Chapter 1

The Importance of Macroeconomics

Principal Uses of Macroeconomics for Business Managers

Understanding the economy

Realizing how changes in economic variables

will affect your business Understanding how changes in fiscal and monetary policy may affect sales and profits. To a limited extent, forecasting the future, although that probably is impossible. But when a major unexpected change does occur, you should be able to react quickly and accurately.

Principal Macroeconomic Goals of any Society

Full Employment. Provide a job for everyone who

wants to work. Low, Stable Inflation. Economic decisions should be based on maximizing producer value or consumer utility, not as a hedge against rising prices. Rapid growth in productivity and the standard of living

Different Types of Policies Used to Control the Economy

Monetary Policy: moves affecting the cost

and availability of credit. Fiscal Policy: spending programs and tax rates Trade Policy: regulations affecting free trade and quotas and tariffs; sometimes try and affect the value of the currency. Regulatory Policy: programs affecting government intervention and regulation, but with a minimal budget impact.

Current Core of Macroeconomic Theory

1. All major components of aggregate demand

consumption, investment, and net exports are negatively related to the real rate of interest, which is the nominal rate minus the expected rate of inflation.

Core Point #2
In the short run, movements in economic activity

are dominated by changes in aggregate demand, while in the long run, the economy tends to return to a steady-state growth path

Core Point #3
The long-run growth rate is determined by (a) the

ratio of investment to GDP, and (b) the degree to which fiscal, trade, and regulatory policies encourage the spread of free markets and technical innovation and invention.

Core Point #4
The central bank controls the nominal short-term

interest rate, but the real long-term interest rate affects aggregate demand. Long-term interest rates are determined in large part on the expected future rate of inflation.

Core Point #5
Economic agents have forward-looking

expectations, which means they base their decisions on what they expect to happen in the future, as contrasted to simpler extrapolations of the past. Of course, their predictions are not always accurate, but people learn from past mistakes and adjust their expectations accordingly.

Core Point #6
Changes in monetary policy affect both output

and prices in the short run, but only prices in the long run. There is no long-run tradeoff between unemployment and inflation.

Core Point #7
Changes in monetary policy affect real output with

a shorter lag than inflation. Because monetary policy is transmitted through a variety of methods, and because the lags are variable, the short-term impact of monetary policy often cannot be predicted accurately

Core Point #8
In the short run, wages are based on

predetermined variables, which means they react to changes in the economy only with a substantial lag. In the long run, the real wage is equal to the marginal productivity of labor, while the nominal wage is determined by monetary factors.

Core Point #9
Federal government budget deficits can be

financed either by selling Treasury securities to the central bank, which is akin to printing money and is inflationary, or by selling them to the private sector, which will raise real interest rates and hence reduce real growth.

Core Point #10

Markets clear and economic agents attempt to

maximize their utility, subject to short-term rigidities and adjustments, liquidity constraints, and incorrect expectations. Nonetheless, labor markets may not clear for many years, leading to extended periods of high unemployment even though the rest of the economy appears to be in equilibrium.

An empirical discipline
Discussions about macroeconomics are often

influenced by personal opinions, since they affect the amount of money that each individual has. As a result, what passes for facts is often weighted by personal bias. As a result, whenever possible, we try and test theories to see if they agree with the existing facts.

Different Reactions to Similar Policies

Similar changes in policies, such as tax cuts,

Federal reserve easing or tightening, or public works spending programs may have far different effects on the economy. In part, the results depend on the phase of the business cycle when these changes are implemented. Expectations are also important. The impact will generally be greater if the policy change was unexpected, and smaller if a similar change has been made in the recent past.

Why Economists Disagree

Difference between positive economics what is

and normative economics what should be. Ceteris paribus conditions often change, so what works one time may not work the next time. Junk science and spurious econometric correlations often dominate the discussion. Political biases often confused with facts.