Chapter 1

What Is
Macroeconomics?

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 The “Big Three” Concepts of
Macroeconomics

• Unemployment Rate
U = (# of Unemployed) / Labor Force
• Inflation Rate
π = %ΔP = (P1 – P0) / P0
• Productivity Growth
– “Productivity” is the average output per hour of work that
a nation produces in goods and services.
– Productivity in 2008 = $55 per worker-hour

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 Macroeconomics vs.
Microeconomics

• Macroeconomics deals with the totals, or

aggregates, of the economy such as:
– The unemployment rate (of all workers)
– Inflation (i.e. the rise of all prices in the a country.)
• Microeconomics deals with parts of the economy
like:
– The unemployment rate of low-skilled workers in a
certain state
– The price of cars
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 Gross Domestic Product (GDP)

• Definition: (Nominal) GDP is the value of all

currently produced goods and services sold on the
market during a particular time interval.
– Real GDP adjusts the value of total output to correct for
changes in prices.
• Sometimes referred to as Actual Real GDP

– Natural Real GDP is the level of real GDP in which

there is no tendency for inflation to rise or fall.

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 Figure 1-1
The Relation Between Actual and Natural
Real GDP and the Inflation Rate

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 Unemployment: Actual and Natural

• Actual Unemployment (U) is the

unemployment rate observed in the
economy.
• The Natural Rate of Unemployment (U*)
is the rate of unemployment at which there
is no tendency for inflation to rise or fall.
– If U > U*  inflation (π) falls
– If U < U*  inflation (π) rises

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 Figure 1-2
The Behavior over Time of Actual and Natural Real
GDP and the Actual and Natural Rates of
Unemployment

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 Short Run vs. Long Run

• The “short run” lasts from 1-5 years and the main
issue is the stability of the economy.
– The ups and downs (or “economic fluctuations”) of an
economy are part of the business cycle. The business
cycle has the following phases:
• Expansion
• Contraction

• The “long run” ranges from one to several decades

and is concerned with economic growth.

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 Figure 1-3 Business Cycles in Volatilia and
Stabilia

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 Figure 1-4
Basic Business-Cycle Concepts

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 Figure 1-5 Economic Growth
in Stag-Nation and Speed-Nation

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 Figure 1-6 Actual and Natural GDP and
Unemployment, 1900–2007 (1 of 2)

Sources: See Appendix A-1 and C-4

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 Figure 1-6 Actual and Natural GDP and
Unemployment, 1900–2007 (2 of 2)

Sources: See Appendix A-1 and C-4

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 Figure 1-6 Actual and Natural GDP and
Unemployment, 1900–2007

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 Macroeconomics at the Extremes

• Three examples of the breakdown of

normal macroeconomic mechanisms:
– The Great Depression of the 1930s
– The German hyperinflation of the 1920s
– South Korea vs. Philippines economic
growth in the last 50 years

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 Figure 1-7 The Unemployment Rate
from 1929–41 Compared with 1992–2007

Source: Bureau of Labor Statistics. See Appendix C-4

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 Figure 1-8
The German Price Level, 1920–23

Source: Groningen Growth and Development Center. See Appendix C-4

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 Figure 1-9 Per-Capita Real GDP, South
Korea and the Philippines, 1960–2008 in
2007 U.S. Dollars

Source: Groningen Growth and Development Center. See Appendix C-4

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 Taming Business Cycles

• Macroeconomic analysts have two main tasks:

– Analyze the causes of changes in macroeconomic
variables
– Predict the consequences of alternative policy
changes
• Macroeconomic target variables important to
analysts and policy makers include:
– Inflation
– Unemployment
– Long-term growth of productivity
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 The Role of Stabilization Policy

• A Stabilization Policy is any policy that

seeks to influence the level of aggregate
demand.
– Monetary policy tries to influence aggregate
demand by changing the money supply
and/or interest rates.
– Fiscal policy tries to influence aggregate
demand by changing government spending
and/or tax rates.
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 The “Internationalization” of
Macroeconomics
• A closed economy has no trade in goods, services, or financial assets
with any other nations.
– In the 1940s and 50s, the U.S. was relatively closed:
• Trade was 5% of the U.S. economy
• Exchange rates were fixed
• Financial flows to and from the U.S. were restricted
• An open economy exports and imports goods and services to and from
other nations, and has financial flows to and from foreign nations.
– Today the U.S. is increasingly open:
• Imports equal 17% of U.S. GDP
• Since 1973, the exchange rate of the $ has been flexible
• International financial flows are massive and almost instantaneous

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 Economic Performance of
the U.S. vs. Europe

• Europe outperformed the U.S. from 1960–

1985.
• But the U.S. has grown much more quickly
than Europe since 1995.
• Puzzle #1: Why has European unemployment
risen so much?
• Puzzle #2: Why has Europe not benefited from
the adoption of computer and internet
technology like the U.S?
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