Macro Lecture 1

7/27/2019 Macro Lecture 1

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SHAD 1053PRINCIPLES OF MACROECONOMICS

MacroLecture1

Lecture Highlights

Definition of economics and explain the kinds ofquestions that economists try to answer

Distinguish between microeconomics and

macroeconomics Positive and normative economics

Origins and issues of macroeconomics

Macroeconomic concerns/ questions

The components of the macroeconomy -Circularflows

Macroeconomic Policy Challenges and Tools


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Definition of Economics

Definition of economics the social science thatstudies the choices that we make as we copewith scarcity and the incentives that influenceand reconcile our choices.

The way this subject is organised two majordivisions of economics:

(1) Microeconomics deals with the functioning ofindividual industries and the behavior of

individual economic decision-making units:business firms and households. Firms choicesabout what to produce and how much to charge,and households choices about what and howmuch to buy, help to explain why the economy

produces the things it does.


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Contd.One big question addressed by microeconomics is

who gets the things that are produced. Wealthyhouseholds get more than poor households, andthe forces that determine this distribution of

output are the province of microeconomics. Whydoes poverty exist. Who is poor? Why do somejobs pay more than others?

Microeconomics also involves policy issues, such asanalyzing the most efficient way to reduce

teenage smoking, and analyzing the mostefficient way to reduce air pollution.


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Contd.

(2) Macroeconomics is concerned with thebehavior of the economy as a whole with booms and recessions, the economys

total output of goods and services, thegrowth of output, the rates of inflation andunemployment, the balance of payments,and the exchange rates. Macroeconomics

deals with both long-run economic growthand the short-run fluctuations thatconstitute the business cycle.


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Contd.

Macroeconomics focuses on theeconomic behavior and policies thataffect consumption and investment,

the value of currency and the tradebalance, the determinants ofchanges in wages and prices,monetary and fiscal policies, the

money stock, the federal budget,interest rates, and the national debt.


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Contd.Whereas microeconomics focuses on individual

product prices and relative prices,macroeconomics looks at the overall price leveland how quickly (or slowly) it is rising (or falling).

Microeconomics questions how many will be hired(or fired) this year in a particular industry or in acertain geographic area, and focuses on thefactors that determine how much labor a firm oran industry will hire. Macroeconomics deals with

aggregate employment and unemployment: howmany jobs exist in the economy as a whole, andhow many people who are willing to work are notable to find work.


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Positive and NormativeEconomics

The micro versus macro distinction is based on thelevel of detail we want to consider. Anotheruseful distinction has to do with our purpose inanalyzing a problem positive & normative

economics.

Positive economics explains how the economyworks, plain and simple. If someone says, Thedecline in home prices during 2008 and 2009 was

a major cause of the recent recession, he or sheis making a positive economic statement. Astatement need not be accurate or even sensibleto be classified as positive.

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Contd.

For ex. , Government policy has noeffect on our standard of living is astatement that virtually every

economist would regard as false. Butit is still a positive economicstatement. Whether true or not, its

about how the economy works andits accuracy can be tested by lookingat the facts.

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Contd.

Normative economics prescribes solutions toeconomic problems. It goes beyond just thefacts and tells us what we should do aboutthem. Normative economics requires us to make

judgments about different outcomes andtherefore depends on our values.

If an economist says, We should cut totalgovernment spending, he or she is engaging in

normative economic analysis. Cuttinggovernment spending would benefit some citizensand harm others, so the statement rests on avalue judgment.

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Contd.

Positive and normative economics areintimately related in practice. Wecannot properly argue about what we

should or should not do unless weknow certain facts about the world.Every normative analysis is therefore

based on an underlying positiveanalysis.

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Origins and issues ofmacroeconomics

Modern macroeconomics emergedduring the Great Depression.

People began to doubt the freemarket economy.

John Maynard Keynes, in 1936,published The general Theory ofEmployment, Interest, and Money.

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Contd.

Short-Term Versus Long-Term Goals

Keynes focused on the short-termprimarily

He felt the depression was caused byinsufficient private spending.

Government should increase its spending.

Long-term consequences were virtuallydisregarded.

In the long run, were all dead.

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Contd.

Today, macroeconomics is concernedwith:

Long-term economic growth andinflation.

Short-term business fluctuations andunemployment.

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Contd.

The focus of macroeconomics hasshifted:

Depression

Inflation of the 1970s

International economics of today

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Economic growth

Economic growth is the expansion of theeconomys production possibilities.

Measured by real gross domestic product

(real GDP)- The value of the total production of all the

nations farms, factories, shops, andoffices linked back to the prices of a singleyear (base year).

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Contd.

The growth of potential GDP

when an economys labor, capital,land, and entrepreneurial ability arefully employed.

Real GDP fluctuates around potentialGDP

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Macroeconomic questions

The standard of living

The cost of living

Economic fluctuations recessions &

expansions


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The standard of living The level of consumption of goods and

services that people enjoy, on theaverage, and is measured by averageincome per person or real GDP per person.

Achieving a high standard of living meansfinding a good job. If we lose our job, itmeans spending some time beingunemployed while we search for the rightnew job.

Unemployment is the state of beingavailable and willing to work but unable tofind an acceptable job.


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The cost of living

The number of dollars it takes to buy thegoods and services that achieve a givenstandard of living.

A rising cost of living

inflation, means ashrinking value of the dollar. A falling costof living, which is called deflation, meansa rising value of the dollar.

