Intro to MacroeconomicsIntro to Macroeconomics

Micro vs. MacroMicro vs. Macro Micro: study individual economic actors Micro: study individual economic actors

(households, firms, gov’t)(households, firms, gov’t) Macro: study of economic systemsMacro: study of economic systems Diff of perspective, same basic ideas (with Diff of perspective, same basic ideas (with

caveats)caveats)• E.g. the economy is not the same as your E.g. the economy is not the same as your

familyfamily Circular flow: let’s all tighten our belts to save Circular flow: let’s all tighten our belts to save

money during these hard times!money during these hard times! If we all cut wages, the economy will grow!If we all cut wages, the economy will grow! The world can grow its way out of the recession by The world can grow its way out of the recession by

increasing exports!increasing exports!

GDPGDP

Gross Domestic ProductGross Domestic Product (measurement (measurement of national economic activity):of national economic activity):

Dollar valueDollar value (nominal vs. real GDP= (nominal vs. real GDP= nominal/price index)nominal/price index)

of all of all final goods and servicesfinal goods and services (vs. (vs. intermediate goods)intermediate goods)

Produced Produced within a countrywithin a country (vs. Gross (vs. Gross National Product/GNP)National Product/GNP)

In a In a calendar yearcalendar year (avoid double (avoid double counting)counting)

4 Main Types GDP4 Main Types GDP Nominal GDP Nominal GDP (prices; how much money (prices; how much money

from selling donuts?)from selling donuts?) Real GDP Real GDP (adjusted for inflation; how (adjusted for inflation; how

many donuts?)many donuts?) GDP per capitaGDP per capita: stuff/# people; : stuff/# people;

• problem for developing countries w/rapid pop problem for developing countries w/rapid pop growthgrowth

Potential/full-employment GDPPotential/full-employment GDP: if : if resources fully employed efficiently, what resources fully employed efficiently, what is possible to produce (think production is possible to produce (think production possibilities curve) w/o increasing inflationpossibilities curve) w/o increasing inflation

Measuring GDPMeasuring GDP Output-Expenditures ModelOutput-Expenditures Model GDP= C + I + G + (x-m)GDP= C + I + G + (x-m) CConsumption (households, 2/3 US onsumption (households, 2/3 US

economy)economy) IInvestment (only capital goods, not stocks; nvestment (only capital goods, not stocks;

most volatile)most volatile) GGovernmentovernment eXeXports – iports – iMMports (domestic production; ports (domestic production;

slightly misleading)slightly misleading)

Income ApproachIncome Approach

GDP= Income generated from GDP= Income generated from productionproduction

Must equal Output-Expenditure: Must equal Output-Expenditure: circular-flowcircular-flow what is spent is what is spent is earnedearned

Short- and Long-runShort- and Long-run

Short-run: period when input prices Short-run: period when input prices (e.g. wages) don’t change in (e.g. wages) don’t change in response price changes (inflation)response price changes (inflation)

Long-run: sufficiently long period Long-run: sufficiently long period when input prices when input prices cancan change in change in response to price changesresponse to price changes• Slight diff. MicroSlight diff. Micro

Aggregate Supply/DemandAggregate Supply/Demand

AD: total quantity of goods and AD: total quantity of goods and services demanded at different price services demanded at different price levelslevels

AS: total quantity of goods and AS: total quantity of goods and services in the economyservices in the economy

Keynesian AS-AD GraphKeynesian AS-AD Graph

““Mainstream” view: developed in response Mainstream” view: developed in response to Great Depressionto Great Depression

Q= real GDPQ= real GDP Price Level: weighted average of all final Price Level: weighted average of all final

g+s in economyg+s in economy 3 ranges: horizontal, intermediate, vertical 3 ranges: horizontal, intermediate, vertical

(at full-capacity/employment level of (at full-capacity/employment level of output)output)

Intersection AS-AD= equilibrium price and Intersection AS-AD= equilibrium price and outputoutput

Q= real GDP

Price Level

Horizontal:

Excess capacity increase output w/o increase price

Intermediate

Some increase output “dissipated” as inflation (PL up)

Vertical

At full-capacity/employment, any increase AD lost entirely to inflation (can’t produce more)

AS

Qf

Q= real GDP

Price Level

Qf

AS

AD1= full-employment production

AD2= recession

AD3= depression

QrQd

Ratchet?Ratchet?

