Macro-economics

INTRODUCTORY
CLASS
INTRODUCTION TO ECONOMICS
CHAPTER OUTLINE
Why Study Economics?
To Learn a Way of Thinking
To Understand Society
To Understand Global Affairs
To Be an Informed Citizen
The Scope of Economics
Microeconomics and
Macroeconomics
The Diverse Fields of
Economics
The Method of Economics
Descriptive Economics and
Economic Theory
Theories and Models
Economic Policy
An Invitation
Appendix: How to Read
and Understand Graphs
The Scope and Method of Economics
Economics: The study of how individuals and
societies choose to use the scarce resources that
nature and previous generations have provided.

Economics is the study of how individuals and societies

choose to use the scarce resources that nature and
previous generations have provided. The key word in this
definition is choose. Economics is a behavioral, or social,
science. In large measure, it is the study of how people
make choices. The choices that people make, when added
up, translate into societal choices.
Why Study Economics?

◼ To Learn a Way of Thinking

◼ Three fundamental concepts:

◼ Opportunity cost
◼ Marginalism
◼ Efficient markets
Why Study Economics?

◼ To Learn a Way of Thinking

Opportunity Cost

Opportunity cost: The best alternative that we

forgo, or give up, when we make a choice or a
decision.

Scarce: Limited.
Why Study Economics?
◼ To Learn a Way of Thinking

Marginalism
Marginalism: The process of analyzing the
additional or incremental costs or benefits
arising from a choice or decision.

Sunk costs: Costs that cannot be avoided

because they have already been incurred.
Sunk costs:
◼ Companies in every industry have to spend money
to make money. Once the company's money is
spent, that money is considered a sunk cost.

◼ Sunk costs cannot be refunded or recovered.

◼ A company spends $50,000 on a marketing study to

see if its new app will succeed in the marketplace.
The study concludes that the app will not be
profitable. At this point, the $50,000 is a sunk cost.
Why Study Economics?

◼ To Learn a Way of Thinking

Efficient Markets—No Free Lunch

Efficient market: A market in which profit

opportunities are eliminated almost
instantaneously.
The study of economics teaches us a way
of thinking and helps us make decisions.
Efficient market:
◼ Suppose you are ready to check out of a busy grocery store
and seven checkout registers are open with several people
in each line.

◼ Which line should you choose? Usually, the waiting time is

approximately the same no matter which register you.

◼ If one line is much shorter than the others, people will

quickly move into it until the lines are equalized again.

◼ Markets like this, where any profit opportunities are

eliminated almost instantaneously, are said to be efficient
markets.
The Scope of Economics
◼ Microeconomics and Macroeconomics
Microeconomics: The branch of economics that examines
the functioning of individual industries and the behavior of
individual decision-making units—that is, firms and
households.
Macroeconomics: The branch of economics that
examines the economic behavior of aggregates—income,
employment, output, and so on—on a national scale.
Microeconomics looks at the individual unit—the household, the firm,
the industry. It sees and examines the “trees.” Macroeconomics looks at
the whole, the aggregate. It sees and analyzes the “forest.”
The Scope of Economics
◼ Microeconomics and Macroeconomics
Examples of Microeconomic and Macroeconomic Concerns
Divisions
of Economics Production Prices Income Employment

Microeconomics Production/output in Price of individual Distribution of Employment by

individual industries and goods and services income and individual businesses
businesses wealth and industries

How much steel Price of medical care Wages in the auto Jobs in the steel
How much office Price of gasoline industry industry
space Food prices Minimum wage Number of employees
How many cars Apartment rents Executive salaries in a firm
Poverty Number of
accountants

Macroeconomics National Aggregate price level National income Employment and

production/output unemployment in
the economy

Total industrial output Consumer prices Total wages and Total number of jobs
Gross domestic Producer prices salaries Unemployment rate
product Rate of inflation Total corporate
Growth of output profits
Three main variables we will study:
1) Gross domestic output (GDP)
2) Inflation in the cost of living (CPI)
3) Unemployment rate

