5 5 An Introduction to Macroeconomics Where the telescope ends, the microscope begins. Which of the...
Transcript of 5 5 An Introduction to Macroeconomics Where the telescope ends, the microscope begins. Which of the...
5
An Introduction to Macroeconomics
Where the telescope ends, the microscope begins. Which of the two has the grander view?
VICTOR HUGO
● Drawing a Line Between Macroeconomics and Microeconomics
● Supply and Demand in Macroeconomics
● Gross Domestic Product
● The Economy on a Roller Coaster
● The Problem of Macroeconomic Stabilization: A Sneak Preview
● Drawing a Line Between Macroeconomics and Microeconomics
● Supply and Demand in Macroeconomics
● Gross Domestic Product
● The Economy on a Roller Coaster
● The Problem of Macroeconomic Stabilization: A Sneak Preview
ContentsContents
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Drawing a Line Between Macro and MicroeconomicsDrawing a Line Between Macro and Microeconomics
● In macroeconomics, we typically assume that most details of resource allocation and income distribution are of secondary importance to the study of the overall rates of inflation and unemployment.
● In macroeconomics, we typically assume that most details of resource allocation and income distribution are of secondary importance to the study of the overall rates of inflation and unemployment.
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Drawing a Line Between Macro and MicroeconomicsDrawing a Line Between Macro and Microeconomics
● Aggregation and Macroeconomics♦ An economic aggregate is nothing but an
abstraction that people use to describe some important feature of economic life, such as total domestic product.
● Aggregation and Macroeconomics♦ An economic aggregate is nothing but an
abstraction that people use to describe some important feature of economic life, such as total domestic product.
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Drawing a Line Between Macro and MicroeconomicsDrawing a Line Between Macro and Microeconomics
● The Foundations of Aggregation♦ The composition of demand and supply in
various markets is of little consequence for the economy-wide issues of growth, inflation, and unemployment.
♦ During economic fluctuations, markets tend to move up or down together.
● The Foundations of Aggregation♦ The composition of demand and supply in
various markets is of little consequence for the economy-wide issues of growth, inflation, and unemployment.
♦ During economic fluctuations, markets tend to move up or down together.
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Supply and Demand in MacroeconomicsSupply and Demand in Macroeconomics
● Moving to Macroeconomic Aggregates♦ Aggregate supply and aggregate demand relate
domestic product (on the horizontal axis) to the price level (on the vertical axis).
● Moving to Macroeconomic Aggregates♦ Aggregate supply and aggregate demand relate
domestic product (on the horizontal axis) to the price level (on the vertical axis).
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Supply and Demand in MacroeconomicsSupply and Demand in Macroeconomics
● Moving to Macroeconomic Aggregates♦ Aggregate demand (AD) = quantity of
domestic product that is demanded at each possible price level
♦ Aggregate supply (AS) = quantity of domestic product that is supplied at each possible price level
● Moving to Macroeconomic Aggregates♦ Aggregate demand (AD) = quantity of
domestic product that is demanded at each possible price level
♦ Aggregate supply (AS) = quantity of domestic product that is supplied at each possible price level
FIGURE 1: Two Interpretations of a Shift in the Demand Curve
FIGURE 1: Two Interpretations of a Shift in the Demand Curve
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Q0
Pri
ce
P0
D1
A
S
D
D
S
E
Quantity(a)
Pri
ce
P0
S
D
D
S
E
Quantity(a)
D1
FIGURE 2: An Economy Slipping into a Recession
FIGURE 2: An Economy Slipping into a Recession
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D2
B
Pri
ce L
evel
S
D0
D0
S
E
Domestic Product
D2
FIGURE 3: Economic GrowthFIGURE 3: Economic Growth
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D1
C
Pri
ce L
evel
S0
D0
D0
S0
E
Domestic Product
D1
S1
S1
Q0 Q1
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● Major concerns of macroeconomics■Inflation■Unemployment■Growth
AD price level
● Major concerns of macroeconomics■Inflation■Unemployment■Growth
AD price level
Supply and Demand in MacroeconomicsSupply and Demand in Macroeconomics
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● Recession and Unemployment AD/AS unemployment
♦ Recession = a period of time during which production falls and people lose jobs
● Recession and Unemployment AD/AS unemployment
♦ Recession = a period of time during which production falls and people lose jobs
Supply and Demand in MacroeconomicsSupply and Demand in Macroeconomics
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● Economic Growth♦ Economic growth = GDP AD and/or AS growth
● Economic Growth♦ Economic growth = GDP AD and/or AS growth
Supply and Demand in MacroeconomicsSupply and Demand in Macroeconomics
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● Money as the Measuring Rod: Real Versus Nominal GDP♦ GDP = sum of the money values of all final
goods and services produced in the domestic economy within the year
♦ Nominal GDP (GDP in current dollars) values each good and service at the price at which it was actually sold during the year.
