Macro I: Introduction To Macroeconomics: The Scope and Method of Economics

PART I INTRODUCTION TO ECONOMICS
Chapter
Macro I:
Introduction to Macroeconomics
The Scope and Method
of Economics
THE OVERALL THEME OF MACRO
CHAPTER 1: The Scope and Method

of Economics
Growth & Stability

Economic Growth An increase in the
total output of an economy. It occurs
when a society acquires new resources or
when it learns to produce more using
existing resources.
Stability A condition in which
national output is growing steadily, with
low inflation and full employment of
resources.
aggregate behavior is the behavior of all households and firms together.
2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

of Economics
MACROECONOMIC CONCERNS
Three of the major concerns of
macroeconomics are:
Inflation
Output growth
Unemployment

of Economics
INFLATION AND DEFLATION

inflation An increase in the overall
price level.
hyperinflation A period of very rapid
increases in the overall price level.
deflation A decrease in the overall
price level.

of Economics
Nominal and Real Prices

Nominal price: the absolute price of a good
in terms of dollars
The price you see on a good in a store
Real price: the nominal price of a good
relative to the average dollar price of all
other goods
Real prices are adjusted for inflation

1897 Sears
Catalog price
1997 dollar
equivalent
1 lb. baking soda
$0.06
100 lb. nails
$1.70
13" hammer
$0.42
Scissors
$0.75
Bread pan
$0.37
Telephone
$13.50
Pair of socks
$0.13
Dictionary
$0.70
Bicycle
$24.95

of Economics
Item

1897 Sears
Catalog price
1997 dollar
equivalent
1 lb. baking soda
$0.06
$5.34
100 lb. nails
$1.70
$151.39
13" hammer
$0.42
$37.40
Scissors
$0.75
$66.79
Bread pan
$0.37
$32.95
Telephone
$13.50
$1,202.23
Pair of socks
$0.13
$11.58
Dictionary
$0.70
$62.34
Bicycle
$24.95
$2,221.90

of Economics
Item
INFLATION

of Economics
PRICE INDEXES
consumer price index (CPI) A price
index computed each month by the
Bureau of Labor Statistics using a
bundle that is meant to represent the
market basket purchased monthly by
the typical urban consumer.
INFLATION

of Economics
Inflation Changes the Distribution of Income

If your income is fixed and prices rise, your
ability to purchase goods and services falls
proportionately.
Effects on Debtors and Creditors

real interest rate The difference
between the interest rate on a loan and
the inflation rate.
Inflation that is higher than expected benefits debtors; inflation that is lower than expected
benefits creditors.

of Economics
UNEMPLOYMENT
unemployment rate The percentage
of the labor force that is unemployed.
unemployed
unemployme nt rate
employed unemployed

of Economics
RECESSIONS, DEPRESSIONS, AND

UNEMPLOYMENT
labor force The number of people
employed plus the number of
unemployed.
labor force = employed + unemployed
population = labor force + not in labor force

of Economics

UNEMPLOYMENT
unemployed A person 16 years old or
older who is not working, is available for
work, and has made specific efforts to
find work during the previous 4 weeks.
not in the labor force A person who is
not looking for work, because he or she
either does not want a job or has given
up looking.

of Economics

UNEMPLOYMENT
discouraged-worker effect The
decline in the measured unemployment
rate that results when people who want
to work but cannot find jobs grow
discouraged and stop looking, thus
dropping out of the ranks of the
unemployed and the labor force.

UNEMPLOYMENT

of Economics
THE COSTS OF UNEMPLOYMENT

Some Unemployment Is Inevitable
When we consider the various costs of unemployment, it
is useful to categorize unemployment into three types:
Frictional unemployment
Structural unemployment
Cyclical unemployment

of Economics
structural unemployment The portion

of unemployment that is due to changes
in the structure of the economy that
result in a significant loss of jobs in
certain industries.
Together, the "natural rate"

of unemployment
frictional unemployment The portion

of unemployment that is due to the
normal working of the labor market; used
to denote short-run job/skill matching
problems.
cyclical unemployment The increase

in unemployment that occurs during
recessions and depressions.
EXPLAINING THE EXISTENCE OF

UNEMPLOYMENT

of Economics
MINIMUM WAGE LAWS

minimum wage laws Laws that set a
floor for wage ratesthat is, a minimum
hourly rate for any kind of labor.
THE U.S. ECONOMY SINCE 1900:

TRENDS AND CYCLES

of Economics
EXPANSION AND CONTRACTION: THE

BUSINESS CYCLE
A Typical Business Cycle

of Economics
recession A period during which
aggregate output declines.
Conventionally, a period in which
aggregate output declines for two
consecutive quarters.
depression A prolonged and deep
recession.