We will begin by looking at trends in the data

for these, and make initial observations.
Macroeconomic Concerns
◼ Unemployment
The unemployment rate is often regarded as the key
indicator of the health of the economy.
◼ Inflation/deflation
Although high inflation (or sever deflation) has not
been a common occurrence in the US some other
countries have had long period of very high inflation.
◼ Slow economic growth
Recessions are periods (lasting two consecutive
quarters) during which aggregate output declines.
A prolonged deep recession is called “depression.”
Important issues in macroeconomics
The Great Depression (1929-1939)
Origins and Issues of Macroeconomics
▪ Economists began to study economic growth,
inflation, and international payments during the
1750s

▪ Modern macroeconomics dates from the Great

Depression, a decade (1929-1939) of high
unemployment and stagnant production
throughout the world economy.

▪ John Maynard Keynes book, The General

Theory of Employment, Interest, and Money,
began the subject.
 What was the Great Depression ?
◼ The Great Depression was a severe worldwide
economic depression in during the decade
before World War II.

◼ In most countries, including the U.S. it started in

about 1929 and lasted until the late 1930s or early
1940s.

◼ It was the longest, most widespread, and

deepest depression of the 20th century.
◼Why didn’t we see it
coming?
The Prosperity of the 1920s Hid the
Growing Economic Problems?
◼ 1. The booming economy of the 1920s led to
overconfidence –Americans thought the good
times would last forever

◼ 2. Americans bought goods on credit and went

into debt.

◼ 3. The Stock Market climbed higher and more

people invested in the market (bull market)
1920s -GOOD TIMES ARE HERE TO STAY!

◼ The stock market went up

◼ Consumption went up
◼ Gross National Product
went up
◼ All economic indicators
showed increased
prosperity
The Stock Market Crashed, 1929
◼ The Great Crash of Wall Street, 1929
◼ In September 1929 stock prices began to fall
rapidly
◼ Investors started to sell shares—which led to
more decline in the market
◼ October 29= “Black Tuesday”—the bottom fell
out of the market. Over 6 million shares were
sold and entire fortunes were lost.

Note: The Crash did not cause the Depression!

CROWD OUTSIDE A CLOSED BANK
RUN ON BANK
 Change in economic indicators 1929–32

United Great
France Germany
States Britain

Industrial
–46% –23% –24% –41%
production

Wholesale prices –32% –33% –34% –29%

Foreign trade –70% –60% –54% –61%

Unemployment +607% +129% +214% +232%

U.S. Unemployment
Impact on the People
◼ 25% Unemployment

◼ People lost their homes -

took to the streets

◼ People that still had jobs had

their hours and wages cut

◼ People only bought

necessities - further led to
lay-offs

◼ “Runs” on banks

❑ people fear losing money

and take all their money
out of banks
Images

◼ Soup Kitchens
◼ Bread Lines
◼ Hoovervilles
◼ Dust Bowls
◼ Okies
◼ Bonus Army
 People
◼ people undernourished

◼ schools closed

◼ Abandonment increases – Men leave

families for work or shame

◼ Suicide rate increases sharply

◼ birthrate fell –

◼ Men no longer the head of the

household

◼ People looked to the government for

help
FOOD LINE FOR UNEMPLOYED
Protests
 If the stock market
crash did not cause the
Great Depression then
what did and why did
it last so long?
 Major Causes of the Depression
1. Wealth was not evenly divided among Americans
2. Overproduction and of agricultural crops and consumer
goods; farmers were in debt
3. Lack of diversification in the economy – built on construction
and auto industry, Americans were buying on credit
4. Declining exports---U.S. trade suffered when Congress
passed the Hawley-Smoot Tariff which reduced
international trade
5. Weak International economy
WWI debt cycles led to global economic depression.
6. Monetary Policy of the Federal Reserve –raised interest
rates instead of lowering them
Origins and Issues of Macroeconomics

◼Short-Term Versus Long-Term Goals

❑Keynes focused on the short-term—on

unemployment and lost production.

❑ “In the long run,” said Keynes, “we’re all dead.”

