Macroeconomics

Econ 1061

LECTURE NOTEs
Chapter One: The state of
macroeconomics: Introduction
 1.1.What Macroeconomics is about?
 Why have some countries experienced rapid growth in
incomes over the past century while others stay mired
in poverty?
 Why do some countries have high rates of inflation

while others maintain stable prices?

 Why do all countries experience recessions and

depressions and how can government policy reduce the

frequency and severity of these episodes?
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 Macroeconomics-is a branch of economic analysis

concerned with the structure, performance and behavior
of the economy as a whole and sub aggregates of the
economy.
 It deals with aggregate units of national economy such as

total output of goods and services (GDP), general price

level (inflation), national employment/unemployment and
international transactions(balance of payments),
population growth, Economic growth, Money & Banking,
Output, and Business Cycle.
Con’d
 In particular, macroeconomic analysis seeks to explain the cause
and impact of short-run fluctuations in GDP (the business cycle),
which in turn leads to unemployment and inflation, and the major
determinants of the long-run path of GDP (=potential output).
 Macroeconomics also includes an evaluation of the relative success
or failure of government economic policies, policies that
governments use to try to affect economic performance.
 The study of government policy means to control and
stabilize the economy over time, that is, to reduce
fluctuations in the economy- the study of monetary
policy, fiscal policy.
Con’d
 The subject matter of macroeconomics is of crucial
importance because in one way or another
macroeconomic events have an important influence on
the lives and welfare of all of us.
 Macroeconomic events arise from the interaction of

many individuals trying to maximize their own welfare.

 Since, aggregate variables are the sum of the variables

describing individuals’ decisions, the study of

macroeconomics is based on microeconomic
foundations.
Con’d
 Why study the economy at the aggregate
level?
• Much of macroeconomics is concerned with
policies such as money supply or tax policy
which is national in scope.
• Equilibrium effects means that outcomes are
different when we consider the economy in
aggregate.
• There are certain phenomenon like economic
growth and business cycles which affect the
aggregate economy equally.
1.2. Basic Concepts and Methods of
Macroeconomics Analysis
 Macroeconomists use variables to measure the
performance of the economy such as real GDP, the
inflation rate, and the unemployment rate among others.
 Economists also use models to understand and explain

economic variables, such as GDP, inflation, and

unemployment.
 Models are simplified theories(often presented in

mathematical terms) that show the key relationships

among economic variables.
 They are useful because they help us to reduce irrelevant

details and to focus on important connections.

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 Models have two kinds of variables: endogenous variables and
exogenous variables.
 Endogenous variables are those variables that a model tries to
explain.
 Exogenous variables are those variables that a model takes as
given.
 The purpose of a model is to show how the exogenous variables
affect the endogenous variables.
 In other words, exogenous variables come from outside the
model and serve as the model’s input, whereas endogenous
variables are determined inside the model and are the model’s
output.
Con’d
 To make these ideas more concrete, let’s review the most
common economic models—the model of supply and
demand.
 Example: to figure out the factors that influence the

quantity of pizza sold, we can represent as follows:

 Qd = D(P, Y),
 Where Qd= the quantity of pizza demanded by

consumers, P=the price of pizza, and Y= aggregate

income.
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 Similarly, we can assume that the quantity of pizza supplied by
pizzerias Qs depends on the price of pizza P and on the price of
materials Pm, such as cheese, tomatoes, flour, etc..
 Qs = S(P, Pm),
 Finally, we assumes that the price of pizza adjusts to bring the
quantity supplied and quantity demanded into balance:
 Qs = Qd.
 These three equations compose a model of the market for pizza.
 This model can also be illustrated using supply-and-demand
diagram. What will be happened on demand of pizza if an
exogenous variable changes?
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 This model of the pizza market has two exogenous
variables and two endogenous variables.
 The model can be used to show how a change in one of

the exogenous variables affects both endogenous

variables.

1.3. Macroeconomic Goals, policies and
Instruments
 Macroeconomic Goals
 These include:
◦ Attain full employment /low unemployment
◦ Achieve stable price/low inflation with in free market: Rapid price
changes lead to economic inefficiency
◦ Sustainable economic growth : The ultimate objective of economic
activity is to provide the goods and services that the population
desires.
 Export and import equilibrium and exchange rate stability,
sustainable position on the balance of payments-----When a
nation’s exchange rate rises, the prices of imported
goods fall while exports become more expensive for
foreigners  the nation becomes less competitive in
world markets and net exports decline.
Cont………
=> Changes in exchange rates can also
affect output, employment, and inflation.
◦ etc