of Economics
GROSS DOMESTIC PRODUCT
gross domestic product (GDP) The total

market value of all final goods and services
produced within a given period by factors of
production located within a country.
GDP is the total market value of a countrys output. It is the market value of all final goods
and services produced within a given period of time by factors of production located within
a country.

of Economics
FINAL GOODS AND SERVICES

final goods and services Goods and
services produced for final use.
intermediate goods Goods that are
produced by one firm for use in further
processing by another firm.
value added The difference between
the value of goods as they leave a stage
of production and the cost of the goods
as they entered that stage.

of Economics
Tires taken from that pile and mounted on the wheels of the new car
before it is sold are considered intermediate goods to the auto producer.
Tires from that pile to replace tires on your old car are considered final
goods. If, in calculating GDP, we included the value of the tires (an
intermediate good) on new cars and the value of new cars (including the
tires), we would be double counting.

of Economics
NOMINAL VERSUS REAL GDP

current dollars The current prices that
one pays for goods and services.
nominal GDP Gross domestic product
measured in current dollars.
Gapminder?
LIMITATIONS OF THE GDP CONCEPT

of Economics
GDP AND SOCIAL WELFARE

Society is better off when crime decreases; however, a
decrease in crime is not reflected in GDP.
An increase in leisure is an increase in social welfare, but
not counted in GDP.
Nonmarket and household activities are not counted in
GDP even though they amount to real production.

of Economics
LIMITATIONS OF THE GDP CONCEPT

underground economy The part of the
economy in which transactions take
place and in which income is generated
that is unreported and therefore not
counted in GDP.
Whenever sellers looking for a
profit come into contact with
buyers willing to pay, markets
will arise, often underground.

of Economics
LONG-RUN AND SHORT-RUN CONCERNS: GROWTH,

PRODUCTIVITY, UNEMPLOYMENT, AND INFLATION
output growth The growth rate of the

output of the entire economy.
per-capita output growth The growth
rate of output per person in the
economy.
Chapter
Macro II:
Aggregate Demand and Supply
of Economics
THE ROOTS OF MACROECONOMICS

of Economics
Classical Models
Classical economists applied microeconomic models, or
market clearing models, to economy-wide problems.
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.
THE ROOTS OF MACROECONOMICS

of Economics
The Keynesian Revolution

In 1936, John Maynard Keynes published The General
Theory of Employment, Interest, and Money.
Much of macroeconomics has roots in Keyness work.
According to Keynes, it is not prices and wages that
determine the level of employment, as classical models
had suggested, but instead the level of aggregate demand
for goods and services.

of Economics
THE METHODOLOGY OF MACROECONOMICS

AGGREGATE DEMAND AND AGGREGATE
SUPPLY
aggregate demand The total demand
for goods and services in an economy.
aggregate supply The total supply of
goods and services in an economy.

of Economics
The Wiki AS curve
Chapter
Macro III:
Fiscal Policy and Taxation

of Economics

of Economics
GOVERNMENT IN THE MACROECONOMY

fiscal policy Government policies
concerning taxes and expenditures
(spending).
monetary policy The tools used by
the Federal Reserve to control the
quantity of money in the economy.
discretionary fiscal policy Changes in
taxes or spending that are the result of
deliberate changes in government policy.
THE FEDERAL BUDGET

of Economics
Debt vs. Deficit

federal debt The total amount owed
by the federal government.
federal surplus (+) or deficit ()
Federal government receipts minus
expenditures.

of Economics
THE ECONOMYS INFLUENCE

ON THE GOVERNMENT BUDGET
automatic stabilizers Revenue and
expenditure items in the federal
budget that automatically change
with the state of the economy in such
a way as to stabilize GDP.
Chapter
Macro IV:
Money and the Banking System
of Economics
AN OVERVIEW OF MONEY

of Economics
WHAT IS MONEY?
store of value An asset that can be
used to transport purchasing power from
one time period to another.
medium of exchange What sellers
generally accept and buyers generally
use to pay for goods and services.
unit of account A standard unit that
provides a consistent way of quoting
prices.

of Economics
AN OVERVIEW OF MONEY
fiat money Items designated as money

that are intrinsically worthless.
The cash in your wallet is fiat money
HOW BANKS CREATE MONEY

of Economics
A HISTORICAL PERSPECTIVE: GOLDSMITHS

run on a bank Occurs when many of
those who have claims on a bank
(deposits) present them at the same
time.

of Economics
Banks usually make loans up to the point where they can no longer do so
because of the reserve requirement restriction.
reserves The deposits that a bank

has at the Federal Reserve bank plus
its cash on hand.
required reserve ratio The
percentage of its total deposits that a
bank must keep as reserves at the
Federal Reserve.

