Transcript Introduction to Macroeconomics

CHAPTER
5
Introduction to
Macroeconomics
Prepared by: Fernando Quijano
and Yvonn Quijano
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Principles of Economics, 7/e
Karl Case, Ray Fair
C H A P T E R 17: Introduction to Macroeconomics
Introduction to Macroeconomics
• Microeconomics examines the behavior of
individual decision-making units—business
firms and households.
• Macroeconomics deals with the economy as a
whole; it examines the behavior of economic
aggregates such as aggregate income,
consumption, investment, and the overall level
of prices.
• Aggregate behavior refers to the behavior of all
households and firms together.
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The classical economist
• Classical economists applied microeconomic
models, or “market clearing” models, to economywide problems.
• Market clearing means: the price at which the
level of demand equals the level of supply
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The Classical View
of the Labor Market
• Classical economists believe
that the labor market always
clears.
• If the demand for labor shifts
from D0 to D1, the equilibrium
wage will fall from W0 to W1.
• Anyone who wants a job at
W1 will have one.
• There is always full
employment in this sense.
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Explaining the
Existence of Unemployment
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• If wages “stick” at W0
rather than fall to the
new equilibrium wage
of W* following a shift
of demand, the result
will be unemployment
equal to
L 0 – L 1.
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The Roots of Macroeconomics
• Under the classical model, the economists assumed
that during the recession period there is unemployment
and excess supply of labors, so, the wages will be
decreased, so this encourages the firms to increase the
demand of labors under these new wages. So, the
unemployment rate will be decreased.
unemployment
wages
Quantity of Labour Demand directly
unemployment
• During the great depression this theory has fallen to
explain this case which creates the macroeconomic
theory.
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Market clearing
AS
The classical economists
assumed that the prices and
wages are always in the
equilibrium which means the
market clearing.
prices
P*
AD
Aq
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Quantity of goods
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C H A P T E R 17: Introduction to Macroeconomics
The Classical Labor Market
and the Aggregate Supply Curve
• The classical idea that wages adjust
to clear the labor market is consistent
with the view that wages respond
quickly to price changes. This means
that the AS curve is vertical.
• When the AS curve is vertical,
monetary and fiscal policy cannot
affect the level of output and
employment in the economy.
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Supply creates Demand
• In the classical view the economists said that the supply
creates demand and this happened when the factories
produced goods and services they sell it in the market
and they will gain income where this income will be used
to purchase all other goods which means:
Supply Creates Demand
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The Roots of Macroeconomics
• However, simple classical models failed to
explain the prolonged existence of high
unemployment
during
the
Great
Depression. This provided the impetus for
the development of macroeconomics.
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The Roots of Macroeconomics
• According to the John Keynz this theory is
wrong and he said that the demand creates
supply,
• The increasing of the AD will increase the
labor demand and will create income and
eliminate the unemployment.
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Sticky price
• Sticky prices are prices that do not always
adjust rapidly to maintain the equality between
quantity supplied and quantity demanded.
• Example: Suppose there is an inflation occurred in Gaza
Strip, and the labor of PALTEL company asked the
administration of the company to increase their wages.
The administration decided to delay this decision in order
to see if the inflation will continue for the long period or
not. So, in the short run the wages will be sticky, but in the
long run it might be increased. So, the response comes
late not rapidly.
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Introduction to Macroeconomics
• Macroeconomists often reflect on the
microeconomic principles underlying
macroeconomic analysis, or the microeconomic
foundations of macroeconomics.
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The Roots of Macroeconomics
• The Great Depression was a period of severe
economic contraction and high unemployment
that began in 1929 and continued throughout the
1930s.
• The great depression has started by the
crashing of stock markets.
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How Great was the Great Depression?
• Real output (GDP)
• Unemployment
•Prices
•Some 7000 banks failed.
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Unemployment
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Stock Market Crash
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THE STOCK MARKET
• By 1929, many Americans were
invested heavily in the Stock
Market
• The Stock Market had become
the most visible sector for
investment.
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THE STOCK MARKET
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STOCK PRICES RISE THROUGH THE 1920s
• Through most of the 1920s, stock prices rose
steadily
• Speculation: Too many Americans were
engaged in speculation – buying stocks &
bonds hoping for a quick profit
• High demands on stocks and bonds before
1929
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The stock Market between 1920 - 1928
Stock prices
S of Stock
b
50
a
5
Ds1
Q1
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Q of stocks
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STOCK PRICES DECREASED DURING 1929
• The prices of bonds and stocks started to
decreased
• High percentage of Americans sold their
bonds and stocks
• The stock market crashed
• The prices of stocks decreased
• The profits of speculators decreased
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The stock Market in 1929 – Great Depression
Prices of stocks
Ss1
a
Ss2
5.00
b
1.00
Ds
Q1
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Number sold stocks
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CONSUMER SPENDING DOWN
• Most people did not have
the money to buy the
flood of goods factories
produced
• The
factories
and
business collapsed and
closed
• Unemployment
increased
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C H A P T E R 17: Introduction to Macroeconomics
FINANCIAL COLLAPSE
• After the crash, many
Americans withdrew their
money from banks
• Banks had invested in
the Stock Market and lost
money
• Banks collapsed
Bank run 1929, Los Angeles
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The Keynesian Revolution
• According to the Keynesian theory , the level of
employment is not determined by the wages and prices
but it determined by the aggregate demands for goods
and services
• Keynes believes that the government has to stimulate
the aggregate demand to affect the levels of
employment and outputs and solve recession
• The increasing of the AD will increase the labor
demand and will create income and eliminate the
unemployment.
