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Chapter 19

Chapter 19 - What Macroeconomics is all about.docx

Course Code
ECON 102
Lanny Zrill

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Chapter 19 What Macroeconomics is all
Macroeconomics – study of how the economy behaves in broad outline without
dwelling on much of the detail that occurs in market for individual products
Look at behavior of economic aggregates and averages (total output, total
investment, total exports, price level, and how they may be influenced by
government policy)
Behaviour results from activities in many different markets and from the
combined behavior of millions of different decision makers
Economists think about the short run behavior of macroeconomic
variables (output, employment, inflation, and about how government policy
can influence these variables)
This concerns the business cycle
Also explain long-run behavior of the same variables including economic
growth and long-run path of aggregate output
A full understanding of macroeconomics requires understanding the nature
of short-run fluctuations as well as the nature of the long-run economic
Two groups who are interested in the same macroeconomic phenomena:
1. 1st group of researchers take an approach to macroeconomics that is
based explicitly on microeconomic foundations
a. economists build models of the economy that are populated by
workers, consumers, firms, and optimizers (individuals are
assumed to maximize their utility and firms are assured to
maximize their profits)
Key Macroeconomic Variables
National Product – measure of a nation’s overall level of economic activity is the
value of its total production of goods/services
One of the most important ideas in economics is that the production of
goods/services generates income
Value of national product is by definition equal to the value of national income
National Income: Aggregation
We add up the values of many different goods/services that are produced to
measure national income

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Cannot add tonnes of steel to loaves of bread but we can add the dollar value of
steel production to the dollar value of bread production
How: multiply # of units of each good produced by the price at which each unit is
This will yield a dollar value of production for each good
We then sum these values across all the different goods produced in the
economy to give us the quantity of total output, national income (measured in
dollars) also known as nominal national income
Nominal National Income – total national income measured in current dollars
A change in nominal national income can be caused by change in either physical
quantities or prices
Real National Income – national income measured in constant (base-period)
dollars. It changes only when quantities change
This measures the value of individual outputs, not at current prices, but at
a set of prices that prevailed in some base period
National income referred to as current-dollar national income
Real national income is referred to as constant-dollar national income
Real national income tells us the value of current output measured at
constant prices – sum of the quantities valued at prices that prevailed in
the same base period
Since prices are held constant when computing real national income,
changes in real national income from year to year reflect only changes in
Comparing real national incomes of different years provides a measure of
the change in real output that has occurred during the period
National Income: Recent History
Gross Domestic Product (GDP) – can be measured in either real or nominal
Real GDP – measure the quantity of total output produced by the nation’s
economy over the period of a year
Business Cycle - fluctuations of national income around its trend value that
follow a more or less wavelike pattern
Ex: a single cycle will usually include an interval of quickly growing output,
followed by an interval of slowly growing or even falling output
Entire cycle may last for several years
No two business cycles are the same – variations occur in duration and

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Others come to an end before high employment and industrial capacity
are reached
Fluctuations are systematic enough that it is useful to identify common
Potential Output and the Output Gap
National output (or income) represents what the economy actually produces
Potential output – the level of output the economy would produce if all
resources – land, labour, and capital were fully employed
Value of potential output must be estimated using stats whereas value of
actual output can be measured directly
This causes disagreement among researchers regarding level of potential
output, owing to their different estimation approaches
Y = economy’s actual output
Y*=potential output
Output Gap – measures difference between potential output and actual output
(Y – Y*)
Recessionary Gap – actual output is less than potential output (Y < Y*)
The gap measures the market value of goods/services that are not produced due
to economy’s resources are not fully employed
Inflationary Gap – actual output exceeds potential output (Y > Y*)
The gap measures the market value of production in excess of what the
economy can produce on a sustained basis
Workers may work longer hours than normal or factories may operate an
extra shift
Often upward pressure on prices
Why National Income Matters
Short-run movements in the business cycle receive most attention in politics and
the press but economists agree that long-term growth due to potential GDP is
more important
Associated with unemployment and lost output
Booms – associated with high employment and high output can bring
problems of their own
Actual GDP is below potential GDP = economic waste and human
suffering result from the failure to fully employ the economy’s resources
Actual GDP exceeds potential GDP = inflationary pressure usually
ensues causing government to keep inflation rate low
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