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SHAD 1053
PRINCIPLES OF MACROECONOMICS
MacroLecture1
Lecture Highlights
Definition of economics and explain the kinds of
questions that economists try to answer
Distinguish between microeconomics and
macroeconomics
Positive and normative economics
Origins and issues of macroeconomics
Macroeconomic concerns/ questions
The components of the macroeconomy -Circular
flows
Macroeconomic Policy Challenges and Tools

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Definition of Economics
Definition of economics the social science that
studies the choices that we make as we cope
with scarcity and the incentives that influence
and reconcile our choices.

The way this subject is organised two major
divisions of economics:
(1) Microeconomics deals with the functioning of
individual industries and the behavior of
individual economic decision-making units:
business firms and households. Firms choices
about what to produce and how much to charge,
and households choices about what and how
much to buy, help to explain why the economy
produces the things it does.
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Contd.
One big question addressed by microeconomics is
who gets the things that are produced. Wealthy
households get more than poor households, and
the forces that determine this distribution of
output are the province of microeconomics. Why
does poverty exist. Who is poor? Why do some
jobs pay more than others?
Microeconomics also involves policy issues, such as
analyzing the most efficient way to reduce
teenage smoking, and analyzing the most
efficient way to reduce air pollution.
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Contd.
(2) Macroeconomics is concerned with the
behavior of the economy as a whole
with booms and recessions, the economys
total output of goods and services, the
growth of output, the rates of inflation and
unemployment, the balance of payments,
and the exchange rates. Macroeconomics
deals with both long-run economic growth
and the short-run fluctuations that
constitute the business cycle.
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Contd.
Macroeconomics focuses on the
economic behavior and policies that
affect consumption and investment,
the value of currency and the trade
balance, the determinants of
changes in wages and prices,
monetary and fiscal policies, the
money stock, the federal budget,
interest rates, and the national debt.
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Contd.
Whereas microeconomics focuses on individual
product prices and relative prices,
macroeconomics looks at the overall price level
and how quickly (or slowly) it is rising (or falling).
Microeconomics questions how many will be hired
(or fired) this year in a particular industry or in a
certain geographic area, and focuses on the
factors that determine how much labor a firm or
an industry will hire. Macroeconomics deals with
aggregate employment and unemployment: how
many jobs exist in the economy as a whole, and
how many people who are willing to work are not
able to find work.
Positive and Normative
Economics
The micro versus macro distinction is based on the
level of detail we want to consider. Another
useful distinction has to do with our purpose in
analyzing a problem positive & normative
economics.
Positive economics explains how the economy
works, plain and simple. If someone says, The
decline in home prices during 2008 and 2009 was
a major cause of the recent recession, he or she
is making a positive economic statement. A
statement need not be accurate or even sensible
to be classified as positive.
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Contd.
For ex. , Government policy has no
effect on our standard of living is a
statement that virtually every
economist would regard as false. But
it is still a positive economic
statement. Whether true or not, its
about how the economy works and
its accuracy can be tested by looking
at the facts.
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Contd.
Normative economics prescribes solutions to
economic problems. It goes beyond just the
facts and tells us what we should do about
them. Normative economics requires us to make
judgments about different outcomes and
therefore depends on our values.
If an economist says, We should cut total
government spending, he or she is engaging in
normative economic analysis. Cutting
government spending would benefit some citizens
and harm others, so the statement rests on a
value judgment.
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Contd.
Positive and normative economics are
intimately related in practice. We
cannot properly argue about what we
should or should not do unless we
know certain facts about the world.
Every normative analysis is therefore
based on an underlying positive
analysis.
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Origins and issues of
macroeconomics
Modern macroeconomics emerged
during the Great Depression.
People began to doubt the free
market economy.
John Maynard Keynes, in 1936,
published The general Theory of
Employment, Interest, and Money.
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Contd.
Short-Term Versus Long-Term Goals
Keynes focused on the short-term
primarily
He felt the depression was caused by
insufficient private spending.
Government should increase its spending.
Long-term consequences were virtually
disregarded.
In the long run, were all dead.
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Contd.
Today, macroeconomics is concerned
with:
Long-term economic growth and
inflation.
Short-term business fluctuations and
unemployment.
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Contd.
The focus of macroeconomics has
shifted:

Depression
Inflation of the 1970s
International economics of today
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Economic growth
Economic growth is the expansion of the
economys production possibilities.
Measured by real gross domestic product
(real GDP)
- The value of the total production of all the
nations farms, factories, shops, and
offices linked back to the prices of a single
year (base year).
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Contd.
The growth of potential GDP
when an economys labor, capital,
land, and entrepreneurial ability are
fully employed.
Real GDP fluctuates around potential
GDP
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Macroeconomic questions
The standard of living

