
5) evaluate the results of your comparisons
if theory fits data poorly start from scratch with a new model
if theory fits data moderately well make do with partially successful
model or modify model with additional assumptions
Data Development
-macroeconomists use econ data to asses current state of econ, make
forecasts, analyze policy alternatives, and test macroeconomic
theories
-most data collected by fed govt
-also collected by private sector i.e. marketing firms
1.3 Why Macroeconomists Disagree
-positive analysis examines economic consequences of a policy but
doesn't address the question of whether those consequences are
desirable
-if one is asked to evaluated effect of 5% reduction in income
tax, that is positive analysis
-normative analysis tries to determine whether a certain policy
should be used
-i.e. if asked if income tax should be reduced by 5% , that is
normative analysis
-involves personal judgments as well as knowledge of economics
Classical Vs Keynesians
-classical and Keynesian approach are two major intellectual traditions
in macro
Classical approach
-goes back to adam smiths invisible hand
-invisible hand if free markets and individuals act in their own best
interests, overall economy will work well

-says that countrys resources and initial distribution of wealth,

use of free markets will make people as economically well off as
possible
-equilibrium situation in which there is no pressure for wages or
prices to change
-under classical approach, economists argue govt should have limited
role
Keynesian Approach
-during great depression, invisible hand seemed completely ineffective
-classical theory seemed inconsistent with data
-offered explanation that was very different from classical assumption
-instead of wages/prices adjusting quickly, they adjust slowly
-says that unemployment can persist bc wages and prices don't
adjust to equalize number of people that firms want to employ
-said that solution to high unemployment was to have govt increase
purcahses of goods and services
-this would raise demand for output and reduce unemployment
bc to meet higher demand, firms would have to hire more
workers
-newly hired workers would also have more income to spend
creating more demand for output
-keynesian advocate for govt to have bigger role in economy
Evolution of the Classical-Keynesian Debate
-keynesian approach dominated macro theory from wwii until 1970s
-Stagflation high unemployment and high inflation
-when us started suffering from stagflation, this weakened economists
confidence in Keynesian approach
-made classical approach look more interesting
-from 1970s modernized classical approach enjoyed major resurgence
among macroeconomic researchers
-in past three decades, advocates of both approaches have reworked
them extensively to repair their weaknesses