Chapter 1

An Introduction to Macroeconomics

Where the telescope ends, the microscope begins. Which of the two has the grander view? VICTOR HUGO

Macroeconomics & Microeconomics

Microeconomics
Decisions of individual units
No matter how large

Macroeconomics
Behavior of entire economies
No matter how small

Economic aggregates

Macroeconomics & Microeconomics

Aggregation
Combine many individual markets Into one overall market

Composition of demand & supply

In various markets Important for microeconomics issues Not important for macroeconomics issues

During economic fluctuations

Markets move up or down together
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Macroeconomics & Microeconomics

Macroeconomics
Assume most details
Resource allocation & income distribution Relatively unimportant

Microeconomics
Ignore macroeconomics issues Focus individual markets
Allocate resources Distribute income
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Supply & Demand in Macroeconomics

Aggregate demand curve
Quantity of domestic product demanded Each possible value of price level

Aggregate supply curve

Quantity of domestic product supplied Each possible value of price level

Figure 1
Two interpretations of a shift in the demand curve
Price Price
D E P0 S D1 D0 P1 P0 E A S

S D 0 Q0 Quantity (a) 0

S D0

D1

Quantity (b)
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Supply & Demand in Macroeconomics

Inflation
Sustained increase in price level Outward shift of aggregate demand curve

Recession period of time

Total output declines
Production falls People lose jobs

Leftward shift of aggregate demand curve

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Figure 2
An economy slipping into a recession
D0 D2 E S

Price Level

P0 P2 B

S 0 Q2 Q0

D2

D0

Domestic Product
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Supply & Demand in Macroeconomics

Macroeconomists study
Inflation Recession & unemployment Economic growth

Figure 3
Economic growth
D1 D0 S0 S1

Price Level

C E

D1 S0 0 S1 Q0 D0 Q1

Domestic Product
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Gross Domestic Product

Gross domestic product (GDP)
Sum: money values All final goods & services
Produced - domestic economy Sold organized markets

Specified period of time

Usually a year

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Gross Domestic Product

Nominal GDP
GDP in current dollars Value outputs current prices

Real GDP
Value outputs of different years
Common prices

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Gross Domestic Product

GDP - particular year
Add up money value of things Goods & services
Produced within the year

Final goods & services Production: geographic boundaries of U.S. Organized markets

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Gross Domestic Product

Final goods and services
Purchased by their ultimate users

Intermediate good - purchased

For resale For use in producing another good

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Gross Domestic Product

Limitations of GDP
Not measure: nations economic well-being Includes only market activity Places no value on leisure Counted: Bads and Goods Ecological costs
Not deducted from GDP

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The Economy on a Roller Coaster

U.S. economy
Growth with fluctuations

Macroeconomic fluctuations
Business cycles

Real GDP per capita

Ratio: real GDP divided by population

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Figure 4
Nominal GDP, real GDP, real GDP per capita since 1959

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Figure 5
The growth rate of U.S. real GDP since 1870

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The Economy on a Roller Coaster

Inflation
Sustained increase General price level

Deflation
Sustained decrease General price level

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Figure 6
The inflation rate in the United States since 1870

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The Economy on a Roller Coaster

The Great Depression, 1929-1933
Decline in economic activity Rapid deflation Production declined 30% Unemployment rate
Increased from 3% to 25%

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The Economy on a Roller Coaster

The Great Depression, 1929-1933
Revolution in economic thought
Before: economy corrects itself After: decrease in aggregate demand Monetary & fiscal policy

Ended: early 1940s

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The Economy on a Roller Coaster

From WWII to 1973
Increased government spending
Increased aggregate demand Accidental fiscal policy Price controls Shortage: consumer goods

1960s strong growth Vietnam war increased spending

Inflation & high unemployment

Wage & price controls

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The Economy on a Roller Coaster

Fiscal policy
Government spending & taxation Used to steer aggregate demand

Stagflation
Inflation While economy
Growing slowly (stagnating) Or recession

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The Economy on a Roller Coaster

The Great Stagflation, 1973-1980
OPEC 1973 oil prices quadrupled Poor harvests Recession
Inflation rate: 12% High unemployment

Stagflation Inward shift of aggregate supply

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The Economy on a Roller Coaster

The Great Stagflation, 1973-1980
Economy recovered
Government actions Natural economic forces

1979 OPEC soaring oil prices

Stagflation Inflation: 16%

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Figure 7
The effects of an adverse supply shift
D S1 A E S0

Price Level

S1 0

S0

Real GDP
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The Economy on a Roller Coaster

Reaganomics and its aftermath
Recovery underway High inflation Federal Reserve
Monetary policy High interest rate

Monetary policy
Actions Federal Reserve
Change interest rates Influence aggregate demand
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The Economy on a Roller Coaster

Reaganomics and its aftermath
1981-1982 recession Large budget deficits Recovery started 1982-1983 President Bush
Inflation Deficit-reduction package Spike in oil prices 1990-1991 recession
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The Economy on a Roller Coaster

Clintonomics: deficit reduction
Deficit-reduction package, 1993 & 1997
Tax increase & spending cuts

Large surplus Economy boomed Lower inflation Aggregate supply curves

Pushed outward rapid pace, 1996 1998

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Figure 8
The effects of a favorable supply shift
D1 D0 S0 S1 S2

Price Level

C E B

D1 S0 0 Real GDP
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S1

S2

D0

The Economy on a Roller Coaster

Tax cuts and the Bush economy
2001 recession
First in 10 years

Tax cut 2001 Budget deficit Burst of government spending

War on terror

Aggregate demand shift outward Federal Reserve

Lowered interest rate
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Problem of Macroeconomic Stabilization

Stabilization policy
Government programs Prevent or shorten recessions Counteract inflation, stabilize prices

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Problem of Macroeconomic Stabilization

Fight unemployment
Increase aggregate demand
Government - Fiscal policy Increase spending Cut taxes Federal Reserve - Monetary policy Lower interest rates

Increase output Reduce unemployment Raise prices

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Figure 9
Stabilization policy to fight unemployment
D1 D0 A S0

Price Level

D1 S0 0 Real GDP
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D0 Increase in output

Problem of Macroeconomic Stabilization

Fight inflation
Decrease aggregate demand
Government - Fiscal policy Cut spending Increase taxes Federal Reserve - Monetary policy Increase interest rates

Decrease inflation (decrease prices) Decrease output Increase unemployment

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Figure 10
Stabilization policy to fight inflation
D0 D2 S

Price Level

E B Decrease in prices S 0 Real GDP

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D2

D0

Stabilization policy
Prewar data
Fluctuations unmanaged economy
Booms & recessions Natural economic reasons Little government intervention

Postwar data
Economy - managed by government policy
Successfully or unsuccessfully

Recessions - less severe More inflation-prone

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