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Macroeconomics

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The study of problems that affect the economy as a whole (lack of growth, recession, unemployment, and inflation) and what to do about them.

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Examples of problems that affect the economy as a whole

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Lack of growth, recessions, unemployment, and inflation

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Potential output

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The highest amount of output an economy can sustainably produce using existing production processes and resources.

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Gross domestic product (GDP)

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Total output. The total market value of all final goods and services produced in a n economy in a one-year period.

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What happened to the U.S. economy in 2008 in terms of output and unemployment?

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A major downtown in output and increase in unemployment.

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What are the heavily-debated policies the United States government used to deal with the aftermath of the bursting financial bubble in 2007?

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The government implemented a financial bailout for banks, and supplemented it with an enormous stimulus package that included spending increasing, tax decreases, and large infusions of money in the economy.

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What was a defining event that undermined people's faith in markets and was the beginning of macro's focus on the demand side of the economy?

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The deep, 10-year U.S. economic recession of the 1930's. During this Depression, output fell by 30% and unemploy,ent rose to 25%.

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What was the focus of macroeconomists before the Depression?

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The problem of growth (keeping the economy growing over the long run). They avoided discussing policies that would affect the short-run prospects of the economy. These earlier economists who focused on long-run issues were called Classical economists.

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How did the focus of macroeconomists change in the 1930s?

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Macroeconomists started focusing on short-run issues such as unemployment and economic ups and downs. These economists who focused on the short run were called Keynesian economists.

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Where do Keynesian economists get their name?

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A leading advocate of the short-run focus - John Maynard Keynes, author of The General Theory of Employment, Interest, and Money, and the originator of macroeconomics as a separate discipline from micro.

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How do Classical economists believe the market is regulated?

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"The market is self-regulating through the invisible hand (the pricing mechanism of the market)."

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Classical economists

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Economists who believe that business cycles (ups and downs of the economy) are temporary glitches, and who generally favor laissez-faire, or non-activist policies.

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How did Classical economists explain the cause of the Depression?

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Using microeconomic supply and demand arguments - labor unions and government policies kept prices and wages from falling. the problem, they said, was that the invisible hand was not being allowed to coordinate economic activity.

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What was the policy prescription of Classical economists attempting to address the Depression?

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Eliminate labor unions and change government policies that held wages too high. If government did so, the wage rate would fall, unemployment would be eliminated, and the Depression would end.

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Keynesian economists

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Economists who believe that business cycles reflect underlying problems that can be addressed with activist government policies.

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What is the essence of Keynes' ideas?

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As wages and overall prices adjusted to sudden changes in overall spending (such as an unexpected decrease in household spending), the economy could get stuck in a rut.

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From a Keynesian perspective, what can happen if people stop buying (decrease their demand in the aggregate)? In other words, how can unemployment be caused by too little spending, resulting in the economy falling into a depression?

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Firms will decrease production, causing people to be laid off. These people, in turn, would by even less - causing other firms to further decrease production, which would cause more workers to be laid off, and so on. Firms' supply decisions would be affected by consumers' buying decisions, and the economy would end up in a cumulative cycle of declining production that would end with the economy stuck at a low level of income.

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Fallacy of composition

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The false assumption that what is true for a part will also be true for the whole. As Keynes argued, the effects differ significantly when everyone does something (e.g. stops spending) vs. when only one person does it. In this way, he was careful to distinguish the adjustment process for a single market (a micro issue) from the adjustment process for the aggregate economy (a macro issue). This difference between individual and economywide reactions to spending decisions creates a possibility for government to exercise control over aggregate expenditures and thereby over aggregate output and income.

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What do Keynesian economists argue is a public good during times of recession?

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Spending - spending benefits not just the person spending but everyone, so government should spend or find ways of inducing private individuals to spend.

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What important issue does Keynesian economics leave out?

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Inflation, for one. If, instead of an oversupply of goods, people spend MORE than is produced, there are pressures for prices to rise and the economy experiences inflation - an increase in the price of all goods. Classical economists had focused on inflation, arguing that when aggregate demand (expenditures in the economy) exceeds aggregate supply (production in the economy), inflation will result. Keynesian economists had assumed the price level was constant.

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Structural stagnation

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A period of protracted slow growth and high unemployment, in which an economy's short-run potential output is limited by structural limitations that most short-run models to not consider. Structural stagnation is a particular kind of cyclical downturn that we do not expect to end any time soon without major changes to the structure of the economy. IT IS A SHORT-TERM PROBLEM THAT EXTENDS INTO THE LONG-TERM.

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What makes up the core of modern macroeconomics (at least, until the crash of 2008)?

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A combination of Keynesian and Classical macroeconomics made up the new conventional macroeconomics.

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What policies do Keynesian economists argue for to address the new structural stagnation problem that we've had since 2008?

