Principles Of
Macroeconomics
Today’s Outline
 Introduction
 Syllabus
 Points of Order
 Lecture one
Introduction
Dr Michael J. Oliver
10th year of teaching in UK
and US
Macroeconomic historian
Currently have three books in
print, another two due out
this year.
Syllabus
The course is ‘electronic’.
Lectures will be available for
downloading AFTER the
lecture.
Emphasis is on YOUR
contribution in class and
outside.
Points of Order
Huge difference between
school and college.
Take a risk!
I do not have all the answers.
Lecture One
Introduction to
Economics
A Definition of “Economics”
Economics is the study of how
individuals and societies choose to
use the scarce resources that nature
and previous generations have
provided.
Another Definition of
“Economics”
Economics is the study of how
scarce resources are allocated
among conflicting demands.
Four Main Reasons to Study
Economics...
 To learn a way of thinking
 To understand society
 To understand global affairs
 To be an informed voter
1. To Learn a Way of Thinking...
Three Fundamental Concepts of
Economic Thinking:
• Opportunity Cost
• Marginalism
• Efficiency
Opportunity Costs
The opportunity cost of
something is that which we give
up when we make that choice or
that decision.
Opportunity costs imply that
nearly all decisions involve
trade-offs
What do we mean by
Opportunity Costs?
“There’s no such thing
as a free lunch!”
Opportunity Cost Question…
What is the opportunity cost
of your attending college?
Marginalism
In weighing the costs and benefits of
a decision, it is important to weigh
only the costs and benefits that arise
from the decision. (That is, the
additional costs/benefits that are
added as a result of that decision.)
Efficient Markets
An efficient market is one in which
any and all profit opportunities are
eliminated instantaneously.
2. To understand society...
“The study of economics is an
essential part of the study of
society”
2. To understand society...
Past and present economic
decisions have an enormous
effect on the character of life in a
society!
3. To understand global affairs...
 Collapse of the Soviet Union
 The European Union
 NAFTA and GATT
 The Gulf War
 Starvation & Poverty in Africa
4. To be an informed voter...
 The number one issue on people’s
minds in recent elections has been the
economy.
 Clinton’s main focus during his
presidency has been primarily on
economic issues such as: deficit
reduction, economic growth,
international trade agreements and
health-care reform
The Scope of Economics
MACROECONOMICS
The branch of economics that
examines economic behavior of the
aggregates - income, employment,
aggregate output, and so on.
The Scope of Economics
MICROECONOMICS
The branch of economics that examines
the functioning of individual industries
and the behavior of individual decisionmaking units such as business firms
and households.
The Method of Economics
Positive Economics
An approach to economics that seeks
to understand behavior and the
operation of systems without making
judgements. It describes what exists
and how it works.
The Method of Economics
Normative Economics
An approach to economics that
analyzes outcomes of economic
behavior, evaluates them as good or
bad, and may prescribe courses of
action. Normative economics will
many times apply value judgements.
Economic Theories & Models
An economic theory is a statement or
set of related statements about cause
and effect, action and reaction.
Economic Theories & Models
An economic model is a formal
statement of an economic theory.
Usually a mathematical
representation of a presumed
relationship between two or more
variables.
Economic Theories & Models
Inductive Reasoning is the process of
observing regular patterns from raw
data and drawing generalizations
from them.
Economic Theories & Models
Ceteris Paribus is a device (i.e.an
assumption) used to analyze the
relationship between two variables while
the values of other variables are held
unchanged. It may be interpreted to mean
“everything else equal or constant.”
Economic Theories & Models
- Cautions & Pitfalls The Post Hoc Fallacy
Post hoc, ergo propter hoc, literally
means “after this, therefore because of
this.” It refers to a common error made in
thinking about causation. If Event A
happens before Event B, it is not
necessarily true that A caused B.
Economic Theories & Models
- Cautions & Pitfalls -
Correlation vs. Causation
Two variables are correlated if one
variable changes when the other variable
changes.
This does not mean that changes in one
variable cause changes in the other.
Economic Theories & Models
- Cautions & Pitfalls The Fallacy of Composition
The fallacy of composition implies that
what is true for a part is necessarily true
for the whole.
Economic Theories & Models
Empirical Economics is the
collection and use of data to test
economic theories.
Economic Policy and the
Criteria for Judging Economic
Outcomes
1.
2.
3.
4.
Efficiency
Equity
Growth
Stability
Economic Policy and the
Criteria for Judging Economic
Outcomes
1. Efficiency
Efficiency in economics means
allocative efficiency. An efficient
economy is one that produces
what people want at the least
possible cost.
Economic Policy and the
Criteria for Judging Economic
Outcomes
2. Equity
Equity means fairness. Equity lies
in the eye of the beholder…few
people agree on what is fair and
what is unfair.
Economic Policy and the
Criteria for Judging Economic
Outcomes
3. Growth
Economic Growth refers to the
increase in total output of an
economy.
Economic Policy and the
Criteria for Judging Economic
Outcomes
4. Stability
Economic Stability refers to a
condition in which output is steady
or growing with low inflation and
full employment of resources.
The Great Depression
The Great Depression was a period
of severe economic contraction and
high unemployment that began in
1929 and continued throughout the
1930’s.
