Chapter 1 Introduction What is macroeconomics n Macroeconomics

Chapter 1 Introduction

What is macroeconomics n Macroeconomics deals with the overall, or aggregate performance of an economy. ¨ Quantities: n GDP: gross domestic product; n Employment and unemployment; n The balance of payments. ¨ Prices: n GDP deflator, CPI, and others: general price level. n Wage rate: the price of labor. n Rental price and interest rate: the price of capital goods. n Exchange rate: the price of a foreign currency.

What is macroeconomics ¨ Markets: The goods market: consumers, firms, government, and foreigners; n The labor market: consumers and firms; n The asset market: consumers, firms, government and foreigners; n The money market: consumers and government. n ¨ Policy implications emphasized: Is fiscal or monetary policy effective in damping economic cycles or stimulating growth?

What is macroeconomics n Connections with microeconomics. ¨ Aggregation: No longer deal with individual consumer or firm, or the market of individual goods; n A representative consumer and firm. n ¨ Methodology (neoclassical): Based on the behavioral theory of consumer and firms; n Intertemporal choice highlighted; n Dynamic general equilibrium approach. n

Issue and Controversies n Economic growth.

Issue and Controversies n Economic growth. ¨ Growth rate of real GDP in year t: ¨ Mean annual growth rate: 3. 5% during 1870 -2005; ¨ Growth rate of real per capita GDP: 2. 0% during 1870 -2005; ¨ What contributes to long-run growth?

Issue and Controversies n Business cycles.

Issue and Controversies n Business cycles. ¨ Off-trend fluctuation in real GDP; ¨ Booms: real GDP is greater than the trend value; ¨ Recessions: real GDP is lower than the trend value; ¨ Pro-cyclical: a variable that moves in the same direction as real GDP; ¨ Counter-cyclical: a variable that moves in the opposite direction of real GDP; ¨ What causes business cycles? ¨ Are fiscal or monetary policies effective in damping business cycles?

Issue and Controversies n Unemployment.

Issue and Controversies n Unemployment. ¨ Persistent unemployment: averagely 6. 3% during 1890 and 2005; ¨ Unemployment is counter-cyclical; ¨ What causes the cyclical behavior of unemployment? ¨ How should government deal with unemployment? Hands-off policy; n Active fiscal or monetary policy. n

Issue and Controversies n Inflation.

Issue and Controversies n Inflation.

Issue and Controversies n Inflation. ¨ Inflation rate in year t: ¨ Mean annual inflation rate: 8. 8% in 1980 -1981 and 2% in 1992 -2005; ¨ What causes inflation? ¨ Does inflation has real consequences? ¨ What is the optimal inflation rate?

Schools of thought n Neoclassical school: ¨ The big names: Lucas, Prescott, Kydland, Sargent, Barro, Romer; ¨ Theoretical framwork: Theories are based on consumer and firms’ behavior; n Intertemporal choice based on rational expectations; n All markets always clear; n Dynamic general equilibrium model. n

Schools of thought ¨ Major hypotheses: Long-run growth is attributed to technological progress, either exogenous or endogenous; n Business cycles are caused by real shocks; n Nominal shocks generate zilch real effects; n Unemployment reflects labor market frictions, instead of persistent disequilibrium; n Counter-cyclical policies are neutral, if not bad; n Inflation is the outcome of faulty monetary policy. n

Schools of thought n Keynesian school: ¨ Big names: Keynes, Mankiw, Summers, Bernanke; ¨ Theoretical framework: No comments on long-run growth; n Concentrates on business cycles; n Markets are in disequilibrium in the short run and adjust slowly toward equilibrium in the long-run; n Atheoretical in early stages but adopts the DGE framework since 1980 s. n

Schools of thought ¨ Major hypotheses: Business cycles can also be the result of nominal shocks; n Unemployment reflects labor market disequilibrium or an equilibrium under monopsony; n Counter-cyclical policies are effective in damping business cycles; n Tradeoffs between employment and inflation. n

Key concepts n GDP: a measurement of final outputs by an economy. ¨ Nominal and real GDP; ¨ GDP and the growth rate of GDP; ¨ GDP and per capita GDP. n Inflation: a measurement of the evolution of the general price level. ¨ GDP deflator; ¨ CPI, PPI.

Key concepts n Unemployment: a measurement of resource utilization. ¨ Unemployment rate, job-finding rate, jobseparation rate, capital utilization rate; ¨ Nominal and real wage. n Interest rate: a measurement of borrowing cost. ¨ Nominal and real interest rate; ¨ Nominal and real rental price; ¨ Money base and M 2.

Relationships among macroeconomic variables n Growth and unemployment. ¨ Okun’s law: the inverse relationship between the growth rate of real GDP and unemployment rate. u=-0. 5(y-2. 25)

Relationships among macroeconomic variables n Growth and unemployment.

Relationships among macroeconomic variables n Inflation-unemployment tradeoffs. ¨ The Phillips curve: the inverse relationship between unemployment rate and inflation rate (the growth of nominal wage rate) in the short run.

Relationships among macroeconomic variables n Inflation-unemployment tradeoffs.

Relationships among macroeconomic variables n Inflation-unemployment tradeoffs.