❑ During the 1970s and 1980s, macroeconomists

became more concerned about the long-term—
inflation and economic growth.
Origins and Issues of Macroeconomics
◼Keynesian economics is a theory that says the
government should increase demand to boost
growth.
◼Keynesians believe consumer demand is the
primary driving force in an economy.
◼Its main tools are government spending on
infrastructure, unemployment benefits, and
education.
◼A drawback is that overdoing Keynesian
policies increases inflation.
Important issues in macroeconomics
Macroeconomics, the study of the economy as
a whole, addresses many topical issues:
◼ Why does the cost of living keep rising?
◼ Why are millions of people unemployed,
even when the economy is booming?
◼ What causes recessions?
Can the government do anything to combat
recessions? Should it?
Important issues in macroeconomics
Macroeconomics, the study of the economy as
a whole, addresses many topical issues:
◼ What is the government budget deficit?
How does it affect the economy?
◼ Why does the U.S. have such a huge trade
deficit?
◼ Why are so many countries poor?
What policies might help them grow out of
poverty?
Long-Run Economic Growth

❑ Rich nations have experienced

extended periods of rapid economic
growth.
❑ Poor nations either have never
experienced them or economic
growth was offset by economic
decline.
Increased Output
◼ Total output is increasing because of
increasing population, i.e. the number of
available workers.
◼ Increasing average labour productivity:
the amount of output produced per unit of
labour input.
Rates of Growth of Output
◼ Rates of growth of output (or output per
worker) are determined by:
❑ rates of saving and investment;
❑ rates of technological change;
❑ rates of change in other factors.
Economic growth in UK, USA and
Germany

3
% p.a.

0
1960-73 1973-81 1981-90 1990-01

UK USA Germany
The growth rate of U.S. real GDP since 1870
Business Cycles
◼ Business cycles are short-run
contractions and expansions of economic
activity.
◼ The most volatile period in the history of
Canadian output was between 1914 and
1945.
The inflation rate in the United States since 1870
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
Unemployme nt Rate =  100%
Labour Force
Unemployment
The Unemployment Rate

◼ The unemployment rate can stay high even

when the economy is doing well.
◼ After eight years of economic growth, in
2000, the unemployment rate in Canada was
near 7%.
Unemployment in UK, USA and
Germany

10

6
% p.a.

0
1960-73 1973-81 1981-90 1990-01

UK USA Germany
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.
Inflation
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.
Inflation in UK, USA and Germany
1960 - 2001
16
14
12
10
UK
Annual % 8 USA
6 Germany
4
2
0
1960-73 1973-81 1981-90 1990-01
 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

◼ Vietnam exports are goods and services

produced in Vietnam and consumed abroad.

◼ Vietnam imports are goods and services

produced abroad and consumed in Vietnam.
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 VND 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.
Macroeconomic Policy Tools
◼ Fiscal policy
◼ Taxation
◼ Government expenditures
◼ Trade policies
◼ Monetary policy
◼ Money and interest rates
◼ Foreign exchange policies
◼ Growth or supply-side policy
Budget Deficits
◼ The economy is affected when there are
large budget deficits: the excess of
government spending over tax collection.
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.
Supply & Demand in Macroeconomics

◼ Aggregate demand (AD) curve

❑ Quantity of domestic product – demanded
❑ Each possible value of price level
◼ Aggregate supply (AS) curve
❑ Quantity of domestic product – supplied
❑ Each possible value of price level
What Macroeconomists Do

◼ Macroeconomic forecasting
◼ Macroeconomic analysis
◼ Macroeconomic research
◼ Data development
Macroeconomic Forecasting
◼ Macroeconomic forecasting – prediction
of future economic trends - has some
success in the short run. In the long run
too many factors are highly uncertain.
Macroeconomic Analysis

◼ Macroeconomic analysis - analyzing and

interpreting events as they happen – helps
both private sector and public policymaking.
Macroeconomic Research

◼ Macroeconomic research - trying to

understand the structure of the economy in
general – forms the basis for macroeconomic
analysis and forecasting.
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.
Economic Growth and Fluctuations
❑Economic growth is the expansion of the
economy’s production possibilities—an outward
shifting PPF.

❑We measure economic growth by the increase in

real GDP.

