Macro Economics – continued

8/3/2019 Macro Economics continued

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PROF. RUSHEN CHAHAL

02/12/12Prof. Rushen Chahal

Macro Economics contd.


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Macro Economics contd.

Macro vs. Micro Aggregate Demand and Supply Measuring Economic Success

Output Employment Inflation

Equilibrium Changes in Macroeconomics

The Problem of Macroeconomic Stabilization U.S. Macroeconomic History



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Macro vs. Micro

In macroeconomics, we dont care about what is producedand who gets to consume what. We do care about howmuch is produced.

Its all about the big picture and not the small detail.

In microeconomics, we focus on individual decisionmaking.

In macroeconomics, we focus on the behavior of theeconomy as a whole.



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Macro vs. Micro

Macroeconomics analyzes the size of theeconomy (pie), not caring what's inside orhow its divided.

Microeconomics looks at the ingredientsand who gets to eat it, not caring about thesize and shape.



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Macro vs. Micro

Aggregation and Macroeconomics Aggregation means combining many individual markets into

one overall market.

Macroeconomic models use abstract concepts like the price

level and gross domestic product that are derived bycombining many different markets into one. This process isknown as aggregation.



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Aggregation

Aggregate supplycurve -shows the quantity ofdomestic product that is supplied at eachpossible value of the price level.

Aggregate Supply describes how much outputbusinesses would willingly produce and sell

given prices, costs, and market conditions



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Aggregation

Aggregate demand curve shows the quantity ofdomestic product that is supplied at each possible

value of the price level.

Aggregate Demand consists of the total spending in aneconomy by households, businesses, governments,and foreigners.



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Warning on AS and AD curves

Domestic product combine all goods and servicesinto one product. AS and AD curves have noindividual products. There is only one product,and it represents all products.

Aggregate demand demand for domestic product.

Aggregate supply supply of domestic product.



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Aggregation

But doesnt it matter what stuff is being boughtand what stuff is being sold?

Isnt it important if we are selling cars orselling cheese?

Yes and no



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Aggregation

Clearly we care about the makeup of theeconomy, but:

1. Exactly what the national output is comprised of

doesnt really affect issues of growth, inflation, andunemployment

2. During economic fluctuations, markets tend tomove together. When demand in an economy

rises, demand for almost all goods rises



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Some Central Questions ofMacroeconomics

Why do output and employment sometimes fall, and howcan unemployment be reduced?

What are the sources of price inflation, and how can it bekept under control?

How can a nation increase its rate of economic growth?

How can an economy balance all three of the aboveproblems?


t


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e enera eory o mp oyment,Interest, and Money - Keynes

1. It is possible for high unemployment andunderutilized capacity to persist in marketeconomies

2. Government fiscal and monetary policies can affectoutput and thereby reduce unemployment andshorten economic downturn



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Measuring Economic Success

Economists evaluate the success of an economysperformance by how well it attains theseobjectives:

High levels and rapid growth of output (usuallymeasured by GDP)

Low levels of unemployment

Price level stability (or low inflation)



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Output

Gross Domestic ProductGDP is the sum of the money values of all final goods and

services produced in the domestic economy and sold onorganized markets in a specified period of time, usually ayear.

Nominal GDP is calculated by valuing all outputs at currentprices.

Real GDP is calculated by valuing outputs of different yearsat common prices. Therefore, real GDP is a far bettermeasure than nominal GDP of changes in total production.



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Output

Disadvantage of Nominal GDP: It changes when prices change evenif there is no change in actual production.

Example: Assume a hamburger cost $1.50 in 2006. In 2007 it cost$2. In 2006 there were 100 hamburgers, which added $150 to

nominal GDP. In 2007 there were 100 hamburgers, added $200 tonominal GDP. Nominal GDP makes it look like there were morehamburgers in 2007, even though there were only 100. So nominalGDP makes it look like there is economic growth, even when there isnot.

Solution: calculate real GDP or GDP in constant dollars.



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Measuring Economic Success: Output

Shortcomings of GDP as a measure of economicwell-being:

-Only Market Activity is Included in GDP-GDP places no value on leisure

- Bads counted as well as Goods

For example, when there is a natural disaster,increased spending to solve the problems of thedisaster are counted as increased GDP.

-No account for ecological costs



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Employment:

-Macroeconomic indicator most felt byindividuals

-Unemployment rate tends to reflect the state ofthe business cycle:

-Falling output = falling demand for labor

-Rising output = rising demand for labor



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Inflation:

When price levels go up, we experienceinflation.

When price levels go down, we experiencedeflation.



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Inflation:

An economy strives to keep inflation steady

Rapid price increases cause problems forcompanies and individuals



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Chinas Inflation

August 2004 inflation rate held steady at 5.3%

Producer Prices rose 6.8%

Food prices rose 14%

Consumer goods rose 6.3%Housing prices rose 6%

Service costs rose 2%



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Q0

Price

P0

D1

A

S

D

D

S

E

Quantity(a)

Price

P0

S

D

D

S

E

Quantity(a)

D1

Inflation.Inflation.02/12/12Prof. Rushen Chahal



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Inflation Major concerns of macroeconomics

InflationUnemployment

Growth

ADprice level



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FIGUREFIGURE 2:2:An Economy Slipping into aAn Economy Slipping into aRecessionRecession

D2

BPrice

Lev

el

S

D0

D0

S

E

Domestic Product

D2




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Recession and Unemployment ADunemployment

Recession = a period of time during which total output falls

and therefore jobs are lost



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FIGUREFIGURE 3:3:Economic GrowthEconomic Growth

Copyright 2006 South-Western/Thomson Learning. All rights reserved.