of Economics
THE MONEY MULTIPLIER

An increase in bank reserves leads to a greater than one-for-one increase in the money
supply. Economists call the relationship between the final change in deposits and the
change in reserves that caused this change the money multiplier. Stated somewhat
differently, the money multiplier is the multiple by which deposits can increase for every
dollar increase in reserves.
money multiplier The multiple by

which deposits can increase for every
dollar increase in reserves; equal to 1
divided by the required reserve ratio.
money multiplier
1
required reserve ratio

of Economics
HOW THE FEDERAL RESERVE CONTROLS

THE MONEY SUPPLY
If the Fed wants to increase the supply of money, it creates more reserves, thereby freeing
banks to create additional deposits by making more loans. If it wants to decrease the
money supply, it reduces reserves.
Three tools are available to the Fed for

changing the money supply:
(1) changing the required reserve ratio;
(2) changing the discount rate; and
(3) engaging in open market operations.
THE EQUILIBRIUM INTEREST RATE

of Economics
SUPPLY AND DEMAND IN THE MONEY MARKET

If the interest rate is initially high
enough to create an excess supply of
money, the interest rate will
immediately fall, discouraging
people from moving out of money
and into bonds.
If the interest rate is initially low
enough to create an excess demand
for money, the interest rate will
immediately rise, discouraging
people from moving out of bonds
and into money.

of Economics
CHANGING THE MONEY SUPPLY TO AFFECT THE

INTEREST RATE
The Effect of an Increase in the Supply of Money on the Interest Rate

of Economics
EXPANSIONARY POLICY EFFECTS

expansionary fiscal policy An increase
in government spending or a
reduction in net taxes aimed at increasing
aggregate output (income) (Y).
expansionary monetary policy An
increase in the money supply aimed at
increasing aggregate output (income) (Y).

of Economics
CONTRACTIONARY POLICY EFFECTS

contractionary fiscal policy A decrease
in government spending or an increase in
net taxes aimed at decreasing aggregate
output (income) (Y).
contractionary monetary policy A
decrease in the money supply aimed at
decreasing aggregate output (income) (Y).
Chapter
Macro V:
Stabilization Policies
of Economics

of Economics
TIME LAGS REGARDING MONETARY

AND FISCAL POLICY
Two Possible Time Paths for GDP

of Economics

AND FISCAL POLICY
stabilization policy Describes both
monetary and fiscal policy, the goals of
which are to smooth out fluctuations
in output and employment and to keep
prices as stable as possible.
time lags Delays in the economys
response to stabilization policies.
(back seat driver?)

AND FISCAL POLICY

of Economics
recognition lag The time it takes for policy makers to

recognize the existence of a boom or a slump.
implementation lag The time it takes to put the
desired policy into effect once economists and policy
makers recognize that the economy is in a boom or a
slump.
response lag The time that it takes for the
economy to adjust to the new conditions after a
new policy is implemented; the lag that occurs
because of the operation of the economy itself.

AND FISCAL POLICY

of Economics
Summary
Stabilization is not easily achieved. It takes
time for policy makers to recognize the
existence of a problem, more time for them
to implement a solution, and yet more time
for firms and households to respond to the
stabilization policies taken.
Chapter
Macro VI:
Stocks, bonds, international trade, and
The Scope
and Method
currency
exchange
of Economics

of Economics
STOCKS AND BONDS

bond A document that formally
promises to pay back a loan under
specified terms, usually over a specific
time period. (may pay interest)
stock A certificate that certifies
ownership of a certain portion of a firm.
(may pay dividends)
capital gain An increase in the value of
an asset.

of Economics
THE STOCK MARKET SINCE 1948
Dow Jones Industrial Average An index based on the

stock prices of 30 actively traded large companies. The
oldest and most widely followed index of stock market
performance.
But who cares?
The Dow is a price-weighted index.
Its simple, and was computationally feasible for 1910.
It's irrelevant today.

of Economics

NASDAQ Composite An index based on
the stock prices of over 5,000 companies
traded on the NASDAQ Stock Market.
The NASDAQ market takes its name from
the National Association of Securities
Dealers Automated Quotation System.
(Tech companies...)

of Economics

Standard and Poors 500 (S&P 500) An index
based on the stock prices of the largest 500 firms
traded on the New York Stock Exchange, the
NASDAQ Stock Market, and the American Stock
Exchange.
This is the standard, typically.
Its not based on the prices as much as the firm size
(value weighted).

of Economics
THE ECONOMIC BASIS FOR TRADE:

COMPARATIVE ADVANTAGE
theory of comparative advantage
Ricardos theory that specialization and free
trade will benefit all trading partners (real
wages will rise), even those that may be
absolutely less efficient producers.
Specialization and free trade will benefit all trading partners (real wages will rise), even those
that may be absolutely less efficient producers.