❑Real GDP—real gross domestic product—is the

value of the total production of all the nation’s farms,
factories, shops, and offices, measured in the prices
of a single year.
Economic Growth and Fluctuations
❑Real GDP is not the perfect measure is not the
perfect measure of total production because it does
not include everything that is produced.

❑It excludes the things we produce for ourselves at

home (preparing meals, doing laundry, house
painting, gardening, and so on)

❑It also excludes the production that people hide to

avoid taxes or because activity is illegal (Underground
economy)
Economic Growth and Fluctuations

◼Economic Growth in
the United States
❑ Figure shows real GDP
in the United States from
1962 to 2002.

The figure highlights:

▪ Fluctuations of real GDP
▪ Smoother growth of
potential GDP
Economic Growth and Fluctuations
❑Potential GDP is the
value of real GDP when
all the economy’s labour,
capital, land, and
entrepreneurial ability
are fully employed.
❑During the 1970s and

early 1980s, real GDP

growth slowed—a
productivity growth
slowdown.
Economic Growth and Fluctuations

❑Real GDP fluctuates

around potential GDP in
a business cycle—a
periodic but irregular up-
and-down movement in
production.
Economic Growth and Fluctuations
❑ Every business cycle has two phases:
1. A recession
2. An expansion
❑ and two turning points:
1. A peak
2. A trough
❑ A recession is a period during which real GDP
decreases.
❑ An expansion is a period during which real GDP
increases.
Economic Growth and Fluctuations
❑ Figure shows the most recent U.S. cycle.
Economic Growth and Fluctuations
❑ Figure shows the long-term growth trend and cycles.
Economic Growth and Fluctuations

◼Economic Growth
Around the World

❑ Figure shows the

growth rate of real GDP
in the United States
alongside that of the
world average growth
rate.
Economic Growth and Fluctuations
◼Economic Growth
Around the World
❑ Figure compares the
growth rate of real GDP
in the United States with
those of other countries
and regions.
❑The economies of Asia
have grown persistently
faster than those of the
rest of the world.
Economic Growth and Fluctuations
◼The Lucas Wedge
❑ The Lucas wedge
is the accumulated
loss of output from a
slowdown in the
growth rate of real
GDP per person.

❑ Figure shows that

the U.S. Lucas
wedge is some $50
trillion or five year’s
GDP.
Economic Growth and Fluctuations

◼The Okun Gap

❑ The Okun gap is
the gap between
potential GDP and
actual real GDP and
is another name for
the output gap.

❑Figure shows that

the Okun gaps.
Economic Growth and Fluctuations
◼Benefits and Costs of Economic Growth
❑ The main benefit of long-term economic growth
is expanded consumption possibilities, including
more health care for the poor and elderly, more
research on cancer and AIDS, better roads, more
and better housing, and a cleaner environment.

❑The costs of economic growth are forgone

consumption in the present, more rapid depletion
of natural resources, and move frequent job
changes.
Jobs and Unemployment
◼Unemployment
❑Unemployment is a state in which a person does
not have a job but willing to work, and has made
some effort to find work within the previous four
weeks.
❑The labour force is the total number of people who
are employed and unemployed.
❑The unemployment rate is the percentage of the

people in the labour force who are unemployed.

❑A discouraged worker is a person who willing to

work, but who has given up the effort to find work.

Jobs and Unemployment
◼Unemployment in the
United States
❑ Figure shows the
unemployment rate in
the United States since
1926.
▪ During the 1930s, the

unemployment rate hit

20 percent
▪ The lowest rate
occurred during World
War II at 1.2 percent
Jobs and Unemployment

▪ The unemployment rate

has averaged 6 percent
since World War II
Jobs and Unemployment
◼Unemployment
Around the World
❑Figure 20.7
compares the
unemployment rate in
the United States with
those in Western
Europe, Japan, and
the United States.
❑U.S. unemployment,

on the average, lies in

the middle of the other
countries shown.
Jobs and Unemployment

◼Why Unemployment Is a Problem

❑ Unemployment is a serious economic, social,
and personal problem for two main reasons:
▪ Lost production and incomes

▪ Lost human capital

Inflation
❑ Inflation is a process of rising prices.

❑We measure the inflation rate as the

percentage change in the average level of prices.