D1

C

Price

Level

S0

D0

D0

S0

E

Domestic Product

D1

S1

S1

Q0 Q1




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Economic Growth Economic growth = GDP

AD and/or AS growth



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FIGUREFIGURE 7:7:The Effects of an AdverseThe Effects of an AdverseSupply Shift (stagflation)Supply Shift (stagflation)


S1

S1 D

D

S0

S0

Price

Le

vel

Real GDP

A

E



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FIGUREFIGURE 8:8:The Effects of a FavorableThe Effects of a FavorableSupply ShiftSupply Shift


Real GDP

Price

Level

D0

D0

S0

S0

S1

S1

D1

D1

S2

S2

C

BE



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The Problem of Macroeconomic Stabilization

The government wants to have a stabilization policythat can shorten recessions and fight inflation.

Combating Unemployment

When recessions are caused by too low aggregate demand,governments can try to increase demand.



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FIGUREFIGURE 99Stabilization Policy to FightStabilization Policy to FightUnemploymentUnemployment


Increase inoutput

Price

Le

vel

Real GDP

S

SD0

D0

E

D1

D1

A



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The Problem of Macroeconomic Stabilization

Combating Inflation When inflation is caused by too high aggregate demand,

governments can try to limit aggregate demand.



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FIGUREFIGURE 10:10:Stabilization Policy to FightStabilization Policy to FightInflationInflation


Decreasein prices

Price

Level

Real GDP

S

S

D0

D0

E

D2

D2

B


U S Macroeconomic History


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U.S. Macroeconomic History

Real GDP

Q

P

Price

Leve

l

E

AD

AS

P

Q

Here we seeequilibrium in themarket.




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Real GDP

Q

P

Price

Leve

l

E

E1

AD AD1

AS

P

P1

Q Q1

As America entered thViet Nam War, defensespending increased

by 55 percent between1965 and 1968.

This increased AggregatDemand, shifting the AD

Curve to the rightWhich resulted in thehigh inflation that thenation experienced

Between 1966-198102/12/12Prof. Rushen Chahal



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PDuring the 1970s the industrial worlwas struck by a supply shock.

Crop failures, shifting ocean current

massive speculation on worldcommodity markets, turmoil in foreiexchange markets, and a MidEast wthat led to a quadrupling (X4) of oilprices marked what was known asthe year of seven plagues in 1973

The result was a rapid increase of tcosts of materials and fuels,which shifted the Aggregate supplycurve inward.

Real GDP

Q

P

E

E1

AD

AS1

AS

P

P1

QQ1




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Real GDP

Q

P

Price

Lev

el

E

E1

AD

AS1

AS

P

P1

QQ1

The United States then experienceda period ofstagflation, whichwas indicated by a sharp increase ininflation and a fall in real output.

This effect can be illustrated by aninwards shift of the Aggregate SuppCurve, which increases prices anddecreases output




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Real GDP

Q

P

Price

Leve

l

E

E1 ADAD1

AS

PP1

QQ1

When President Regan tookoffice in 1981, the economy waexperiencing severe inflation,near 10 percent, an unacceptanumber.The Chairman of the FederalReserve, Paul Volcker,influenced interest rates in theso that spendingwould decrease, and in effect

decrease demand in theeconomy.The result was a decrease inoutput, and an increase inunemployment. The reward

was a decrease in inflation.02/12/12Prof. Rushen Chahal



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Q

During President Clintons firstterm, the national economyimproved remarkably. Businesimproved, unemployment fell

rapidly, and inflation was steadand low.Economic growth thenaccelerated even more duringhis second term.

Unemployment dropped to 3.9and inflation dropped below 2for a brief period

How did this happen?Real GDP

Q

P

Price

Leve

l

EAD

AS

P

Q Q1

P1

AD1

AS1

Q2

P2




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Real GDP

Q

P

Price

Leve

l

EAD

AS

P

Q

A combined increase ofAggregate Demand as well asan unexpected huge increasein Aggregate supply provides

An good explanation.

A shift out in AD will increaseoutput as well as prices

But if at the same time AS

shifts out, output can continuto increase while prices do norise a lot.

Q1

P1

AD1

AS1

Q2

P2



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. .

The economic history of the United States (or anycountry) in the twentieth century can be more

easily understood using the AS/AD model.

Growth over the past century has been due toboth increases in aggregate supply as well as

aggregate demand.



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. .

Historically, economies do not generally producesteady growth without inflation.

Instead, economies are hit with periodic bouts of

unemployment or inflation, and sometimes both.



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. .

Thus it has become a goal of economies to minimizethe damage done by inflation and unemployment.

These stabilization policies are designed to shorten

recessions, reduce unemployment, and stabilizeinflation.

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Macro Economics – continued