INTRODUCTION TO MACRO ECONOMICS

Zoubida SAMLAL - MBA , CFA Member, PHD candidate for HBS program

ECONOMICS

Why do people study economics? Many study it because they hope to make money.

Some worry that they will be considered illiterate if they cannot understand the difference between supply and demand.

Others are interested in learning how computers and the information revolution are shaping our society or why the inequality in the distribution of income has risen so sharply in recent years.

The study of how the forces of supply and demand allocate scarce resources. Subdivided into microeconomics, which examines the behavior of firms, consumers and the role of government; and macroeconomics, which looks at inflation, unemployment, industrial production, and the role of government.

ECONOMICS

ECONOMICS

MICRO-ECONOMICS MACRO-ECONOMICS

MACRO-ECONOMICS

Macroeconomics is a branch of economics that deals with the performance,structure, and behavior of a national or regional economy as a whole.

USES OF MACRO-ECONOMICS

The study of macroeconomics is imp as it tell us how the economy as a whole works.

We cannot understanding or derive the laws governing macroeconomic variables such as national income total employment general price level by studding micro-eco decision of consumers firms and industries.

What is true in case of an individual firm or industry may not be true for the economy as a whole

MACROECONOMIC CONCERNS

•Three of the major concerns of macroeconomics are • Output growth

• Unemployment

• Inflation and deflation

MACROECONOMIC CONCERNS Output Growth

business cycle The cycle of short-term ups and downs in the economy.

aggregate output The total quantity of goods and services produced in an economy in a given period.

recession A period during which aggregate output declines. Conventionally, a period in which aggregate output declines for two consecutive quarters.

depression A prolonged and deep recession.

MACROECONOMIC CONCERNS Output Growth

expansion or boom The period in the business cycle from a trough up to a peak during which output and employment grow.

contraction, recession, or slump The period in the business cycle from a peak down to a trough during which output and employment fall.

MACROECONOMIC CONCERNS Output Growth

FIGURE 5.1 A Typical Business Cycle

In this business cycle, the economy is expanding as it moves through point A from the trough to the peak. When the economy moves from a peak down to a trough, through point B, the economy is in recession.

MACROECONOMIC CONCERNS Unemployment

unemployment rate The percentage of the labor force that is unemployed.

Inflation and Deflation

inflation An increase in the overall price level.

hyperinflation A period of very rapid increases in the overall price level.

deflation A decrease in the overall price level.

SUPPLY AND DEMAND

Since we are convinced now that trading goods and services makes people better off, the next step is to understand how markets- places or situations in which people interact and trade- are theorized to operate.

We’ll use the example of gold jewelry to develop a model for demand and supply.

The model, in its graphical representation, can also demonstrate how different events can affect the demand and supply for gold jewelry.

The Law of Demand

Any phonetic resemblance to “The Law of The Man” is purely a linguistic artifact of the English language.

The Law of Demand (aka Theory of Demand) simply states that as prices of things rise, people buy less.

This should not be exciting, as you have probably operated according to this law all of your life.

Example on the board of individual and market demands

Aggregate Demand for Goods & Services

Aggregate demand (AD) curve: indicates the various quantities of domestically produced goods and services that purchasers are willing to buy at different price levels.

The AD curve slopes downward to the right, indicating an inverse relationship between the amount of goods and services demanded and the price level.

Goods & Services (real GDP)

Price Level

AD

P2

Y1 Y2

P1

Aggregate Demand Curve

As illustrated here, when the general price level in the economy declines from P1 to P2, the quantity of goods and services purchased will increase from Y1 to Y2.

A reduction in the price level will increase the quantity of goods & services demanded.

Goods & Services (real GDP)

Price Level

Each of these factors tends to increase the quantity of goods & services purchased at the lower price level.

Other things constant, a lower price level will increase the wealth of people holding the fixed quantity of money, lead to lower interest rates, and make domestically produced goods cheaper relative to foreign goods.

AD

P2

Y1 Y2

P1 A reduction in the price level will increase the quantity of goods & services demanded.

The Law of Supply

From the producers’ perspective, the higher the market price of a good happens to be, the more they’re willing to sell.

Continue the example on the board of individual and market supplies.

Factors that can affect shifts in supply include input prices, technology, expectations, etc…

economics

Goods & Services (real GDP)

Price Level

• The ASC shows the relationship between the price level and the quantity supplied of goods & services by producers.

AS (P100)

P105

P100

P95

Y1 Y2 Y3

Aggregate Supply Curve

An increase in the price level will increase the quantity supplied in the short run.

economics

Goods & Services (real GDP)

Price Level

• In the short-run, firms will expand output as the price level increases because higher prices improve profit margins since many components of costs will be temporarily fixed as the result of prior long-term commitments.

