Chapter 19

Overview of Macroeconomics
Book: Economics (19th edition)
by: Paul A. Samuelson, William D. Nordhaus
 Outline
• Micro vs Macroeconomics
• Two Central themes of Macroeconomics
• History
• 3 Central Questions of Macroeconomics
• Objectives and Instruments of Macroeconomics
• The tools of Macroeconomic Policy
• Aggregate Supply and Demand
 Macroeconomics
• Abundant Jobs or hard to find?

• Improvement in real wages and living

standards?, or, are consumers struggling to
make ends meet as price inflation reduces real
wages?

• Is there a period of financial exuberance with

stock prices rising rapidly?
 Macroeconomics (Cont.)
• Falling housing prices and a financial crisis →
Role of central bank using monetary policy

• Impacts of globalization and foreign trade on

domestic employment and output?

These questions are central to macroeconomics

 Micro vs Macroeconomics
• Macroeconomics is the study of the
behavior of the economy as a whole. It
examines the forces that affect firms,
consumers, and workers in the aggregate

• It contrasts with microeconomics , which

studies individual prices, quantities, and
markets
 Two Central Themes of
Macroeconomics
1. The Short-term fluctuations in output,
employment and prices that we call the
Business Cycles
 Two Central Themes of
Macroeconomics
2. The Long-term trends in output and
living standards known as Economic
Growth
 History
• 1930s → production, employment, and prices
collapsed in the US and across much of the
industrial world, economists and political
leaders wrestled with the calamity of the Great
Depression

• During the Vietnam War in the 1960s and the

energy crises of the 1970s, the burning issue
was “stagflation,” a combination of slow growth
and rising prices
 History (Cont.)
• The 1990s witnessed a period of rapid growth,
falling unemployment, and stable prices → In
2000s a sharp decline in the prices of
technology stocks, and this was followed by a
sharp decline in housing prices after 2007

• The 2007–2009 housing-price decline produced

a profound financial crisis and led to a deep and
long recession
3 Central Questions of Macroeconomics
1. Why do output and employment sometimes
fall, and how can unemployment be reduces?

- Business cycle recession: Expansion and

contraction of market economies

- Business recession in US (2007) → Housing and

stock prices fallen, & banks tightened credit and
lending → Output and employment fell sharply
3 Central Questions of Macroeconomics
- Tools used → Monetary and Fiscal Policy to
reduce unemployment and stimulate economic
activity
3 Central Questions of Macroeconomics
2. What are the sources of price inflation, and
how can it be kept under control?
- Rising Prices → Inflation: Households on fixed
incomes find that inflation is eating away at their
real incomes

- Macro economic policy emphasized low and

stable inflation as a key goal
3 Central Questions of Macroeconomics
3. How can a nation increase its rate of economic
growth?
- High economic growth (Countries): over the last
5 decades, Asian countries such as Japan, South
Korea and Taiwan

- Key factors for high economic growth: Stable

macroeconomic policy, high rates of saving and
investment, openness to international trade, &
accountable & non-corrupt governing
institutions
 Objectives and Instruments of
Macroeconomics
The major macroeconomic goals are a high level
and rapid growth of output, low unemployment,
and stable prices

1. Output: The "quantity of goods or services

produced in a given time period, by a firm,
industry, or country", whether consumed or
used for further production
 Objectives and Instruments of
Macroeconomics (Cont.)
• The most comprehensive measure of the total
output in an economy is the Gross Domestic
Product (GDP)

• GDP is the measure of the market value of all

final goods and services produced by a country
over a given period of time
e.g. beer, cars, etc.
 Objectives and Instruments of
Macroeconomics (Cont.)
Ways to measure GDP:
- Nominal GDP: is measured in actual market
prices

- Real GDP: is calculated in constant or invariant

prices (where we measure the number of cars
times the prices of cars in a given year such as
2000)
𝐺𝐷𝑃𝒕 − 𝐺𝐷𝑃𝒕 − 𝟏
% 𝑔𝑟𝑜𝑤𝑡ℎ 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑎𝑙 𝐺𝐷𝑃 𝑖𝑛 𝑦𝑒𝑎𝑟 𝒕 = 100 ∗
𝐺𝐷𝑃𝒕 − 𝟏
 Objectives and Instruments of
Macroeconomics (Cont.)
2. High Employment, Low unemployment:
Directly felt by individual
Labor force: It includes all employed persons and
those unemployed individuals who are seeking
jobs, and exclude those without work, who are not
looking for a job

Business Cycle: When output ↓, → the demand

for labor ↓, → Unemployment rate ↑ (Great
Depression)
 Objectives and Instruments of
Macroeconomics (Cont.)
3. Price Stability: Consumer Price Index: Which
measures the trend in the average price of
good and services bought by consumers

