Chapter 6: An Introduction to Macroeconomics: Performance, Growth, and Price Stickiness

Macroeconomics focuses on the performance and policy of the economy as a whole, addressing broad indicators and long-term trends.
Business Cycle: Represents the fluctuations in economic activity, with a particular focus on recessions.
Real Gross Domestic Product (Real GDP): A measure of the value of final goods and services produced within a country during a specific period. It is adjusted to correct for price changes (inflation or deflation).
Nominal Gross Domestic Product (Nominal GDP): Measures output using the current prices at the time of production, without adjusting for price changes over time.
Unemployment: A state where individuals who are willing and able to work cannot find jobs.
Inflation: Defined as an increase in the overall level of prices across the economy.

Measurement: The standard of living is primarily measured by output per person.
Historical Context: Prior to the Industrial Revolution, there was virtually no growth in living standards. Modern economic growth is characterized by a sustained rise in output per person.
Regional Disparity: Modern economic growth has not been experienced equally by all countries, leading to significant global gaps in wealth.
Global GDP per Person (2020 Data, USD based on Purchasing Power Parity):
- Switzerland: $71,352$
- United States: $63,544$
- Germany: $53,694$
- Canada: $48,072$
- Saudi Arabia: $46,763$
- United Kingdom: $44,916$
- Japan: $42,197$
- Russia: $28,213$
- Mexico: $18,333$
- China: $17,312$
- India: $6,454$
- Nigeria: $5,187$
- Afghanistan: $2,088$
- Somalia: $875$
- Burundi: $771$

Saving: Occurs when current consumption is less than current output; it represents a trade-off where current consumption is sacrificed for the sake of future consumption.
Investment: Occurs when resources are devoted to increasing future output.
- Financial Investment: The purchase of assets like stocks, bonds, or real estate in expectation of financial gain.
- Economic Investment: Specifically refers to the creation and expansion of business enterprises, involving the purchase of newly produced capital goods (e.g., machinery, tools, factories).
Banks and Financial Institutions: These entities act as intermediaries, collecting the savings of households and lending them to businesses for economic investment.

Importance of Expectations: Expectations about the future influence current investment decisions. If businesses expect a downturn, they reduce investment; if they expect growth, they increase it.
Shocks: These occur when actual economic outcomes differ from what was expected.
- Demand Shocks: Unexpected changes in the demand for goods and services.
- Supply Shocks: Unexpected changes in the supply of goods and services.
Demand Shocks and Flexible Prices:
- If prices are fully flexible, a decrease in demand will lead to a drop in price while the quantity of sales remains unchanged.
- Graphical Representation (Flexible): A vertical supply curve at a fixed production level of $900$ units. Demand curves shift as follows:
- High Demand ( $D_H$ ): Price is approx. $40,000$ .
- Medium Demand ( $D_M$ ): Price is approx. $37,000$ .
- Low Demand ( $D_L$ ): Price is approx. $35,000$ .
Demand Shocks and Sticky Prices:
- If prices are sticky (inflexible), a decrease in demand leads to changes in sales and inventory levels rather than price changes. This mechanism is a primary driver of the business cycle.
- Graphical Representation (Fixed): A horizontal supply line fixed at a price of $37,000$ . Quantity sold changes based on demand:
- High Demand ( $D_H$ ): Sales increase to approx. $1,150$ units.
- Medium Demand ( $D_M$ ): Sales are approx. $900$ units.
- Low Demand ( $D_L$ ): Sales drop to approx. $700$ units.

Flexible Prices: Prices that react quickly to changes in supply and demand. Examples include commodities like corn, oil, and natural gas.
Sticky (Inflexible) Prices: Prices that change slowly or only at long intervals.
Average Months Between Price Changes by Industry:
- Services: $11.3$ months
- Manufacturing: $8.1$ months
- Finance: $7.1$ months
- Utilities: $4.7$ months
- Retail: $4.6$ months
- Agriculture: $3.2$ months
Reasons for Stickiness:
- Consumer Preference: Consumers generally prefer stable, predictable prices and may react negatively to frequent fluctuations.
- Price Wars: Firms may avoid cutting prices to prevent initiating a competitive "price war" with rivals.
Time Horizons: Many prices are sticky in the short run. However, all prices are considered flexible in the long run, as firms eventually adjust to permanent and unexpected shifts in demand.

Economists categorize models based on the degree of price stickiness used to explain economic behavior:
- Sticky Prices: Reflects the reality that prices are slow to adjust (rather than being completely "stuck").
- Aggregate Expenditures Model: A model focused on how total spending (demand) determines the level of GDP, often assuming sticky prices.
- Aggregate Demand-Aggregate Supply (AD-AS) Model: A fundamental model used to explain price levels and real output through the interaction of total demand and total supply.

Labor Costs: Wages and salaries constitute approximately $70\%$ of a firm's total costs. Because wages are often set by contracts or social norms, they are highly sticky.
Per-Unit Labor Costs: Attempts to reduce per-unit labor costs during a downturn can be self-defeating, as they may lower worker morale and productivity, further hurting the business.
Summary of Stickiness Factors: Consumer preferences for stability and the fear of business price wars remain the leading behavioral explanations for Why prices do not adjust instantaneously to market shocks.