Macro i ch_1
- 1. Chapter One:The State of Macroeconomics: Introduction Adisie T. ASU,Economics Department May 4, 2021 1 / 27
- 2. Course Outline Course Name: Macroeconomics I Course Code: Econ2031 Instructor Name:Adisie T.(MSc.) Office Location:CoBE, Economics Department Email address: adisiet@gmail.com Course description:In this course students are exposed to look at I the aggregate analysis of an economy and I the interrelationship between various aggregate economic variables. Course Content 1. The state of Macroeconomics: Introduction (Chapter 1) 2. National Income Accounting (Chapter 2) 3. Aggregate Demand in the Closed Economy (Chapter 3) 4. Aggregate Demand in the Open Economy (Chapter 4) 5. Aggregate Supply (Chapter 5) 6. Behavioral Foundations:Theories of consumption (Chapter 6) 2 / 27
- 3. Course Reference Text Books 1. N. Gregory Mankiw, 2007, Macroeconomics 4th edition Worth Publishers USA 2. William H. Branson, 2006 Macroeconomic Theory and Policy 3. Dornbusch, R. and S. Fischer: Macroeconomics Additional readings 1. Edward Shapiro, 2007. Macroeconomic Analysis 5th edition New Delhi 2. Olivier Blanchard, 1997.Macroeconomics Prentice Hall Inc. New jersey USA 3. Frederick Mishkin, 1998. The Economics of Money, Banking and Financial Markets 5th edition USA. 4. Colander, 2001. Macreconomics 4th edition Newyork. 3 / 27
- 4. Course Delivery and assessment Methods Delivery methods I It is student centered specifically lecture, reading assignments and home-take assignments. I Students are, however, advised not to entirely depend on the lecture notes but rather complement them with the reference materials suggested. Assessment Methods I Assignment with presentation:30 percent I Mid-Exam:20 percent I Attendance and class activity:10 percent I Final Exam:40 percent I Total:100 percent 4 / 27
- 5. Chapter Outline 1. What macroeconomics is about? 2. Basic Concepts and Methods of Macroeconomics Analysis 3. Macroeconomic Goals and Instruments 4. The State of Macroeconomics: Evolution and Recent Developments I Classical macroeconomics I Keynesian macroeconomics I Post Keynesian Macroeconomics (After 1970) 5 / 27
- 6. Chapter Objectives After completing the chapter, you will be able to I Understand what the subject matter Macroeconomics is all about; I Explain the scope of macroeconomics I Elaborate the goals and instruments of Macroeconomics I Understand the historical development of macroeconomic thoughts and explain their difference 6 / 27
- 7. What macroeconomics is about? Modern economists divide the subject economics into two compartments: Microeconomics and Macroeconomics. Macroeconomics deals I not with individual quantities as such, but with aggregate of the quantities, I not with individual incomes but with national income, I not with individual prices, but with the general price level, I not with individual output, but with national output. Macroeconomics (from the Greek prefix makro meaning large + economics) is, therefore, a branch of economics dealing with the performance, structure, behavior, and decision- making of an economy as a whole. From this we can infer that Macroeconomics is concerned not with one particular unit, but with all units combined together. 7 / 27
- 8. What macroeconomics is about? Macroeconomics attempts to answer the f.f and many related questions. I Why have some countries experienced rapid growth in incomes over the past century while others stay mired in poverty? I Why do some countries have high rates of inflation while others maintain stable prices? I Why do all countries experience recessions and depressions and I How can government policy reduce the frequency and severity of these episodes? In Macroeconomics, generally, we do two things: I First, we seek to understand the economic functioning of the world we live in; and, I Second, we ask if we can do anything to improve the performance of the economy. That is, we are concerned with both explanation and policy prescriptions. 8 / 27
- 9. Basic Concepts and Methods of Macroeconomics Analysis Like any science, economics has its own set of tools or terminology, data, and a way of thinking that can seem foreign and arcane to the layman. The three Macroeconomic variables which are important to measure the performance of an economy: 1. The Real GDP measures the total income of everyone in the economy (adjusted for the level of prices) 2. The Inflation rate measures how fast prices are rising. 3. The unemployment rate measures the fraction of the labor force that is out of work. Macroeconomists study how these variables are determined, why they change over time, and how they interact with one another. 9 / 27
- 10. Basic Concepts and Methods of Macroeconomics Analysis To understand the economy or to explain macroeconomic variables relationship, economists use models or theories that simplify reality in order to reveal how exogenous variables influence endogenous variables. 1. Endogenous variables are those variables that a model tries to explain. 2. Exogenous variables are those variables that a model takes as given. Economists use equations, graphs, and Tables to illustrate the relationships or models. For example, demand-supply equation, demand-supply curve. 10 / 27
- 11. Basic Concepts and Methods of Macroeconomics Analysis Since Macroeconomists study many facets of the economy, they use different models. For example I They examine the role of saving in economic growth, I The impact of minimum-wage laws on unemployment, I The influence of trade policy on the trade balance and exchange rate. There is no single model that can answer every question. Just as carpenters use different tools for different tasks, economists use different models to explain different economic phenomena. Remember that a model is only as good as its assumption , an assumption is useful for some specific purpose. When using a model to address a question, the economist must keep in mind the underlying assumptions and judge whether they are reasonable for studying the matter at hand. 11 / 27