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Policies that encourage more demand stimulus - more spending! More government spending would result in a significant increase in the government deficit, and in government debt.

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What policies do Classical economists advocate for to address this new structural stagnation problem?

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Some argued that what the economy needed was severe cuts in government spending accompanied by cuts in taxes. Other more traditional Classical economists who were not categorically opposed to tax increases, but who were very concerned about government budget deficits, saw the need to eliminate the deficit.

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Which framework of macroeconomic issue analysis do issues of growth fall within?

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Long-run framework

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Which framework of macroeconomic issue analysis do business cycles fall within?

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Short-run framework

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Which framework of macroeconomic issue analysis do inflation and unemployment fall within?

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Both long-run and short-run frameworks

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Long-run framework

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Growth framework; focuses on incentives for supply, which is why it's sometimes called SUPPLY-SIDE ECONOMICS.

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Which policies are key in the long-run?

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Policies that affect production or supply - incentives that promote work, capital accumulation (factors of production), and technological change

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Short-run framework

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Business cycle framework; focuses on demand, which is why it's sometimes called DEMAND-SIDE ECONOMICS.

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What policies are key in the discussion of short-run business cycles?

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Policies that focus on ways to increase or decrease aggregate expenditures, such as policies to get consumers and businesses to increase their spending.

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What policy position does the short-run framework lead to?

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All we have to do is to have government stimulate the economy by increasing government spending enormously to get the economy back to its potential. Focus of Keynesian economists.

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What policy position does the long-run framework lead to?

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The economy will solve its own problems and government spending will hurt the economy. Focus of Classical economists.

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What is wrong with the stark division between short-run and long-run frameworks?

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Dividing up macro problems into short-run and long-run problems does not fit the real world. In reality the short run and the long run are not separate. The economy is simultaneously in the long run and short run. Any analysis must take both runs into account. The short-run and long-run frameworks have to be blended into a composite framework in which both supply and demand influence long-run and short-run forces.

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Compounding

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The reason small differences in growth rates over long periods of time can mean huge differences in income levels. Compounding means that growth is based not only on the original level of income but also on the accumulation of previous-year increases in income.

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How do economists measure growth?

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With changes in total output over a long period of time.

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When an economy is growing, what is happening to total output and total income?

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Since when people produce and sell their goods, they earn income, when an economy is growing, both total output and total income are increasing.

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What has the historical growth rate of the U.S. economy been since World War I?

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U.S. economic output has grown at an annual 2.5 to 3.5% rate since World War I. What it will be in the future is uncertain.

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Secular growth trend

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The long-run (secular) growth trend represents the rise in potential output

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Is potential output a purely physical measure?

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No. For example, if workers are asking for a wage that is higher than any firm is willing to pay, those workers will not contribute to an economy's potential out put. Similarly, a factory that is technologically obsolete does not contribute to potential output either.

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Does the production that contributes to potential output need to be sustainable?

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Yes. If a level of output leads to accelerating inflation, or to a financial collapse, that level of output is not sustainable and hence does not meet the potential output definition.

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Besides changes in total output over a long period of time, what is an alternative measure of growth?

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Changes in per capita output (output divided by the total population).

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Why is output per person (per capita output) an important measure of growth?

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Because even if total output is increasing, the population may be growing even faster, so per capita output would be falling.

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Describe the growth trend of China and India.

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Slow growth until the 1990s, and then their growth rate increased substantially.

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Describe the postwar era Western European growth rate.

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Economies grew by an average 3.0 % per year.

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Describe the postwar era growth rate of Japan.

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Japan grew by 4% following the war, but its growth rate fell considerably in the 1990s and has remained low.

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Describe the postwar era growth rate of the U.S.

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The U.S. grew at an annual rate of 2.5% from 1940 to 1970, bu tits growth rate has slowed in recent years.

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Per capita output

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Total output divided by total population.

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What is different about India and China?

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Over the next 10 years, economic growth in India and China is likely to significantly outpace growth in most economies throughout the world, particularly industrialized countries in western Europe, the U.S., and Japan. What's different about them is their size; combined, they have a population of 2.6 billion, making their potential for growth significant.

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How will the world economic landscape change as India and china develop into highly industrialized countries?

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It will likely place more and more pressures on U.S. firms in both services and manufacturing industries either to become more competitive by holding down wage increases and developing more efficient production methods, or moving their production facilities abroad. It will also be accompanied by greater demand for natural resources.

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Business cycle

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A short-run, temporary upward or downward movement of economic activity, or real GDP, that occurs around the growth trend (even if the economy is on a steady long-run growth path, there are inevitably fluctuations around that trend)

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How do the different schools of economic thought view business cycles?