Prices + wages “downwardly Prices + wages “downwardly inflexible”: decline ADinflexible”: decline AD firms can’t firms can’t (labor contracts)/ don’t want to (labor contracts)/ don’t want to (efficiency wages) decrease wages (efficiency wages) decrease wages price level doesn’t fall w/decrease ADprice level doesn’t fall w/decrease AD

RecessionsRecessions depressions depressions

Q= real GDP

Price Level

Qf

AD1

AD2

QrQd

AS

Keynesian AssumptionsKeynesian Assumptions

1) Input prices (wages, rent, etc.) 1) Input prices (wages, rent, etc.) downwardly inflexible (hard to lower downwardly inflexible (hard to lower wages)wages)

2) Changes in Investment esp. important 2) Changes in Investment esp. important affecting GDP (“animal spirits”)affecting GDP (“animal spirits”)

3) “In the long-run we’re all dead”: 3) “In the long-run we’re all dead”: Unemployment equilibriumUnemployment equilibrium economy can economy can get stuck in recession/depression w/o get stuck in recession/depression w/o external force (G)external force (G)

Neo-Classical AS-ADNeo-Classical AS-AD

Assumes v/ efficient markets (including Assumes v/ efficient markets (including labor market)labor market)

Distinction Short-run AS and Long-run ASDistinction Short-run AS and Long-run AS Long-run AS vertical at Long-run AS vertical at

full-capacity/employment GDPfull-capacity/employment GDP Long-run equilibrium Long-run equilibrium onlyonly at intersection at intersection

ASsr-AD-ASlrASsr-AD-ASlr economy will economy will by itselfby itself return to ASlr (self-regulating)return to ASlr (self-regulating)

No long-run trade-off inflation + No long-run trade-off inflation + unemployment: unemployment: justjust inflation inflation

Q= real GDP

Price Level

AD

ASsr

ASlr

Long-run equilibrium

AD2

Short-run equilibrium

Business CycleBusiness Cycle

Cyclical not periodicCyclical not periodic• Regression to the meanRegression to the mean

Contraction > 2 consecutive quarters Contraction > 2 consecutive quarters (6 months) = recession(6 months) = recession

Deep, long recession = depressionDeep, long recession = depression Stagflation: stagnation + inflationStagflation: stagnation + inflation

Factors Affecting Business CycleFactors Affecting Business Cycle

1) Investment (prob. excess 1) Investment (prob. excess capacity)capacity)

2) Availability $ and credit (interest 2) Availability $ and credit (interest rates)rates)

3) Expectations future economy3) Expectations future economy 4) Capital deepening (increase labor 4) Capital deepening (increase labor

productivity; often result I)productivity; often result I) 5) External shocks (supply shock)5) External shocks (supply shock)

IndicatorsIndicators

Leading: where we’re going (housing Leading: where we’re going (housing starts)starts)

Lagging: where we’ve been; confirms Lagging: where we’ve been; confirms change in cycle (unemployment)change in cycle (unemployment)

Coincident: where we are (income)Coincident: where we are (income)

Limitations of GDPLimitations of GDP 1) estimate: slow to gather, 1) estimate: slow to gather,

sampling/surveyssampling/surveys 2) Underground/ nonmarket transactions2) Underground/ nonmarket transactions 3) National: hard at local level3) National: hard at local level 4) Changes in quality: can’t track change 4) Changes in quality: can’t track change

Apple IIGApple IIG Alienware Alienware 5) Distribution of income/goods5) Distribution of income/goods 6) Blind: doesn’t differentiate uses of g+s 6) Blind: doesn’t differentiate uses of g+s

(externalities)(externalities) Green GDP: + happiness, sustainability, Green GDP: + happiness, sustainability,

etc.; - pollution, crime, etc.etc.; - pollution, crime, etc.