CHAPTER 1
INTRODUCTION TO
MACROECONOMICS
A LT I P L A N O U N I V E R S I T Y
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Performance
Addressed Consumption
Issues Pattern
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Long run
Fluctuate Short run
Unemployment Growth
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Price
Worst Rise
Improve Policies
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Crises
Poor Afflicted
Policy
Tear
makers
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Offset
Save Output
Available Input
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Saving
Recession Investment
Business cycles Rates
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Downward
Inflation Phase
Seeking Concern
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Fall
Reaches Falling
Level Average
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Tends
Trading Poorly
As soon as Erodes
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Borrowing
Reaches Trade
Business
Trading
cycles
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Abroad
Stock Imbalances
Foreign
Citizen
currency
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Divert
Trend Economywide
Forecasting Forecast
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Framework
Stagflation Approach
Alleviate Further
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Thrift Households
WHAT MACROECONOMICS IS ABOUT
Macroeconomics is the study of the structure and performance of
national economies and of the policies that governments use to try to
affect economic performance.
When we study the consumption behavior or equilibrium of a consumer;
the production pattern & equilibrium of a firm, the entire analysis is
‘micro’ in nature……because we study a UNIT and not the SYSTEM in
which it is operating
ISSUES ADDRESSED BY
MACROECONOMISTS
What
determines a
nation’s long-
run economic What causes
growth? unemployment?
What causes a
nation’s
economic
activity to
fluctuate?
ISSUES ADDRESSED BY
MACROECONOMISTS
Can government
policies be used
to improve
What causes economic
prices to rise? performance?
How does being a
part of a global
economic system
affect nations’
economies?
ISSUES ADDRESSED BY
MACROECONOMISTS
Study of Macroeconomics also
help governments avoid the worst
economic crises that have afflicted
modern industrial societies in the
past century—depressions and
hyperinflations.
These extreme situations can tear
at a society’s social fabric, yet can
be prevented when policy-makers
apply sound economic principles.
LONG-RUN ECONOMIC GROWTH
Rich nations have Poor nations either have
experienced extended never experienced them or
periods of rapid economic economic growth was
growth. offset by economic decline.
INCREASED OUTPUT
Total output is increasing Increasing average labour
because of increasing productivity: the amount
population, the number of output produced per
of available workers. unit of labour input.
RATES OF GROWTH OF OUTPUT
Rates of growth of output (or output
per worker) are determined by:
rates of rates of rates of
saving and technological change in
investment; change; other factors.
BUSINESS CYCLES
Business cycles are
short-run contractions
and expansions of
economic activity.
RECESSIONS
Recession is the downward phase of a business cycle
when national output is falling or growing slowly.
• Hard times for many people
• A major political concern
UNEMPLOYMENT
Recessions are usually accompanied by
high unemployment: the number of people
who are available for work and are actively
seeking it but cannot find jobs.
Unemployed
Unemployment Rate = 100%
Labour Force
THE UNEMPLOYMENT RATE
The unemployment rate can stay high even
when the economy is doing well.
Example:
After eight years of economic growth, in 2000,
the unemployment rate in Perú was near 5%.
INFLATION
When prices of most goods and services
are rising over time it is inflation. When
they are falling it is deflation.
The inflation rate is the percentage
increase in the average level of prices.
EFFECTS OF INFLATION
When the inflation rate reaches an
extremely high level the economy
tends to function poorly. The
purchasing power of money erodes
quickly, which forces people to
spend their money as soon as they
receive it.
THE INTERNATIONAL ECONOMY
An economy which has extensive
trading and financial relationships
with other national economies is
an open economy. An economy
with no relationships is a closed
economy.
THE INTERNATIONAL ECONOMY
International trade and
borrowing
relationships can
transmit business
cycles from country to
country.
EXPORTS AND IMPORTS
Peruvian exports are goods
and services produced in Peru
and consumed abroad.
Peruvian imports are goods
and services produced abroad
and consumed in Peru.
TRADE IMBALANCES
Trade imbalances (trade
surplus and deficit) affect
output and employment.
• Trade surplus: exports exceed
imports.
• Trade deficit: imports exceed
exports.
THE EXCHANGE RATE
The trade balance is affected
by the exchange rate: the
amount of USA dollars that
can be purchased with a unit
of foreign currency.
MACROECONOMIC POLICY
A nation’s economic
performance depends
on:
• natural and human resources;
• capital stock;
• technology
• economic choices made by
citizens;
• macroeconomic policies of the
government.
MACROECONOMIC POLICY
Macroeconomic policies:
• Fiscal policy: government spending and taxation at different government levels.
• Monetary policy: the central bank’s control of short-term interest rates and the money supply.
BUDGET DEFICITS
The economy is affected when
there are large budget deficits: the
excess of government spending
over tax collection.
BUDGET DEFICITS
The large • Borrowing from the public
budget might divert funds from
deficits of more productive uses.
the 1985s • Estate budget deficits
and early might be linked to the
1990s are decline in productivity
growth.
dangerous .
AGGREGATION
Macroeconomists ignore distinctions between individual
product markets and focus on national totals.
The process of summing individual economic variables
to obtain economywide totals is called aggregation.
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Summing
Research Sum
Uncertain Trends
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Assess
Employment A set of
Unemployment Welfare
Maintain
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Approach
Roots Asset
Arise Wages
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Throughout
Felt
Stock markets
Crashed
Filed
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Loans Piling up
Layoffs Retaliation
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Remain Adverse
Adversely Thrift
WHAT MACROECONOMISTS DO
Macroeconomic • Macroeconomic forecasting – prediction of future economic trends - has some
forecasting success in the short run. In the long run too many factors are highly uncertain.
