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PROF. RUSHEN CHAHAL
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Macro Economics contd.
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Macro Economics contd.
Macro vs. Micro Aggregate Demand and Supply Measuring Economic Success
Output Employment Inflation
Equilibrium Changes in Macroeconomics
The Problem of Macroeconomic Stabilization U.S. Macroeconomic History
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Macro vs. Micro
In macroeconomics, we dont care about what is producedand who gets to consume what. We do care about howmuch is produced.
Its all about the big picture and not the small detail.
In microeconomics, we focus on individual decisionmaking.
In macroeconomics, we focus on the behavior of theeconomy as a whole.
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Macro vs. Micro
Macroeconomics analyzes the size of theeconomy (pie), not caring what's inside orhow its divided.
Microeconomics looks at the ingredientsand who gets to eat it, not caring about thesize and shape.
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Macro vs. Micro
Aggregation and Macroeconomics Aggregation means combining many individual markets into
one overall market.
Macroeconomic models use abstract concepts like the price
level and gross domestic product that are derived bycombining many different markets into one. This process isknown as aggregation.
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Aggregation
Aggregate supplycurve -shows the quantity ofdomestic product that is supplied at eachpossible value of the price level.
Aggregate Supply describes how much outputbusinesses would willingly produce and sell
given prices, costs, and market conditions
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Aggregation
Aggregate demand curve shows the quantity ofdomestic product that is supplied at each possible
value of the price level.
Aggregate Demand consists of the total spending in aneconomy by households, businesses, governments,and foreigners.
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Warning on AS and AD curves
Domestic product combine all goods and servicesinto one product. AS and AD curves have noindividual products. There is only one product,and it represents all products.
Aggregate demand demand for domestic product.
Aggregate supply supply of domestic product.
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Aggregation
But doesnt it matter what stuff is being boughtand what stuff is being sold?
Isnt it important if we are selling cars orselling cheese?
Yes and no
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Aggregation
Clearly we care about the makeup of theeconomy, but:
1. Exactly what the national output is comprised of
doesnt really affect issues of growth, inflation, andunemployment
2. During economic fluctuations, markets tend tomove together. When demand in an economy
rises, demand for almost all goods rises
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Some Central Questions ofMacroeconomics
Why do output and employment sometimes fall, and howcan unemployment be reduced?
What are the sources of price inflation, and how can it bekept under control?
How can a nation increase its rate of economic growth?
How can an economy balance all three of the aboveproblems?
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t
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e enera eory o mp oyment,Interest, and Money - Keynes
1. It is possible for high unemployment andunderutilized capacity to persist in marketeconomies
2. Government fiscal and monetary policies can affectoutput and thereby reduce unemployment andshorten economic downturn
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Measuring Economic Success
Economists evaluate the success of an economysperformance by how well it attains theseobjectives:
High levels and rapid growth of output (usuallymeasured by GDP)
Low levels of unemployment
Price level stability (or low inflation)
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Output
Gross Domestic ProductGDP is the sum of the money values of all final goods and
services produced in the domestic economy and sold onorganized markets in a specified period of time, usually ayear.
Nominal GDP is calculated by valuing all outputs at currentprices.
Real GDP is calculated by valuing outputs of different yearsat common prices. Therefore, real GDP is a far bettermeasure than nominal GDP of changes in total production.
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Output
Disadvantage of Nominal GDP: It changes when prices change evenif there is no change in actual production.
Example: Assume a hamburger cost $1.50 in 2006. In 2007 it cost$2. In 2006 there were 100 hamburgers, which added $150 to
nominal GDP. In 2007 there were 100 hamburgers, added $200 tonominal GDP. Nominal GDP makes it look like there were morehamburgers in 2007, even though there were only 100. So nominalGDP makes it look like there is economic growth, even when there isnot.
Solution: calculate real GDP or GDP in constant dollars.
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Measuring Economic Success: Output
Shortcomings of GDP as a measure of economicwell-being:
-Only Market Activity is Included in GDP-GDP places no value on leisure
- Bads counted as well as Goods
For example, when there is a natural disaster,increased spending to solve the problems of thedisaster are counted as increased GDP.
-No account for ecological costs
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Measuring Economic Success
Employment:
-Macroeconomic indicator most felt byindividuals
-Unemployment rate tends to reflect the state ofthe business cycle:
-Falling output = falling demand for labor
-Rising output = rising demand for labor
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Measuring Economic Success
Inflation:
When price levels go up, we experienceinflation.
When price levels go down, we experiencedeflation.
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Measuring Economic Success
Inflation:
An economy strives to keep inflation steady
Rapid price increases cause problems forcompanies and individuals
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Chinas Inflation
August 2004 inflation rate held steady at 5.3%
Producer Prices rose 6.8%
Food prices rose 14%
Consumer goods rose 6.3%Housing prices rose 6%
Service costs rose 2%
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Equilibrium Changes in Macroeconomics
Q0
Price
P0
D1
A
S
D
D
S
E
Quantity(a)
Price
P0
S
D
D
S
E
Quantity(a)
D1
Inflation.Inflation.02/12/12Prof. Rushen Chahal
Equilibrium Changes in Macroeconomics
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Equilibrium Changes in Macroeconomics
Inflation Major concerns of macroeconomics
InflationUnemployment
Growth
ADprice level
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FIGUREFIGURE 2:2:An Economy Slipping into aAn Economy Slipping into aRecessionRecession
D2
BPrice
Lev
el
S
D0
D0
S
E
Domestic Product
D2
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Equilibrium Changes in Macroeconomics
Recession and Unemployment ADunemployment
Recession = a period of time during which total output falls
and therefore jobs are lost
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FIGUREFIGURE 3:3:Economic GrowthEconomic Growth
Copyright 2006 South-Western/Thomson Learning. All rights reserved.