❑The Consumer Price Index—the CPI—is a

common measure of the price level.
Measuring the Cost of Living

◼ Inflation refers to a situation in which the economy’s

overall price level is rising.

◼ The inflation rate is the percentage change in the

price level from the previous period.
THE CONSUMER PRICE INDEX
◼ The consumer price index (CPI) is a measure
of the overall cost of the goods and services
bought by a typical consumer.

◼ The Bureau of Labor Statistics reports the

CPI each month.

◼ It is used to monitor changes in the cost of

living over time.
THE CONSUMER PRICE INDEX

◼ When the CPI rises, the typical family has to

spend more dollars to maintain the same
standard of living.
How the Consumer Price Index Is
Calculated
◼ Compute the inflation rate: The inflation
rate is the percentage change in the price
index from the preceding period.
How the Consumer Price Index Is
Calculated
◼ The Inflation Rate
❑ The inflation rate is calculated as follows:

CPI in Year 2 - CPI in Year 1

Inflation Rate in Year 2 =  100
CPI in Year 1
How the Consumer Price Index Is
Calculated
◼ Calculating the Consumer Price Index and
the Inflation Rate: Another Example
❑ Base Year is 2002.
❑ Basket of goods in 2002 costs $1,200.
❑ The same basket in 2004 costs $1,236.
❑ CPI = ($1,236/$1,200)  100 = 103.
❑ Prices increased 3 percent between 2002 and
2004.
FYI: What’s in the CPI’s Basket?
16%
Food and
beverages

17% 41%
Transportation Housing

Education and
6%
communication 6%
6% 4% 4%

Medical care
Other goods
Recreation Apparel and services
Copyright©2004 South-Western
Fixed market baskets for a CPI
Good/service 1980 quantity 1980 price 1980 cost

Pizza 100 $7 each $700

Textbooks 20 $40 each $800

Haircuts 5 $5 each $25

Total cost $1,525
Good/service 1980 quantity 2016 price 2016 cost
Pizza 100 $16 each $1,600
Textbooks 20 $100 each $2,000
Haircuts 5 $12 each $60
Total cost $3,660
Problems in Measuring the Cost of
Living
◼ The CPI is an accurate measure of the
selected goods that make up the typical
bundle, but it is not a perfect measure of the
cost of living.
Inflation
◼Inflation in the United
States
❑ Figure shows the
inflation rate in the
United States since
1961.
▪ Inflation was low
during the 1960s
▪ Inflation increased

during the 1970s

Inflation
❑ The inflation rate
fluctuates, but it is
always positive—the
price level has not
fallen during the
years shown in the
figure.
❑A falling price
level—a negative
inflation rate—is
called deflation.
Inflation
◼Inflation Around the World
❑ Figure 20.9 shows the
inflation rate in the United
States compared with
other countries.
▪ U.S. inflation has been
similar to that in other
industrial countries

▪ U.S. inflation has been

much lower than that in
developing countries
Surpluses and Deficits
◼Government Budget Surplus and Deficit
❑If a government collects more in taxes than it
spends, it has a government budget surplus.

❑If a government spends more than it collects in

taxes, it has a government budget deficit.
Surpluses and Deficits
❑ Figure shows the
changing surplus and
deficit of the federal
and provincial
governments in the
United States since
1971.
▪ Persistent federal

deficit during the 1970s

through 1990s.
▪ Surplus since 1998
Surpluses and Deficits

◼International Surplus and Deficit

❑ If a nation imports more than it exports, it has an
international deficit.
❑If a nation exports more than it imports, it has an
international surplus.
❑The current account deficit or surplus is the

balance of exports minus imports plus net interest

paid to and received from the rest of the world.
Surpluses and Deficits

❑ Figure 20.10(b)
shows The U.S.
current account
balance since 1962.
▪ Persistent current

account deficit since

1983
▪ The deficit has

swollen during the

past few years
Macroeconomic Policy Challenges
and Tools
❑ Two broad groups of macroeconomic policy tools
are :

1. Fiscal policy—making changes in tax rates and

government spending

2. Monetary policy—changing interest rates and

changing the amount of money in the economy
THE END