Introduction to Macroeconomics

1. Introduction to Macroeconomics Chapter 20 © 2006 Thomson/South-Western

2. The National Economy • Macroeconomics concerns the overall performance of the economy • The term economy describes the structure of economic activity in a community, a region, a country, a group of countries, or the world • Gross domestic product:the market value of final goods and services produced in the United States during a given period, typically a year

3. Flow and Stock Variables • Flow Variable • An amount per period of time • Average spending per week, hours worked per month, etc. • Stock Variable • An amount measured at a particular point in time • Amount of cash on hand you have now • Number of housing units in existence today

4. Economic Fluctuations • Economic fluctuations • The rise and fall of economic activity relative to the long-term growth trend of the economy • Business cycles • Vary in length and intensity but have some features in common

5. Components of Business Cycles • Two phases • Periods of expansion • Periods of contraction • Depression • Severe contraction • Lasting longer than one year and accompanied by high unemployment • Recession • Milder contraction • Decline in total output lasting at least two consecutive quarters

6. Exhibit 1: Hypothetical Business Fluctuations • Contraction begins after a previous expansion has reached its peak and continues until the economy reaches a trough • Long-term growth trend is shown by upward sloping straight line. • Period between a peak and a trough is a contraction • Period between a trough and subsequent peak is an expansion

7. Exhibit 2: Annual Percentage Change in U.S. Real GDP from 1929 to 2003

8. Exhibit 3: U.S. – U.K. Annual Growth Rates in Output

9. Economic Indicators • Leading economic indicators • Variables that predict, or lead to, a recession or recovery; foreshadow a turning point in economic activity and predict, or lead to, upturns and downturns • Coincident economic indicators • Those measures that reflect peaks and troughs as they occur • Lagging economic indicators • Follow or trail changes in overall economic activity

10. Aggregate Output • Aggregate output • Total amount of goods and services produced in the economy during a given period • Best measure is real gross domestic product, or real GDP • Aggregate demand • The relationship between the economy’s price level and the quantity of aggregate output demanded

11. Price Level • Average price of aggregate output is called the price level • A composite measure reflecting the prices of all goods and services in the economy relative to prices in a base year • The price level in the base year has a benchmark value of 100

12. Price Level • Price levels in other years are expressed relative to the base-year price level • Price level or price index used to make • Comparisons in prices across time • Accurate comparisons of real aggregate output over time

13. GDP Price Index • Real GDP: Gross domestic product after adjusting GDP for price changes • The GDP price index • Shows how the economy’s general price level changes over time • Can be used to convert production in different years into dollars of constant purchasing power

14. Aggregate Demand Curve • Aggregate demand curve: shows the relationship between the price level in the economy and the real GDP demanded, other things constant • Sums demands of the four economic decision makers: households, firms, governments, and the rest of the world • Among the factors held constant along a given aggregate demand curve are • The price levels in other countries • The exchange rates between the U.S. dollar and foreign currencies

15. Exhibit 4: Aggregate Demand Curve • Sums the demands of four economic decision makers: households, firms, governments, and the rest of the world • The inverse relationship reflects the fact that as the price level increases, other things constant, purchases by the four major decision makers decline

16. Aggregate Supply Curve • Shows how much output U.S. producers are willing and able to supply at each price level, other things constant • Assumed constant along an aggregate supply curve are • Resource prices, including wage rates • The state of technology • The rules of the game that provide production incentives

17. Exhibit 5:Aggregate Demand & Supply • Wage rates assumed constant along the AS curve; firms find a higher price level more profitable, so they increase real GDP supplied • Equilibrium occurs where the AD and AS curves intersect • Although employment is not measured directly, firms must usually hire more workers to produce more output

18. Exhibit 6: Decrease in Aggregate Demand from 1929 to 1933 • The Great Depression can be viewed as a shift to the left of the AD curve • This resulted in a drop of both the price level and real GDP AS Price level (2000 = 100) 11.9 8.9 AD1929 AD1933 0 636 865 Real GDP (billions of 2000 dollars)

19. Short History of U.S. Economy • Age of Keynes: After the Great Depression to the Early 1970s • Federal budget deficit: amount by which federal outlays exceed federal revenues • Demand-side economics: focus was on how changes in aggregate demand could promote full employment

20. AS 1975 38.0 4.31 Exhibit 7: Stagflation Between 1973-1975 The stagflation of the mid-1970s can be represented as a reduction in aggregate supply AS 1973 Price level (2000 = 100) 31.9 AD 0 4.34 RealGDP (trillions of 2000 dollars)

21. Short History of U.S. Economy • Experience since 1980 • Supply Side economics: federal government would provide incentives to increase the supply of labor and other resources by lowering tax rates • Government debt: net accumulation of prior deficits

22. Exhibit 8: Tracking U.S. Real GDP and Price Level Since 1929