Copyright © 2012 Pearson Addison-Wesley. All rights reserved. Chapter 1 What Is Macroeconomics?

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Chapter 1

What Is Macroeconomics?

Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 1-2

The “Big Three” Concepts of Macroeconomics

• Unemployment RateU = (# of Unemployed) / Labor Force

• Inflation Rate ∏ = %ΔP = (P1 – P0) / P0

• Productivity Growth– “Productivity” is the average output per hour of work that a nation produces in goods and services.

– Productivity in 2010 = $61 per worker-hour


The Global Economic Crisis and the 3 Big Concepts

• The global economic crisis started in 2008

• Results:– High sustained level of unemployment

• U = 10% in 2009-2010• Not expected to fall to 5% until 2015 or 2016

– But inflation has remained low– Productivity growth has also been robust


Macroeconomics vs. Microeconomics

• Macroeconomics deals with the totals, or aggregates, of the economy such as:– The unemployment rate (of all U.S. workers)– Inflation (i.e. the rise of all prices in the U.S.)

• Microeconomics deals with parts of the economy like:– The unemployment rate of low-skilled workers in a certain state

– The price of cars


Gross Domestic Product (GDP)

• Definition: (Nominal) GDP is the value of all currently produced goods and services sold on the market during a particular time interval.– Real GDP adjusts the value of total output to correct for changes in prices.• Sometimes referred to as Actual Real GDP

– Natural Real GDP is the level of real GDP in which there is no tendency for inflation to rise or fall.


Figure 1-1 The Relation Between Actual and Natural Real GDP and the Inflation Rate


Unemployment: Actual and Natural

• Actual Unemployment (U) is the unemployment rate observed in the economy.

• The Natural Rate of Unemployment (U*) is the rate of unemployment at which there is no tendency for inflation to rise or fall.– If U > U* ∏ rises– If U < U* ∏ falls


Figure 1-2 The Behavior Over Time of Actual and Natural Real GDP and the Actual and Natural Rates of Unemployment


Short Run vs. Long Run

• The “short run” lasts from 1-5 years and the main issue is the stability of the economy.– The ups and downs (or “economic fluctuations”) of

an economy are part of the business cycle. The business cycle has the following phases:• Expansion• Contraction

• The “long run” ranges from one to several decades and is concerned with economic growth.


Figure 1-3 Business Cycles in Volatilia and Stabilia


Figure 1-4 Basic Business-Cycle Concepts


Figure 1-5 Economic Growth in Stag-Nation and Speed-Nation


Figure 1-6 Actual and Natural GDP and Unemployment, 1900–2010 (1 of 2)


Figure 1-6 Actual and Natural GDP and Unemployment, 1900–2010 (2 of 2)

Sources: See Appendix A-1 and C-4.


Macroeconomics at the Extremes

• Three examples of the breakdown of normal macroeconomic mechanisms:– The Great Depression of the 1930s– The German hyperinflation of 1922-23– South Korea vs. Philippines economic growth in the last 50 years


Figure 1-7 The Unemployment Rate from 1929–41 Compared with 1998–2010

Source: Bureau of Labor Statistics. See Appendix C-4.


Figure 1-8 The German Price Level, 1920–23

Source: Groningen Growth and Development Center. See Appendix C-4.


Figure 1-9 Per-Capita Real GDP, South Korea and the Philippines, 1960–2010

Source: Groningen Growth and Development Center. See Appendix C-4.


Taming Business Cycles

• Macroeconomic analysts have two main tasks:– Analyze the causes of changes in macroeconomic variables

– Predict the consequences of alternative policy changes

• Macroeconomic target variables important to analysts and policy makers include:– Inflation– Unemployment– Long-term growth of productivity


The Role of Stabilization Policy

• A Stabilization Policy is any policy that seeks to influence the level of aggregate demand.– Monetary policy tries to influence aggregate demand by changing the money supply and/or interest rates.

– Fiscal policy tries to influence aggregate demand by changing government spending and/or tax rates.

• New Challenges: The global economic crisis has brought forth novel and controversial strategies in both monetary and fiscal policy (see Chapters 5 and 6).


Economic Performance of the U.S. vs. Europe

• Europe outperformed the U.S. from 1960 – 1985.• But the U.S. has grown much more quickly than

Europe since 1995.• Puzzle #1: Why has European unemployment risen so

much?• Puzzle #2: Why has Europe not benefited from the

adoption of computer and internet technology like the U.S?– During the current crisis, US productivity soared while

EU productivity lagged because European workers were protected from layoffs even as EU output slumped.


The “Internationalization” of Macroeconomics

• A closed economy has no trade in goods, services or financial assets with any other nations.– In the 1940s and 50s, the U.S. was relatively closed:

• Trade was 5% of the U.S. economy • Exchange rates were fixed• Financial flows to and from the U.S. were restricted

• An open economy exports and imports goods and services to and from other nations, and has financial flows to and from foreign nations.– Today the U.S. is increasingly open:

• Imports equal 17% of U.S. GDP• Since 1973, the exchange rate of the $ has been flexible• International financial flows are massive and almost instantaneous

Copyright © 2012 Pearson Addison-Wesley. All rights reserved. Chapter 1 What Is Macroeconomics?

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