D1
C
Price
Level
S0
D0
D0
S0
E
Domestic Product
D1
S1
S1
Q0 Q1
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Equilibrium Changes in Macroeconomics
Economic Growth Economic growth = GDP
AD and/or AS growth
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FIGUREFIGURE 7:7:The Effects of an AdverseThe Effects of an AdverseSupply Shift (stagflation)Supply Shift (stagflation)
Copyright 2006 South-Western/Thomson Learning. All rights reserved.
S1
S1 D
D
S0
S0
Price
Le
vel
Real GDP
A
E
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FIGUREFIGURE 8:8:The Effects of a FavorableThe Effects of a FavorableSupply ShiftSupply Shift
Copyright 2006 South-Western/Thomson Learning. All rights reserved.
Real GDP
Price
Level
D0
D0
S0
S0
S1
S1
D1
D1
S2
S2
C
BE
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The Problem of Macroeconomic Stabilization
The government wants to have a stabilization policythat can shorten recessions and fight inflation.
Combating Unemployment
When recessions are caused by too low aggregate demand,governments can try to increase demand.
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FIGUREFIGURE 99Stabilization Policy to FightStabilization Policy to FightUnemploymentUnemployment
Copyright 2006 South-Western/Thomson Learning. All rights reserved.
Increase inoutput
Price
Le
vel
Real GDP
S
SD0
D0
E
D1
D1
A
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The Problem of Macroeconomic Stabilization
Combating Inflation When inflation is caused by too high aggregate demand,
governments can try to limit aggregate demand.
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FIGUREFIGURE 10:10:Stabilization Policy to FightStabilization Policy to FightInflationInflation
Copyright 2006 South-Western/Thomson Learning. All rights reserved.
Decreasein prices
Price
Level
Real GDP
S
S
D0
D0
E
D2
D2
B
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U S Macroeconomic History
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U.S. Macroeconomic History
Real GDP
Q
P
Price
Leve
l
E
AD
AS
P
Q
Here we seeequilibrium in themarket.
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U.S. Macroeconomic History
Real GDP
Q
P
Price
Leve
l
E
E1
AD AD1
AS
P
P1
Q Q1
As America entered thViet Nam War, defensespending increased
by 55 percent between1965 and 1968.
This increased AggregatDemand, shifting the AD
Curve to the rightWhich resulted in thehigh inflation that thenation experienced
Between 1966-198102/12/12Prof. Rushen Chahal
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U.S. Macroeconomic History
PDuring the 1970s the industrial worlwas struck by a supply shock.
Crop failures, shifting ocean current
massive speculation on worldcommodity markets, turmoil in foreiexchange markets, and a MidEast wthat led to a quadrupling (X4) of oilprices marked what was known asthe year of seven plagues in 1973
The result was a rapid increase of tcosts of materials and fuels,which shifted the Aggregate supplycurve inward.
Real GDP
Q
P
E
E1
AD
AS1
AS
P
P1
QQ1
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U.S. Macroeconomic History
Real GDP
Q
P
Price
Lev
el
E
E1
AD
AS1
AS
P
P1
QQ1
The United States then experienceda period ofstagflation, whichwas indicated by a sharp increase ininflation and a fall in real output.
This effect can be illustrated by aninwards shift of the Aggregate SuppCurve, which increases prices anddecreases output
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U.S. Macroeconomic History
Real GDP
Q
P
Price
Leve
l
E
E1 ADAD1
AS
PP1
QQ1
When President Regan tookoffice in 1981, the economy waexperiencing severe inflation,near 10 percent, an unacceptanumber.The Chairman of the FederalReserve, Paul Volcker,influenced interest rates in theso that spendingwould decrease, and in effect
decrease demand in theeconomy.The result was a decrease inoutput, and an increase inunemployment. The reward
was a decrease in inflation.02/12/12Prof. Rushen Chahal
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U.S. Macroeconomic History
Q
During President Clintons firstterm, the national economyimproved remarkably. Businesimproved, unemployment fell
rapidly, and inflation was steadand low.Economic growth thenaccelerated even more duringhis second term.
Unemployment dropped to 3.9and inflation dropped below 2for a brief period
How did this happen?Real GDP
Q
P
Price
Leve
l
EAD
AS
P
Q Q1
P1
AD1
AS1
Q2
P2
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U.S. Macroeconomic History
Real GDP
Q
P
Price
Leve
l
EAD
AS
P
Q
A combined increase ofAggregate Demand as well asan unexpected huge increasein Aggregate supply provides
An good explanation.
A shift out in AD will increaseoutput as well as prices
But if at the same time AS
shifts out, output can continuto increase while prices do norise a lot.
Q1
P1
AD1
AS1
Q2
P2
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. .
The economic history of the United States (or anycountry) in the twentieth century can be more
easily understood using the AS/AD model.
Growth over the past century has been due toboth increases in aggregate supply as well as
aggregate demand.
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. .
Historically, economies do not generally producesteady growth without inflation.
Instead, economies are hit with periodic bouts of
unemployment or inflation, and sometimes both.
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. .
Thus it has become a goal of economies to minimizethe damage done by inflation and unemployment.
These stabilization policies are designed to shorten
recessions, reduce unemployment, and stabilizeinflation.