Macroeconomics focuses on national economies while seeking answers to large-scale economic questions including:
Why are some countries really rich while others are poor?
Why do all countries - even the richest - go through alternating boom and bust periods?
Can governments do anything to improve living standards or fight recessions?
What does macroeconomics study?
It studies the behavior of the economy as a whole
What is macroeconomics concerned with?
Long-run economic growth
Short-run fluctuations in output and employment that comprise the business cycle
Rate of growth is not constant
True
Most economies enjoy a distinct growth trend that leads to higher output and higher standards of living in the long run
True
Recession
Sometimes rate of growth proceeds rapidly, sometimes slowly, but in this case it turns negative for awhile
Sticky wages - wage goes down, you will be upset
What do economists do?
They collect and analyze economic data and more to understand how economies operate and how to improve their performance
What 3 key statutes do macroeconomists focus on, when assessing an economy’s health and development?
Real GDP
Unemployment
Inflation
Real Gross Domestic Product
Measures the value of the final goods and services produced within a country’s borders during a specific period of time, typically a year
Stands for the whole pizza
Tells us whether an economy’s output is growing
How do you calculate the value of real GDP?
First calculate the value of real GDP
Nominal GDP
The dollar value of all goods and services produced within a country’s borders using their prices during the year they were produced.
Wage right now = nominal wage
What is nominal GDP’s major problem?
It can increase from one year to the next even if there is no increase in output
Real GDP avoids this problem by accounting for price changes
More output means more consumption possibilities
True
Unemployment
Occurs when a person cannot get a job despite being willing to work and actively seeking work
Why are high unemployment rates undesireable?
They indicate that a nation is not using a large portion of its most important resource - the talents and skills of its people
It is wasteful because we lose all the goods and services that unemployed workers could have produced if they were working
Higher unemployment rates lead to more major social problems such as higher crime rates, political unrest, higher rates of depression, and heart disease.
True
Inflation
Increase in the overall level of prices
What are the problems with inflation?
Families won’t be able to purchase as much as it used to
A surprise jump in inflation reduces the purchasing power of people’s savings
Their savings will buy less than expected due to the higher-than expected prices
Rapid and sustained economic growth is a modern phenomenon
True
Industrial Revolution
Lead to Modern Economic Growth
People started to work in factories - therefore they had more leisure time
Output began to grow faster than the population, and living standards began to rise as the amount of output per person increased
In countries, experiencing modern economic growth, output per person rises.
True
Modern Economic Growth
Output grows faster than population, living standards rise over time
What are vast differences in living standards due to?
They are almost entirely the result of the fact that different countries began modern economic growth at different rates.
The countries that have been at it the longest have ended up far richer than those that began modern economic growth only recently.
How should an economy devote its time if it wants to raise living standards over time?
They must devote at least some part of its current output to increasing future output.
This process requires both saving and investment
Saving
Occurs when current consumption is less than current income; the difference between them is savings
Investment
Happens when resources are directed toward increasing future output - either by paying for research to develop more efficient production technologies or by paying for the production of newly created capital goods (such as machinery, tools, and infrastructure) that will increase future output.
The amount of investment is ultimately linked by the amount of saving
True
The only way that more output can be directed at investment activities is if saving increases
True
What is the only way to pay for more investment?
To increase present saving
Increase saving comes at what cost?
It can only come at the price of reduced current consumption
What do economists mean when they say “investment"“?
They mean economic investment
Financial Investment
Captures what ordinary people mean when they say investment, namely, the purchase of assets like stocks, bonds, and real estate in the hope of reaping a financial gain.
Economic Investment
Relates to the expansion of the economy’s productive capacity
Includes spending that pays for the production of newly created capital goods like factories and wireless networks as well as the costs of developing new technologies like solar powered helicopters or a cure for cancer
Economists do not see pure financial transactions as “investment” because they do not increase the economy’s productive capacity - therefore not an “investment”
True
What is the principal source of savings?
Households
Who are the main economic investors?
Businesses
How does the pool of savings generated by households get transferred to businesses?
Banks and other financial institutions (mutual funds, pension plans, and insurance companies) act as intermediaries between households and businesses.
Banks and other financial institutions
Collect households’ savings, rewarding savers with interest, dividends, or capital gains (increases in asset values)
Lend funds to businesses, which invest in equipment, factories, and other capital goods as well as research and development
What does a well functioning system promote?
It promotes economic growth and stability by encouraging saving and by directing that saving into the most productive possible investments
What does a poorly functioning financial system do?
It causes serious problems for an economy
Firms spend considerable time trying to predict future trends so that they invest only in projects that are likely to succeed
True
Why do expectations have a large effect on economic growth?
Because increased pessimism leads to less current investment and, subsequently, less future consumption
Expectations are important because…
Involves the effects of changing expectations on current behavior
Concerns what happens when expectations are unmet
Huge when it comes to investments
Drive businesses decisions whether its a firm or consumers
Firms are often forced to cope with the shocks
True
Shocks
Situations in which they were expecting one thing to happen but something else happened instead.
Economies experience both demand shocks
True
Demand Shocks
Unexpected changes in the demand for good services
Sales unchanged
Can have positive (answer) shocks like masks and toilet paper during Covid-19 pandemic
Positive demand shock
Refers to a situation in which actual demand is higher than expected
A negative demand shock
Refers to a situation in which actual demand is lower than expected
They make less and put it into inventory
Supply Shocks
Unexpected changes in the supply of goods and services
Sales change
Business cycle
The word “shock” does not tell us whether what has happened is unexpectedly good or bad.
