Introduction to Macroeconomics

1
Macro
ECON
McEachern 2008-2009
5
CHAPTER
Introduction to Macroeconomics
Designed by Amy McGuire, B-books, Ltd.
2
The National Economy
LO1
3
The National Economy
LO1
4
The National Economy
LO1
5
The National Economy
LO1
6
Economic Fluctuations and Growth

• Rise and fall of economic activity
• Business cycles
• Expansions Output increases
• Contractions Output decreases
• Depression
• Sharp reduction in output
• Lasts gt 1 year
• High unemployment
• Recession
• Lasts gt 6 months

LO2
7
Economic Fluctuations and Growth

• Inflation
• Economys average price level increase
• U.S. economic fluctuations
• 14 times more output than in 1929
• Increased production
• Quantity and quality of resources
• Better technology
• Rules of the game

LO2
8
Exhibit 1
LO2
Hypothetical Business Cycles
9
Economic Fluctuations and Growth

• Business cycle
• Peak-to-trough-to-peak
• Contraction
• Between peak and trough
• Expansion
• Between trough and peak
• Longest
• 10 years (March 1991 to March 2001)

LO2
10
Exhibit 2
LO2
Annual Percentage Change in U.S. Real GDP Since
1929
11
The Global Economy
LO2

• Business cycles
• Linked among economies
• Slump in a major economy
• Worsen other economies
• Economic strength in major economies
• Improve other economies

Case Study
12
Exhibit 3
LO2
U.S. and U.K. Annual Growth Rates in Output Are
Similar
13
Leading Economic Indicators

• Leading economic indicators
• Predict a change in economy
• Recovery
• Downturn
• Coincident economic indicators
• Reflect changes as they occur
• Lagging economic indicators
• Follow changes in economy

LO2
14
Aggregate Demand Aggregate Supply

• Aggregate output
• Total amount of goods and services
• Produced in economy
• Given period
• Real GDP
• Aggregate demand
• Price level
• Quantity of aggregate
• output demanded

LO3
15
Aggregate Demand Aggregate Supply

• Price level
• Index number
• Base year 100
• Real GDP
• GDP adjusted for price level changes

LO3
16
Aggregate Demand Curve

• Sum of D of economic decision makers
• Households Firms
• Governments Rest of the world
• Inverse relationship
• Price level
• Real GDP demanded
• Other things constant
• Price levels in other countries
• Exchange rates

LO3
17
Exhibit 4
LO3
Aggregate Demand Curve
The quantity of aggregate output demanded is
inversely related to the price level, other
things constant. This inverse relationship is
reflected by the aggregate demand curve AD.
18
Aggregate Supply Curve

• Positive relationship
• Price level
• Real GDP supplied
• Other things constant
• Resource prices
• State of technology
• Rules of the game

LO3
19
Exhibit 5
LO3
Aggregate Demand and Aggregate Supply in 2006
The total output of the economy and its price
level are determined at the intersection of the
Ad and AS curves. This point reflects real GDP
and the price level for 2006 using 2000 as the
base year.
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Equilibrium

• AD curve intersects AS curve
• Equilibrium price level
• Equilibrium real GDP
• Higher real GDP
• More goods
• and services
• Higher
• employment

LO3
21
Short History of the U.S. Economy

• Before and during Great Depression
• After Great Depression to early 1970s
• The Age of Keynes
• From early 1970s to early 1980s
• Stagflation
• Since early 1980s
• Normal times

LO4
22
The Great Depression and Before

• 1873 1879 Longest contraction
• 80 railroads bankrupt
• 1890s
• Contractions
• 18 unemployment rate
• 1929 The Great Depression

LO4
23
The Great Depression and Before

• 1929 - 1933 Deepest economic contraction
• Stock market crashed
• Investment dropped
• Consumer spending fell
• Banks failed
• Money supply dropped by 1/3
• High tariffs restricted trade
• Big decline in AD
• Real GDP dropped 27
• Price level dropped 26
• Unemployment rate 33

LO4
24
Exhibit 6
LO4
The Decrease in Aggregate Demand from 1929 to 1933
The Great Depression of the 1930s can be
represented by the shift to the left of the AD
curve, from AD1929 to AD1933. In the resulting
depression, real GDP fell from 865 billion to
636 billion, and the price level dropped from
11.9 to 8.9, measured relative to a price level
of 100 in the base year 2000.
25
The Age of Keynes

• After the Great Depression to early 1970s
• 1936 John Maynard Keynes
• The general theory of employment, interest, and
  money
• AD inherently unstable
• Government - increase AD
• Expansionary fiscal policy
• Increase government spending
• Cut taxes
• Federal budget deficit

LO4
26
The Age of Keynes

• Increase in AD
• Increase real GDP
• Increase employment
• Demand-side economics
• WWII
• Increased employment
• Increased government spending
• Federal deficits

LO4
27
The Age of Keynes

• Employment act of 1946
• 1950s Prosperity, no fiscal policy
• 1960s Golden age Keynesian economics
• Fiscal policy fine tune
• Low unemployment
• Healthy growth
• Modest inflation
• Early 1970s
• Recession
• High inflation

LO4
28
Stagflation 1973 to 1980

• 1970 Inflation rate 5.3
• 1971 Ceilings prices, wages
• 1973 Crop failures
• Soaring grain prices
• OPEC cut oil supply
• Increased oil prices

LO4
29
Stagflation 1973 to 1980

• 1973 - 1975 Decrease in AS
• Stagflation
• Stagnation or contraction in output
• Inflation
• Real GDP decreased
• Unemployment increased to 8.5
• Price level increased 19
• 1979 - 1980 Stagflation decrease AS
• OPEC cutbacks

LO4
30
Exhibit 7
LO4
Stagflation from 1973 to 1975
The stagflation of the mid-1970s can be
represented as a leftward shift of the AS curve
from AS1973 to AS1975. Aggregate output fell
from 4.34 trillion in 1973 to 4.31 trillion in
1975, for a decline of about 30 billion
(stagnation). The price level rose from 31.9 to
38.0, for a growth of 19 (inflation).
31
Normal Times Since 1980

• Combat stagflation
• Increase AS
• Supply-side economics
• Lower price level
• Increase output
• Increase employment
• Through
• lower taxes

LO4
32
Normal Times Since 1980

• 1981 Recession
• Unemployment rate 10
• Lower output
• Economic growth for 10 years
• Federal budget deficit
• 1990 higher taxes
• 1993 higher taxes
• 1995 slower growth in federal spending
• Lower federal deficits

LO4
33
Normal Times Since 1980

• 1998 Federal budget surplus
• Longest expansion 1991-2001
• 22 millions new jobs
• Unemployment rate 4.2
• Modest inflation
• 2001 Recession (8 months)
• Slow recovery
• 2003, unemployment rate 6.3
• Tax cuts
• Increased output
• Federal budget deficit

LO4
34
LO4
Nearly Eight Decades of Real GDP and Price Levels

• Since 1981 - only 2 years declining GDP
• Long-tern growth in output
• Real GDP
• 0.9 trillion in 1929
• 11.3 trillion in 2006
• Average inflation 3 per year
• Population increased 146
• 122 million in 1929
• 300 million in 2006

Case Study
35
LO4
Nearly Eight Decades of Real GDP and Price Levels

• Employment increased 207
• 47 million in 1929
• 144 million in 2006
• Higher education
• Better technology
• Higher productivity
• Standard of living increased
• Real GDP per capita

Case Study
36
Exhibit 8
LO4
Tracking U.S. Real GDP and Price Level Since 1929