Chapter 23

An Introduction to Macroeconomics

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

23-2

Chapter Objectives

• Long-run economic growth and short-run fluctuations

• GDP, inflation, and unemployment

• Sustained increase in living standards

• Savings and investment• Shocks and sticky prices

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Performance and Policy

• Real GDP–Corrects for price changes

• Nominal GDP–Uses current prices

• Unemployment

• Inflation –Increase in overall level of prices

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Performance and Policy

• Can governments:–Promote economic growth?

–Reduce severity of recession?

• Is monetary or fiscal policy more effective at mitigating recession?

• Is there a tradeoff between inflation and unemployment?

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Economic Performance

• Output growth–3.1% per year 1995-2005

• Unemployment rate–4.6% in 2007

• Inflation rate–2.7% in 2007

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Economic Growth

• Standard of living measured by output per person

• No growth in living standards prior to Industrial Revolution

• Modern economic growth–Output per person rises

–Not experienced by all countries

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GDP Per Person 2007

Zimbabwe $188

United States $45,845Canada $38,345

Japan $33,576United Kingdom $35,134

South Korea $24,782France $33,187

Russia $14,692Saudi Arabia $23,243

Burundi $371Tanzania $1,256North Korea $1,900India $2,659China $5,292Mexico $12,774

U.S. dollars based on purchasing power parity

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Savings and Investment

• Saving–Tradeoff current for future

consumption

• Investment–Financial investment

–Economic investment

• Banks and financial institutions

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Shocks

• Demand shocks and flexible prices–Price falls if demand low

–Sales unchanged

• Demand shocks and sticky prices–Maintain inventory

–Sales change

–Business cycles

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Expectations

• The future is uncertain

• Expectations affect investment

• Shocks –What happens is not what you

expected

• Demand shocks

• Supply shocks

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Demand Shocks

Cars per week

Pri

ce

DMDL

DH

900

$40,000

$37,000

$35,000

Flexible Prices

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Demand Shocks

Cars per week

DMDL

DH

700 900 1150

$37,000

Fixed Prices

Pri

ce

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Sticky Prices

• Explain fluctuations is GDP• Average months between price changes

Coin-operated Beer 4.3

Laundry Machine 46.4 Microwave Ovens 3.0

Newspaper 29.9 Milk 2.4

Haircut 25.5 Electricity 1.8

Taxi fare 19.7 Airline ticket 1.0

Veterinary service 14.9 Gasoline 0.6

Magazine 11.2 Computer software 5.5

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Sticky Prices

• Many prices sticky in short run–Consumers prefer stable prices

–Firms want to avoid price wars

• All prices flexible in long run–Firms adjust to unexpected, but

permanent changes in demand

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Inventory Management

• Computerized inventory tracking

• Unexpected changes in demand easier to observe

• Firms make better output and employment decisions

• Less severe business cycles

• Only two mild recessions since adoption – Possible explanation

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Key Terms

• business cycle• recession• real GDP• nominal GDP• unemployment• inflation• modern economic

growth• savings • investment

• financial investment• economic investment• expectations• shocks• demand shocks• supply shocks• inventory• inflexible prices (“sticky prices”)• flexible prices

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Measuring Domestic Output and National Income