The cost of living

Economic fluctuations recessions &
expansions
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The standard of living
The level of consumption of goods and
services that people enjoy, on the
average, and is measured by average
income per person or real GDP per person.
Achieving a high standard of living means
finding a good job. If we lose our job, it
means spending some time being
unemployed while we search for the right
new job.
Unemployment is the state of being
available and willing to work but unable to
find an acceptable job.
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The cost of living
The number of dollars it takes to buy the
goods and services that achieve a given
standard of living.
A rising cost of living inflation, means a
shrinking value of the dollar. A falling cost
of living, which is called deflation, means
a rising value of the dollar.
Has the cost of living increased or
decreased? Over the past 50 years, we
see the cost of living has increased and
the value of the dollar has shrunk.
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Economic fluctuations:
recessions & expansions
Over long periods, both the standard
of living and the cost of living have
increased. But these increases have
not been smooth and continuous.
Our economy fluctuates in a business
cycle, a periodic but irregular up-
and-down movement in production
and jobs.
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Contd.
Every business cycle can be described
in terms of 4 stages:
1. The expansion stage the usual
condition of the economy. During
this period, real GDP is rising.
2. Peak the highest level of real GDP
that has been attained up to that
time.
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Contd.
3. Recession a period of falling
production that lasts for at least 6
months. During a recession, incomes
are falling, people get laid off from
their jobs, and new jobs are harder
to find.
4. Trough real GDP reaches a
temporary low point and from which
the next expansion begins.
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Business cycle
Year
Total
production
peak
recession
expansion
trough
peak
recession
expansion
Benefits and Costs of
Economic Growth
Benefits
Expanded production possibilities
Health care
Medical research
Space exploration
Roads
Environmental improvements
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Contd.
Costs
Foregone consumption
Depletion of natural resources
Increased pollution
More frequent job and location
changes
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What, How, and for whom?
What do we produce?
How will society decide whether to produce more
economics textbooks or more DVD players?
More day care facilities or more football
stadiums? Of course, society does not make
decisions; only individuals make decisions. The
answer to the question of what will be produced
is determined by the choices made by
consumers, firms, and the government.
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Contd.
What do we produce?
In macroeconomics, we divide the vast
array of goods and services
produced into 4 large groups:
(1)Consumption goods & services
(2)Investment goods
(3)Government goods & services
(4)Export goods & services
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Contd.
(1) Consumption goods & services - Items
that are bought by individuals and used
to provide personal enjoyment e.g.
housing, food, movies, dry cleaning
services.
(2) Investment goods goods that are
bought by businesses to increase their
productive resources e.g. auto assembly
lines, shopping malls, factories,
airplanes.
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Contd.
(3) Government goods & services
items that are bought by
governments e.g. missiles & weapon
systems, travel services, police
protection, roads.
(4) Export goods & services items
produced in one country and sold in
other countries.
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How do we produce?
How will the goods and services be produced?

Firms choose how to produce the goods and
services they sell. In many cases, firms face a
trade-off between using more workers or using
more machines. For example, a local service
station has to choose whether to provide car
repair services using more diagnostic computers
and fewer auto mechanics or more auto
mechanics and fewer diagnostic computers.
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How do we produce? Contd.
Goods & services are produced by
using productive resources (inputs)/
factors of production.
Factors of production are grouped
into 4 categories:
(i) Land includes all the gift of
nature, natural resources land,
minerals, energy, water, and air, and
wild plants, animals, birds, and fish.
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Contd.
(ii) Labor the work time and work effort
that people devote to producing goods
and services. The quantity of labor
increases as the adult population
increases.
The quality of labor depends on how
skilled people are human capital is the
knowledge and skill that people obtain
from education, training, and work
experience.
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Contd.
(iii) Capital consists of the tools,
instruments, machines, buildings, and
other constructions that have produced in
the past and that businesses or firms now
use to produce goods & services e.g.
hammers & screwdrivers, computers, auto
assembly lines, office buildings, dams,
airports & airplanes, and factories.
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Contd.
(iv) Entrepreneurship the human
resource that organizes labor, land,
and capital. Entrepreneurs come up
with new ideas about what and how
to produce, make business decisions,
and bear the risks.
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For whom do we produce?
Who gets the goods & services that are
produced depends on the incomes that people
earn and the goods and services that they
choose to buy.
People earn their incomes by selling the
services of the factors of production they own.
(i) Rent income paid for the use of land.
(ii) Wages income paid for the services of labor.
(iii) interest income paid for the use of capital.
(iv)Profit (or loss) income earned by an
entrepreneur for running a business.
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Circular flows
The circular flow model shows the
circular flow of expenditures and
incomes that result from decision
makers choices and the way those
choices interact to determine what,
how, and for whom goods and
services are produced.
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Contd.
Goods markets
Factor markets
Households
Firms
Labor,land,capital &
entrepreneurship
Labor,land,capital &
entrepreneurship hired
Expenditure on
goods & services
Revenue from
sale of goods
& services
Rent,wages,interest
,and profit paid
Rent,wages,interest
& profit
Goods & services
supplied
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Real flows and money flows
When households choose the quantities of
land, labor, capital, and entrepreneurship
to offer in factor markets, they respond to
the incomes they receive.
When firms choose the quantities of goods
& services to produce and offer for sale in
goods market, they respond to the
amounts that they receive from the
expenditures that households make.
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Governments in the circular
flow
Households
Firms
Governments
Goods markets
Factor markets
taxes
taxes
transfers
transfers
Expenditures on
goods & services
Rent,wages,interest,
and profit
Rent,wages,interest,
and profit
Macroeconomic policy
Challenges and Tools
Policy Challenges
1) Boost economic growth
2) Stabilize the business cycle
3) Reduce unemployment
4) Keep inflation low
5) Reduce the government deficits
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Contd.
Policy Tools
1) Fiscal policy
making changes in taxes and
government spending
Long-term growth
Smooth the business cycle
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Contd.
2) Monetary policy
Changing interest rates and the
amount of money in the economy

Control inflation
Smooth business cycle
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