- 12. Basic Concepts and Methods of Macroeconomics Analysis Because economy-wide events arise from the interaction of many households and firms, macroeconomics and micro- economics are inextricably linked. For example, I To understand what determines total consumer spending, we must think about a family deciding how much to spend today and how much to save for the future. I To understand what determines total investment spending, we must think about a firm deciding whether to build a new factory. Therefore, when we study the economy as a whole, we must consider the decisions of individual economic actors. Because aggregate variables are the sum of the variables describing many individual decisions, macroeconomic theory rests on a microeconomic foundation. 12 / 27
- 13. Macroeconomic Goals and Instruments An economy that has successful macroeconomic management should experience I low unemployment and inflation, and I steady and sustained economic growth. In contrast, in a country where there is macroeconomic mismanagement, we will observe I low living standards and I high unemployment opportunities . So, the overarching goals of macroeconomics are to I Maximize the standard of living and I Achieve stable(non-inflationary) economic growth The goals are supported by objectives such as I Minimizing unemployment, increasing productivity (growth), I Controlling inflation or stabilizing price, interest, exchange rate. 13 / 27
- 14. Macroeconomic Goals and Instruments Macroeconomic policy instruments are macroeconomic quantities that can be directly controlled by an economic policy maker to achieve the stated goals. These instruments can be divided into three subsets 1. Monetary policy instruments: these the use of interest rates, money supply and exchange rates to influence economic growth and inflation. • This is done by the central bank of a country 2. Fiscal policy Instruments: these are use of government expenditures and taxes to affect aggregate demand and aggregate supply. • This is done by the Executive and legislative branch of the government. 3. Income policies instruments: these are economy-wide wage and price controls, most commonly instituted as a response to inflation, and usually below market level. 14 / 27
- 15. Evolution and Recent Developments in Macroeconomics Macroeconomics is relatively a recent phenomena. The term ‘MACRO’ was first used in economics by RAGNER FRISCH in 1933 following the 1930s Great depression. But as a separate discipline it was laid down by a British Economist John Maynard Keynes (1983-1946) in his revolutionary book of ”The General Theory of Employment, Interest and Money”(1936). This should, however, doesn’t mean that the economists before Keynesians, followers of Keynes, era had not given thought to the macroeconomic problems. The use of macro approach traces back to the writing of 16th and 17th centuries Economists called ”Mercantalists”. 15 / 27
- 16. Evolution and Recent Developments in Macroeconomics However, we give here a brief review of growth of macroeconomics thought beginning with Classical macroeconomics issues. The review will be divided under three subsections: I Classical (1776-1936) I Keynesian (1936-1970) I Post Keynesian( After 1970): The New classical, The New Keynesians and others 16 / 27
- 17. Classical Macroeconomics Thought (1776-1870) The school of economic thought dominated the economic world before the publication of Keynes’s (1936) General theory also called Keynesian revolution is known as Classical Macroeconomics school or Thought . In this period, the distinction between micro and macro was not clear and they had not developed any coherent macroeconomic theory or model. According to this school of thought, If market forces of demand and supply are allowed to work freely(no government intervention), then I There will always full employment in the long run and unemployment (involuntary), if any, will be a short run phenomena; I There will be neither overproduction nor underproduction; I The economy will always be in equilibrium in the long run. 17 / 27
- 18. Classical Macroeconomics Thought (1776-1870) The notion of classicals full employment is based on the assumption of flexibility of wages(in labor), interest rate (in financial) and prices(in product) market i.e., prices are determined by the supply and demand forces in the market. I In the labor market, labor demand and labor supply are brought into equilibrium by the real wage. As a result there is no involuntary unemployment. I In the product market, product demand and product supply are brought into equilibrium by the price, then there will be neither over production(excess supply) nor under production(excess demand). I In financial the market, for saving and investment are brought into equilibrium by the interest rate and investment respond to the interest rate. In general, for this school markets (be it, commodity, factor, and money) works best if left to themselves. They are the proponents of laissez-faire (no need of government intervention). 18 / 27
- 19. Classical Macroeconomics Thought (1776-1870) The Great depression of 1930s, however, proved all the classical postulations wrong. It exposed the inadequacy of the theoretical foundations of the laissez fair doctrine. During the period of Great depression, there was large scale of unemployment in most industrial economies, their GNP declined disastrously and the market mechanism of classical could not restore full employment. And the classical economics could offer neither an explanation nor a solution to the economic problems created by Great depression. This marked the collapse of classical macroeconomics school. 19 / 27
