Macroeconomics
• Macroeconomic theories try to explain the
business cycle, economic policies try to
control it.
Business cycles are alternating periods of
economic growth and contraction.
The Business Cycle
20
Great
15 Depression
10
20
World War II
15
Korean War
Vietnam War
Long-term average growth (3%)
5
3
0
–5
–10
15
10
5
3
0
Growth recession
Recession
–5
–10
–15
1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
REAL GDP (units per time period)
The Business Cycle
Peak
Growth trend
Peak
Peak
Trough
Trough
TIME
The Unemployment Record
Rate of Unemployment
(Percent)
25
20
15
10
5
0
1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
The Historical Record
20
Inflation
16
A
12
8
4
B
0
4
8
Deflation
12
1920
1930
1940
1950
1960
1970
1980
1990
2000
Evolution of Macro Theory
• Classical economics Based on the concept of
laissez faire, the doctrine of “leave it alone,”
of nonintervention by government in the
market mechanism
• The Great Depression was a stunning blow to
classical economists.
• Keynes developed an alternate view of the
macro economy.
• market forces and changing prices did not
solve high unemployment, required
government intervention
Evolution of Macro Theory cont.
• Keynesian policy suggests government
stimulate economy when high unemployment
• Contract economy when inflationary
• Monetarist Policy, expansionary policies lead
to inflation
• Supply-Side Policy, stimulate economy’s ability
to produce
• Current policy combination of Keynesian and
supply-side
Macroeconomic Model
Aggregate Demand and Supply
Examines forces that effect macroeconomy
Provides avenues for government policy
fiscal policy
monetary policy
Aggregate Demand
• Aggregate demand is the total quantity of
output demanded at alternative price levels in
a given time period, ceteris paribus.
• It is used to refer to the collective behavior of
all buyers in the marketplace.
Aggregate Demand
• Three separate reasons explain the downward
slope of the aggregate demand curve:
– The real-balances effect.
– The foreign-trade effect.
– The interest-rate effect.
Aggregate Supply
• Aggregate supply is the total quantity of
output producers are willing and able to
supply at alternative price levels in a given
time period, ceteris paribus.
Aggregate Supply
• Two reasons explain the upward slope of the
aggregate supply curve:
– The profit effect.
– The cost effect.
Macro Equilibrium
• Aggregate supply and demand curves
summarize the market activity of the whole
(macro) economy.
• Equilibrium occurs at intersection of aggregate
demand and supply
• It is the only price-output combination that is
mutually compatible with aggregate supply
and demand.
PRICE LEVEL (average price)
Macro Equilibrium
Aggregate
supply
P1
E
PE
Aggregate
demand
D1
QE
S1
REAL OUTPUT (quantity per year)
Demand-Side Theories
Inadequate demand
Excessive demand
AS0
AS0
E0
E2
P2
E1
AD0
AD1
Q1 QF
REAL OUTPUT
P0
E0
AD2
AD0
QF Q 2
REAL OUTPUT
PRICE LEVEL (average price)
Supply-Side Theories
AS1
AS0
E3
P3
E0
P0
AD0
Q3
QF
REAL OUTPUT (quantity per year)
Long-Run Self Adjustment
• Some economists argue that short-run
theories are pointless.
• In their view, short-run fluctuations in real
output or prices are just statistical noise.
• This argument is based on Classical and
monetarist views of long-run stability.
PRICE LEVEL (average price)
The “Natural” Rate of Output
AS
P2
P1
AD2
AD1
QN
REAL OUTPUT(quantity per year)
Three Basic Policy Strategies
• Shift aggregate demand curve - find and use
policy tools that stimulate or restrain total
spending.
• Shift the aggregate supply curve - find and
implement policy levers that reduce the costs
of production or otherwise stimulate more
output at every price level.
• Laissez-faire - if we can’t identify or control
the determinants of aggregate supply and
demand, then we shouldn’t interfere with the
market.
Specific Policy Options
• All the following policy strategies have been
tried at one time or another:
l
l
l
Classical
approaches.
Fiscal policy.
Monetary policy.
l
l
l
Supply-side policy.
Trade policy.
Eclecticism.