Principles Of Macroeconomics

Today’s Outline

Introduction Syllabus Points of Order Lecture one

Introduction Dr Michael J. Oliver 10th year of teaching in UK

and US Macroeconomic historian Currently have three books in

print, another two due out this year.

Syllabus The course is ‘electronic’. Lectures will be available for

downloading AFTER the lecture.

Emphasis is on YOUR contribution in class and outside.

Points of Order Huge difference between

school and college. Take a risk! I do not have all the answers.

Lecture One

Introduction to Economics

A Definition of “EconomicsEconomics”

EconomicsEconomics is the study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided.

Another Definition of “EconomicsEconomics”

EconomicsEconomics is the study of how scarce resources are allocated among conflicting demands.

Four Main Reasons to Study Economics...

To learn a way of thinking To understand society To understand global affairs To be an informed voter

1. To Learn a Way of Thinking...

Three Fundamental Concepts of Economic Thinking:

• Opportunity Cost

• Marginalism

• Efficiency

Opportunity CostsOpportunity Costs

The opportunity costopportunity cost of something is that which we give up when we make that choice or that decision.

Opportunity costs imply that nearly all decisions involve trade-offs

What do we mean byOpportunity Costs?

“There’s no such thing as a free lunch!”

Opportunity Cost Question…

What is the opportunity cost of your attending college?

MarginalismMarginalism

In weighing the costs and benefits of a decision, it is important to weigh only the costs and benefits that arise from the decision. (That is, the additional costs/benefits that are added as a result of that decision.)

Efficient MarketsEfficient Markets

An efficient market is one in which any and all profit opportunities are eliminated instantaneously.

“The study of economics is an essential part of the study of

society”

2. To understand society...

Past and present economic decisions have an enormous

effect on the character of life in a society!

2. To understand society...

3. To understand global affairs...

Collapse of the Soviet Union The European Union NAFTA and GATT The Gulf War Starvation & Poverty in Africa

4. To be an informed voter... The number one issue on people’s minds in recent elections has been the economy. Clinton’s main focus during his presidency has been primarily on economic issues such as: deficit reduction, economic growth, international trade agreements and health-care reform

The Scope of Economics

MACROECONOMICS

The branch of economics that examines economic behavior of the aggregates - income, employment,

aggregate output, and so on.

The Scope of Economics

MICROECONOMICS

The branch of economics that examines the functioning of individual industries

and the behavior of individual decision-making units such as business

firms and households.

The Method of Economics

Positive Economics

An approach to economics that seeks to understand behavior and the

operation of systems without making judgements. It describes what exists

and how it works.

The Method of Economics

Normative Economics

An approach to economics that analyzes outcomes of economic

behavior, evaluates them as good or bad, and may prescribe courses of action. Normative economics will

many times apply value judgements.

Economic Theories & Models

An economic theoryeconomic theory is a statement or set of related statements about cause

and effect, action and reaction.

Economic Theories & Models

An economic modeleconomic model is a formal statement of an economic theory.

Usually a mathematical representation of a presumed

relationship between two or more variables.

Economic Theories & Models

Inductive ReasoningInductive Reasoning is the process of observing regular patterns from raw

data and drawing generalizations from them.

Economic Theories & Models

Ceteris ParibusCeteris Paribus is a device (i.e.an assumption) used to analyze the relationship between two variables while the values of other variables are held unchanged. It may be interpreted to mean “everything else equal or constant.”

Economic Theories & Models- Cautions & Pitfalls -

Post hoc, ergo propterPost hoc, ergo propter hochoc, literally means “after this, therefore because of this.” It refers to a common error made in thinking about causation. If Event A happens before Event B, it is not necessarily true that A caused B.

The Post Hoc Fallacy

Economic Theories & Models- Cautions & Pitfalls -

Two variables are correlated if one variable changes when the other variable changes.

This does not mean that changes in one variable cause changes in the other.

Correlation vs. Causation

Economic Theories & Models - Cautions & Pitfalls -

The fallacy of compositionfallacy of composition implies that what is true for a part is necessarily true for the whole.

The Fallacy of Composition

Economic Theories & Models

Empirical EconomicsEmpirical Economics is the collection and use of data to test economic theories.

Economic Policy and theCriteria for Judging Economic

Outcomes

1. Efficiency

2. Equity

3. Growth

4. Stability

Economic Policy and theCriteria for Judging Economic

Outcomes

Efficiency in economics means allocative efficiencyallocative efficiency. An efficient economy is one that produces what people want at the least possible cost.

1. Efficiency

Economic Policy and theCriteria for Judging Economic

Outcomes

EquityEquity means fairness. Equity lies in the eye of the beholder…few people agree on what is fair and what is unfair.

2. Equity

Economic Policy and theCriteria for Judging Economic

Outcomes

Economic GrowthEconomic Growth refers to the increase in total output of an economy.

3. Growth

Economic Policy and theCriteria for Judging Economic

Outcomes

Economic Stability Economic Stability refers to a condition in which output is steady or growing with low inflation and full employment of resources.

4. Stability

The Great Depression

The Great DepressionGreat Depression was a period of severe economic contraction and high unemployment that began in 1929 and continued throughout the 1930’s.