Macroeconomic Concerns
 Aggregate Price Level
 Aggregate Output
 Total Employment
 Rest of the World
Inflation and Prices
Price level: a measure of the
behavior of all prices in the economy
Price level is a yardstick -- a tool for
comparison of prices over time.
Inflation: the rate of change in the
price level
Percentage change in GDP deflator, 1959 - 1994
12.0
Inflation Rate
10.0
8.0
6.0
4.0
2.0
0.0
1959
1963
1967
1971
1975
Year
1979
1983
1987
1991
Aggregate Output (GDP)
Gross Domestic Product (GDP)
is the dollar value of all final
goods and services produced.
Final good: a product which is
ready to be used by consumers
Business Cycle
Periodic movements in output,
prices, and employment
Business cycles are not created
equal.
–Duration
–Severity
Business Cycle
GDP rises and falls over short
spans of time
At any point in time, it may be
above or below its long run trend
These fluctuations define the
business cycle
Unemployment
The unemployment rate refers to
the percentage of people in the
labor force who can’t find a job.
Labor Force: people
who are actively seeking
or are currently holding
a job
Unemployment Rate, 1959 - 1994
10.0
Unemployment Rate
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
1959
1963
1967
1971
1975
Year
1979
1983
1987
1991
Government Policies for
Influencing the Macroeconomy
Fiscal Policy: Government policies
regarding taxes and expenditures
Monetary Policy: The tools used by the
Federal Reserve to control the money supply
Supply-side Policies: policies that focus on
aggregate supply and increasing production
The Circular Flow Diagram
The Players
Households
Firms
Government
Rest of the World
The Circular Flow Diagram
Households
Consume
(C)
Save
(S)
Work
(N)
Pay
taxes
(T)
The Circular Flow Diagram
Firms
Produce
(GDP)
Invest
(I)
Buy inputs
(N)
Pay taxes
(T)
The Circular Flow Diagram
Government
Buys goods
(G)
Borrows
(B)
Taxes
(T)
Issues
money
(M)
The Circular Flow Diagram
Rest of the World
Exports
(X)
Imports
(IM)
The Circular Flow Diagram
Firms
Households
The Circular Flow Diagram
Purchases of Goods and Services
Firms
Households
Wages, Interest, Dividends, and rent
The Circular Flow Diagram
Purchases of
Goods and Services
Taxes
Government
The Circular Flow Diagram
Purchases of
Goods and Services
Taxes
Wages, Interest,
Transfer Payments
Taxes
Government
The Circular Flow Diagram
Purchases of
Imports
Purchases of
Exports
Rest of the World
Three Market Arenas
Goods and services market
Labor market
Money (financial) market
Goods and Services Market
Firms supply goods and services
Goods and Services Market
Household, Firms and Government
purchase goods and services
Labor Market
Households supply labor
Labor Market
Firms and Government
demand labor
Financial Markets
Households supply funds
Financial Markets
Households, Firms and Government
demand funds
Aggregate Demand
Aggregate demand represents
the total demand for goods and
services in an economy.
Aggregate Demand Curve
Price
Level
P1
AD
Y1
Aggregate Output
Aggregate Supply
Aggregate supply represents the
total supply of goods and
services in an economy.
Aggregate Supply Curve
Price
Level
AS
P1
Y1
Aggregate Output
Equilibrium
Aggregate equilibrium is a level
of prices and GDP such that the
quantity of goods and services
purchased equals the overall
quantity of goods and services
produced
Equilibrium
Price
Level
AS
Equilibrium
P*
AD
Y*
Aggregate Output
Parts of the Business Cycle
Aggregate
Output
Peak
Recession
Expansion
time
Trough
Percentage Deviation of GDP from Trend, 1960 - 1994
Percentage Deviation of GDP
7
6
5
4
3
2
1
0
-1
-2
-3
1960
1964
1968
1972
1976
Year
1980
1984
1988
1992 1994
Recession
 Growth rate of GDP falls
 Firms decrease production
 Unemployment rises
GDP
Unemployment
Percentage Deviation of GDP from Trend, 1960 - 1994
Recessions
Percentage Deviation of GDP
7
6
5
4
3
2
1
0
-1
-2
-3
1960
1964
1968
1972
1976
Year
1980
1984
1988
19921994
Expansion
 GDP growth rate rises
 Firms increase production
 Unemployment falls
GDP
Unemployment
Percentage Deviation of GDP from Trend, 1960 - 1994
Expansions
Percentage Deviation of GDP
7
6
5
4
3
2
1
0
-1
-2
-3
1960
1964
1968
1972
1976
Year
1980
1984
1988
19921994
Real GDP in the U.S., 1959 - 1994
5,500.0
5,000.0
4,500.0
Real GDP
4,000.0
3,500.0
3,000.0
2,500.0
2,000.0
1,500.0
1959
1963
1967
1971
1975
Year
1979
1983
1987
1991 1994
Real GDP in the U.S., 1959 - 1994
5,500.0
5,000.0
4,500.0
Real GDP
4,000.0
3,500.0
3,000.0
Trend Line
2,500.0
2,000.0
1,500.0
1959
1963
1967
1971
1975
Year
1979
1983
1987
1991 1994