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Stimulation of AD
AS
Inflation
b
2.5%
2.0%
A shift in the AD
In
thisto
situation,
curve
AD1 as athe
economy
bein
result of awould
change
operating
at the
less
any or all of
than
capacity,
there
factors
affecting
AD
would
be
would increase
unemployment
growth, reduce and
the
economy might
unemployment
but at
be
growing
only
a cost of higher
slowly.
inflation
a
AD 1
AD
Y1
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Real National Income
Karl Case, Ray Fair
C H A P T E R 17: Introduction to Macroeconomics
The Roots of Macroeconomics
• In 1936, John Maynard Keynes published
The General Theory of Employment,
Interest, and Money.
• During periods of low private demand, the
government can stimulate aggregate
demand to lift the economy out of
recession.
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Recent Macroeconomic History
• Fine-tuning in 1960 was the phrase used by
Walter Heller to refer to the government’s role
in regulating inflation and unemployment.
• The use of Keynesian policy to fine-tune the
economy in the 1960s, led to disillusionment
(‫ )خيبة أمل‬in the 1970s and early 1980s where
the stagflation has been born in 1970.
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Recent Macroeconomic History
• Stagflation occurs when the overall
price level rises rapidly (inflation)
during periods of recession or high
and persistent unemployment
(stagnation).
• Stagflation : Increasing of inflation
rapidly when unemployment
increased in the same period
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Macroeconomic Concerns
• Three of the major concerns of
macroeconomics are:
• Inflation
• Output growth
• Unemployment
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Inflation and Deflation
• Inflation is an increase in the overall price level.
• Hyperinflation is a period of very rapid increases in the
overall price level. Hyperinflations are rare, but have been
used to study the costs and consequences of even
moderate inflation.
• Hyperinflation is a situation in which prices and wages
rise very fast, causing damage to a country’s economy:
• Deflation is a decrease in the overall price level.
Prolonged periods of deflation can be just as damaging for
the economy as sustained inflation.
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Questions related to inflation
• Who will gain from inflation ?
• How could we solve inflation ?
• What cost does inflation impose on the society ?
• What causes of inflation?
• What are the types of inflation ?
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Output Growth:
Short Run and Long Run
• The business cycle is the cycle of short-term
ups and downs in the economy.
• The main measure of how an economy is doing
is aggregate output:
• Aggregate output is the total quantity of goods
and services produced in an economy in a
given period.
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Output Growth:
Short Run and Long Run
• A recession is a period during which aggregate
output declines. Two consecutive quarters of
decrease in output signal a recession.
• A prolonged and deep recession becomes a
depression.
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Unemployment
• The unemployment rate is the percentage of the
labor force that is unemployed.
• The unemployment rate is a key indicator of the
economy’s health.
• The existence of unemployment seems to imply
that the aggregate labor market is not in
equilibrium. Why do labor markets not clear
when other markets do?
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Government in the Macroeconomy
• There are three kinds of policy
that the government has used to
influence the macroeconomy:
1. Fiscal policy
2. Monetary policy
3. Growth or supply-side policies
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Government in the Macroeconomy
• Fiscal policy refers to government policies
concerning taxes and spending.
• Monetary policy consists of tools used by
the Federal Reserve to control the quantity
of money in the economy.
• Growth policies are government policies
that focus on stimulating aggregate supply
instead of aggregate demand.
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The Components of
the Macroeconomy
The circular flow diagram shows
the income received and
payments made by each sector of
the economy.
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The Components of
the Macroeconomy
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• Everyone’s
expenditure is
someone else’s
receipt. Every
transaction must
have two sides.
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The Components of
the Macroeconomy
• Transfer payments are payments
made by the government to people
who do not supply goods, services,
or labor in exchange for these
payments.
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The Three Market Arenas
•
Households, firms, the government,
and the rest of the world all interact
in three different market arenas:
1. Goods-and-services market
2. Labor market
3. Money (financial) market
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The Three Market Arenas
• Households and the government purchase goods and
services (demand) from firms in the goods-and services
market, and firms supply to the goods and services
market.
• In the labor market, firms and government purchase
(demand) labor from households (supply).
• The total supply of labor in the economy
depends on the sum of decisions made by
households.
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The Three Market Arenas
• In the money market—sometimes called
the financial market—households purchase
stocks and bonds from firms.
• Households supply funds to this market in the
expectation of earning income, and also demand
(borrow) funds from this market.
• Firms, government, and the rest of the world
also engage in borrowing and lending,
coordinated by financial institutions.
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Financial Instruments
• Treasury bonds, notes, and bills are promissory
notes issued by the federal government when it
borrows money for a long period of time, it pays
interest
• Corporate bonds are promissory notes issued by
corporations when they borrow money.
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Financial Instruments
• Shares of stock are financial instruments that
give to the holder a share in the firm’s
ownership and therefore the right to share in
the firm’s profits.
• Dividends are an amount of the profits that a
company pays to shareholders each period
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Aggregate Supply and
Aggregate Demand
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• Aggregate demand is the
total demand for goods and
services in an economy.
• Aggregate supply is the
total supply of goods and
services in an economy.
• Aggregate supply and
demand curves are more
complex than simple
market supply and demand
curves.
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Expansion and Contraction:
The Business Cycle
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• An expansion, or boom, is
the period in the business
cycle from a trough up to a
peak, during which output
and employment rise.
• A contraction, recession,
or slump is the period in
the business cycle from a
peak down to a trough,
during which output and
employment fall.
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