Introduction to macroeconomics

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Introduction to macroeconomics

• Notes and Summary of Readings

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Note

• Links to online resources are highlighted in
  yellow. Right click and choose Open Hyperlink
  to access them.

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Topics Covered
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References

• Macroeconomics by Abel, Bernanke and Croushore
  Chapter 1 (main reference)
• Macroeconomics by Dornbusch and Fischer Chapter
  1 (for supplementary reading)
• These chapters are available online for free
  reading.

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What Macroeconomics is about

• Let us start by reading about some news topics
  that generated debate and discussion in the world
  of economics...
• FDI in multi-brand retail (India, Sep 2012)
• Debt crisis (Eurozone)
• Fiscal cliff (USA, Dec 2012 / Jan 2013)
• Direct cash transfer program (India, Jan 2013)
• Record high unemployment rate (Eurozone, Jan
  2013)

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• While reading the above articles, you would have
  come across terms like growth, unemployment,
  inflation, depression, debt, deficit, interest
  rate, savings, exchange rate, economic policy
  etc. The branch of economics that deals with all
  these issues, and much more, is called
  macroeconomics.
• Formally, macroeconomics is defined as the field
  concerned with the structure and performance of
  national economies and the policies governments
  use to try to affect economic performance.
• Structure refers to the relationship
  between input-output accounts, levels of
  consumption and investment, sectors of the
  economy, relationships between different sectors,
  degree of independence of the economy etc.
• Performance the values of macroeconomic
  variables, such as inflation rate, unemployment
  rate, GDP etc., and how they are related to one
  another.

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• Difference between microeconomics and
  macroeconomics
• The difference between the two fields is
  primarily one of approach and emphasis.
• Diff. in approach

Microeconomics Macroeconomics
Focuses on the choices made by the individual decision-making units of the society-typically the consumers and firms- and the impact of those choices on individual markets Concerns itself with choices made by the macro players of the economy- such as the government, the central bank etc. and the impact of those choices on the economy as a whole
Bottoms-up approach Top-down approach
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• Diff. in emphasis

Microeconomics Macroeconomics
Studies the demand and supply in individual markets, each of which is too small to have an impact on the national economy Emphasizes on aggregate quantities such as aggregate consumption, aggregate investment and aggregate output fine distinctions among different kinds of goods, firms and markets are usually ignored
Phenomena affecting the economy as a whole, like inflation or unemployment, are either not mentioned or are taken as given, as these are not variables that individual buyers or sellers can change Phenomena such as inflation and unemployment are among the key variables studied
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Some basic issues in Macroeconomics
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• Long-run economic growth
• Economic growth is the increase in the amount of
  the goods and services produced by
  an economy over time. i.e. the quantitative
  changes taking place in an economy.
• Economic growth is measured in terms of real
  Gross National Product (GNP) or Gross Domestic
  Product (GDP). It is different from economic
  development because the latter also takes into
  account qualitative changes taking place in the
  economy, such as improvement in socio-cultural
  relations, health care, literacy etc.
• Rich nations Experienced periods of rapid
  economic growth at some point in their history.
• Developing nations Never experienced sustained
  growth / Periods of growth offset by periods of
  economic decline.

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• Factors important for long-term economic growth

Output per unit of employed labour
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• 2. Business cycles
• As said earlier, an increase in the availability
  of resources and improvements in efficiency help
  a country to register an upward trend in long-run
  economic growth. But it has been observed that at
  any given point of time, the rate of economic
  growth is greater than, smaller than, or
  sometimes equal to, the general trend.
• For example, the trend in the USA over the last
  century has been one of rising economic growth.
  However, the growth hasnt been smooth and has
  numerous hills and valleys. During the 1960s,
  national output nearly doubled, but during
  1973-75, 1981-82, and 1990-91, output declined
  from one year to the next.