Has the cost of living increased ordecreased? Over the past 50 years, wesee the cost of living has increased andthe value of the dollar has shrunk.


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Economic fluctuations:recessions & expansions

Over long periods, both the standardof living and the cost of living haveincreased. But these increases have

not been smooth and continuous.

Our economy fluctuates in a businesscycle, a periodic but irregular up-

and-down movement in productionand jobs.


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Contd.

Every business cycle can be describedin terms of 4 stages:

1. The expansion stage the usualcondition of the economy. Duringthis period, real GDP is rising.

2. Peak the highest level of real GDPthat has been attained up to thattime.

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Contd.

3. Recession a period of fallingproduction that lasts for at least 6months. During a recession, incomes

are falling, people get laid off fromtheir jobs, and new jobs are harderto find.

4. Trough real GDP reaches atemporary low point and from whichthe next expansion begins.

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Business cycle

Year

Total

production peak

recessionexpansion

trough

peak

recession

expansion


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Benefits and Costs ofEconomic Growth

Benefits

Expanded production possibilities

Health care Medical research

Space exploration

Roads Environmental improvements

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Contd.

Costs

Foregone consumption

Depletion of natural resources Increased pollution

More frequent job and location

changes

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What, How, and for whom?What do we produce?

How will society decide whether to produce moreeconomics textbooks or more DVD players?More day care facilities or more football

stadiums? Of course, society does not makedecisions; only individuals make decisions. Theanswer to the question of what will be producedis determined by the choices made byconsumers, firms, and the government.


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Contd.

What do we produce?

In macroeconomics, we divide the vastarray of goods and services

produced into 4 large groups:(1)Consumption goods & services

(2)Investment goods

(3)Government goods & services(4)Export goods & services


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Contd.

(1)Consumption goods & services - Itemsthat are bought by individuals and usedto provide personal enjoyment e.g.

housing, food, movies, dry cleaningservices.

(2) Investment goods goods that arebought by businesses to increase their

productive resources e.g. auto assemblylines, shopping malls, factories,airplanes.


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(3) Government goods & services items that are bought bygovernments e.g. missiles & weapon

systems, travel services, policeprotection, roads.

(4) Export goods & services items

produced in one country and sold inother countries.


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How do we produce?How will the goods and services be produced?

Firms choose how to produce the goods andservices they sell. In many cases, firms face a

trade-off between using more workers or usingmore machines. For example, a local servicestation has to choose whether to provide carrepair services using more diagnostic computersand fewer auto mechanics or more auto

mechanics and fewer diagnostic computers.


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How do we produce? Contd.

Goods & services are produced byusing productive resources (inputs)/factors of production.

Factors of production are groupedinto 4 categories:

(i) Land includes all the gift of

nature, natural resources land,minerals, energy, water, and air, andwild plants, animals, birds, and fish.


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(ii) Labor the work time and work effortthat people devote to producing goodsand services. The quantity of labor

increases as the adult populationincreases.

The quality of labor depends on howskilled people are human capital is the

knowledge and skill that people obtainfrom education, training, and workexperience.


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(iii) Capital consists of the tools,instruments, machines, buildings, andother constructions that have produced in

the past and that businesses or firms nowuse to produce goods & services e.g.hammers & screwdrivers, computers, autoassembly lines, office buildings, dams,

airports & airplanes, and factories.


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(iv) Entrepreneurship the humanresource that organizes labor, land,and capital. Entrepreneurs come up

with new ideas about what and howto produce, make business decisions,and bear the risks.


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For whom do we produce? Who gets the goods & services that are

produced depends on the incomes that peopleearn and the goods and services that theychoose to buy.

People earn their incomes by selling theservices of the factors of production they own.

(i) Rent income paid for the use of land.

(ii) Wages income paid for the services of labor.

(iii) interest income paid for the use of capital.(iv)Profit (or loss) income earned by an

entrepreneur for running a business.


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Circular flows

The circular flow model shows thecircular flow of expenditures andincomes that result from decision

makers choices and the way thosechoices interact to determine what,how, and for whom goods and

services are produced.


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Contd.

Goods marketsFactor markets

Households

Firms

Labor,land,capital &

entrepreneurship

Labor,land,capital &entrepreneurship hired

Expenditure ongoods & services

Revenue fromsale of goods

& services

Rent,wages,interest

,and profit paid

Rent,wages,interest& profit

Goods & servicessupplied


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Real flows and money flows

When households choose the quantities ofland, labor, capital, and entrepreneurshipto offer in factor markets, they respond to

the incomes they receive. When firms choose the quantities of goods

& services to produce and offer for sale ingoods market, they respond to the

amounts that they receive from theexpenditures that households make.

G t i th i l


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Governments in the circularflow

Households

Firms

Governments Goods marketsFactor markets

taxes

taxes

transfers

transfers

Expenditures ongoods & services

Rent,wages,interest,and profit

Rent,wages,interest,and profit

M i li


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Macroeconomic policyChallenges and Tools

Policy Challenges

1)Boost economic growth

2)Stabilize the business cycle3)Reduce unemployment

4)Keep inflation low

5)Reduce the government deficits

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Policy Tools

1)Fiscal policy

making changes in taxes andgovernment spending

Long-term growth

Smooth the business cycle

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2) Monetary policy

Changing interest rates and theamount of money in the economy

Control inflation

Smooth business cycle

Macro Lecture 1

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Transcript of Macro Lecture 1