Unit 1: Introduction to

Macroeconomics
 Learning objectives

• Identify three economic issues.

• Describe microeconomics, macroeconomics, and the diverse
fields of economics.
• Describe the primary concerns of macroeconomics.
• Identify components of the macroeocnomy.
• Understand the roles of firms, entrepreneurs, and households
in the market.
• Use of models to analyze economic issues

Introduction to Macroeconomics 2
 Contents
1.1 Definition of Economics
1.2 Microeconomics and macroeconomics
1.3 Macroeconomics concerns
1.4 The components of macroeconomy
1.5 Thinking like an economist
1.6 Why economics disagree?

Introduction to Macroeconomics 3
1.1 What is an economics?

Labour
Capital Goods Wants,
Processes Service Needs
Land
etc,

Scarce
resources
Limited
Outputs
? Unlimited

What to produce?
How to produce?
For whom to produce?

Introduction to Macroeconomics 4
 1.1 What is an Economics?
• Scarcity. . . means that society has limited resources and
therefore cannot produce all the goods and services people
wish to have.

• The management of society’s resources is important because

resources are scarce.

▪ Economics is the study of how society manages its scarce

resources.

Introduction to Macroeconomics 5
 Economic Study
▪ Economists study how people make decisions
▪ How much they work
▪ What they buy
▪ How much they save
▪ How they invest their savings

▪ Economists also study how people interact such as buyers and sellers
▪ Price determination

▪ Economists also analyze forces and trends that affect the economy as a
whole
▪ Growth in average income
▪ The rate of price increase.

Introduction to Macroeconomics 6
 1.2 Microeconomics and Macroeconomics
• Microeconomics: focuses on the individual parts of the
economy.
• The study of how individual households and firms make decisions,
interact with one another in markets.
• Macroeconomics: looks at the economy as a whole.
• Study the structure of aggregate economies and the impact of policies
on their performance.
• What determines economic fluctuations? (business cycle)
• Why some countries grow faster than others? (economic growth)
• What causes unemployment?
• What drives prices changes? (inflation)
• What is the role of economic policies and the government? (monetary and fiscal
policies)
• How being part of a global economic system affects the economy of a country?
Introduction to Macroeconomics 7
 1.3 Macroeconomics concerns
Three of the major concerns of macroeconomics are:

• Output growth

• Unemployment

• Inflation and deflation

Introduction to Macroeconomics 8
 Output Growth
• aggregate output The total quantity of goods and services
produced in an economy in a given period.
• business cycle The cycle of short-term ups and downs in the
economy.
• 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.
• contraction, recession, or slump The period in the business cycle
from a peak down to a trough during which output and employment
fall.
• expansion or boom The period in the business cycle from a trough
up to a peak during which output and employment grow.
Introduction to Macroeconomics 9
 A Typical Business Cycle

In this business cycle, the

economy is expanding as it
moves through point A from
the trough to the peak.

The economy is in
recession when it moves
through point B from a peak
down to a trough.

Introduction to Macroeconomics 10
U.S. Real GDP per capita

Introduction to Macroeconomics 11
U.S. inflation rate
(% per year)

Introduction to Macroeconomics 12
U.S. unemployment rate
(% of labor force)

Introduction to Macroeconomics 13
Vietnam growth rate and GDP per capita
3000 12.00

2500 10.00

2000 8.00

1500 6.00

1000 4.00

500 2.00

0 0.00
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Real GDP per capita (constant 1995, USD) GDP Growth Rate(%)

Introduction to Macroeconomics 14
 Unemployment and Inflation

• Unemployment
• unemployment rate The percentage of the labor force that is
unemployed.

• 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.

Introduction to Macroeconomics 15
 1.4 The Components of the Macroeconomy
• Understanding how the macroeconomy works can be challenging
because a great deal is going on at one time. Everything seems to
affect everything else.
• To see the big picture, it is helpful to divide the participants in the
economy into four broad groups:
• Households.
• Firms.
• The government.
• The rest of the world.
• Households and firms make up the private sector, the government
is the public sector, and the rest of the world is the foreign sector.

