Lecture 1

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LECTURE#1

INTRODUCTION TO
MACROECONOMICS

Presented by: Muhammad Husnain


INTRODUCTION TO MACROECONOMICS

• Microeconomics examines the behavior of individual decision


making units – Business firms and households.
• Macroeconomics deals with the economy as a whole; it examines the
behavior of economic aggregates such as aggregate income,
consumption, investment, and the overall level of prices.
• Aggregate behavior refers to the behavior of all households and
firms together.
INTRODUCTION TO MACROECONOMICS

• Microeconomists generally conclude that markets work well.


Macroeconomists, however, observe that some important prices often
seem “sticky.”
• Sticky prices are prices that do not always adjust rapidly to maintain
the equality between quantity supplied and quantity demanded.
INTRODUCTION TO MACROECONOMICS

• Macroeconomists often reflect on the microeconomic principles


underlying macroeconomic analysis, or the microeconomic
foundations of macroeconomics.
THE ROOTS OF MACROECONOMICS

• The Great Depression was a period of severe economic contraction


and high unemployment that began in 1929 and continued throughout
the 1930s.
CONT…

• Classical economists applied microeconomic models, or “market


clearing” models, to economy-wide problems.
• However, simple classical models failed to explain the prolonged
existence of high unemployment during the Great Depression. This
provided the impetus for the development of macroeconomics.
CONT…

• In 1936, John Maynard Keynes published The General Theory of


Employment, Interest, and Money.
• Keynes believed governments could intervene in the economy and
affect the level of output and employment.
• During periods of low private demand, the government can stimulate
aggregate demand to lift the economy out of recession.
MACROECONOMIC CONCERNS

• Three of the major concerns of macroeconomics are:


1. Inflation
2. Output growth
3. Unemployment
INFLATION AND DEFLATION

• Inflation is an increase in the overall price level.


• Hyperinflation is a period of very rapid increases in the overall price
level. Hyperinflations are rare, but have been used to study the costs
and consequences of even moderate inflation.
• Deflation is a decrease in the overall price level. Prolonged periods of
deflation can be just as damaging for the economy as sustained
inflation.
OUTPUT GROWTH: SHORT RUN AND LONG
RUN

• The business cycle is the cycle of short-term ups and downs in the
economy.
• The main measure of how an economy is doing is aggregate output:
• Aggregate output is the total quantity of goods and services produced
in an economy in a given period.
CONT…

• A recession is a period during which aggregate output declines. Two


consecutive quarters of decrease in output signal a recession.
• A prolonged and deep recession becomes a depression.
• Policy makers attempt not only to smooth fluctuations in output
during a business cycle but also to increase the growth rate of output
in the long-run.
UNEMPLOYMENT

• The unemployment rate is the percentage of the labor force that is


unemployed.
• The unemployment rate is a key indicator of the economy’s health.
• The existence of unemployment seems to imply that the aggregate
labor market is not in equilibrium.
GOVERNMENT IN THE MACROECONOMY

• There are three kinds of policy that the government has used to
influence the macroeconomy:
1. Fiscal policy
2. Monetary policy
3. Growth or supply-side policies
CONT…

• Fiscal policy refers to government policies concerning taxes and


spending.
• Monetary policy consists of tools used by the Federal Reserve to
control the quantity of money in the economy.
• Growth policies are government policies that focus on stimulating
aggregate supply instead of aggregate demand.
THE COMPONENTS OF THE
MACROECONOMY

• The circular flow diagram shows the income received and payments
made by each sector of the economy.
CONT…

• Transfer payments are payments made by the government to people


who do not supply goods, services, or labor in exchange for these
payments.
THE THREE MARKET ARENAS

• Households, firms, the government, and the rest of the world all
interact in three different market arenas:
1. Goods-and-services market
2. Labor market
3. Money (financial) market
CONT…

• Households and the government purchase goods and services


(demand) from firms in the goods-and services market, and firms
supply to the goods and services market.
• In the labor market, firms and government purchase (demand) labor
from households (supply).
• The total supply of labor in the economy depends on the sum of
decisions made by households.
CONT…

• In the money market—sometimes called the financial market—


households purchase stocks and bonds from firms.
• Households supply funds to this market in the expectation of earning
income, and also demand (borrow) funds from this market.
• Firms, government, and the rest of the world also engage in
borrowing and lending, coordinated by financial institutions.
FINANCIAL INSTRUMENTS

• Treasury bonds, notes, and bills are promissory notes issued by the
federal government when it borrows money.
• Corporate bonds are promissory notes issued by corporations when
they borrow money.
CONT…

• Shares of stock are financial instruments that give to the holder a


share in the firm’s ownership and therefore the right to share in the
firm’s profits.
• Dividends are the portion of a corporation’s profits that the firm pays
out each period to its shareholders.
THE METHODOLOGY OF
MACROECONOMICS

• Connections to microeconomics:
Macroeconomic behavior is the sum of all the microeconomic
decisions made by individual households and firms. We cannot
understand the former without some knowledge of the factors that
influence the latter.
AGGREGATE SUPPLY
AND AGGREGATE
DEMAND

• Aggregate demand is the total


demand for goods and services in
an economy.
• Aggregate supply is the total supply
of goods and services in an
economy.
• Aggregate supply and demand
curves are more complex than
simple market supply and demand.
EXPANSION AND
CONTRACTION: THE
BUSINESS CYCLE

• An expansion, or boom, is the


period in the business cycle
from a trough up to a peak,
during which output and
employment rise.
• A contraction, recession, or
slump is the period in the
business cycle from a peak
down to a trough, during
which output and employment
fall.
REAL GDP, 1900-2002
REAL GDP, 1970 I-2003 II
UNEMPLOYMENT RATE, 1900 - 2010
REVIEW TERMS & CONCEPTS

• Microeconomics • Circular Flow • The Great


• Macroeconomics Diagram Depression

• Aggregate Supply & • Expansion & • Sticky Prices


Aggregate Demand Contraction • Transfer Payments
• Business Cycle • Hyperinflation • Unemployment
• Fiscal Policy & Rate
Monetary Policy
THANK YOU.

ANY QUESTIONS?

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