MACROECONOMICS
Macroeconomics:
Analyzes the performance of the whole Canadian and global
economy – the combined outcomes of all individual
microeconomic choices.
Economic success is affected and measured by:
a) GDP
higher GDP per person allows higher living standards
b) Unemployment
affects odds of finding a job
c) Inflation
reduces living standards if income does not rise as fast as
the prices of what you buy
Copyright © 2021 Pearson Canada Inc. Chapter 5 Slide 1
The circular flow model reduces the complexity of the
Canadian economy to three players and two markets:
Households, Firms, Government
a) Input markets determine wages, rent and interest
income (demand for labor, supply of labor)
b) Output markets determine the value of all goods and
services sold (demand for goods and services, and
supply of goods and services)
Macroeconomics focuses on connections between input and
output markets and the three players
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Circular Flow of Economic Life
Copyright © 2021 Pearson Canada Inc. Chapter 5 Slide 3
Circular Flow Dynamics
a) Green arrow is money
b) Blue arrow is goods, services and inputs
1. In the goods market:
Consumers are demanders and Firms are Suppliers
2. In the input market:
Consumers are suppliers and Firms are Demanders
…and around and around and around it goes
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ECONOMICS AND POLITICS
Economists disagree about the fundamental
macroeconomic question
1. Market failure
market outcomes are inefficient or inequitable and
fail to serve the public interest
2. Government failure
government policy fails to serve the public interest
Copyright © 2021 Pearson Canada Inc. Chapter 5 Slide 5
The Fundamental Macroeconomic Question
“If left alone by government, do the price mechanisms
of market economies adjust quickly to maintain steady
growth in living standards, full employment, and stable
prices?”
1.Yes - Markets Self-Adjust
JB Say’s Law: supply creates its own demand
2. No - Markets Fail Often
Keynes: founder of macroeconomics in the 1930s
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Yes - Left Alone, Markets Self-Adjust - Hands Off:
a) Macroeconomic and microeconomic outcomes are the
same
b) External events or government policy cause business
cycles
c) Government failure is more likely than market failure
d) Government should be hands-off
e) Right Wing View
Copyright © 2021 Pearson Canada Inc. Chapter 5 Slide 7
No - Left Alone, Markets Fail Often - Hands On:
a) Fallacy of composition — macroeconomic and
microeconomic outcomes are different
b) Markets cause business cycles through connection
failures between input and output markets, roles of
money, banking, and expectations
c) Market failure is more likely than government failure
d) Government should be hands-on
e) Left Wing View
Copyright © 2021 Pearson Canada Inc. Chapter 5 Slide 8
MACROECONOMIC OUTCOMES
AND PLAYERS
Good macroeconomic outcomes are:
1. higher gross domestic product
2. lower unemployment
3. low and predictable inflation
Copyright © 2021 Pearson Canada Inc. Chapter 5 Slide 9
1. Consumer choices:
a) Spend income or save (consumption v savings)
b) Buy Canadian products and services (exports)
c) Buy Foreign products and services (imports)
2. Business choices:
a)
b)
c)
d)
Investment spending - new factories, equipment
Hire workers
Buying inputs domestically or importing
Selling outputs domestically or exporting
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Government choices: Fiscal policy
Government purchases, taxes/ transfers to achieve the
macroeconomic outcomes
Bank of Canada choices: Monetary policy
Bank of Canada changes interest rates and money
supply to achieve the macroeconomic outcomes
Making loans
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4. Rest of World (R.O.W.)
(a) Buying Canadian exports
(b) Selling imports to Canada
(c) Investing money in Canada
(d) Accepting Canadian investments
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Key Macroeconomic Variables
The most used measure of national income is
Gross Domestic Product (GDP)
a) Measures the value of final goods and services bought by the final user - produced in one
country - in a given time period
b) Measured in real (goods) or nominal (money)
terms
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The Business Cycle
1. Trough
2. Recession
3. Recovery
4. Peak
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Key Macroeconomic Variables
a) Potential output (Y *) or Full Employment
b) All inputs (land, labour and capital) at maximum capacity.
c) The output gap measures the difference between potential
output and actual output = (Y − Y *)
d) When Y < Y * → output gap is a recessionary gap
e) When Y > Y * → output gap is an inflationary gap
Copyright © 2021 Pearson Canada Inc. Chapter 5 Slide 15
Employment, Unemployment, and the Labor Force
a) Employment
b) Unemployment
c) Labor force (employed + unemployed)
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Employment, Unemployment, and the Labor Force
a) If the economy is at full employment, Y = Y * or in an
inflationary gap, Y > Y * unemployment exists due to
labor market turnover (frictional unemployment) and
or job-worker mismatch (structural unemployment).
(b) In a recessionary gap Y < Y *, there is cyclical
unemployment due to falling GDP.
Copyright © 2021 Pearson Canada Inc. Chapter 5 Slide 17
Inflation and Price Level
a) The price level is the average level of all prices in the economy
expressed as an index number
b) Inflation (percentage increase in the price level)
c) Inflation Rate = ((𝐶𝑃𝐼!"#− 𝐶𝑃𝐼! )/ 𝐶𝑃𝐼! ) * 100
Copyright © 2021 Pearson Canada Inc. Chapter 5 Slide 18
Why Inflation Matters
a) We value money for what we can purchase with it
b) The purchasing power of money is the amount of goods
and services that can be purchased with a unit of money
c) Inflation reduces the purchasing power of money and the real
value of any sum measured in nominal (dollar) terms
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Purchasing Power of Money
a) M is Nominal Money, P = Price Level
b)
!
Purchasing Power of Money = "
c) M up → PP up
d) P up → PP down (Inflation)
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Interest Rates
a) The interest rate is the price paid per dollar
borrowed per period of time, expressed as a
percentage.
b) Nominal interest rate vs. real interest rate
c) Why do interest rates matter?
a) Compare effects on savers and borrowers
b) Impact on investment plans
Copyright © 2021 Pearson Canada Inc. Chapter 5 Slide 21
Nominal v Real Interest Rate
a) Let R = Real Interest Rate
b) Let i = Nominal Interest Rate
c) Let 𝜋 = Rate of Inflation
d) R = i − π
Copyright © 2021 Pearson Canada Inc. Chapter 5 Slide 22
Exchange Rates and Trade Flows
a) Exchange rate = Price of domestic currency in terms of
foreign currency (or the price of foreign currency in terms of
domestic currency)
b) Domestic currency is your currency
c) Foreign currency is not your currency
d) Appreciation (increase in the value of domestic currency) vs.
Depreciation (decrease in the value of domestic currency)
Copyright © 2021 Pearson Canada Inc. Chapter 5 Slide 23
Exchange Rates and Trade Flows
Net exports are the difference between exports and imports
and are often called the trade balance.
a) NX > 0 → X > M → Net Exporter → Positive Trade Balance
b) NX < 0 → X < M → Net Importer → Negative Trade Balance
c) NX = 0 → (X = M → Balanced Trade
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