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These short-run fluctuations, called business
cycles, exist not only for economic growth, but
also for other macroeconomic variables such as
inflation and unemployment. Formally, a
business cycle is defined as the more or less
regular pattern of expansion and contraction in
economic activity around the path of trend
growth. It is important to note that business
cycles do not include fluctuations that last only
for a few months, such as the spurts in economic
activity that occur around major festivals. In
the past few years, we often came across the term
recession in newspaper articles. Recession
simply refers to the downward phase of a business
cycle, during which national output may be
falling or growing very slowly.
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• 3. Unemployment
• Unemployment (joblessness) occurs when people are
  without work and actively seeking work.
• The prevalence of unemployment in an economy is
  measured by the unemployment rate, which is
  calculated as a percentage by dividing the number
  of unemployed individuals by all individuals
  currently in the labour force.
• An economy usually experiences a relatively high
  unemployment rate during periods of recession.
  But even if the economy on the whole is doing
  very well, the unemployment rate can remain
  fairly high.
• Example
• 1933 USA Great Depression era. Unemployment
  rate 24.9
• 1944 USA Peak of war time boom. National
  output doubles. Unemployment rate significantly
  small, 1.2
• 2000 USA 4 even after prolonged economic
  growth with no recession.

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• 4. Inflation
• When the prices of most goods and services are
  rising over time, the economy is said to be
  experiencing inflation. The percentage increase
  in the average level of prices over a year is
  called the inflation rate. If the inflation rate
  in consumer prices is 10, then on an average the
  prices of items that consumers buy are rising by
  10 per year.
• In contrast, deflation is the fall in the average
  level of prices. The last major deflation in the
  USA was seen during the Great Depression. After
  that, rising prices have been the normal state of
  affairs.
• High inflation is a major issue because it
  greatly reduces the purchasing power of
  consumers. When inflation rates are extremely
  high, the economy tends to function poorly. A
  deflation too, is nothing to be excited about, as
  falling prices reduce the incentive of producers
  to sell goods.

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• 5. The international economy
• Today, every major economy is an open economy,
  which means that it has extensive trading and
  financial relationships with other national
  economies. (This is in contrast to a closed
  economy, which doesnt interact economically with
  the rest of the world.)
• A macroeconomist studying the international
  economy would be interested in knowing how
  economic links among nations, such as
  international trade and borrowing, affect the
  performance of individual economies and the world
  economy as a whole.

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• Some major issues related to the international
  economy are
• How are business cycles transmitted from one
  country to another?
• Why do trade imbalances take place? Are they good
  or bad for the economy? Exports are goods and
  services produced within the nation and sold to
  other countries. Imports are goods and services
  produced abroad and purchased by people within
  the country. An excess of exports over imports is
  called trade surplus, while an excess of imports
  over exports is called trade deficit.
• How does the foreign exchange rate (value of one
  countrys currency in terms of another currency)
  affect international trade?
• How do immigration and outsourcing affect an
  economy?
• Related articles Immigration in Canada,
  Outsourcing in the USA

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• 6) Macroeconomic policy
• An extremely important factor affecting economic
  performance is the set of macroeconomic policies
  pursued by the government.
• The two major types of policies are
• Fiscal policy
• concerns government spending and taxation
• determined at the national, state and local
  levels
• Monetary policy
• determines the rate of growth of money supply in
  the country
• under the control of the central bank

What are federal budget surpluses and deficits?
Do governments usually run a surplus or a deficit?
Which is the central bank in India? In the USA?
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What macroeconomists do
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• Macroeconomic forecasting
• An economist trying to forecast (predict) the
  performance of the economy will be concerned with
  questions such as How will a severe drought in
  agricultural regions affect food quantities and
  prices? Will productivity rise as rapidly in the
  future as it did during the tech boom of the
  early 2000s? How will a crisis in the middle east
  affect fuel prices?
• Owing to the complexity of the economic system,
  answering such questions with a high degree of
  accuracy is close to impossible. So, a
  macroeconomic forecaster will usually talk in
  terms of most likely forecasts, while offering
  optimistic and pessimistic alternative
  scenarios. In this sense, he/she is very similar
  to a meteorologist both can only talk about the
  probability of an event taking place.
• Related news article

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• Macroeconomic analysis
• Macroeconomic analysts monitor the economy and
  think about the implications of current economic
  events.
• In private sector organizations (like banks and
  large corporations), the job of an analyst is to
  try to determine how general economic trends will
  affect their employers financial investments,
  their opportunities for expansion, the demand for
  their products, and so on.
• In public sector agencies (such as the
  government, the World Bank and the International
  Monetary Fund) the main function of analysts is
  to assist in policymaking. The ultimate decisions
  regarding economic policy are taken by
  politicians, who may or may not heed the advice
  of macroeconomists in the face of numerous
  political considerations.

