Introduction

Chapter 1

2013/6/18

ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip

What is Macroeconomics?
Macroeconomics focuses on
the aggregate behavior of consumers and firms the behavior of government the overall level of economic activity in individual countries the economic interactions among nations the effects of fiscal and monetary policies

2013/6/18

ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip

What is Macroeconomics?
Macroeconomics differs from microeconomics in that it deals with the overall effects on economies of the choices that all economic agents make, rather than on the choices of individual consumers or firms. Long-run growth refers to the increase in a nations productive capacity and average standard of living over a long period of time. Business cycles refer to the short-run ups and downs in aggregate economic activity.

2013/6/18

ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip

Gross Domestic Product, Economic Growth and Business Cycles

The most basic set of facts in macroeconomics has to do with the behavior of aggregate economic activity over time. One measure of aggregate economic activity is gross domestic product (GDP), i.e. the quantity of goods and services produced within a countrys borders over a particular period of time. The series of real GNP per capita for the U.S. over the period 1900 2005 is shown in Figure 1.1

2013/6/18

ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip

Gross Domestic Product, Economic Growth and Business Cycles

Figure 1.1 Per Capita Real GNP (in 1996 dollars) for the United States, 1900 - 2005 2013/6/18 ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip 5

Two Useful Transformation of Data

1) Taking natural logarithm of time series.
The slope of the graph of the natural logarithm of a time series yt is a good approximation to the growth rate of yt when the growth rate is small. Since if yt yt-1, we have

y t y t 1 log y t log y t 1 y t 1

2013/6/18

ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip

Two Useful Transformation of Data

Figure 1.2 Natural Logarithm of Per Capita Real GNP 2013/6/18 ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip 7

Two Useful Transformation of Data

2) Detrending
The process of decomposing the series into 2 components: the growth (or trend) component, and the business cycle component. The trend in the log of real per capita GNP is shown as a colored line, while the log of actual real per capita GNP is the black one.
Figure 1.3 Natural Logarithm of Per Capita Real GNP and Trend

2013/6/18

ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip

Two Useful Transformation of Data

2) Detrending
Figure 1.4 shows only the percentage deviations from trend in real per capita GNP.

Figure 1.4 Percentage Deviations from Trend in Per Capita Real GNP 2013/6/18 ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip 9

Macroeconomic Models
Purpose: To capture the essential features of the world needed for analyzing a particular economic problem. To be useful then, a model must be simple. Basic structure of a macroeconomic model:
The consumers and firms in the economy, who are assumed to optimize The sets of goods that consumers wish to consume Consumers preferences over goods The technology available to firms for producing goods The resources available

Competitive Equilibrium: All agents (consumers and firms) act as price-takers, and prices clear markets.

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ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip

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Microeconomic Principles
Macroeconomic behavior is the aggregation of microeconomic decisions made by all the consumers and firms in the economy. Very often, we are interested in the macroeconomic effects of a policy change. In particular, we want to make predictions on those effects that are consistent with individual decisions. To achieve this, we must work our way up from decision making at the micro-level, then aggregating these decisions to arrive at the macroeconomic effects of the policy change.

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ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip

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Disagreement in Macroeconomics
There is little disagreement in macroeconomics concerning the general approaches to modeling growth. There is much controversy concerning business cycle theory and the role of the government policy in smoothing out cycles:
Keynesian Sticky-Price Theory (Keynes, Hicks & Samuelson) Money Surprise Theory (Friedman & Lucas) Real Business Cycle Theory (Prescott & Kydland) Keynesian Coordination Failure Theory (Diamond, Cooper & John)

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ECO 2021 Intermediate Macroeconomic Theory Professor C. K. Yip

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