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Chapter 21 Macroeconomics: the big pictureThe nature macroeconomics
Macroeconomic questions
Macroeconomics examines the overall behaviour of the economy → how the actions of all the
individuals and firms in the economy interact to produce a particular economy-wide level of
economic performance.
Macroeconomics: the whole is greater than the sum of its parts.
The paradox of thrift: when families and businesses are worried about the possibility of
economic hard times, they prepare by cutting their spending. When everyone does this, it is
devastating: the combined effect of individual decisions can have results that are very different
from the intention or the sum of these decisions.
Macroeconomics: theory and policy
In a self-regulating economy, problems such as unemployment are resolved without
government intervention, through the working of the invisible hand. According to Keynesian
economics, economic slumps are caused by inadequate spending and they can be mitigated
by government intervention through monetary and fiscal policy. Monetary policy uses changes
in the quantity of money to alter interest rates and affect overall spending. Fiscal policy uses
changes in government spending and taxes to affect overall spending.
The business cycle
Charting the business cycle
The business cycle is the short-run alternation between
recessions and expansions. Recessions, or contractions, are
periods of economic downturn when output and employment
are falling. Expansions, or recoveries, are periods of economic
upturn when output and employment are rising. The point at
which the economy turns from expansion to recession is a
business-cycle peak. The point at which the economy turns from recession to expansion is a
business-cycle trough.
,The pain of recession
The most important effect of a recession is its effect on the ability of workers to find and hold
jobs, measured with the unemployment rate. REcessions are associated with a rise in the
number of people living below the poverty line and is also bad for firms.
Taming the business cycle
According to Keynes, to reduce the frequency and severity of recession, monetary and fiscal
policy could be used to mitigate the effects of recession. Friedman led to a consensus that its
important to rein in booms as well as to fight slumps. However, they have not been completely
successful. They did help to make the economy more stable
Long-run economic growth
The long-run economic growth is the sustained upward trend in the economy’s output over
time. Long-run economic growth is fundamental to many of the most pressing economic
questions today.
Inflation and deflation
The causes of inflation and deflation
A rising overall level of prices is inflation. A falling level of prices is deflation. Supply and
demand can only explain why a particular good or service becomes more expensie=ve relative
to other goods and services, and thus supply and demand cannot explain what happens to the
overall level of prices. In the short-run, inflation and deflation are closely realted to the business
cycl (depressing economy = deflation, booming economy = inflation). In the long run, the overall
level of prices is mainly determined by changes in the money supply. Hyperinflation occurs
when governments print money to pay a large part of their bills.
The pain of inflation and deflation
Inflation discouraged people from holding on to cash, because cash loses value over time → no
money in banks. Deflation deepens a recession because holding on to your money is more
rewarding in the future. In conclusion, both inflation and deflation cause a lot of problems. The
desirable goal is price stability, which an economy achieves when the overall level of prices
changes slowly or not at all.
International imbalances
An open economy is an economy that trades goods and services with other countries. A
country runs a trade deficit when the value of goods and services imported > exported. A
country runs a trade surplus when the value of goods and services imported < exported.
,Chapter 22 GDP and the CPI: tracking the
macroeconomy
The national accounts
The national income and product accounts, or national accounts keep track of the flows of
money between different sectors of the economy. The accuracy of a country’s accounts is a
remarkably reliable indicator of its state of economic development: the more reliable, the more
economically advanced the country is.
Following the money: the expanded circular-flow diagram
In this chapter, the focus lies on the left side of the
diagram. The flows of money into the markets for goods
and services come from 4 distinct kinds of buyer:
1. Governments spend tax revenue in 2 broad areas:
Government purchases of goods and services,
the total expenditures on goods and services by
federal, state and local governments, and transfer
payments, like social security
2. Households engage in consumer spending by
purchasing goods and services through the market
for goods and services.
3. Firms engage in investment spending, the
spending on productive physical capital
(machinery, construction of buildings) and on changes to inventories
4. The rest of the world spends through exports, selling goods and services to other
countries
An outflow for the markets for goods and services are the imports, when goods and services
are purchased from other countries. Adding up the government purchases, consumer spending,
investment spending, exports and subtracting the import gives us a measure of the overall
market value of the goods and services the economy produces: the gross domestic product.
Gross Domestic Product; GDP
Final goods and services are goods and services sold to the final, or end, user (a car).
Intermediate goods and services are goods and services - bought from one firm by another
firm - that are inputs for production of final goods and services (wheel). The gross domestic
, product, or GDP, is the total value of all final goods and services in the economy in a given
year. Aggregate spending, the sum of government purchases, consumer spending, investment
spending, exports minus imports, is the total spending on domestically produced goods and
services in the economy
Calculating GDP
1. Measuring GDP as the value of production of
final goods and services
The first method for calculating GDP is to add up the
value of all final goods and services produced in the
economy - a calculation that excludes the value of
intermediate goods and services because this would
result in counting the intermediate goods twice while
adding the final good. The value added of a producer
is the value of its sales - the value of its purchases of
intermediate goods and services, which is only added to the GDP.
2. Measuring GDP as spending on domestically produced final goods
Another way to calculate GDP is to add up aggregate spending on domestically produced final
goods and services. To avoid double counting, only the value of sales to final buyers
(consumers, firms investing, the government, foreign buyers ). This results in the following equation:
𝐺𝐷𝑃 = 𝐶 + 𝐼 + 𝐺 + 𝑋 − 𝐸𝑀 = 𝑐𝑜𝑛𝑠𝑢𝑚𝑒𝑟 𝑠𝑝𝑒𝑛𝑑𝑖𝑛𝑔 + 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑠𝑝𝑒𝑛𝑑𝑖𝑛𝑔 + 𝑔𝑜𝑣𝑒𝑟𝑛𝑚𝑒𝑛𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 +
𝑒𝑥𝑝𝑜𝑟𝑡 − 𝑖𝑚𝑝𝑜𝑟𝑡
3. Measuring GDP as factor income earned from firms in the economy
A final way to calculate GDP is to add up all the income earned by factors of production from
firms in the economy: the wages earned by labor, the interest paid to those who lend savings to
firms and the government, the rent earned by those who lease their land or structures to firms,
the dividends and profits paid to shareholders.
The components of GDP
Net exports are the difference between the value of
exports and the value of imports. The components of
GDP differ by the method used. The left bar shows
the value added by sector (method 1.) and the right
bar shows the spending on domestically produced
final goods and services (method 3.)
What GDP tells us
Firstly, GDP is a measure of the size of the economy. When using GDP numbers, one must be
careful because part of the increase in the value of GDP represents increases in prices instead
of output. To measure actual changes in aggregate input, real GDP is used.
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