Introduction To Macroeconomics: © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair

CHAPTER 5
Introduction to
Macroeconomics
Prepared by: Fernando Quijano

and Yvonn Quijano
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair
Introduction to Macroeconomics
C H A P T E R 17: Introduction to Macroeconomics
• Microeconomics examines the behavior

of individual decision-making units—
business firms and households.
• Macroeconomics deals with the economy
as a whole; it examines the behavior of
economic aggregates such as aggregate
income, consumption, investment, and the
overall level of prices.
• Aggregate behavior refers to the behavior of
all households and firms together.
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 2 of 31
• Microeconomists generally conclude

that markets work well.
Macroeconomists, however, observe
that some important prices often
seem “sticky.”
• Sticky prices are prices that do not
always adjust rapidly to maintain the
equality between quantity supplied
and quantity demanded.
• Macroeconomists often reflect on the

microeconomic principles underlying
macroeconomic analysis, or the
microeconomic foundations of
macroeconomics.
The Roots of Macroeconomics
• The Great Depression

was a period of severe
economic contraction
and high unemployment
that began in 1929 and
continued throughout the
1930s.
• Classical economists applied

microeconomic models, or “market
clearing” models, to economy-wide
problems.
• However, simple classical models failed to

explain the prolonged existence of high
unemployment during the Great
Depression. This provided the impetus for
the development of macroeconomics.
• In 1936, John Maynard Keynes published

The General Theory of Employment,
Interest, and Money.
• Keynes believed governments could

intervene in the economy and affect the
level of output and employment.
• During periods of low private demand, the

government can stimulate aggregate
demand to lift the economy out of
recession.
Recent Macroeconomic History
• Fine-tuning was the phrase used by

Walter Heller to refer to the
government’s role in regulating
inflation and unemployment.
• The use of Keynesian policy to fine-

tune the economy in the 1960s, led
to disillusionment in the 1970s and
early 1980s.
Recent Macroeconomic History
• Stagflation occurs when the overall

price level rises rapidly (inflation)
during periods of recession or high
and persistent unemployment
(stagnation).
Macroeconomic Concerns
• Three of the major concerns of

macroeconomics are:
• Inflation
• Output growth
• Unemployment
Inflation and Deflation
• Inflation is an increase in the overall price

level.
• Hyperinflation is a period of very rapid

increases in the overall price level.
Hyperinflations are rare, but have been
used to study the costs and consequences
of even moderate inflation.
• Deflation is a decrease in the overall price

level. Prolonged periods of deflation can be
just as damaging for the economy as
sustained inflation.
Output Growth:
Short Run and Long Run
• The business cycle is the cycle of

short-term ups and downs in the
economy.
• The main measure of how an

economy is doing is aggregate
output:
• Aggregate output is the total quantity
of goods and services produced in an
economy in a given period.
Output Growth:
Short Run and Long Run
• A recession is a period during which

aggregate output declines. Two
consecutive quarters of decrease in output
signal a recession.
• A prolonged and deep recession becomes

a depression.
• Policy makers attempt not only to smooth

fluctuations in output during a business
cycle but also to increase the growth rate
of output in the long-run.
Unemployment
• The unemployment rate is the

percentage of the labor force that is
unemployed.
• The unemployment rate is a key
indicator of the economy’s health.
• The existence of unemployment
seems to imply that the aggregate
labor market is not in equilibrium.
Why do labor markets not clear
when other markets do?
Government in the Macroeconomy
• There are three kinds of policy

that the government has used to
influence the macroeconomy:
1. Fiscal policy
2. Monetary policy
3. Growth or supply-side policies
Government in the Macroeconomy
• Fiscal policy refers to government policies

concerning taxes and spending.
• Monetary policy consists of tools used by

the Federal Reserve to control the quantity
of money in the economy.
• Growth policies are government policies

that focus on stimulating aggregate supply
instead of aggregate demand.
The Components of
the Macroeconomy
• The circular flow

diagram shows the
income received and
payments made by
each sector of the
economy.
The Components of
the Macroeconomy
• Everyone’s
expenditure is
someone else’s
receipt. Every
transaction must
have two sides.
The Components of
the Macroeconomy
• Transfer payments are payments