● Money as the Measuring Rod: Real Versus Nominal GDP♦ GDP = sum of the money values of all final
goods and services produced in the domestic economy within the year
♦ Nominal GDP (GDP in current dollars) values each good and service at the price at which it was actually sold during the year.
Gross Domestic ProductGross Domestic Product
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♦ Drawback of Nominal GDP: it changes when prices change even if there is no change in actual production.
♦ Solution: calculate real GDP or GDP in constant dollars.
♦ Distinction between Nominal and Real GDP a working definition of a recession as a period in which real GDP declines
♦ Drawback of Nominal GDP: it changes when prices change even if there is no change in actual production.
♦ Solution: calculate real GDP or GDP in constant dollars.
♦ Distinction between Nominal and Real GDP a working definition of a recession as a period in which real GDP declines
Gross Domestic ProductGross Domestic Product
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GDP ExampleGDP Example
2005 2006
Pounds Produced Price per lb. Pounds Produced Price per lb.
Beef 15 15 20 13
Corned Beef 5 10 2 12
Beef Jerky 3 20 8 8
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GDP ExampleGDP Example
2005 Nominal Output
Pounds Produced Price per lb.
Beef 15 15
Corned Beef 5 10
Beef Jerky 3 20
Nominal GDP =
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GDP ExampleGDP Example
2005 Nominal Output
Pounds Produced Price per lb.
Beef 15 15 225
Corned Beef 5 10 50
Beef Jerky 3 20 60
Nominal GDP = 335
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GDP ExampleGDP Example
2006 2006 2005 Nominal OutputReal Output in 2005 Dollars
Pounds Produced Price per lb. Price per lb.
Beef 20 13 15
Corned Beef 2 12 10
Beef Jerky 8 8 20
Nominal GDP = xxxxxxxxxxxxxxxx
Real GDP in 2005 Dollars = xxxxxxxxxxxxxxxxxx
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GDP ExampleGDP Example
2006 2006 2005 Nominal OutputReal Output in 2005 Dollars
Pounds Produced Price per lb. Price per lb.
Beef 20 13 15 260 300
Corned Beef 2 12 10 24 20
Beef Jerky 8 8 20 64 160
Nominal GDP = 348
Real GDP in 2005 Dollars = 480
FIGURE 4: Nominal GDP, Real GDP, and Real GDP per Capita
FIGURE 4: Nominal GDP, Real GDP, and Real GDP per Capita
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0
10,000
5,000
20,000
30,000
15,000
25,000
35,000
$40,000
0
2,000
1,000
4,000
6,000
8,000
3,000
5,000
7,000
$9,000
$10,000
Real GDP(right scale)
$11,000
Year1995 2000
2004
19901985198019751970196519601955
Nominal GDP (right scale)
NOTE: Real GDP figures are in 2000 dollars.
