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Macroeconomics
Chapter 4
Macro vs. Micro Aggregate Demand and Supply Measuring Economic Success
Output Employment Inflation
Equilibrium Changes in Macroeconomics The Problem of Macroeconomic Stabilization U.S. Macroeconomic History
Learning Objectives
A new understanding of the difference between micro and macro Explain aggregate demand and aggregate supply Explain the measurements of economic success Describe the effects of a change in aggregate demand or aggregate supply Understand the problem of macroeconomic stabilization
In macroeconomics, we dont care about what is produced and who gets to consume what. We do care about how much is produced. Its all about the big picture and not the small detail. In microeconomics, we focus on individual decision making. In macroeconomics, we focus on the behavior of the economy as a whole.
Aggregation means combining many individual markets into one overall market. Macroeconomic models use abstract concepts like the price level and gross domestic product that are derived by combining many different markets into one. This process is known as aggregation.
Aggregation
Aggregate supply curve - shows the quantity of domestic product that is supplied at each possible value of the price level. Aggregate Supply describes how much output businesses would willingly produce and sell given prices, costs, and market conditions
Aggregation
Aggregate demand curve shows the quantity of domestic product that is supplied at each possible value of the price level. Aggregate Demand consists of the total spending in an economy by households, businesses, governments, and foreigners.
Aggregate demand demand for domestic product. Aggregate supply supply of domestic product.
Aggregation
But doesnt it matter what stuff is being bought and what stuff is being sold? Isnt it important if we are selling cars or selling cheese? Yes and no
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Aggregation
Clearly we care about the makeup of the economy, but: 1. Exactly what the national output is comprised of doesnt really affect issues of growth, inflation, and unemployment 2. During economic fluctuations, markets tend to move together. When demand in an economy rises, demand for almost all goods rises
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economys performance by how well it attains these objectives: High levels and rapid growth of output (usually measured by GDP) Low levels of unemployment Price level stability (or low inflation)
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Nominal GDP is calculated by valuing all outputs at current prices. Real GDP is calculated by valuing outputs of different years at common prices. Therefore, real GDP is a far better measure than nominal GDP of changes in total production.
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Disadvantage of Nominal GDP: It changes when prices change even if there is no change in actual production. Example: Assume a hamburger cost $1.50 in 2006. In 2007 it cost $2. In 2006 there were 100 hamburgers, which added $150 to nominal GDP. In 2007 there were 100 hamburgers, added $200 to nominal GDP. Nominal GDP makes it look like there were more hamburgers in 2007, even though there were only 100. So nominal GDP makes it look like there is economic growth, even when there is not. Solution: calculate real GDP or GDP in constant dollars.
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Chinas Inflation
August 2004 inflation rate held steady at 5.3% Producer Prices rose 6.8% Food prices rose 14% Consumer goods rose 6.3% Housing prices rose 6% Service costs rose 2%
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D1 D S D A E P0 S
Price
P0
Price
D1 S D S D
Q0 Quantity (a)
Quantity (a)
Inflation.
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Inflation
AD price level
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D0 S D2 Domestic Product
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AD unemployment Recession = a period of time during which total output falls and therefore jobs are lost
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FIGURE
3: Economic Growth
D1 S0 S1
D0 C Price Level E
S0 S1 D0 Q0 Q1 Domestic Product
D1
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Copyright 2006 South-Western/Thomson Learning. All rights reserved.
Economic Growth
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D1 S0 S1 S2 Real GDP
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Copyright 2006 South-Western/Thomson Learning. All rights reserved.
D0
S1 S0 Real GDP
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Copyright 2006 South-Western/Thomson Learning. All rights reserved.
The government wants to have a stabilization policy that can shorten recessions and fight inflation. Combating Unemployment
When recessions are caused by too low aggregate demand, governments can try to increase demand.
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Combating Inflation
When inflation is caused by too high aggregate demand, governments can try to limit aggregate demand.
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D0 S D2 Real GDP
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Copyright 2006 South-Western/Thomson Learning. All rights reserved.
E AD Q Real GDP Q
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P1 P
P1 P
E1 E AD Q1 Q Real GDP Q
P1 P
E1 E AD Q1 Q Real GDP Q
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P P1
E E1 AD1 AD
Q1 Q Real GDP
When President Regan took office in 1981, the economy was experiencing severe inflation, near 10 percent, an unacceptable number. The Chairman of the Federal Reserve, Paul Volcker, influenced interest rates in the so that spending would decrease, and in effect decrease demand in the economy. The result was a decrease in Q output, and an increase in unemployment. The reward was a decrease in inflation.
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P1 P2 P
E AD Q Q1 Q2 Real GDP
AD1
P1 P2 P
E AD Q Q1 Q2 Real GDP
AD1 Q
But if at the same time AS shifts out, output can continue to increase while prices do not rise a lot.
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