Macroeconomic Concerns

Aggregate Price Level Aggregate Output Total Employment Rest of the World

Inflation and Prices

Price levelPrice level: a measure of the behavior of all prices in the economyPrice level is a yardstick -- a tool for comparison of prices over time.InflationInflation: the rate of change in the price level

Percentage change in GDP deflator, 1959 - 1994

0.0

2.0

4.0

6.0

8.0

10.0

12.0

1959 1963 1967 1971 1975 1979 1983 1987 1991

Year

Inflation Rate

Aggregate Output (GDP)

Gross Domestic ProductGross Domestic Product (GDP) is the dollar value of all finalfinal goods and services produced.

Final goodFinal good: a product which is ready to be used by consumers

Final goodFinal good: a product which is ready to be used by consumers

Business Cycle

Periodic movements in output, prices, and employmentBusiness cycles are not created equal.

–Duration–Severity

Business Cycle

GDP rises and falls over short spans of timeAt any point in time, it may be above or below its long run trendThese fluctuations define the business cyclebusiness cycle

Unemployment

The unemployment rateunemployment rate refers to the percentage of people in the labor force who can’t find a job.

Labor ForceLabor Force: peoplewho are actively seekingor are currently holding

a job

Labor ForceLabor Force: peoplewho are actively seekingor are currently holding

a job

Unemployment Rate, 1959 - 1994

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

1959 1963 1967 1971 1975 1979 1983 1987 1991

Year

Unemployment Rate

Government Policies for Influencing the Macroeconomy

Fiscal PolicyFiscal Policy: Government policies regarding taxes and expendituresMonetary PolicyMonetary Policy: The tools used by the Federal Reserve to control the money supplySupply-side PoliciesSupply-side Policies: policies that focus on aggregate supply and increasing production

The Circular Flow Diagram

The PlayersThe Players

HouseholdsFirms

GovernmentRest of the World

Consume (C)

Save (S)

Work (N)

Paytaxes (T)

Households

The Circular Flow DiagramThe Circular Flow Diagram

Produce (GDP)

Invest (I)

Buy inputs (N)

Pay taxes (T)

Firms

The Circular Flow DiagramThe Circular Flow Diagram

The Circular Flow Diagram

Buys goods (G)

Borrows (B)

Taxes (T)

Issuesmoney (M)

Government

The Circular Flow Diagram

Rest of the World

Exports (X)

Imports (IM)

The Circular Flow Diagram

FirmsHouseholds

The Circular Flow Diagram

Firms Households

Purchases of Goods and Services

Wages, Interest, Dividends, and rent

The Circular Flow Diagram

Government

Purchases of Goods and Services

Taxes

The Circular Flow Diagram

Government

Purchases of Goods and Services

Taxes

Taxes

Wages, Interest, Transfer Payments

The Circular Flow Diagram

Rest of the World

Purchases ofExportsExports

Purchases of ImportsImports

Three Market Arenas

Goods and services marketLabor marketMoney (financial) market

Goods and Services Market

Goods and Services Market

Household, Firms and Governmentpurchasepurchase goods and services

Firms supplysupply goods and services

Labor Market

Labor Market

Firms and Governmentdemanddemand labor

Households supplysupply labor

Financial Markets

Financial Markets

Households, Firms and Governmentdemand demand funds

Households supplysupply funds

Aggregate Demand

Aggregate demandAggregate demand represents the total demand for goods and services in an economy.

Aggregate Demand Curve

PriceLevel

Aggregate Output

P1

Y1

AD

Aggregate Supply

Aggregate supplyAggregate supply represents the total supply of goods and services in an economy.

Aggregate Supply Curve

PriceLevel

Aggregate Output

P1

Y1

AS

Equilibrium

Aggregate equilibriumequilibrium is a level of prices and GDP such that the quantity of goods and services purchased equals the overall quantity of goods and services produced

Equilibrium

PriceLevel

Aggregate Output

P*

Y*

AS

AD

Equilibrium

Parts of the Business Cycle

Peak

Trough

Recession

Expansion

AggregateOutput

time

Percentage Deviation of GDP from Trend, 1960 - 1994

-3

-2

-1

0

1

2

3

4

5

6

7

1960 1964 1968 1972 1976 1980 1984 1988 1992

Year

Percentage Deviation of GDP

1994

Recession

Growth rate of GDP falls Firms decrease production Unemployment rises

GDP Unemploy-ment

Percentage Deviation of GDP from Trend, 1960 - 1994

-3

-2

-1

0

1

2

3

4

5

6

7

1960 1964 1968 1972 1976 1980 1984 1988 1992

Year

Percentage Deviation of GDP

Recessions

1994

Expansion

GDP growth rate rises Firms increase production Unemployment falls

GDPUnemploy-

ment

Percentage Deviation of GDP from Trend, 1960 - 1994

-3

-2

-1

0

1

2

3

4

5

6

7

1960 1964 1968 1972 1976 1980 1984 1988 1992

Year

Per

cen

tage

Dev

iati

on o

f G

DP

Expansions

1994

Real GDP in the U.S., 1959 - 1994

1,500.0

2,000.0

2,500.0

3,000.0

3,500.0

4,000.0

4,500.0

5,000.0

5,500.0

1959 1963 1967 1971 1975 1979 1983 1987 1991

Year

Rea

l GD

P

1994

Real GDP in the U.S., 1959 - 1994

1,500.0

2,000.0

2,500.0

3,000.0

3,500.0

4,000.0

4,500.0

5,000.0

5,500.0

1959 1963 1967 1971 1975 1979 1983 1987 1991

Year

Rea

l GD

P

Trend Line

1994