Do
llars
pe
r Y
ea
rB
illion
s of D
olla
rs pe
r Ye
ar
Real GDP per capita (left scale)
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Gross Domestic ProductGross Domestic Product
● What Gets Counted in GDP?♦ Only goods and services produced within the
year
♦ Only final goods and services
♦ Only production within the geographic boundaries of the United States
● What Gets Counted in GDP?♦ Only goods and services produced within the
year
♦ Only final goods and services
♦ Only production within the geographic boundaries of the United States
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● Limitations of the GDP: What GDP Is Not♦ Includes only market activities
♦ Places no value on leisure
♦ Counts “bads” as well as “goods”
♦ Does not deduct ecological costs of economic activity
● Limitations of the GDP: What GDP Is Not♦ Includes only market activities
♦ Places no value on leisure
♦ Counts “bads” as well as “goods”
♦ Does not deduct ecological costs of economic activity
Gross Domestic ProductGross Domestic Product
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Well-Being?Well-Being?
● If national income is a good measure of well-being, why is Switzerland's Gross Domestic Product so much lower than India's GDP or China's GDP?
● What measures would better compare the well-being for residents of different countries?
● How do you expect these direct measures to correlate with per capita GDP?
● If national income is a good measure of well-being, why is Switzerland's Gross Domestic Product so much lower than India's GDP or China's GDP?
● What measures would better compare the well-being for residents of different countries?
● How do you expect these direct measures to correlate with per capita GDP?
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Well Being?Well Being?
● If national income is a good measure of well-being, why is Switzerland's Gross Domestic Product so much lower than India's GDP or China's GDP?
● What measures would better compare the well-being for residents of different countries?
● How do you expect these direct measures to correlate with per capita GDP?
● If national income is a good measure of well-being, why is Switzerland's Gross Domestic Product so much lower than India's GDP or China's GDP?
● What measures would better compare the well-being for residents of different countries?
● How do you expect these direct measures to correlate with per capita GDP?
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The Economy on a Roller CoasterThe Economy on a Roller Coaster
● Growth, but with Fluctuations♦ The U.S. has seen significant fluctuations in
economic growth, unemployment, and inflation.
♦ Before WWII, the business cycle was particularly strong, the worst episode being the Great Depression of the 1930s.
● Growth, but with Fluctuations♦ The U.S. has seen significant fluctuations in
economic growth, unemployment, and inflation.
♦ Before WWII, the business cycle was particularly strong, the worst episode being the Great Depression of the 1930s.
FIGURE 5: The Growth Rate of U.S. Real GDP, 1870-2004
FIGURE 5: The Growth Rate of U.S. Real GDP, 1870-2004
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–20
–15
–10
–5
5
10
15
20
1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
2004
Year
0
Post–1950
Pre–1940
Rapidindustrialization
Railroadprosperity
Depressionof 1890s
Panicof 1907
Postwardepression
GreatDepression
Postwarrecession
WorldWar I
WorldWar II Korean
WarExpansion
of1960s
1974–75Recession
1982–83Recession
RoaringTwenties
1990–91Recession
Expansionof
1980s
Boomof
1990s
FIGURE 6: The Inflation Rate in the United States, 1870-2004
FIGURE 6: The Inflation Rate in the United States, 1870-2004
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–15
–10
0
5
10
15
20
25
1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
Year
–5Post–1950
Pre–1940
2004Postwardeflation
Post-Civil Wardeflation Great
Depression
WorldWar I
WorldWar II
Postwaradjustment
Inflationof the 1970s
Vietnam Warinflation
Disinflationof the 1980s
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The Economy on a Roller CoasterThe Economy on a Roller Coaster
● The Great Depression♦ A worldwide event
♦ Caused a much-needed revolution in economic thinking
♦ Until the 1930s, the prevailing economic theory held that a capitalist economy could cure recessions or inflations by itself.
● The Great Depression♦ A worldwide event
♦ Caused a much-needed revolution in economic thinking
♦ Until the 1930s, the prevailing economic theory held that a capitalist economy could cure recessions or inflations by itself.
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The Economy on a Roller CoasterThe Economy on a Roller Coaster
● The Great Depression♦ The Great Depression led John Maynard
Keynes, one of the world’s most renowned economists, to write The General Theory of Employment, Interest, and Money (1936).