Rate of Inflation:
𝑃𝒕 − 𝑃𝒕 − 𝟏
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑖𝑛 𝑦𝑒𝑎𝑟 𝒕 = 100 ∗
𝑃𝒕 − 𝟏
e.g. The CPI was 201.6 in 2006 & 207.3 in 2007, so the
rate of inflation in year t will be
207.3 −201.6
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑖𝑛 𝑦𝑒𝑎𝑟 𝒕 = 100 ∗
201.6
= 2.8% per year
 Objectives and Instruments of
Macroeconomics (Cont.)
Deflation:
- It occurs when prices decline, which means that
the rate of inflation is negative

Hyper Inflation:
- A rise in the price level of a thousand or a million
percent a year (Weimer Germany in the 1920s,
Brazil in the 1980s, Russia in 1990s, Venezuela
2019)
 Objectives and Instruments of
Macroeconomics (Cont.)
Objectives Instruments
1. Output: High level & Monetary Policy
rapid growth of output - Controlling the money
supply to determine
2. Employment: High interest rate
level of employment
with low level of Fiscal Policy
unemployment - Government
expenditures and
3. Price-level stability taxation
 The tools of Macroeconomic Policy
Fiscal Policy (FP)
- It consists of government expenditure & taxation

- Government expenditure influences the relative

size of collective as opposed to private
consumption

- Taxation subtracts from incomes, reduces

private spending, affects private saving &
investment and potential output
 The tools of Macroeconomic Policy
(Cont.)
Expansionary Fiscal Policy: It uses budgetary tools
to either increase spending or cut taxes. That
provides consumers and businesses with more
money to spend

Purpose:
- To boost growth to a healthy economic level to
get out of the contractionary phase of the
business cycle
- To reduce unemployment, increase consumer
demand, and avoid a recession
 The tools of Macroeconomic Policy
(Cont.)
Contractionary Fiscal Policy:
- Increasing taxes, decreasing government
expenditures or both in order to fight inflationary
pressures

- Due to an increase in taxes, households have less

disposal income to spend & it will decreases
consumption

- An increase in taxes also reduces profits available

to businesses and they cut down their investment
expenditures
 The tools of Macroeconomic Policy
(Cont.)
Monetary Policy (MP)
- Conducted by Central Bank, determines the
money supply

- Changes in the money supply move interest rate

up or down and affect spending in sectors such
as business investment, housing and net exports
 Aggregate Supply and Demand
Aggregate Supply (AS):
- Refers to the total quantity of goods and
services that the nation’s businesses willingly
produce and sell in a given period

- AS depends upon the price level, the productive

capacity of the economy, and the level of costs
 Aggregate Supply and Demand (Cont.)
Aggregate Demand:
- It refers to the total amount that different
sectors in the economy willingly spend in a
given period

- It is the sum of spending by consumers,

businesses, and governments, and it depends
on the level of prices, as well as on monetary,
fiscal policy and on other factors
 Aggregate Supply and Demand (Cont.)
Graphically:
 Aggregate Supply and Demand (Cont.)
Explanation:
Point E
- National output & overall price levels are
determined at the intersection of the Aggregate
Demand & Supply Curve

- Overall economy is in equilibrium at point E,

where the level of output is Q = 3000 and P =
150, and spenders and sellers satisfied
 Aggregate Supply and Demand (Cont.)
Explanation:
Point E
- Only at point E, demanders are willing to buy
exactly the amount that businesses are willing to
produce and sell

- It shows equilibrium occurs at an overall price

level where firms willingly produce and sell
what consumers and other demanders willingly
buy
 Aggregate Supply and Demand (Cont.)
How does the economy reach its equilibrium?
- If the price level were higher than equilibrium
(150), say, at P=200, sellers would want to sell
more than buyers would want to buy

- Sellers would desire to sell quantity C, while

buyers would want to purchase only amount B

- As a result, Goods would pile up on the shelves

as firms produced more than consumers bought
 Aggregate Supply and Demand (Cont.)
How does the economy reach its equilibrium?
- Because of the excess aggregate supply of
goods, firms would cut production and shave
their prices

- The overall price level would begin to decline or

rise less rapidly
 Aggregate Supply and Demand (Cont.)
How does the economy reach its equilibrium?
- As the price level declined from its original too
high level, the gap between desired total
spending and desired total sales would narrow

- Eventually, prices would decline to the point

where overall demand and production were in
balance
 Aggregate Supply and Demand (Cont.)
AD Curve:
- We can see that with overall price level of $150,
total spending would be $3000 billion (per year)

- If price level rises to $200, total spending will fall

to $2300 billions
 Aggregate Supply and Demand (Cont.)
AS Curve:
- It represents the quantity of good and services
that business are willing to produce and sell at
each price level

- According to AS curve, businesses will want to

sell $3000 billion at a price level of $150

- If prices rose to $200 they would sell a higher

quantity of almost $3300 billion