CHAPTER 8a

Introduction to
Macroeconomics

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 Introduction to Macroeconomics
Microeconomics
INTHISLECTURE
Macroeconomics

The Microeconomic Foundations of Macroeconomics

Flexible Price VS Sticky Price

The Roots of Macroeconomics

Classical Model
Keynesian Revolution

Macroeconomic Concerns
Price Stability
Low Unemployment
High & Sustained Economic Growth

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 The Components of the Macroeconomy
Households & Firms (Private Sector)
INTHISLECTURE
Government (Public Sector)
Rest of the World (International Sector)

The Three Market Arenas

The goods-and-services market
The labor market
The money (financial) market

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 INTRODUCTION TO MACROECONOMICS
Microeconomic
The branch of economics that deals with the
functioning of individuals industries & the behaviour
of individual decision-making units (business firm &
household).
Macroeconomics
The branch of economics that deal with the economy
as a whole.
Macroeconomics focuses on the determinants of total
national income, deals with aggregates such as
aggregate consumption & investment & look at the
overall level of prices rather than individual prices.

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The Microeconomic Foundations of
Macroeconomics
Macroeconomic analysis is consistent with
microeconomic postulates.

Both microeconomics & macroeconomics are

concern with the decision of household & firms.

Microeconomics deals with individual decisions,

while macroeconomics deals with the sum of
these individual decisions.

When we speak of aggregate behaviour, we mean

the behaviour of all households & firms taken
together.
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 Flexible Price VS Sticky Price

Microeconomists generally conclude that markets work

well.
They see prices as flexible, adjusting to maintain equality
between quantity supplied & quantity demanded.

Macroeconomists, however, observe that important

prices in the economy -- for example, the wage rate
often seem sticky.
Price (wage) do not always adjust rapidly to maintain equality
between quantity supplied & quantity demanded.
As a result, there will be a period of high unemployment
where the quantity of labour supplied > the quantity of labour
demanded.

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 The Roots of Macroeconomics
Great Depression
The period of severe economic contraction & high
unemployment that began in 1929 & continued throughout
the 1930s.

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 The Roots of Macroeconomics
Classical Models
Before the Great Depression, economists generally applied
microeconomic models, sometimes referred to as classical
models, to economy-wide problems.
Classical economists believed that recessions (downturns in the
economy) were self correcting.
For example, classical supply & demand analysis assumed that an
excess supply of labour would drive down wages to a new
equilibrium level; as a result, unemployment would not persist.
In fact, however, during the Great Depression unemployment
levels remained very high for nearly ten years.
The failure of simple classical models to explain the prolonged
existence of high unemployment provided the impetus for the
development of macroeconomics in the 1930s.

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The Keynesian Revolution
Much of the framework of modern macroeconomics
comes from the work of John Maynard Keynes [The
General Theory of Employment, Interest & Money
(1936)].
According to Keynes, it is not prices & wages that
determine the level of employment, as classical models
had suggested, but rather the level of aggregate
demand for good & services.
Keynes believed that government could intervene in
the economy by stimulating the aggregate demand &
lifting the economy out of recession (fiscal policy &
monetary policy).

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MACROECONOMIC CONCERNS

Price Stability
Low Unemployment
High & Sustained Economic Growth

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11
THE COMPONENTS OF THE MACROECONOMY
Understanding how the macroeconomy works can be
challenging because a great deal is going on at one
time. Everything seems to affect everything else.

To see the big picture, it is helpful to divide the

participants in the economy into four broad groups:
Households.
Firms.
The government.
The rest of the world.

Households & firms make up the private sector, the

government is the public sector & the rest of the world
is the foreign sector.
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THE CIRCULAR FLOW OF PAYMENTS

Households receive income from firms & the

government, purchase goods & services from
firms & pay taxes to the government.

They also purchase foreign-made goods &

services (imports).
Firms receive payments from households & the
government for goods & services; they pay
wages, dividends, interest & rents to
households & taxes to the government.
The government receives taxes from firms &
households, pays firms & households for goods
& servicesincluding wages to government
workersand pays interest & transfers to
households.
Finally, people in other countries purchase
goods & services produced domestically
(exports).
Note: Although not shown in this diagram,
firms & governments also purchase imports.
 THE THREE MARKET ARENAS

Another way of looking at the ways households, firms,

the government & the rest of the world relate to one
another is to consider the markets in which they
interact.

We divide the markets into three broad arenas:

The goods-and-services market.

The labor market.
The money (financial) market.

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 The goods-and-services market
Households & the government purchase goods & services
from firms in the goods & services market.
Firms purchase goods & services from each other & also
supply to the goods & services market.
Households, the government & firms demand from this
market.
The rest of the world buys from & sells to the goods & services
market.

The labour market

In the labor market, households supply labor and firms & the
government demand labor.
Labor is also supplied to & demanded from the rest of the
world.

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 The money (financial) market
Households supply funds to the money marketsometimes
called the financial marketin the expectation of earning
income in the form of dividends on stocks & interest on
bonds.

Households also demand (borrow) funds from this market to

finance various purchases.
Firms borrow to build new facilities in the hope of earning
more in the future.
The government borrows by issuing bonds.
The rest of the world borrows from & lends to the money
market.

Much of this borrowing & lending is coordinated by financial

institutions, which take deposits from one group & lend them
to others.

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