Introduction to Macroeconomics 16
 The Circular Flow Diagram
• The circular-flow Revenue
MARKETS
FOR Spending

diagram is a visual Goods

GOODS AND SERVICES
•Firms sell Goods and
•Households buy
model of the and services
sold
services
bought

economy that
shows how dollars FIRMS HOUSEHOLDS

flow through •Produce and sell

goods and services
•Buy and consume
goods and services
•Hire and use factors •Own and sell factors
markets among of production of production

households and
firms. Factors of Labour, land,
MARKETS
production FOR and capital
FACTORS OF PRODUCTION
Wages, rent, •Households sell Income
and profit •Firms buy
= Flow of inputs
and outputs
= Flow of dollars

Introduction to Macroeconomics 17
 The Circular Flow of Payments
Households receive income from firms and the
government, purchase goods and services from
firms, and pay taxes to the government.
They also purchase foreign-made goods and
services (imports).
Firms receive payments from households and the
government for goods and services; they pay
wages, dividends, interest, and rents to households
and taxes to the government.
The government receives taxes from firms and
households, pays firms and households for goods
and services—including wages to government
workers—and pays interest and transfers to
households.
Finally, people in other countries purchase goods
and services produced domestically (exports).
Note: Although not shown in this diagram, firmsto Macroeconomics
Introduction 18
and governments also purchase imports.
 The Three Market Arenas
• Another way of looking at the ways households, firms, the
government, and the rest of the world relate to one another is
to consider the markets in which they interact.

• We divide the markets into three broad arenas:

• The goods-and-services market.

• The money (financial) market.

• The labor market.

Introduction to Macroeconomics 19
 The Three Market Arenas
• Goods-and-Services Market
• Households and the government purchase goods and services from
firms in the goods-and-services market.
• Firms purchase goods and services from each other and also supply
to the goods-and-services market.
• Households, the government, and firms demand from this market.
• The rest of the world buys from and sells to the goods-and-services
market.
• Labor Market
• In the labor market, households supply labor and firms and the
government demand labor.
• Labor is also supplied to and demanded from the rest of the world.

Introduction to Macroeconomics 20
 The Three Market Arenas
• Money Market
• Households supply funds to the money market—sometimes called the
financial market—in the expectation of earning income in the form of
dividends on stocks and interest on bonds.
• Households also demand (borrow) funds from this market to finance
various purchases.
• Firms borrow to build new facilities in the hope of earning more in the
future.
• The government borrows by issuing bonds.
• The rest of the world borrows from and lends to the money market.
• Much of this borrowing and lending is coordinated by financial
institutions, which take deposits from one group and lend them to
others.

Introduction to Macroeconomics 21
 Financial Instruments in the Financial Market
• Treasury bonds, notes, and bills Promissory notes issued by
the government when it borrows money.
• Corporate bonds Promissory notes issued by firms when
they borrow money
• Shares of stock Financial instruments that give to the holder
a share in the firm’s ownership and therefore the right to share
in the firm’s profits.
• dividends The portion of a firm’s profits that the firm pays out each
period to its shareholders.

Introduction to Macroeconomics 22
 Role of the Government in Macroeconomy
• Fiscal policy Government policies concerning taxes and
spending.
• Monetary policy The tools used by the government/Central
Bank to control the short-term interest rate.
• Trade policy The set of agreements, regulations, and
practices by a government that affect trade with foreign
countries.
• Incomes policy Intervention by the government in the process
of price formation for labor and products (aimed at preventing
pretax money incomes from rising faster than the growth of
national income in real terms).

Introduction to Macroeconomics 23
 1.5 Thinking Like an Economist
Every field of study has its own terminology
• Mathematics
• integrals ❖ axioms ❖ vector spaces
• Psychology
• ego ❖ id ❖ cognitive dissonance
• Law
• promissory ❖ estoppels ❖ torts ❖ venues
• Economics
• supply ❖ opportunity cost ❖ elasticity ❖ consumer
surplus ❖ demand ❖ comparative advantage ❖
deadweight loss
Introduction to Macroeconomics 24
 The Economist as a Scientist
• Economics trains you to. . . .
• Think in terms of alternatives.
• Evaluate the cost of individual and social choices.
• Examine and understand how certain events and issues are related.

• The economic way of thinking . . .

• Involves thinking analytically and objectively.
• Economists…
• Devise theories
• Collect data
• Analyze the data to verify or refute their theories
• Economics makes use of the scientific method.

Introduction to Macroeconomics 25
 Economic Models
• The Scientific Method: observation, theory, and more observation
• Uses abstract models to help explain how a complex, real world operates.
Develops theories, collects, and analyzes data to evaluate the theories.

