ECO 502

BRAC University,
Spring, 2006
Lectures 1 – 3 part 1

Lutfun N. K. Osmani

Chapter 1
What Is
Macroeconomics?
Course details

• Course details: Will be given next week

• Reading list:
• Main Text:
• Robert J. Gordon, Macroeconomics, 10th
Edition, 2006.
• Supplimentary Texts:
• R. H. Frank & B. S. Bernanke, Principles of
Macroeconomics, 2nd edition
• Mankiw, Gregory. Macroeconomics, 4th edition
& Dornbusch, Fischer and Startz,
Macroeconomics, 7th edition.
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Basic Concepts of Macroeconomics

• Some basic concepts:

• Defining macroeconomics
• Differentiating macroeconomics and
microeconomics
• Three big concepts of macroeconomics
• Actual and natural GDP
• Macroeconomics in the short-run and long-run
• Stabilization Policy
• Internationalization of macroeconomics

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Difference between Microeconomics and
Macroeconomics

• Macroeconomics is the study of the

performance of national economies, and of
the policies that governments use to try to
improve that performance.

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Difference between Microeconomics and
Macroeconomics
Macro comes from Greek word meaning
large and Micro comes from Greek word
meaning small.

Macroeconomics deals with total or

aggregate like national income and
unemployment rate but Microeconomics
deals with the parts – examines the
behaviour of individuals households and
firms, e.g., price of a particular commodity.

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“Big Three” Concepts of Macroeconomics

• The basic task of Macroeconomics is to study

the good or bad performances of the three
important concepts – rate of unemployment,
inflation rate and economic growth - the “Big
Three” Concepts of Macroeconomics.

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“Big Three” Concepts of Macroeconomics

• Unemployment rate: It is the number of

persons unemployed divided by the total of
those employed and unemployed (labour
force). or
• % of the labor force that is out of work
• Labor force: adult people who are able to and
willing to work at the going wage.
• Labor force = employed + unemployed

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Measuring Unemployment

• Total labour force:

• A. Civilian employed
• B. Armed forces
• C. Unemployed.

• Measurement: The actual unemployment

rate is defined as the ratio:
number of unemployed
U = ----------------------------------------------
(civilian employed + unemployed)
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Unemployment

• Ex: In February 2005 the BLS reported an

unemployment rate of 5.4% in the US. It was
calculated as:

• number of unemployed
U = ----------------------------------------------
(civilian employed + unemployed)

• 7,988,000
U = -------------------------------- = 5.4%
140,144,000 + 7,988,000

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Unemployment

• Problems:

– Not an accurate measure of social,

psychological and economic distress
– Does not distinguish between full time and
part time unemployment
– Does not account well for discouraged
workers and disguised unemployment

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Figure 2-5 Employment From the Household
and Payroll Survey, 1990–2004

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Conflicting Measurement

Observations:
• BLS has two kinds of survey – household
survey and the payroll employment survey.

• Payroll survey considered more reliable as

the sample size is larger 400,000
establishment as opposed to 60,000
households in the household survey.

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“Big Three” Concepts of Macroeconomics

Observations:
• Unemployment rises during recessions
• Always greater than zero
• Actual vs. natural unemployment:
• Actual unemployment is unemployment that
exists in an economy at a particular point in
time.
• Natural Rate of Unemployment: rate of
unemployment that persists (e.g., structural,
frictional, etc.) even when the economy is at
full-employment
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“Big Three” Concepts of Macroeconomics

• Full Employment: the situation when there is

no cyclical or involuntary unemployment. In
this situation all those who are willing to work
at the going wage rate are at work

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“Big Three” Concepts of Macroeconomics

• Inflation
– Measures how fast the average price level
is increasing over time
• Rate of Inflation
– The annual percentage increase in the
price level

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“Big Three” Concepts of Macroeconomics

• Hyperinflation: A situation in which the rate of

inflation is extremely high ranging from 50%
or more per month..

