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Chapter 5: Introduction to

Macroeconomics

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Guideline

I. The Roots of Macroeconomics

II. Macroeconomic Concerns

III. Government Policies

IV. The Components of theMacroeconomics

V. The Methodology

VI. The U.S. Economy in the 20th Century

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Introduction to Macroeconomics

MicroeconomicsV.S. Macroeconomics

Aggregate behaviorrefers to thebehavior of all households and firms

together.

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Microeconomists generally conclude

that markets work well.

Macroeconomists, however, observethat some important prices often

seem sticky.

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Macroeconomists often reflect on the

microeconomic principles underlying

macroeconomic analysis, or the

microeconomic foundations ofmacroeconomics.

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The Great Depressionwas aperiod of severe economic

contraction and high

unemployment that began in

1929 and continued throughout

the 1930s.

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However, simple classical models failed to

explain the prolonged existence of high

unemployment during the Great

Depression.

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In 1936, John Maynard Keynes published TheGeneral Theory of Employment, Interest, and Money.

Keynes believed governments could intervene in the

economy and affect the level of output and

employment.

During periods of low private demand, the

government can stimulate aggregate demand to lift

the economy out of recession.

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Recent Macroeconomic History

Fine-tuningwas the phrase used by WalterHeller to refer to the governments role in

regulating inflation and unemployment.

The use of Keynesian policy to fine-tune theeconomy in the 1960s, led to disillusionment

in the 1970s and early 1980s.

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Recent Macroeconomic History

Stagflationoccurs when the overall pricelevel rises rapidly (inflation) during periods of

recession or high and persistent

unemployment (stagnation).

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II. Macroeconomic Concerns

Three of the major concerns of

macroeconomics are:

Inflation

Output growth

Unemployment

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Inflation and Deflation

Inflationis an increase in the overall pricelevel.

Hyperinflationis a period of very rapid

increases in the overall price level. Deflationis a decrease in the overall price

level. Prolonged periods of deflation can be

just as damaging for the economy as

sustained inflation.

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Output Growth:

Short Run and Long Run

The business cycleis the cycle of short-termups and downs in the economy.

The main measure of how an economy is

doing is aggregate output: Aggregate outputis the total quantity of

goods and services produced in an economy

in a given period.

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Output Growth:

Short Run and Long Run

A recessionis a period during whichaggregate output declines. Two

consecutive quarters of decrease in output

signal a recession. A prolonged and deep recession becomes

a depression.

Policy makers attempt not only to smooth

fluctuations in output during a businesscycle but also to increase the growth rate

of output in the long-run.

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VI. The U.S. Economy in 20th Century

Expansion and Contraction:

The Business Cycle

An expansion, orboom, isthe period in the business

cycle from a trough up to a

peak, during which outputand employment rise.

A contraction, recession,or slump is the period in

the business cycle from apeak down to a trough,

during which output and

employment fall.

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Real GDP, 1900-2002

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Unemployment

The unemployment rateis the percentage ofthe labor force that is unemployed.

The unemployment rate is a key indicator of

the economys health.

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Unemployment Rate, 1970 I-2003

II

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III. Government in the

Macroeconomy

There are three kinds of policy that the

government has used to influence the

macroeconomy:

1. Fiscal policy

2. Monetary policy

3. Growth or supply-side policies

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III. Government in the

Macroeconomy Fiscal policyrefers to government policies

concerning taxes and spending.

Monetary policyconsists of tools used by theFederal Reserve to control the quantity of money in

the economy.

Growth policiesare government policies that focuson stimulating aggregate supply instead of aggregate

demand.

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IV. The Components of

the Macroeconomy

The circular flow diagramshows the income received

and payments made byeach sector of the

economy.

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the Macroeconomy

Everyones

expenditure is

someone elses

receipt. Every

transaction musthave two sides.

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the Macroeconomy

Transfer paymentsare payments made bythe government to people who do not supply

goods, services, or labor in exchange for

these payments.

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The Three Market Arenas

Households, firms, the government, and the

rest of the world all interact in three different

market arenas:

1. Goods-and-services market2. Labor market

3. Money (financial) market

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Households and the government purchase goods

and services (demand) from firms in the goods-andservices market, and firms supplyto the goods andservices market.

In the labor market, firms and government purchase(demand) labor from households (supply).

The total supply of labor in the economy depends on

the sum of decisions made by households.

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In the money marketsometimes called thefinancial markethouseholds purchase stocks andbonds from firms.

Households supplyfunds to this market in the

expectation of earning income, and also demand(borrow) funds from this market.

Firms, government, and the rest of the world also

engage in borrowing and lending, coordinated by

financial institutions.

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Financial Instruments

Treasury bonds, notes, and billsarepromissory notes issued by the federal

government when it borrows money.

Corporate bondsare promissory notesissued by corporations when they borrow

money.

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Financial Instruments

Shares of stockare financial instrumentsthat give to the holder a share in the firms

ownership and therefore the right to share in

the firms profits. Dividendsare the portion of a corporations

profits that the firm pays out each period to its

shareholders.

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V. The Methodology of

Macroeconomics

Connections to microeconomics:

Macroeconomic behavior is the sum of

all the microeconomic decisions made

by individual households and firms. Wecannot understand the former without

some knowledge of the factors that

influence the latter.

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Aggregate Supply and

Aggregate Demand

Aggregate demandis thetotal demand for goods and

services in an economy.

Aggregate supplyis thetotal supply of goods and

services in an economy.

Aggregate supply and

demand curves are more

complex than simple

market supply and demand

curves.

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Review Terms and Concepts

aggregate behavior

aggregate demand

aggregate output

aggregate supply

business cycle

circular flow

contraction, recession, orslump

corporate bonds

deflation

depression

microeconomics

monetary policy

recession

shares of stock

stagflation

sticky prices

supply-side policies

transfer payments

Treasury bonds, notes,bills

unemployment rate

dividends

expansion orboom

fine tuning

fiscal policy

Great Depression

hyperinflation

inflation

macroeconomics

microeconomicfoundations ofmacroeconomics
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