This is comprehensive notes on all the macroeconomic chapters covered in class in the first semester. It includes explanations about all the important graphs covered and it discusses every learning objective in the module framework.
Chapter 1
Introduction
What is Macroeconomics? (LO1.1)
• It is the study of the behaviour of large collections of economic agents.
• It focuses on:
o The behaviour of consumers, firms, and governments
o The overall level of economic activity in individual countries
o The economic interactions upon nations and their fiscal and
monetary policies.
Difference between Micro and Macro?
• Micro and Macro are two separate fields
o Micro focuses on the choices of individual consumers and firms
o Macro focuses on the overall effects on economies of the
choices that all economic agents make.
• Macroeconomics focuses more on long-run growth and business
cycles
o Long-run growth refers to the increase in the nation’s productive
capacity and average standard of living that occurs over a long
period of time
o Business cycles are the short-run ups and downs in aggregate
economic activity
Similarities between Micro and Macro
• The distinction between Micro and Macro has blurred in that
microeconomists and macroeconomists now uses much more of the
same kind of tools, such as economic models.
• These economic models that macroeconomists use consists of
descriptions of consumers and firms, their objectives, and constraints,
and how they interact, and are built up from microeconomic
principles.
• These models are analysed and fit to data using similar methods of
microeconomics.
Gross Domestic Product, Economic Growth and Business Cycles (LO1.2)
• The most basic sets of facts in macroeconomics have to do with the
behaviour of aggregate economic activity over time.
o Gross Domestic Product: It is the quantity of goods and services
produced within a country’s borders during some specified
period of time.
o It is a measure of aggregate economic activity.
o GDP also represents the quantity of income earned by those
contributing to domestic output.
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, • Economic growth: an increase in the production of goods and services,
compared from one period to another
o It creates more profit for businesses which results in an increase in
stock price
o One of the ways to carry out an economic time series is to
separate the series into two components
§ The growth or trend component
• A trend is a smooth growth path around which an
economic variable cycles.
§ The business cycle component
• Business cycles: short-run ups and downs or booms and recessions in
aggregate economic activity.
o They have implications for the welfare of the broad population
as well as for private institutions
Macroeconomic Models (LO1.3)
• Economics is a scientific pursuit involving the formulation and
refinement of theories that can help us better understand how
economies work and how they can be improved.
• Sciences uses laboratory experiments to test theories.
Why are models useful?
• In economics experimentation is a new and growing activity.
o In macroeconomics, most experiments that could be informative
are simply too costly to carry out
o Therefore, economists use models.
o Models: artificial devices that can replicate the behaviour of real
systems.
• Models are used to explain long-run economic growth.
o These models help to explain why there are business cycles and
what role economic policy should play in the macroeconomic
environment
o All economic models are abstractions. They are not completely
accurate, nor do they intend to be.
• The purpose of an economic model is to capture the essential features
of the world needed for analysing a particular economic problem
o A model must be simple, meaning there shouldn’t be focused on
looking good rather than explaining what it is about.
Basic structure of an economic model
1. The consumers and firms that interact in the economy
2. The set of goods that consumers wish to consume
3. Consumer’s preferences over goods
4. The technology available to firms for producing goods
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, 5. The resources available
• Once we know the features from above, we use it to make a model.
• This is done in two steps:
• Step 1: we need to know what the goals of the consumers and firms in the
model are.
o For this we assume that consumers and firms optimize, meaning
that they do the best they can given the constraints they face
• Step 2: we must specify how consistency is achieved in terms of the
actions of consumers and firms
o This means that the economy must be in equilibrium
o In a competitive equilibrium, we assume that goods are bought
and sold in markets in which consumers and firms are price
takers; they behave as if their actions have no effect on market
prices
o The economy is in equilibrium when market prices are as such
that the quantity of each good offered for sale is equal to the
quantity that economic agents want to buy in each market.
• In keeping with the principle that models should be simple and designed
specifically for the problem at hand, we do not stick to a single all-purpose
model.
• We use different models for different purposes and through these models
we share a common approach and some of the same principal building
blocks
• Generally, macroeconomic research is a process whereby we
continuously attempt to develop better models, along with better
methods for analysing those models
Microeconomic principles (LO1.4)
• Macroeconomics is the sum of many microeconomic decisions of
micro consumers and firms.
• Microeconomics uses a set of fundamental principles to make
predictions about how individuals behave in certain situations involving
economic or financial transactions.
• Some principles include:
o Efficiency
o Opportunity costs
o Incentives
o Production
o Profits and monopoly
o Fundamental concepts of supply and demand
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, o Rational choice
• Changes in government policies generally alter the behaviour of
consumers and firms in ways that significantly affect the behaviour of
the economy as a whole
o Any change in government policy effectively alters the features
of the economic environment in which consumers and firms must
make their decisions.
o We must analyse how the change in policy affects individual
consumers and firms
• Before the rational expectations revolution, most macroeconomists
worked with models that did not have solid microeconomic
foundations, though there were some exceptions.
Disagreement in Macroeconomics (LO1.5)
• There is little disagreement between macroeconomists concerning the
general approach to be taken to construct models of economic
growth.
• The study of business cycles in macroeconomics is another story
o There is much controversy concerning business cycle theory and
the role of the government in smoothing business cycles over
time.
o Business cycles can be differentiated between being:
• Keynesian: there is an active role for government to
smooth business cycles
• Non-Keynesian: there is not an active role for the
government to smooth business cycles.
What do we learn from macroeconomic analysis? (LO1.6)
There are 12 key insights that can be learned from macroeconomic analysis
1. What is produced and consumed in the economy is determined jointly
by the economy’s productive capacity and the preferences of
consumers
2. In free market economies, there are strong forces that tend to produce
socially efficient economic outcomes
3. Unemployment is painful for individuals, but it is a necessary evil in
modern economics
• There will always be unemployment in a well-functioning
economy.
• It is economically efficient for workers to be well matched
with jobs, in terms of their skills, and if an individual spends
a longer time searching for work, this increases the
chances of a good match.
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