AS (P100)

P105

P100

P95

Y1 Y2 Y3

An increase in the price level will increase the quantity supplied in the short run.

Components of the Macroeconomy

Macroeconomics focuses on four groups. To see the big picture, it is helpful to divide the participants in the economy into four broad groups: (1) households,

(2) firms,

(3) the government, and

(4) the rest of the world.

Goods and Services market

Resource market

Loanable Funds market

Foreign Exchange market

Four Key Markets Coordinate the Circular Flow of Income

Components of Macroeconomy The Three Market Arenas

Another way of looking at the ways households, firms, the government, and the rest of the world relate to each other is to consider the markets in which they interact. We divide the markets into three broad arenas: (1) the goods-and-services market,

(2) the labor market, and

(3) the money (financial) market.

The Three Market Arenas

Goods-and-Services Market

Firms supply to the goods-and-services market. Households, the government, and firms demand from this market.

Labor Market

In this market, households supply labor and firms and the government demand labor.

Components of the Macroeconomy

Components of Macroeconomy

The Three Market Arenas

Money Market

Households supply funds to this market in the expectation of earning income in the form of dividends on stocks and interest on bonds.

Firms, the government, and the rest of the world also engage in borrowing and lending which is coordinated by financial institutions.

The Three Market Arenas

Money Market

Treasury bonds, notes, and bills Promissory notes issued by the federal government when it borrows money.

corporate bonds Promissory notes issued by firms when they borrow money.

shares of stock Financial instruments that give to the holder a share in the firm’s ownership and therefore the right to share in the firm’s profits.

dividends The portion of a firm’s profits that the firm pays out each period to its shareholders.

Components of Macroeconomy

All of the following are debt instruments, or promissory notes issued by a borrower, except one. Which one?

a. Treasury bonds. b. Treasury notes. c. Treasury bills. d. Corporate Stocks. e. Corporate bonds.

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All of the following are debt instruments, or promissory notes issued by a borrower, except one. Which one?

a. Treasury bonds. b. Treasury notes. c. Treasury bills. d. Corporate Stocks. e. Corporate bonds.

Goods and Services Market: Businesses supply goods & services in exchange for sales revenue. Households, investors, governments, and foreigners (net exports) demand goods.

Resource Market: Highly aggregated market where business firms demand resources and households supply labor and other resources in exchange for income.

Four Key Markets

Loanable Funds Market: Coordinates actions of borrowers and lenders.

Foreign Exchange Market: Coordinates the actions of Americans that demand foreign currency (in order to buy things abroad) and foreigners that supply foreign currencies in exchange for dollars (so they can buy things from Americans).

• Four key markets coordinate the circular flow of income. • The resource market coordinates the actions of businesses demanding resources and households supplying them in exchange for income.

• The loanable funds market brings net household saving and the net inflow of foreign capital into balance with the borrowing of businesses and governments.

• The foreign exchange market brings the purchases (imports) from foreigners into balance with the sales (exports plus net inflow of capital) to them.

• The goods & services market coordinates the demand for and supply of domestic production (GDP).

The Circular Flow Diagram

Which of the following statements is correct? a. Macroeconomics examines the behavior of individual industries. b. Both macroeconomics and microeconomics are concerned with

the decisions of households and firms. c. Microeconomists look for macroeconomic foundations to explain

why most markets arrive at equilibrium. d. All of the above.

Which of the following statements is correct? a. Macroeconomics examines the behavior of individual industries. b. Both macroeconomics and microeconomics are concerned with

the decisions of households and firms. c. Microeconomists look for macroeconomic foundations to explain

why most markets arrive at equilibrium. d. All of the above.

For economists, the main measure of how an economy is doing is: a. Aggregate output. b. Aggregate employment. c. The aggregate price level. d. The growth rate of the population.

For economists, the main measure of how an economy is doing is: a. Aggregate output. b. Aggregate employment. c. The aggregate price level. d. The growth rate of the population.

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Components of the Macroeconomy

The Role of the Government in the Macroeconomy

fiscal policy Government policies concerning taxes and spending.

monetary policy The tools used by the Federal Reserve to control the quantity of money, which in turn affects interest rates.

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A Brief History of Macroeconomics

Great Depression The period of severe economic contraction and high unemployment that began in 1929 and continued throughout the 1930s.

fine-tuning The phrase used by Walter Heller to refer to the government’s role in regulating inflation and unemployment.

stagflation A situation of both high inflation and high unemployment.

The U.S Economy Since 1970

John Maynard Keynes

Much of the framework of modern macroeconomics comes from the works of John Maynard Keynes, whose General Theory of Employment, Interest and Money was published in 1936.

CASE STUDY : BUDHIST ECONOMY