● The Great Depression♦ The Great Depression led John Maynard
Keynes, one of the world’s most renowned economists, to write The General Theory of Employment, Interest, and Money (1936).
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The Economy on a Roller CoasterThe Economy on a Roller Coaster
● The Great Depression♦ Keynes believed that:
■The economy did not naturally gravitate toward smooth growth and high levels of employment
■A pessimistic outlook could lead business firms and consumers to curtail their spending plans
■The economy could then be condemned to years of stagnation
● The Great Depression♦ Keynes believed that:
■The economy did not naturally gravitate toward smooth growth and high levels of employment
■A pessimistic outlook could lead business firms and consumers to curtail their spending plans
■The economy could then be condemned to years of stagnation
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The Economy on a Roller CoasterThe Economy on a Roller Coaster
● The Great Depression♦ In terms of the AD-AS framework, Keynes
suggested that there were times when the AD curve shifted inward by large amounts.
♦ The consequence would be declining output and deflation.
● The Great Depression♦ In terms of the AD-AS framework, Keynes
suggested that there were times when the AD curve shifted inward by large amounts.
♦ The consequence would be declining output and deflation.
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● The Great Depression♦ Keynes showed how governments can manage
their economies so that recessions will not turn into depressions and depressions will not last as long as the Great Depression.
● The Great Depression♦ Keynes showed how governments can manage
their economies so that recessions will not turn into depressions and depressions will not last as long as the Great Depression.
The Economy on a Roller CoasterThe Economy on a Roller Coaster
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The Economy on a Roller CoasterThe Economy on a Roller Coaster
● From World War II to 1973♦ During this period, the economy experienced
some fairly mild business cycles, but grew considerably.
♦ By the end of the period, inflation was rising.
● From World War II to 1973♦ During this period, the economy experienced
some fairly mild business cycles, but grew considerably.
♦ By the end of the period, inflation was rising.
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The Economy on a Roller CoasterThe Economy on a Roller Coaster
● The Great Stagflation, 1973-1980♦ The international price of oil was raised
sharply in 1973 and again in 1979.
♦ For that reason and some others, the period saw the emergence of stagflation, both unemployment and inflation increasing together.
● The Great Stagflation, 1973-1980♦ The international price of oil was raised
sharply in 1973 and again in 1979.
♦ For that reason and some others, the period saw the emergence of stagflation, both unemployment and inflation increasing together.
FIGURE 7: The Effects of an Adverse Supply Shift
FIGURE 7: The Effects of an Adverse Supply Shift
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S1
S1 D
D S0
S0
Pri
ce L
evel
Real GDP
A
E
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The Economy on a Roller CoasterThe Economy on a Roller Coaster
● Reaganomics and its Aftermath♦ When Reagan assumed office in 1981, the
economy went into a sharp tailspin, and soon the rate of inflation fell.
♦ This was followed by a period of steady, non-inflationary growth during most of the 1980s. In 1990-91, recession hit.
● Reaganomics and its Aftermath♦ When Reagan assumed office in 1981, the
economy went into a sharp tailspin, and soon the rate of inflation fell.
♦ This was followed by a period of steady, non-inflationary growth during most of the 1980s. In 1990-91, recession hit.
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The Economy on a Roller CoasterThe Economy on a Roller Coaster
● Clintonomics: Deficit Reduction and “The Best Economy in 30 Years”♦ Clinton’s initial objectives were spurring
growth and increasing public investment.
♦ Soon, however, the overriding goal in Washington became deficit reduction.
● Clintonomics: Deficit Reduction and “The Best Economy in 30 Years”♦ Clinton’s initial objectives were spurring
growth and increasing public investment.
♦ Soon, however, the overriding goal in Washington became deficit reduction.
FIGURE 8: The Effects of a Favorable Supply Shift
FIGURE 8: The Effects of a Favorable Supply Shift
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Real GDP
Pri
ce L
evel
D0
D0
S0
S0
S1
S1
D1
D1
S2
S2
C
B E
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The Economy on a Roller CoasterThe Economy on a Roller Coaster
● Clintonomics: Deficit Reduction and “The Best Economy in 30 Years”♦ A variety of transitory factors pushed the
economy’s AS curve outward at an unusually rapid pace between 1996 and 1999.