of Economics
ABSOLUTE ADVANTAGE VERSUS

absolute advantage The advantage in the
production of a product enjoyed by one
country over another when it uses fewer
resources to produce that product than the
other country does.
comparative advantage The advantage in
the production of a product enjoyed by one
country over another when that product can
be produced at lower cost in terms of other
goods than it could be in the other country.


of Economics
Why Does Ricardos Plan Work?
Comparative Advantage Means Lower Opportunity Cost

When countries specialize in producing goods in which they have a comparative advantage,
they maximize their combined output and allocate their resources more efficiently.

of Economics
TRADE BARRIERS: TARIFFS, EXPORT

SUBSIDIES, AND QUOTAS
protection The practice of shielding a sector
of the economy from foreign competition.
tariff A tax on imports.
export subsidies Government payments
made to domestic firms to encourage exports.
dumping A firm or industrys sale of
products on the world market at prices
below the cost of production.
quota A limit on the quantity of imports.
Open-Economy Macroeconomics:
Exchange Rates

of Economics
When people in different countries buy from and sell to each other, an exchange of
currencies must also take place.
exchange rate The price of one

countrys currency in terms of
another countrys currency; the
ratio at which two currencies are
traded for each other.
THE OPEN ECONOMY WITH FLEXIBLE

EXCHANGE RATES
The Equilibrium Exchange Rate
of Economics
The equilibrium exchange rate occurs at the point at which the quantity demanded of
a foreign currency equals the quantity of that currency supplied.
appreciation of a
currency The rise in value
of one currency relative to
another.
depreciation of a
currency The fall in value
of one currency relative to
another.
The Equilibrium Exchange Rate
THE OPEN ECONOMY WITH FLEXIBLE

EXCHANGE RATES
FACTORS THAT AFFECT EXCHANGE RATES
of Economics
Purchasing Power Parity: The Law of One Price

law of one price If the costs of
transportation are small, the price of the
same good in different countries should be
roughly the same.
purchasing-power-parity theory A
theory of international exchange holding
that exchange rates are set so that the
price of similar goods in different countries
is the same.

Macro I: Introduction To Macroeconomics: The Scope and Method of Economics

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Macro I: Introduction To Macroeconomics: The Scope and Method of Economics

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PART I INTRODUCTION TO ECONOMICS

THE OVERALL THEME OF MACRO

CHAPTER 1: The Scope and Method

Growth & Stability

CHAPTER 1: The Scope and Method

CHAPTER 1: The Scope and Method

INFLATION AND DEFLATION

CHAPTER 1: The Scope and Method

Nominal and Real Prices

Nominal and Real Prices

1 lb. baking soda

100 lb. nails

CHAPTER 1: The Scope and Method

Nominal and Real Prices

1 lb. baking soda

100 lb. nails

CHAPTER 1: The Scope and Method

CHAPTER 1: The Scope and Method

CHAPTER 1: The Scope and Method

Inflation Changes the Distribution of Income

Effects on Debtors and Creditors

CHAPTER 1: The Scope and Method

CHAPTER 1: The Scope and Method

RECESSIONS, DEPRESSIONS, AND

CHAPTER 1: The Scope and Method

RECESSIONS, DEPRESSIONS, AND

CHAPTER 1: The Scope and Method

RECESSIONS, DEPRESSIONS, AND

RECESSIONS, DEPRESSIONS, AND

CHAPTER 1: The Scope and Method

THE COSTS OF UNEMPLOYMENT

CHAPTER 1: The Scope and Method

structural unemployment The portion

Together, the "natural rate"

frictional unemployment The portion

cyclical unemployment The increase

EXPLAINING THE EXISTENCE OF

CHAPTER 1: The Scope and Method

MINIMUM WAGE LAWS

THE U.S. ECONOMY SINCE 1900:

CHAPTER 1: The Scope and Method

EXPANSION AND CONTRACTION: THE

A Typical Business Cycle

CHAPTER 1: The Scope and Method

CHAPTER 1: The Scope and Method

GROSS DOMESTIC PRODUCT

gross domestic product (GDP) The total

GROSS DOMESTIC PRODUCT

CHAPTER 1: The Scope and Method

FINAL GOODS AND SERVICES

CHAPTER 1: The Scope and Method

GROSS DOMESTIC PRODUCT

CHAPTER 1: The Scope and Method

NOMINAL VERSUS REAL GDP

LIMITATIONS OF THE GDP CONCEPT

CHAPTER 1: The Scope and Method

GDP AND SOCIAL WELFARE

CHAPTER 1: The Scope and Method

LIMITATIONS OF THE GDP CONCEPT

CHAPTER 1: The Scope and Method

LONG-RUN AND SHORT-RUN CONCERNS: GROWTH,

output growth The growth rate of the

PART I INTRODUCTION TO ECONOMICS