• Observation:
• 1. Purchasing power of currency goes down
• 2. Inflation exerts pervasive uncertainty - lives
become unpredictable.

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 “Big Three” Concepts of
Macroeconomics
Productivity
Average output produced per hour of work.
In the US it was about $49 per worker-hour in
2005
• Productivity growth: The faster average
productivity grows, the easier it is for
members of society to improve their standard
of living.
• Economic growth is sustained growth in real
GDP over periods of a decade or more
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Actual and natural gross domestic
product (GDP).

Gross domestic product (GDP) & real GDP:

GDP: The official measure of the economy’s

total output is called gross domestic
product (GDP).

Real GDP - is the measure of output

reflecting the quantity of output produced
corrected for any changes in prices.

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Actual and natural gross domestic product
(GDP).

Actual real GDP vs. natural real GDP

Actual real GDP is the amount the economy

actually produces at any given time.

Actual real GDP could be too low causing

unemployment rate to be higher than
necessary, wasting resources and
depriving people of jobs.

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Actual and natural gross domestic product
(GDP).

Actual real GDP could be too high straining

the nation’s ability to produce and putting
upward pressure on the inflation rate.

The compromise between too low and too

high level of real GDP is called natural real
GDP, a level of real GDP in which there is
no tendency for inflation to accelerate or
decelerate (that is, when the economy is
producing at a normal rate).

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Figure 1-1

The Relation Between

Actual and Natural Real
GDP and the Inflation
Rate
When actual real
GDP is below the
natural real GDP
inflation rate slows
down
When actual real
GDP is above the
natural real GDP
inflation rate speeds
up 1-21
Figure 1-2
The Behavior over Time of
Actual and Natural Real GDP
and the Actual and Natural
Rates of Unemployment

When actual real GDP

is below the natural
real GDP rate of
unemployment rises
above the natural rate
When actual real GDP
is above the natural
real GDP rate of
unemployment falls
below the natural rate
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Real GDP and the Three Macro Concepts
• Therefore, actual real GDP is closely related
to the three central concepts of
macroeconomics.
• The difference between actual and natural
real GDP moves inversely with the difference
between the actual and natural
unemployment rates (we saw in figure)
• Inflation tends to speed up when actual real
GDP is higher than natural real GDP.
• And the third link is with productivity, that is
the actual real GDP per hour.

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Macroeconomics in the Short and Long
Runs
• Macroeconomic theories and debates can be
divided into two main groups:
• 1. Those concern the short-run stability of the
economy and
• 2. Those concern the long-run growth rate.
• Short run: Much of macroeconomic analysis
concerns the first group of topics involving the
short-run - period lasting from one year to five
years and focuses on the ups and downs of
two major concepts: unemployment and
inflation.
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Macroeconomics in the Short and Long
Runs

• Business cycles: The ups and downs of

unemployment and inflation are called short-
term economic fluctuations or business cycles.
• Therefore, the main concern of
macroeconomists in the short-run is to
minimize fluctuations in the unemployment and
inflation rates
• And that requires fluctuations in the real GDP
to be minimized

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Figure 1-3 Business Cycles
in Volatilia and Stabilia

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Macroeconomics in the Short and Long
Runs

• In the imaginary nation Volatilia we see huge

business cycles – creating huge gap between
actual real GDP and natural real GDP

• In Stabilia, on the other hand, short-run

macroeconomics tries to dampen business
cycles so that the path of actual real GDP is
as close as possible to natural real GDP

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Figure 1-4 Basic Business-Cycle Concepts

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Basic Business-Cycle Concepts
• Short run: Business cycles
• Peak – the highest point reached by real output
in each business cycle
• Trough - the lowest point reached by real
output in each business cycle
• Expansion – the period in the business cycle
between the trough and the peak
• Recession - the interval in the business cycle
between the peak and the trough

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Basic Business-Cycle Concepts

• Long run: The other main topic in

macroeconomics concerns the long-run,
which is a longer period ranging from one
decade to several decades. It attempts to
explain the rate of productivity growth or more
generally, economic growth.