• Economists use models to simplify reality in order to improve our

understanding of the world

• The Role of Assumptions

• Economists make assumptions in order to make the world easier to
understand.
• The art in scientific thinking is deciding which assumptions to make.
• Economists use different assumptions to answer different questions.

“Certeris paribus”
Introduction to Macroeconomics 26
Example of a model:
Supply & demand for new cars

• shows how various events affect price and quantity of cars

• assumes the market is competitive: each buyer and seller
is too small to affect the market price
• Variables:
Q d = quantity of cars that buyers demand
Q s = quantity that producers supply
P = price of new cars
Y = aggregate income
Ps = price of steel (an input)

Introduction to Macroeconomics 27
The demand for cars

demand equation: Q d = D (P,Y )

• shows that the quantity of cars consumers demand is
related to the price of cars and aggregate income

Introduction to Macroeconomics 28
Digression: functional notation

• General functional notation

shows only that the variables are related.
Q d = D (P,Y )
• A specific functional form shows
the precise quantitative relationship.
A list of the
• Example:
variables
D (P,Y ) = 60 – 10dP + 2Y
that affect Q

Introduction to Macroeconomics 29
The market for cars: Demand

demand equation: P
Price
d
Q = D (P ,Y ) of cars

The demand curve

shows the relationship
between quantity D
demanded and price, Q
other things equal. Quantity
of cars

Introduction to Macroeconomics 30
The market for cars: Supply

supply equation: P
Price
s
Q = S (P , Ps ) of cars S

The supply curve shows

the relationship
between quantity D
supplied and price, Q
other things equal. Quantity
of cars

Introduction to Macroeconomics 31
The market for cars: Equilibrium

P
Price
of cars S

equilibrium
price
D
Q
Quantity
of cars
equilibrium
quantity

Introduction to Macroeconomics 32
The effects of an increase in income
demand equation: P
Q d = D (P ,Y ) Price
of cars S

An increase in income
increases the quantity P2
of cars consumers P1
demand at each price… D2
D1
Q
…which increases the Q1 Q 2
Quantity
equilibrium price and
of cars
quantity.

Introduction to Macroeconomics 33
The effects of a steel price increase
supply equation: P
s
S2
Q = S (P , Ps ) Price
of cars S1

An increase in Ps reduces
the quantity of cars P2
producers supply at each P1
price…
D
Q
…which increases the Q2 Q1
market price and Quantity
reduces the quantity. of cars

Introduction to Macroeconomics 34
 Endogenous vs. exogenous variables

• Endogenous variables are those variables that a model

explains.
• The values of endogenous variables are determined in the model.
• Exogenous variables are those variables that a model
takes as given.
• The values of exogenous variables are determined outside the model.
• In the model of supply & demand for cars,

endogenous: P , Qd , Qs
exogenous: Y , Ps
Introduction to Macroeconomics 35
 Now you try:

1. Write down demand and supply

equations for laptops;
include two exogenous variables
in each equation.
2. Draw a supply-demand graph
for laptops.
3. Use your graph to show how a change in
one of your exogenous variables affects
the model’s endogenous variables.

Introduction to Macroeconomics 36
 A multitude of models
• No one model can address all the issues we care about.
• e.g., our supply-demand model of the car market…
• can tell us how a fall in aggregate income affects price & quantity of cars.
• cannot tell us why aggregate income falls.

• So we will learn different models for studying different issues (e.g.,

unemployment, inflation, long-run growth).
• For each new model, you should keep track of
its assumptions which variables are endogenous,
which are exogenous
the questions it can help us understand,
and those it cannot
Introduction to Macroeconomics 37
Prices: flexible vs. sticky

• Market clearing: An assumption that prices are flexible,

adjust to equate supply and demand.
• In the short run, many prices are sticky –
adjust sluggishly in response to changes in supply or
demand.
• For example,
• many labor contracts fix the nominal wage for a year or longer
• many magazine publishers change prices only once every 3-4
years

Introduction to Macroeconomics 38
 Prices: flexible vs. sticky

• The economy’s behavior depends partly on whether

prices are sticky or flexible:
• If prices are sticky, then demand won’t always equal
supply. This helps explain
• unemployment (excess supply of labor)
• why firms cannot always sell all the goods they produce
• Long run: prices flexible, markets clear, economy
behaves very differently

Introduction to Macroeconomics 39
 1.6 Why Economists Disagree?
• They may disagree about the validity of alternative positive
theories about how the world works.

• They may have different values and, therefore, different

normative views about what policy should try to accomplish.

Introduction to Macroeconomics 40