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Classical economists take such cycles as a fact of life and argue that the government should just accept that they occur. Keynesian economists argue that government can temper these economic fluctuations with policy actions.

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Who announces the government's official dates of business cycle expansions and contractions?

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The National Bureau of Economic Research

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Peak

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The top of a business cycle

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Boom

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A very high business cycle peak, representing a big jump in output - most everyone who wants a job has one

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Downturn

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The phenomenon of economic activity starting to fall from a peak

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Recession

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A decline in real output that persists for more than two consecutive quarters of a year - many people are unemployed

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Trough

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The bottom of a recession or depression

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Upturn

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When total output begins to expand and the economy comes out of the trough

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Expansion

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An upturn that lasts at least two consecutive quarters of a year - leads us back up to the peak

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Why are businesses so interested in the state of the economy?

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They want to be able to predict whether it's going into a contraction or an expansion, because making the right prediction can determine whether the business will be profitable or not.

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What do the concepts business cycle and growth trend convey?

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The concept of a "business cycle" conveys a sense that a fall in output is going to reverse itself. The concept of a "growth trend" conveys a sense that the current growth rate will continue. In reality, we never know for sure whether a cyclical downturn is a cycle or a change in the growth trend.

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What occurs with employment during a structural stagnation?

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Many of the unemployed cannot get a job at the pay they were getting or in the field where they worked. Unemployment is not due to temporary layoffs as it is in a business cycle, it is due to longer-term changes. THERE IS NO FORMAL LINE THAT INDICATES WHEN A BUSINESS CYCLE BECOMES A STRUCTURAL STAGNATION.

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Depression

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A deep and prolonged recession - a general definition could be, if unemployment exceeds 12% for more than a year, the economy is in a depression.

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In the U.S. government/central bank policy response to the financial crisis of 2008, was the government trying to smooth a business cycle around a growth trend?

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No, it was trying to save the economy from falling into a depression.

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Unemployment rate

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The percentage of people in the economy who are both able to and looking for work but who cannot find jobs. When an economy is growing and is in an expansion, unemployment is usually falling; when an economy is in a recession, unemployment is usually rising, although often with a lag.

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Has unemployment always been a problem associated with business cycles?

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No - in preindustrial societies, households produced goods and services. The entire family contributed to farming, weaving, or blacksmithing. When times were good, the family enjoyed a higher level of income. When times weren't good, they still worked, but accepted less income for the goods they produced. Low income was a problem, but since people didn't become unemployed, CYCLICAL UNEMPLOYMENT was not a problem

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Cyclical unemployment

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Unemployment resulting from fluctuations in economic activity. Did not exist in a preindustrial society.

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Structural unemploy,ent

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Unemployment caused by the institutional structure of an economy or by economic restructuring making some skills obsolete. Did exist in a preindustrial society. For example, scribes in Europe had less work after the invention of the printing press in the 1400s.

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Is the current unemployment problem in the U.S. cyclical or structural?

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It depends on whether we believe the economy is in a structural stagnation or a conventional business cycle. If it is experiencing structural stagnation, the current unemployment problem facing the U.S. is in large part structural and will require structural changes to solve. In the conventional business cycle view, the current unemployment problem is primarily cyclical; it will disappear as the economy comes out of the recession.

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How did the Industrial Revolution change the nature of work?

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It was accompanied by a shift to wage labor and to a division of responsibilities, Some individuals (capitalists) took ownership of the means of production and hired others to work for them, paying them an hourly wage.

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How did the Industrial Revolution change the nature of the unemployment problem?

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It created the possibility of cyclical unemployment - with wages set at a certain level, when economic activity fell, workers' income per hour did not fall. Instead, factories would lay off or fire some workers. What was previously a family problem became a social problem.

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What was the unemployment solution of early capitalism?

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Fear of hunger. If people were unemployed, it was their own fault (economists and society still did not view this as a social problem - it was the individual's problem). Hunger, or at least the fear of hunger, and people's desire to maintain their lifestyle, would drive them to find other jobs relatively quickly.

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Employment Act of 1946

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U.S. government specifically took responsibility for unemployment. It assigned government the responsibility of creating "full employment." Government was responsible for offsetting cyclical fluctuations and thereby preventing cyclical unemployment, and somehow dealing with structural unemployment.

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Full employment

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An economic climate in which just about everyone who wants a job can have one (this term has fallen out of favor; see target rate of unemployment)

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Frictional unemployment

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Unemployment caused by people entering the job market and people quitting a job just long enough to look for and find another one

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Target rate of unemployment

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The lowest sustainable rate of unemployment that policy makers believe is achievable given existing demographics and the economy's institutional structure. This target rate of unemployment is the rate of unemployment that exists when the economy is at potential output.

ECON 201 CH 6 – Economic Growth, Business Cycles, and Structural Stagnation – Flashcards

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