*****identify the Complementary and

Conflicting Goals…Low unemployment
and high economic growth; Low
unemployment and low inflation
1.3.1. Macroeconomic Policies and policy Instruments
 Macroeconomic policies:….?
• It includes:
 Fiscal Policy: is concerned with the composition of and
changes in the level of government expenditure and taxation.
 Monetary Policy: is defined as the measures taken by the
government and the central banks to control the quantity of
money which in turn influence the cost of borrowing (i.e. the
rate of interest) and availability of credit and liquidity in the
economy there by affecting the over all demand for and
supply of money.
Con’d
 Exchange rate policy: refers to government and the
central bank intervention in the foreign exchange
markets to influence the level and direction of the
external value of a country’s currency.
 Exchange rate represents the price of own currency in

terms of the currency of other nation

 This policy depends up on the country’s exchange rate

objectives whether to have

◦ Fixed
◦ Freely floating or
◦ Managed floating exchange rate policy
Con’d
 International Trade Policy: measures taken by the
government, in addition to the exchange rate policy, to
influence the magnitude and direction of foreign trade
(….. Net export, trade surplus, trade deficit)
 Like correction of Balance of payment (BoP)

problems, export subsidies, tariffs on imports, import

quotas etc.
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 Price and income policies: refers to the direct
intervention by government in the working of a
market economy concerned with the setting of prices
for goods and services and wage settlements. These
policies have two major aims
◦ Control of general inflation
◦ Protection of wages
Con’d
 Moreover, it have significant impact up on the
distribution of national income.
 Note: However, they should be regarded as temporary

or emergency measures since they distort market

operations by undermining wages & price levels and
therefore the supply of & demand for goods, services
and labor.
Con’d
 Employment Policy: is concerned with government
efforts to create jobs and thereby reduce
unemployment.
 The policy may be implemented either indirectly, via

stimulation of aggregate demand in the economy, or

directly through supply-side measures such as job
creation schemes and the provision of training
programmes
Con’d
 policy Instruments:
 A policy instrument is an economic variable under the

control of government that can affect one or more of

the macroeconomic goals
 These include:

◦ Interest rate
◦ Credit restriction
◦ Exchange rate control
◦ Taxation
◦ etc
Unemployment, Inflation and Business
Cycle
Unemployment:
 The labor force is defined as the sum of the employed and unemployed.

 The labor-force participation rate is the percentage of the adult population

who are in the labor force.

Labor-force participation rate = Labor force_____ x 100
Adult population
 Unemployment rate is defined as the percentage of the labor force that is

unemployed, measures the fraction of the labour force that is looking for but
cannot find the work.
 A person is said to be unemployed if he/she is within the working age group

and actively searching for a job but couldn’t get a job.

Unemployment rate = Number of unemployed x 100
Total labor force
, At a given period of time
Con’d
 Types of Unemployment
 Economists define 4 different types of unemployment:

◦ Seasonal unemployment,
◦ Frictional unemployment,
◦ Structural unemployment, and
◦ Cyclical unemployment.
Con’d
 Seasonal unemployment: this type of unemployment
happens due to seasonal variations in the demand for
labor.
 Example: farmers, construction workers, etc faces

seasonal unemployment.
 Frictional unemployment: occurs when workers are

engaged in voluntary job search. For this reason, it is

sometimes referred to as "search unemployment.“
 Workers searching for their first jobs or who have quit

their jobs to try to find a better one are considered to be

frictionally unemployed.
Con’d
 Structural unemployment: Some workers lose their
jobs because of technological change or changes in the
demand for final output. This situation reduce the
demand for labor in a particular job type.
 Structural unemployment can persist if the job skills of
those who lost their jobs do not necessarily match the
skills required in the new jobs that are open.
Con’d
 Cyclical unemployment: happen when the economy
faces recession. That is, some labor force lose their jobs
because of the general decline in the economy.
 One of the main objectives of macroeconomic policy is

to keep the level of cyclical unemployment as close to

zero as possible.
Con’d
Inflation
 The rate of inflation measures changes in the level of prices. It
denotes the rate of growth or decline of the price level from one
year to the next.
 Theories:
 Cost-push inflation: occurs as a result of increases in
production costs.
 Example: the inflation that resulted from rising energy prices
Con’d
 Demand-pull inflation: is caused by an
increase in the demand for output.
◦ Aggregate Demand >Aggregate Supply Demand
pull Inflation
Con’d
o Measure of Inflation
 When prices of almost everything increase, we can say

there is inflation; consequently the cost of living also

increases.
 But how exactly is the inflation rate measured?
 Inflation Rate (year t) =

price level at (t) - price level at (t-1) x 100

price level at (t-1)
o Inflation or deflation:
 An inflation occurs when the level of price is growing

(the rate of inflation is positive).

 A deflation denotes that the level of price declines (the

rate of inflation is negative).

 A disinflation is a decrease in the rate of inflation. The

slowing of the rate of inflation per unit of time.

Con’d
 Business Cycle
 Market economies experience fluctuations in real GDP

and employment over time. These fluctuations are

referred to as the business cycle.
◦ A recession is said to occur when real GDP falls (typically
economists only say that a recession has occurred if real GDP
has fallen for two consecutive quarters).
*Hard times for many people
*A major political concern
Con’d
 An expansion occurs when output is rising. The graph
below depicts the stages of a simple business cycle.
 The peak of the cycle is the point at which an expansion

ends and a recession begins.

 Trough is a point where a recession ends and an

expansion begins at the business cycle.

 A very severe recession is called a depression. Such

situation experienced during the 1930s.

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