• Macroeconomic analysis - analyzing and interpreting events as they happen –
Macroeconomic analysis helps both private sector and public policymaking.
• Macroeconomic research - trying to understand the structure of the economy in
Macroeconomic research general – forms the basis for macroeconomic analysis and forecasting.
• Macroeconomists use data to assess the state of the economy, make forecasts,
Data development analyze policy alternatives, and test theories.
ECONOMIC THEORY
Economic theory: a set of ideas
about the economy to be
organized in a logical framework.
Economic model: a simplified
description of some aspects of
the economy.
THE CLASSICAL APPROACH
The invisible hand of
Economics: General
welfare will be maximized
(not the distribution of Thus, according to the
wealth) if: classical approach, the
•there are free markets; government should have a
•individuals act in their own best limited role in the
interest. economy.
To maintain markets’
equilibrium – the quantities
demanded and supplied are
equal:
•Markets must function without
impediments.
•Wages and prices should be
flexible.
THE KEYNESIAN APPROACH
Keynes (1936) The government can
assumed that wages purchase goods and
and prices adjust services, thus
slowly. increasing the demand
• Thus, markets could be out for output and
of equilibrium for long
periods of time and reducing
unemployment can persist. unemployment.
Therefore, according Newly generated
to the Keynesian incomes would be
approach, spent and would raise
governments can take employment even
actions to alleviate further.
unemployment.
CLASSICAL-KEYNESIAN DEBATE
After stagflation – high unemployment and
high inflation – of the 1970s, a modernized
classical approach reappeared.
Substantial communication and cross-
pollination is taking place between the
classical and the Keynesian approaches.
UNIFIED APPROACH TO
MACROECONOMICS
Individuals, firms and the government interact in goods, asset and labour markets.
The macroeconomic analysis is based on the analysis of individual behaviour.
Keynesian and classical economists agree that in the long run prices and wages adjust
to equilibrium levels.
The basic model will be used either with classical or Keynesian assumptions about
flexibility of wages and prices.
ROOTS OF MACRO ECONOMICS
The Roots of Macroeconomics
The Great Depression was a period
Before the publication of Keynes of severe economic contraction and
“General Theory….”, the distinction high unemployment that began in
between Micro & Macro economic 1929 and continued throughout the
issues did not arise at all. 1930s.
The need for separate study of macro
economics was felt by Keynes while
understanding and analysing the Great
Depression of 1929.
THE GREAT DEPRESSION – WHAT HAPPENED ?
Stock Markets crashed!
9000 banks filed for bankruptcy
Banks that survived stopped giving loans.
People cut down spending
Large amounts of inventories started piling up
Businesses stopped production….layoffs!( 25% unemployment)
Purchasing power declined
Decline in world trade & economic retaliation.
THE ROOTS OF
MACROECONOMICS
The accepted economic theory of the pre – Keynesian
era, believed that the economy usually remains at full
employment level( full utilization of resources). If there
are any departures from this situation, these are purely
temporary and for a short period of time.
However, these 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
In 1936, John Maynard Keynes published The General Theory of
Employment, Interest, and Money.
Keynes believed governments could intervene in the economy and
affect the level of output and employment.
During periods of low private demand, the government can
stimulate aggregate demand to lift the economy out of recession.
IMPORTANCE OF MACRO ECONOMICS
To understand the working of the economy. Macroeconomic variables like Total Income,
Total Output, Employment and General Price level help us in analysing the
functioning of the economy.
In Economic Policies. Macro economic study helps us to find a solution to complex
economic problems of modern times. Ex. 1.General Unemployment, National
Income data helps in forecasting the level of economic activity & to understand the
distribution of income among different groups of people in the economy.
In Economic Growth. To plan for economic growth, it is necessary that the macro
economic variables like income, output and employment are evaluated.
IMPORTANCE OF MACRO ECONOMICS
In Monetary Problems . Frequent changes in the value
of money ( ?) affects the economy adversely!!
In Business Cycles. Macro economics began to be
studied only after the Great Depression. Thus, its
importance lies in analyzing the causes of economic
fluctuations and in providing remedies.
NEED FOR A SEPARATE THEORY OF MACRO
ECONOMICS
• Fallacy of composition – Behaviour of an aggregate system. Example crowd behaviour,
unemployment problem, paradox of thrift
CIRCULAR FLOW OF INCOME MODEL
• Functioning of an Economy
• A model to understand the functioning of a macro economic system or the economy as a
whole is called the ‘Circular Flow of Income Model’
CIRCULAR FLOW OF INCOME ( REAL FLOW)
TWO SECTOR ECONOMY
Goods for
consumption
Households Firms
Factor Services for
production
CIRCULAR FLOW OF INCOME ( REAL + MONEY
FLOW) IN A TWO SECTOR ECONOMY
Consumption
Expenditure
Goods for
consumption
Households Firms
Factor
Factor Services for
Payments production
THREE SECTOR ECONOMY
Taxes
Taxes Firms
Govt.
Households
Payment of Payment
salaries to for G&S
Govt.
employees
THE COMPONENTS OF • Everyone’s expenditure
is someone else’s
THE MACROECONOMY receipt. Every
transaction must have
two sides.