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• Macroeconomic research
• The role of a macroeconomist engaged in research
  is to make general statements about how the
  economy works. Research can take a variety of
  forms, from abstract mathematical analyses to
  psychological experimentation to simulation
  experiments representing the randomness of
  day-to-day economic activity.
• Like many other fields, macroeconomic research
  proceeds primarily through the formulation and
  testing of theories. An economic theory is a set
  of ideas about the economy organized in a logical
  framework. Most economic theories are developed
  in terms of an economic model, which is a
  simplified description of some aspect of the
  economy, usually expressed in mathematical form.
• A useful economic theory has the following
  characteristics
• It is based on reasonable and realistic
  assumptions
• It is easy to use
• It is consistent with data obtained from the real
  world

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• Data development
• Several macroeconomists are involved in the
  process of collecting data on macroeconomic
  variables such as the price level, measures of
  output etc. This economic data is used to assess
  the current state of the economy, make forecasts,
  analyze policy alternatives, and test
  macroeconomic theories.
• In the USA, most economic data is collected by
  agencies such as the Bureau of the Census, the
  Bureau of Labour Statistics, and the Bureau of
  Economic Analysis.

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Why macroeconomists disagree
Disagreements between macroeconomists may arise
due to differences in normative conclusions, and
because of differences in the positive analysis
of a policy proposal. There have always been
many schools of thought in macroeconomics, but
the most important and enduring disagreements on
positive issues involve the two schools of
thought called the classical approach and the
Keynesian approach.
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• The classical approach
• Origin Can be traced back to as early as 1776,
  when Scottish economist Adam Smith published The
  Wealth of Nations.
• Main idea
• Free markets are guided by the invisible hand,
  which operates through the price mechanism.
  Economic agents-typically firms and
  households-look at the prices in the market, and
  use the available information to make rational
  decisions that maximize their self-interest in
  the given circumstances. If they could increase
  their welfare by adjusting their wages or prices,
  there is no reason why they would not do so. As a
  result, wages and prices in an economy adjust
  reasonably quickly to equate supply and demand in
  all markets. A major implication of these
  assumptions is that there is no possibility for
  involuntary unemployment in the economy.
• Proponents of the classical approach believe
  that the invisible hand works well to ensure the
  economic welfare of the whole society, so that
  there is only a limited scope for government
  intervention.
• Well-known classicals Robert Lucas, Thomas
  Sargent, Robert Barro, Edward Prescott and Neil
  Wallace, all of whom were influenced by the ideas
  of Adam Smith and Milton Friedman.

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• The Keynesian approach
• Origin Relatively recent, during the Great
  Depression of the 1930s. Introduced by John
  Maynard Keynes in his book General Theory of
  Employment, Interest, and Money (1936)
• Main idea The unprecedentedly high rates of
  unemployment of the 1930s could not be explained
  by the classical theory. The thoery appeared to
  be inconsistent with the data collected from the
  real world, and the invisible hand seemed
  completely ineffective. This led Keynes to
  suggest an alternative explanation for
  unemployment There are problems of asymmetric
  information, and high costs related to frequent
  price changes, due to which prices and wages do
  not adjust rapidly enough to maintain market
  equilibrium at all times. Slow price and wage
  adjustment means that the supply of labour may
  exceed the demand for long periods of
  time-leading to high and persistent unemployment.
• Proponents of this approach tend to be sceptical
  about the invisible hand and thus are more
  willing to advocate a role for government in
  improving macroeconomic performance.
• Influential Keynesians Franco Modigliani and
  James Tobin were among the early Keynesians. The
  new generation of Keynesians includes George
  Akerlof, Janet Yellen, David Romer, Olivier
  Blanchard, Gregory Mankiw, Larry Summers and Ben
  Bernanke.

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