Chapter 16 - What Macroeconomics Tries to Explain

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					Ch 4:
What Macroeconomics Tries to Explain

 Microeconomic deals with behavior of
  individual decision makers and
  individual markets
 Macroeconomic deals with broad
  outlines of the economy
 Which view is better?
     Depends on what we’re trying to do


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Macroeconomic Goals
 Economists—and society at large—agree on three
  important macroeconomic goals
   Economic growth
   Full employment
   Stable prices

 Why is there such universal agreement on these three
  goals?
   Because achieving them gives us opportunity to
     make all of our citizens better off

 There are some disagreement among economists
  about how to make the macro-economy perform well

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    Economic Growth

     - the increase in our production of goods and services that occurs
      over long period of time.
     - in most developed economies, the annual output of goods and
      services has risen over time and risen faster than population
      (therefore…?????)

    Economists monitor economic growth
      By keeping track of real gross domestic product (real GDP)
        - The total quantity of goods and services produced in a country
           over a year

    Real GDP has actually increased faster than the population
      During this period (1929 to 2004), while U.S. population did not
        quite triple
         Quantity of goods and services produced each year has
            increased more than tenfold
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Economic Growth

   Part of the reason for the rise in real GDP is an increase in
    population(why?)… therefore..

   Although output has grown, rate of growth has varied over the decades

   Over long periods of time small differences in growth rates can cause
    huge differences in living standards

   Economists and government officials are very concerned when economic
    growth slows down- growth increases the size of the economic pie (for
    every citizen to have a larger slice?)
           - growth doesn’t benefit everyone. example?)
           - some people believe that in the long run everyone will benefit
    from growth
           - others see role for the government (in ?)

   Macroeconomics helps us understand a number of issues surrounding
    economic growth.

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      Figure 1: U.S. Real Gross
      Domestic Product, 1929-2002

            Real GDP         9000
(Billions of 1998 dollars)
                             8000
                             7000
                             6000
                             5000
                             4000
                             3000
                             2000
                             1000



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High Employment (or Low
Unemployment)
 Unemployment affects distribution of
  economic well being among our citizens
     People who cannot find jobs suffer a loss of
      income

 Joblessness affects all of us—even those
  who have jobs
   - A high unemployment rate means
  economy is not achieving its full economic
  potential

 Average standard of living falls
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High Employment (or Low
Unemployment)
   Unemployment rate
           Percentage of the workforce that would like to work, but
            cannot find jobs (unemployment rate is never zero, even
            though the economy is doing well)
           Used to keep track of employment
   The nation’s commitment to high employment has twice
    been written into law
           With memory of Great Depression still fresh, Congress passed
            Employment Act of 1946
               Required federal government to “promote maximum
                employment, production, and purchasing power”
   A numerical target was added in 1978, when Congress
    passed Full Employment and Balanced Growth Act
           Called for an unemployment rate of 4%



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 In the 1990s, we came closer and
  closer and finally—in December
  1999—we reached the target again
  for the first time since the 1960s
     In 2001 unemployment rate began to
      creep up again, and fluctuated between
      5.2 and 6.3 percent though the first half
      of 2005
 All these facts are critically examined
  under the subject Macroeconomics.
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Figure 2: U.S. Unemployment
Rate, 1920-2003
Unemployment   25
    Rate
  (Percent)
               20


               15


               10


                5


                0


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Employment and the Business
Cycle
 When firms produce more output, they hire
  more workers—when they produce less
  output, they tend to lay off workers
     We would thus expect real GDP and employment
      to be closely related, and indeed they are
 Business cycles
     Periodic fluctuations in GDP around its long-term
      growth trend- the bumps in the figure
 Expansion
     A period of increasing real GDP
 Contraction
     A period of declining real GDP
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Employment and the Business
Cycle
 Recession
     A contraction of significant depth, breadth and
      duration
 Depression
     An unusually severe recession
 In the twentieth century, United States
  experienced one decline in output serious
  enough to be considered a depression—the
  worldwide Great Depression of the 1930s
     From 1929 to 1933, the first four years of Great
      Depression, U.S. output dropped by more than
      25%
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Figure 3: The Business Cycle
Real                          Long-run upward
GDP                           trend of real GDP




                                                  The business cycle
                                                  fluctuation of actual
                                                  output around its
                                                  long-run trend.


            Expansion   Recession     Expansion


                                              Time
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Stable Prices
   With very few exceptions, inflation rate has been positive
   During 1990s, inflation rate averaged less than 3% per year
   During the 2000s (through June 2005) inflation rate averaged
    about 2.5%
   Other countries have not been so lucky
     An extreme case was the new nation of Serbia—prices rose
       by 1,880% in August 1993
   Why are stable prices—a low inflation rate—an important
    macroeconomic goal?
     Because inflation is costly to society
     With annual inflation rates in the thousands of percent, the
       costs are easy to see
        Purchasing power of currency declines so rapidly that
           people are no longer willing to hold it
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 Economists regard some inflation as
  good
 Price stabilization requires not only
  preventing inflation rate from rising too
  high
   But also preventing it from falling too
     low, where it would be dangerously
     close to turning negative


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Figure 4: U.S. Annual Inflation
Rate, 1922-2003

                               15
    Inflation Rate (Percent)




                               10

                                5

                                0

                                -5

                               -10

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The Macroeconomic Approach

 In macroeconomics, we want to understand
  how the entire economy behaves
   Thus, we apply the steps to all markets
     simultaneously
 How can we possibly hope to deal with all
  these markets at the same time?
 The answer is aggregation—process of
  combining different things into a single
  category and treating them as a whole


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  Aggregation in Macroeconomics
 Aggregation plays a key role in both micro- and
  macro-economics
 In macroeconomics, we take aggregation to the
  extreme
   Because we want to consider the entire economy at
    once, and yet keep our model as simple as possible
     Must aggregate all markets into broadest possible
      categories
 By aggregating in this way, can create workable
  and reasonably accurate models that teach us a
  great deal about how overall economy operates
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Macroeconomic Controversies
 Macroeconomics is full of disputes and disagreements
   Modern macroeconomics began with publication of
     The General Theory of Employment, Interest, and
     Money by British economist John Maynard Keynes in
     1936
 Keynes was taking on conventional wisdom of his time
   Which held that the macroeconomy worked very well
     on its own, and the best policy for the government to
     follow was laissez faire – ‘leave it alone’.
 This new school of thought held that the economy
  does not do well on its own and needed guidance
  from an activists and well-intentioned government.



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Macroeconomic Controversies

 While some of the early disagreements have been
  resolved, others have arisen to take their place
 For example—the controversy over the Bush
  administration’s $330-billion ten-year tax cut
 Because of such political battles, people who follow
  the news often think that there is little agreement
  among economists about how the macroeconomy
  works
   In fact, the profession has come to a consensus on
     many basic principles, and we will stress these as we
     go



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