__________________________________________________CHAPTER 1______________INTRODUCTION TO MACROECONOMICS___________________________________________________________________________Macroeconomists study the determination of and movements in economy-wide averagesand aggregates. Some of the averages and aggregates are well-known. For example, theconsumer price index and the unemployment rate receive considerable attention each monthfrom the media. Others, such as gross domestic product, are less well-known. What determinesthe level of prices and unemployment, and other averages and aggregates, and why do theselevels change? Can or should government policy manipulate these variables? These are thefundamental questions of macroeconomics. The breadth of the averages and aggregates distinguishes macroeconomics from regional, urban, and other fields of economics. Macroeconomists are interested in the output produced byan entire nation, while a regional economist is concerned with output, or other averages andaggregates, at the regional level, for example the southern region of the U.S. An urban econo-mist is concerned with economic activity at the city or county level. More generally, the level ofaggregation distinguishes macroeconomics from microeconomics. Microeconomists areconcerned with the behavior of prices and output in individual industries and markets. Forexample, microeconomists study the markets for automobiles, semi-conductors, health services,and labor. Their analysis is often rich in detail, carefully differentiating behavior in one type ofindustry or market from behavior in another. The macroeconomist must often be content toignore the details of individual markets in order to focus on the economy as a whole.Perhaps the most important economy-wide aggregate is a nation's total output of goods andservices. The total output of a nation determines how many square feet are in the average home,how many bathrooms are in it, the number of TVs, microwaves, shoes, shirts and so on that theaverage family has. In short, the total output of a nation tells us how well the citizens of thatnation live, or, to put it another way, the total output of a nation determines the standard of livingof its citizens.The close connection between total output and the material well-being of people motivatesthe study of macroeconomics. Ultimately we are interested in people and their welfare. Most ofus prefer more things to fewer things, and we associate an increase in total output with anincrease in welfare. Of course, material well-being is not the only dimension of human welfare,or even the most important. Physical, spiritual, and emotional health supersede in importancematerial gain for most people. Nevertheless, material well-being is an important aspect of thehuman condition; and it is easier to work on your physical, spiritual, and emotional health whenthere is a roof over your head, three squares in your stomach, and a bright future.Growth vs the Business CycleFigure 1.1 shows total output for the U.S. from 1877 to 1995.1 Two features stand out inthis picture. First, total output has been increasing over time. It has a distinctive upward trend. 2 chapter 1 1We use a so-called proportional scale. All this means is that the slope of the line equals the rateof growth in real output. The data in the diagram from 1870 to 1986 comes from Nathan Balke andRobert Gordon's "Appendix B: Historical Data." In The American Business Cycle edited by Robert J.Gordon. Chicago: University of Chicago Press (for the NBER), 1986.345678timeproportional scale1877 1883 1889 1895 1901 1907 1913 1919 1925 1931 1937 1943 1949 1955 1961 1967 1973 1979 1985 1991Figure 1.1 Total Output in the U.S: 1877-1995source: Balke and Gordon (1986) and Economic Report of the PresidentSecond, although outputtrends upward, it fluctuatesirregularly. Total outputwiggles around a lot and oversome relatively short periodsit actually falls.The positive trend intotal output reflects economicgrowth. The wiggles in totaloutput are business cycles.Traditionally, macroeconomics divides itself into two topics: business cycle analysis and theanalysis of economic growth. In a sense, the distinction between growth and cycles is artificial.For example, a time of rapid technological growth may well be associated with an economicboom. Nevertheless, we follow the tradition that distinguishes between the two topics. Ouremphasis is on business cycles, but we pay considerable attention to the effects of technologicalprogress, the engine of growth.There is another feature of total output that stands out in Figure 1.1. The large decline intotal output in the 1930s and its rapid rebound in the 1940s mark the Great Depression andWorld War II. These profound experiences shaped the lives of those who lived through themand continue to affect events today. Many of the programs and institutions of today are childrenof this era; Social Security, many of the "alphabet" federal agencies, and the United Nations areexamples.2 Economists often split the economic history of the U.S. into the post-World War II, inter-war, and pre-World War I periods. With its depression and world war, the inter-war perioddiffers significantly from the post-war era. The pre-war period lacks many important, moderninstitutions, such as the income tax system, and data for the two early periods are not as reliableor as plentiful as data for the post-war period. For these reasons, discussions of the businesscycle usually focus on the period since World War II. introduction to macroeconomics 3 2The alphabet agencies refer to the FDIC (Federal Deposit Insurance Corporation), SEC(Securities and Exchange Commission), FCC (Federal Communications Commission) and other federalagencies that are known by their abbreviations.levelofoutputtimeFigure 1.2 Turning Points in the Level of Outputt1t2t3t4peaks troughsThe Stages of the Business CycleTo focus on the cyclical aspects of total output we need to "take out" the growth part. Astandard way to "detrend" total output is to look at its rate of growth. To see how this works,Figure 1.2 shows a hypothetical plot of total output. To make our discussion easier, outputfluctuates in nice, smooth cycles in the figure. The slope of this line is the rate of growth in totaloutput. Total output is increasing until time t1, so its rate of growth is positive over the initialregion. From t1