True
What do economists believe that most short-run fluctuations in GDP and the business cycle are the result of?
Demand Shocks
Supply shocks do happen in some cases and are very important when they do occur
True
Why are demand shocks such a big problem?
Prices of many goods and services are inflexible (slow to change, or “sticky”) in he short run
Implies that price changes do not quickly equalize the quantities demanded of such goods and services with their respective quantities supplied
Because the prices are inflexible - economy forced to respond in the short run through changes in output and employment rather than through prices
If the prices of goods and services can always adjust quickly to unexpected changes in demand, then…
the economy can always produce at its optimal capacity because prices will adjust to ensure that the quantity demanded of each good and service always equals the quantity supplied.
If prices are fully flexible, then…
There will be no short-run fluctuations in output. Production levels will remain constant, and unemployment levels will not change because firms will always need the same number of workers to produce the same amount of output.
In reality, many prices in the economy are inflexible and do not change rapidly when demand changes unexpectedly.
True
One way to deal with these unexpected shifts in quantity demanded is to try to adjust the factory’s output to match them. However what is its negative?
This flexible output strategy is very expensive because factories operate at their lowest costs when they are producing constantly at their optimal output levels.
Operating at either a higher or lower production rate results in higher per-unit production costs.
Manufacturing firms typically attempt a deal with unexpected changes in demand by maintaining an inventory
True
Inventory
A stock of output that has been produced but not yet sold.
Why are inventories useful?
Because companies can allow them to grow or decline in periods when demand is unexpectedly low or high - thereby allowing production to proceed smoothly and constantly at the optimal output level even when demand is variable
What do constantly rising inventories do?
They hurt profits and management will want to reduce output if it sees inventories rising week after week due to unexpectedly low demand.
As output falls, the firm will have to lay off workers, and unemployment will increase
What do economists believe is the key to understanding the short-run fluctuations that affect real-world economies?
A combination of unexpected changes in demand and inflexible prices
If demand falls off for many goods and services across the entire economy for an extended period of time, then…
The firms that make those goods and services will be forced to cut production
As both manufacturing and service output decline, what happens to GDP and unemployment?
Real GDP will fall and unemployment will rise.
If demand is unexpectedly high for a prolonged period of time, what will the economy and unemployment do?
Economy will boom and unemployment will fall
Inflexible prices
Economists call these “sticky” prices
Sticky Prices
Help to explain how unexpected changes in demand lead to the fluctuations in GDP and employment that occur over the course of the business cycle.
Not all prices are sticky
True
Flexible Prices
The markets for many commodities and raw materials such as corn, oil, and natural gas feature extremely flexible prices that react within seconds to changes in supply and demand
Allow prices to move freely
Ex. Corn, Oil, Natural Gas
Most consumer products are rather sticky
True
Firm try to maintain stable prices because…
Consumers would be annoyed if the prices changed everyday
Consumers would feel like they are being taken advantage of if the price were high
Why may a firm fear cutting prices?
A firm might feel this because they might think it will be counterproductive because its rivals might simply match the price cut - a situation often referred to as a “price war”
Price War
Rivals matching the price cut
Ex. Coca Cola and Pepsi
Firms that face this often have sticky prices
Price stickiness moderates over time
True
What will firms do if unexpected changes in demand begin to look permanent?
Firms will allow their prices to change so that price changes (in addition to quantity changes) can help to equalize quantities supplied with quantities demanded.
Economist speak of “sticky prices” rather than “stuck prices”
True, because it moderates over time
As time passes on, what happens to prices
Prices are fully flexible and inflexible for a short amount of time
Differences in behavior result from the fact that prices go from completely stuck immediately after a shock to what?
To fully flexible in the long run
GDP
How big is the pizza
GDP Per Capita
Best way to evaluate an economy
How big is each person’s slice
If you want to compare prices do you use nominal GDP or real GDP?
Real GDP
Fiscal Policy
Government controls this
Monetary Policy
Federal reserve controls this
adjust interest rates
currently the Fed is trying to slow us down due to inflation
What can you do with money?
Spend it
Save it
We (consumers and businesses) have a tradeoff between spending and saving money
True
Firms do not like shocks but they are inevitable, that is why expectations are a huge thing
True
Big Businesses Expectations
5-20 year expectations and/or goals
Small Business Expectation
1-3 year expectations and/or goals
When expectations are broken, what happens?
Chaos ensues
When you are uncertain, what do you do with your money?
You save your money
Domino Ripple Effect
Less money you are spending, less money the employers take in
When would you want to take out a loan?
Now because it makes the loan more expensive because the interest rates are high
Covid-19 caused both a demand and supply shock
True, our GDP went significantly down in 3 months
Flexible Demand Shocks
Price changes due to demand shocks
Sticky Demand Shocks
Quantity changes due to demand shocks
Menu Costs
Refers to the costs of changing listed prices
Sticky prices are also called this
Services take about a year to change (so like a plumber or barber shop)
True because they take longer to adjust because they are more complicated
If they raise prices, people will react
Finance takes about 7 months to change
True because they are usually on salary
Manufacturing takes about 3 months
True