♦ Strong economic growth continued through the late 1990s.
♦ Inflation remained low.
● Clintonomics: Deficit Reduction and “The Best Economy in 30 Years”♦ A variety of transitory factors pushed the
economy’s AS curve outward at an unusually rapid pace between 1996 and 1999.
♦ Strong economic growth continued through the late 1990s.
♦ Inflation remained low.
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The Economy on a Roller CoasterThe Economy on a Roller Coaster
● The Bush Economy and the 2004 Election♦ Real GDP grew very slowly then declined
slightly in 2nd half of 2001■1st recession in 10 years■Recession ended November 2001
● The Bush Economy and the 2004 Election♦ Real GDP grew very slowly then declined
slightly in 2nd half of 2001■1st recession in 10 years■Recession ended November 2001
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The Economy on a Roller CoasterThe Economy on a Roller Coaster
● The Bush Economy and the 2004 Election♦ Policies that helped shift AD curve, mitigating
recession■2001-2003 tax cuts■war of terrorism, burst of government spending■consumers spending remained strong, despite 9/11■low interest rates encouraged spending
● The Bush Economy and the 2004 Election♦ Policies that helped shift AD curve, mitigating
recession■2001-2003 tax cuts■war of terrorism, burst of government spending■consumers spending remained strong, despite 9/11■low interest rates encouraged spending
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● Combating Unemployment♦ When recessions are caused by too low
aggregate demand, governments can try to stimulate demand.
● Combating Unemployment♦ When recessions are caused by too low
aggregate demand, governments can try to stimulate demand.
The Problem of Macroeconomic StabilizationThe Problem of Macroeconomic Stabilization
FIGURE 9 Stabilization Policy to Fight Unemployment
FIGURE 9 Stabilization Policy to Fight Unemployment
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Increase in output
Pri
ce
Le
ve
l
Real GDP
S
S D0
D0
E
D1
D1
A
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● Combating Inflation♦ When inflation is caused by too high aggregate
demand, governments can try to restrain aggregate demand.
● Combating Inflation♦ When inflation is caused by too high aggregate
demand, governments can try to restrain aggregate demand.
The Problem of Macroeconomic StabilizationThe Problem of Macroeconomic Stabilization
FIGURE 10: Stabilization Policy to Fight Inflation
FIGURE 10: Stabilization Policy to Fight Inflation
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Decrease in prices
Pri
ce L
evel
Real GDP
S
S
D0
D0
E
D2
D2
B
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The Problem of Macroeconomic StabilizationThe Problem of Macroeconomic Stabilization
● Does It Really Work?♦ Before 1940, the economy endured
pronounced business fluctuations and inflation was rare.
♦ Since World War II the business fluctuations have been much less severe, but inflation has been a common occurrence.
♦ How successful government policy can be is a question to be explored throughout the text.
● Does It Really Work?♦ Before 1940, the economy endured
pronounced business fluctuations and inflation was rare.
♦ Since World War II the business fluctuations have been much less severe, but inflation has been a common occurrence.
♦ How successful government policy can be is a question to be explored throughout the text.
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FIGURE 5: The Growth Rate of U.S. Real GDP, 1870-2004
FIGURE 5: The Growth Rate of U.S. Real GDP, 1870-2004
Copyright © 2006 South-Western/Thomson Learning. All rights reserved.
–20
–15
–10
–5
5
10
15
20
1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
2004
Year
0
Post–1950
Pre–1940
Rapidindustrialization
Railroadprosperity
Depressionof 1890s
Panicof 1907
Postwardepression
GreatDepression
Postwarrecession
WorldWar I
WorldWar II Korean
WarExpansion
of1960s
1974–75Recession
1982–83Recession
RoaringTwenties
1990–91Recession
Expansionof
1980s
Boomof
1990s