ECON 201 5 12 Final 5 14 and the Lecture of 3 Recessions Chapter 5 Introduction to Macroeconomics Microeconomics examines the functioning of individual industries and the behavior of individual decision making units typically firms and households firms maximize profits households maximize utility Microeconomics helps derive useful conclusions about how markets work and how resources are allocated Macroeconomics deals with the economy as a whole focuses on the determinants of total national output focuses on the determinants of total national income deals with aggregates aggregate consumption and investment and looks at the overall level of prices instead of individual prices Example Macroeconomics does not analyze the demand for labor in the auto mobile industry but instead total employment in the economy Relationship of Micro and Macro Both are concerned with the decisions of households and firms Micro deals with individual decisions Macro deals with the sum of these individual decisions Aggregate used in macroeconomics to refer to sums Aggregate Behavior the behavior of all households and firms together aggregate consumption aggregate investment refer to total consumption and to tal investment in the economy Microeconomics think that markets work well see prices as flexible adjusting to maintain equality between quantity supplied and quantity demanded Macroeconomics observe important prices in the economy wage rate price of labor often seem sticky Sticky Prices Prices that do not always adjust rapidly to maintain equality between quantity supplied and quantity demanded Example Macroeconomics during period of high unemployment quantity of labor sup plied exceeds the quantity of labor demanded wage rates do not adjust fast enough to equate the quantity of labor supplied and the quantity of labor demanded Major Concerns of macroeconomics are Aggregate OUTPUT GROWTH UNEM PLOYMENT AND INFLATION DEFLATION Government policy makers wants HIGH OUTPUT GROWTH LOW UNEMPLOYMENT and LOW INFLATION these three goals conflict OUTPUT GROWTH Business cycle The cycle of short term ups and downs in the economy economies do not grow at an even rate at all times The ups and downs in the economy tend to be erratic Aggregate Output The total quantity of goods and services produced in an economy in a given period When aggregate output decreases less is produced there are fewer goods and services to go around and the average standard of living declines When firms cut back on production lay off workers increase rate of unem ployment quarters Recession A period during which aggregate output declines conventionally a period in which aggregate output declines for two consecutive US has experienced 8 recessions most recent 2008 2009 Depression A prolonged and deep recession economists do not agree on when a recession becomes a depression Since the 1930 s the US has experienced one depression 1930 s Expansion or Boom The period in the business cycle from a trough up to a peak during which output and employment grow Contraction recession a trough during which output and employment fall or slump The period in the business cycle from a peak down to UNEMPLOYMENT Unemployment Rate The percentage of the labor force that is unemployed key indicator of the economy s health Unemployment implies that the aggregate labor market is not in equilibrium something prevents the quantity supplied and the quantity demanded from equating INFLATION DEFLATION Inflation An increase in the overall price level Keeping inflation low has long been a goal of government policy Example of high inflation Bolivia 1984 1985 inflation rates approached 2 000 per year the economy and the whole organization of a country begin to break down Hyperinflation Especially problematic a period of very rapid increases in the overall price level Deflation A decrease in the overall price level Goal of policy makers is to avoid prolonged periods of deflation as well as inflation in order to pursue the macroeconomic goal of stability Components of the Macroeconomy Households private sector 1 Firms private sector 2 Government public sector 3 Rest of the World foreign sector 4 These 4 interact in a variety of ways many involving receiving or paying income Circular Flow A diagram showing the income received and payments made by each sector of the economy Circular Flow Diagram interactions between Households Firms and Government 1 Households receive income from firms and the government 2 Firms purchase goods and services from firms pay taxes to the government purchase foreign made goods and services imports receive payments from households and the government for goods and services pay wages dividends interest and rent to households and taxes to the government 3 Government receives taxes from firms and households pays firms and households for goods and services including wages to government workers pays interest and transfers to households Everyone s expenditure is someone else s receipt Transfer Payments Cash payments made by the government to people who do not supply goods services or labor in exchange for these payments Social security benefits veterans benefits and welfare payments Three Market Arenas 1 2 3 Goods and Services Market Labor Market Money financial market Goods and Services Market Households and government purchase goods and services Firms purchase goods and services from each other Firms supply to the goods and services market Households and the government and other firms demand from this market Rest of the world buys from and sells to the good and services market Labor Market chase labor from households Interaction in the labor market takes place when firms and the government pur Households supply labor Firms and the government demand labor In the US firms are the largest demanders of labor government is also a sub stantial employer Applies to rest of world also labor is supplied and demanded from the rest of the world Money Financial Market stocks and interest on bonds Households purchase stocks and bonds from firms Households supply funds in the expectation of earning income in dividends on Households also demand funds to finance purchases Firms borrow to build new facilities in the hope of earning more in the future Government borrows by issuing bonds Promissory Note promise to repay when a loan is given the borrower signs this note and gives it to the lender Treasury bonds notes and bills Promises Promissory notes issued by the federal
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