Chapter 1 notes

Average labor productivity – amount of output produced per unit of labor input-average worker produces more now than before

Business Cycles – describes short run contractions and expansions in economic activity

-recession – output falling/growing slowlyUnemployment – people available to work but cannot find jobs

-highest and most prolonged period of unemployment during Great Depression

Inflation – when price of goods and services rise over time-inflation primarily occurred during wartime-periods of inflation followed by periods of deflation

-deflation – prices of goods and servies fell-inflation and deflation offset each other and prices remain fairly constant in long run

inflation rate – percentage increase in average level of prices over the year

International Economy-open economy – economy that has extensive trading and financial relationships with other national economies

-closed economy – doesn't interact economically with rest of world-trade surplus – when exports exceed imports-trade deficit – when imports exceed exports

Macroeconomic Policy-two major types of macroeconomic policies:

-fiscal policy – determined at national state and local levels concerns gov’t spending and taxation-monetary policy – determined rate of growth of nation’s money supply and under control of gov’t institution known as central bank

-in US, central bank = Federal Reserve System or Fed-main macroeconomic policies in recent years is in fiscal

-fed had large budget deficits during wartime, but deficits started emerging in 1980s outside of war time

-during 1980’s fed had large trade and budget deficits

Aggregation-macroeconomics ignore find distinctions among goods, firms and markets

-instead focus on national totals-Aggregation – process of summing individual economic variables to obtain economy wide totals

1.2 What Macroeconomists Do

Macroeconomic Forecasting-minor part of what macroeconomists do

-difficult to incorporate all variables and don't have complete understanding of economy

Macroeconomic Analysis-due to complexity of economy, macroeconomic policies will always be uncertain regardless of amount of qualified macroeconomic analysts-politicians not economics often make economic policies

-poliicians less concerned with abstract desirability of policy than immediate effect on its constituents

Macroeconomic Research-goal of macroeconomic research to make general statements of how economy works-macroeconomists able to offer advice by looking at historical cases and working out theories-research takes place primarily in colleges and universities and non profitsand public sector

-in public sector line is more fuzzy between macro and economic research-many have to jump around between issues

Economic Theory-economic theory – set of ideas about economy that has been organized in a logical framework-economic model – simplified description of some aspect of the economy, usually expressed in mathematical form

-economic theories developed in terms of a mathematical model-economic models evaluated by applying four criteria

1) are its assumptions reasonable and realistic?2) is it understandable and manageable enough to be used in studying real problems 3) does it have implications that can be tested by empirical analysis?

-can its implications be evaluated by comparing them with data obtained in real world?

4) when the implications and the data are compared, are the implications of the theory consistent with the data?

-for theory or model to be useful, answer to all questions must be yes

Developing and Testing an Economic Theory1) state the research question2) make provisional assumptions that describe the economic setting and behavior of the economic actors

-these ssumptions should be simple yet capture the most important aspect of the problem

3) work out the implications of the theory

4) conduct an empirical analysis to compare the implications of the theory with the data5) evaluate the results of your comparisons

if theory fits data poorly – start from scratch with a new modelif theory fits data moderately well – make do with partially successful model or modify model with additional assumptions

Data Development-macroeconomists use econ data to asses current state of econ, make forecasts, analyze policy alternatives, and test macroeconomic theories-most data collected by fed gov’t

-also collected by private sector – i.e. marketing firms

1.3 Why Macroeconomists Disagree

-positive analysis – examines economic consequences of a policy but doesn't address the question of whether those consequences are desirable

-if one is asked to evaluated effect of 5% reduction in income tax, that is positive analysis

-normative analysis – tries to determine whether a certain policy should be used-i.e. if asked if income tax should be reduced by 5% , that is normative analysis-involves personal judgments as well as knowledge of economics

Classical Vs Keynesians-classical and Keynesian approach are two major intellectual traditions in macro

Classical approach-goes back to adam smith’s invisible hand-invisible hand – if free markets and individuals act in their own best interests, overall economy will work well

-says that country’s resources and initial distribution of wealth, use of free markets will make people as economically well off as possible

-equilibrium – situation in which there is no pressure for wages or prices to change-under classical approach, economists argue gov’t should have limited role

Keynesian Approach-during great depression, invisible hand seemed completely ineffective

-classical theory seemed inconsistent with data-offered explanation that was very different from classical assumption

-instead of wages/prices adjusting quickly, they adjust slowly-says that unemployment can persist bc wages and prices don't adjust to equalize number of people that firms want to employ

-said that solution to high unemployment was to have gov’t increase purcahses of goods and services

-this would raise demand for output and reduce unemployment bc to meet higher demand, firms would have to hire more workers-newly hired workers would also have more income to spend creating more demand for output

-keynesian advocate for gov’t to have bigger role in economy

Evolution of the Classical-Keynesian Debate-keynesian approach dominated macro theory from wwii until 1970’s

-Stagflation – high unemployment and high inflation-when us started suffering from stagflation, this weakened economists confidence in Keynesian approach

-made classical approach look more interesting-from 1970s modernized classical approach enjoyed major resurgence among macroeconomic researchers -in past three decades, advocates of both approaches have reworked them extensively to repair their weaknesses