▯ What You Will Learn in This Chapter
▯ An overview of macroeconomics, the study of the economy as a
whole, and how it differs from microeconomics
▯ The importance of thebusiness cycle and why policy-makers seek to
diminish the severity of business cycles
▯ What long-run growth is and how it determines a country’s standard
▯ The meaning ofinflation and deflation and why price stability is
▯ What is special about the macroeconomics of anopen economy, an
economy that trades goods, services, and assets with other countries
Macroeconomics vs. Microeconomics
Let’s begin by looking more carefully at the difference between
microeconomic and macroeconomic questions.
Go to business school or take a How many people are employed
job? in the economy as a whole?
What determines the salary offeredWhat determines the overall
by Citibank to Cherie Camajo, a salary levels paid to workers in a
new Columbia MBA? given year?
▯ Microeconomics focuses on how decisions are made by individuals
and firms and the consequences of those decisions.
▯ Example: How much it would cost for a university or collegeto offer
a new course ─ the cost of the instructor’s salary, the classroom
facilities, the class materials, and so on. Having determined the cost,
the school can then decide whether or not to offer the course by
weighing the costs and benefits.
▯ Macroeconomics examines the aggregate behavior of the economy
(i.e. how the actions of all the individuals and firms in the economy
interact to produce a particular level of economic performance as a
1 Chapter 6
▯ Example: Overall level of prices in the economy (how high or how
low they are relative to prices last year) rather than the price of a
particular good or service.
Macroeconomics: The Whole is Greater Than the Sum of Its Parts
▯ Example: Paradox of thrift: when families and businesses are worried
about the possibility of economic hard times, they prepare by cutting
▯ This reduction in spending depresses the economy asconsumers
spend less and businesses react by laying off workers.
▯ As a result, families and businesses may end up worse off than if they
hadn’t tried to act responsibly by cutting their sp ending.
Macroeconomics: Theory and Policy
▯ In a self-regulating economy, problems such as unemployment are
resolved without government intervention, through the working of the
▯ According to Keynesian economics, economic slumps are caused by
inadequate spending and they can be mitigated by government
▯ Monetary policy uses changes in the quantity of money to alter
interest rates and affect overall spending.
▯ Fiscal policy uses changes in government spending and taxes to affect
ECONOMICS IN ACTION
FENDING OFF DEPRESSION
• In 2008, the world economy experienced a severe financial crisis that
was all too reminiscent of the early days of the Great Depression.
• In the spring of 2009, the economic historians Barry Eichengreen and
Kevin O’Rourke, reviewing the available data, pointed out that
“globally, we are tracking or even doing worse than the Great
• But the worst did not come to pass. Why?
• During the Great Depression, it was widely argued that the slump
should simply be allowed to run its course.
2 Chapter 6
• In the early 1930s, some countries’ monetary authorities actually
raised interest rates in the face of the slump, while governments cut
spending and raised taxes—actions that deepened the recession.
• In the aftermath of the 2008 crisis, by contrast, interest rates were
slashed, and a number of countries, the United States included, used
temporary increases in spending and reductions in taxes in an attempt
to sustain spending.
The Business Cycle
▯The business cycle is the short-run alternation between economic
downturns and economic upturns.
▯A depression is a very deep and prolonged downturn.
▯Recessions are periods of economic downturns when output and
employment are falling.
▯Expansions, sometimes called recoveries, are periods of economic upturns
when output and employment are rising. Charting theBusiness Cycle
▯The point at which the economy turns from expansionto recession is a
▯The point at which the economy turns from recessionto expansion is a
3 Chapter 6
Defining Recessions and Expansions
▯ There is no exact way of defining recessions and expansions. But in
Canada and many other countries adopt the rule that a recession is a
period of at least two consecutive quarters during which the total
▯ In the U.S., the task of determining when a recession begins and ends
is assigned to an independent panel of experts at the National Bureau
of Economic Research (NBER). They look at a number of economic
indicators, with the main focus on employment and production, but
ultimately the panel makes a judgment call.
▯ In Canada, no one person or group has the official responsibility for
dating and measuring business cycles. However, Statistics Canada
partially fills this gap by publishing periodic ass essments.
4 Chapter 6
The Pain of Recession
The unemployment rate, a measure of joblessness, rises sharply during
recessions and usually falls during expansions.
Taming the Business Cycle
▯Policy efforts undertaken to reduce the severity of recessions are called
▯One type of stabilization policy ismonetary policy : changes in the quantity
of money or the interest rate.
▯The second type of stabilization policy isfiscal policy: changes in tax
policy, government spending, government transfers or a combination
Long-run Economic Growth
• Long-run economic growth is the sustained upward trend in the
economy’s output over time.
• A country can achieve a permanent increase in the standard of living
of its citizens only through long-run growth.
• A central concern of macroeconomics is what determines long-run
5 Chapter 6
When Did Long-Run Growth Start?
▯Long-run growth is a relatively modern phenomenon.
▯From 1000 to 1800, real aggregate output around the world grew less than
0.2% per year, with population rising at about the same rate.
▯Economic stagnation meant unchanging living standards. For example,
information on prices and wages from such sources as monastery records
shows that workers in England weren’t significantly better off in the early
eighteenth century than they had been five centuries earlier.
▯However, long-run economic growth has increased significantly since 1800.
▯In the last 50 years or so, real GDP per capita has grown about 2.1% per
Aggregate Price Level
The aggregate price levelis the overall level of prices in the economy
Inflation and Deflation
▯A rising aggregate price level isinflation
▯A falling aggregate price level isdeflation
▯The inflation rate is the annual percent change in the aggregate prie c level
▯The economy has price stability when the aggregate price level is
changing only sl