- 20. The Keynesian Macroeconomics School(1936 – 1970) Keynesian Macroeconomics (also called Keynesianism) . Reaction to the empirical observation of persistent mass unemployment as well as decline GNP during the Great depression gives rise to the birth of Keynesian school. The main thesis of the Keynesian stream is that the economy is subjected to failure so that it may not achieve full employment level. Thus, government intervention is inevitable. According to this school. I In the labor market workers and firms bargain for a money or nominal wage, not for real wage. I Money wages adjust slowly, it is sticky or rigid, and workers resist any drop in the money wage, then there will be involuntary unemployment. 20 / 27
- 21. The Keynesian Macroeconomics School(1936 – 1970) For Keynesians, low aggregate demand is responsible for the low income (GNP) and high unemployment that characterize economic downturns during the Great depression. Aggregate demand is the total amount of goods demanded by different economic agents (households, firms, governments and foreigners) in the economy. They criticized classical theory for assuming that aggregate supply alone, capital, labor, and technology, determines national income. They proposed that the government should intervene through fiscal and monetary policy to increase the aggregate demand(AD). 21 / 27
- 22. Post Keynesian Macroeconomics (After 1970) For four decades from the mid of 1930s to the 1970s, Keynesian’s have been monopolized the economic policy in united state and around the world, I it was firmly believed that economic stability though wise government management of monetary and fiscal policies. During this period, economists believed that there was stable inverse relationship between inflation and unemployment I assuming that increasing AD increases price and high price encourage firms to expand and higher more employees. And they believed that inflation was tolerable it means the economy is growing and unemployment would be at lower levels. 22 / 27
- 23. Post Keynesian Macroeconomics (After 1970) However, the 1970s stagflation, slow economic growth coupled with high rate unemployment and inflation, raised question on the Keynesian thought and they failed to explain it. This phenomena leads the Keynesian to rethink their model and the classical school to revive again. And there was no dominan macroeconomics school of thought after 1970s to now. There have been two main intellectual traditions in macroeconomics. I One school of thought believes that markets work best if left to themselves, the economy will be at equilibrium through price and wage adjustment. I This school is known as the New Classical school. 23 / 27
- 24. Post Keynesian Macroeconomics (After 1970) New classical macroeconomic holds that 1. There is perfect competition 2. Prices including wage and interest are flexible; and 3. Agents maximizes under a rational expectations. Meaning People use all available information in making decisions and form their expectations on the basis of it. Under these assumptions, I they believe that the government cannot deceive the people and should not intervene, I because people are well-informed and have access to the same information as much as the government have. 24 / 27
- 25. Post Keynesian Macroeconomics (After 1970) The other believes that government intervention can significantly improve the operation of the economy. I This school is The New Keynesian school; New Keynesian economics is a school of macroeconomics that strives to provide microeconomic foundations for Keynesian economics based on the f.f assumptions I There is imperfect competition (all agents may not have equal information) I Nominal wage, interest and price are sticky which means they do not adjust instantaneously to changes in economic conditions. Therefore, they argue that macroeconomic stabilization by the government (using fiscal policy) and the central bank (using monetary policy) can lead to a more efficient macroeconomic outcome than a laissez faire policy would. 25 / 27
- 26. In sum For classical I Output and level of employment determined by technological progress and the amount of input used. I Assuming flexible price notifies that always market clear and no government intervention is needed to achieve full employment of resources. I The market works as quickly as possible to restore full employment. For Keynesians I The level output determined by effective aggregate demand. I Assume rigidity of prices and state that labor market always characterized by involuntary unemployment. I For market to be clear there is a call for government intervention. 26 / 27
- 27. Review Questions 1. Define the subject macroeconomics. 2. Explain the difference between macroeconomics and microeconomics. How are these two fields related? 3. What are the focus areas of Macroeconomics? 4. Explain the goals, objectives and instruments of Macroeconomics. 5. What are macroeconomic models? Why do Economists build models? 6. What do you think are the defining characteristics of a science? Do you think macroeconomics should be called a science? Why or why not? 7. Discuss how the great depression of 1929 led to the emergence of new economic thinking. 8. Explain the main differences between the Keynesians and the classical schools, new Keynesians and the New-classical of thought? 9. Explain the determinant of economic growth or wealth of a nation according to classicas and Keynesians. 27 / 27