• And this economic growth is the long-run

concern of macroeconomists

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Figure 1-5 Economic Growth
in Stag-Nation and Speed-Nation

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Basic Business-Cycle Concepts

The two hypothetical nations, Stag-nation

(include Germany and Japan) and speed-
nation (include China and India) may
experience mild business cycles.

Stag-nation, however, experiencing slow growth

in real GDP whereas Speed-nation is
experiencing a very fast growth in real GDP.

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Figure 1-6
Actual and Natural
GDP and
Unemployment, 1900–
2001
Actual real GDP
was below natural
real GDP during the
Great Depression
of 1930s and above
it during World War
II
On the contrary,
actual
unemployment was
very high during the
Great Depression
of 1930s
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Basic Business-Cycle Concepts

For contrast with the 1930s, the US

unemployment rate fell as low as 4% during
the prosperity year of 2000 and was never
higher than 7.5% the rate reached in 1992.

During the Great Depression it went up from

3.2% in 1929 to 25.2% in 1933 and never fell
below 10% until 1941.

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Figure 1-7 The Unemployment Rate
from 1929–41 Compared with 1992–2004

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Figure 1-8
The German Hyperinflation of 1920–23

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The German Hyperinflation of 1920–23

• The German Price Level increased from a

little above 1 in 1920 and 1921 to 550 at the
end of 1922 and to 100,000,000,000 in
November 1923.

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Fast and slow growth in Asia

• However, the effects that really matter over

the decades is the productivity growth.

• Difference in growth rates that may appear

small can compound over the decades and
create enormous difference in the standard of
living.

• A classic example of the importance of rapid

growth is displayed in the next figure

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Figure 1-9 Per-Capita Real GDP, South Korea
and the Philippines, 1960–2005

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Per-Capita Real GDP, South Korea and the
Philippines, 1960–2000

• In 1960, per-Capita Real GDP in

Philippines was 14% higher than in South
Korea.

• But between 1960 to 2005 the real GDP per

capita grew at 5.7%per year in South
Korea compared to only 1.4% in the
Philippines.

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Stabilisation Policy

• Two tasks of Macroeconomic analysts:

• 1. To analyze the causes of changes in
important aggregates– called target
variables
• 2. To predict the consequences of
alternative policy changes
• Target variables or goals
– Inflation
– Unemployment
– Long term growth rate
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Stabilisation Policy

• Policy instruments are elements that

government policymakers can manipulate
directly to influence target variables.

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Stabilisation Policy

• Stabilization policy is any policy that seeks

to influence the level of aggregate demand.
• Policy instruments – three broad
categories:
• Fiscal policies – include changes in
government expenditures and tax rates
• Monetary policies – include control of the
money supply and interest rates

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Stabilisation Policy

• Third – miscellaneous group includes

policies to equip workers with skills they
need to qualify for jobs.

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Stabilisation Policy

• Problem:

• Closed economy
• Open economy

As economies have become internationalized,

fiscal policy and monetary policy can not be
used in isolation with their effects abroad.

Repercussions abroad affect the way fiscal and

monetary policy work and how the inflation
process operates.

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How Does U.S. Economic Performance
Rank?

• As a result of internationalization of
macroeconomics there has been an
increased attention to the comparative
performance of the US.

• The figure shows how the US compares

with Japan and the major European
nations in unemployment, inflation and
productivity growth rates

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International Perspective How Does U.S.
Economic Performance Stack Up?

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How Does U.S. Economic Performance
Rank?

• Despite recent problems, economic

performance of Japan is superior to both
the US and Europe in most periods:

• Lower unemployment,
• Lower inflation
• Faster economic growth rates

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