made by the government to people
who do not supply goods, services,
or labor in exchange for these
payments.
The Three Market Arenas
• Households, firms, the government,

and the rest of the world all interact
in three different market arenas:
1. Goods-and-services market
2. Labor market
3. Money (financial) market
• Households and the government purchase

goods and services (demand) from firms in
the goods-and services market, and
firms supply to the goods and services
market.
• In the labor market, firms and government

purchase (demand) labor from households
(supply).
• The total supply of labor in the economy
depends on the sum of decisions made by
households.
• In the money market—sometimes called

the financial market—households purchase
stocks and bonds from firms.
• Households supply funds to this market in the
expectation of earning income, and also demand
(borrow) funds from this market.
• Firms, government, and the rest of the world
also engage in borrowing and lending,
coordinated by financial institutions.
Financial Instruments
• Treasury bonds, notes, and bills

are promissory notes issued by the
federal government when it borrows
money.
• Corporate bonds are promissory

notes issued by corporations when
they borrow money.
Financial Instruments
• Shares of stock are financial

instruments that give to the holder a
share in the firm’s ownership and
therefore the right to share in the
firm’s profits.
• Dividends are the portion of a
corporation’s profits that the firm pays
out each period to its shareholders.
The Methodology of Macroeconomics
• Connections to microeconomics:
• Macroeconomic behavior is the
sum of all the microeconomic
decisions made by individual
households and firms. We cannot
understand the former without
some knowledge of the factors
that influence the latter.
Aggregate Supply and
Aggregate Demand
• Aggregate demand is the

total demand for goods and
services in an economy.
• Aggregate supply is the
total supply of goods and
services in an economy.
• Aggregate supply and
demand curves are more
complex than simple
market supply and demand
curves.
Expansion and Contraction:
The Business Cycle
• An expansion, or boom, is
the period in the business
cycle from a trough up to a
peak, during which output
and employment rise.
• A contraction, recession,
or slump is the period in
the business cycle from a
peak down to a trough,
during which output and
employment fall.
Real GDP, 1900-2002
Real GDP, 1970 I-2003 II
Unemployment Rate, 1970 I-2003 II
Percentage Change in the GDP Deflator
(Four-Quarter Average), 1970 I-2003 II
Review Terms and Concepts
aggregate behavior dividends microeconomics

aggregate demand expansion or boom monetary policy
aggregate output fine tuning recession
aggregate supply fiscal policy shares of stock
business cycle Great Depression stagflation
circular flow hyperinflation sticky prices
contraction, recession, or inflation supply-side policies
slump
macroeconomics transfer payments
corporate bonds
microeconomic Treasury bonds, notes,
deflation foundations of bills
macroeconomics
depression unemployment rate

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CHAPTER 5

Prepared by: Fernando Quijano

• Microeconomics examines the behavior

• Microeconomists generally conclude

• Macroeconomists often reflect on the

• The Great Depression

• Classical economists applied

• However, simple classical models failed to

• In 1936, John Maynard Keynes published

• Keynes believed governments could

• During periods of low private demand, the

• Fine-tuning was the phrase used by

• The use of Keynesian policy to fine-

• Stagflation occurs when the overall

• Three of the major concerns of

• Inflation is an increase in the overall price

• Hyperinflation is a period of very rapid

• Deflation is a decrease in the overall price

• The business cycle is the cycle of

• The main measure of how an

• A recession is a period during which

• A prolonged and deep recession becomes

• Policy makers attempt not only to smooth

• The unemployment rate is the

• There are three kinds of policy

• Fiscal policy refers to government policies

• Monetary policy consists of tools used by

• Growth policies are government policies

• The circular flow

• Transfer payments are payments

• Households, firms, the government,

3. Money (financial) market

• Households and the government purchase

• In the labor market, firms and government

• In the money market—sometimes called

• Treasury bonds, notes, and bills

• Corporate bonds are promissory

• Shares of stock are financial

• Aggregate demand is the

aggregate behavior dividends microeconomics

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