Macroeconomics, Introduction

Posted on April 18, 2015

Macroeconomics is concerned with the behavior of the economy as a whole—with booms and recessions, the economy’s total output of goods and services, the growth of output, the rates of inflation and development, et cetera. In brief, macroeconomics deals with major economic issues and problems of the day.
The study of macroeconomics is organized around three models that describe the world, each model having its greatest applicability in a different time frame.
The very-long run behaviour of the economy is the domain of growth theory, which focuses on the growth of the economy’s capacity to produce goods and services.
- This model focuses on historical accumulation of capital and improvements in technology.
In a long-run model, we take a snapshot of very-long run model.
- We assume that the capital stock and the level of technology remains fixed. Fixed capital and technology determine the production capacity of the economy and this capacity is known as potential output.
- In long run, the supply of goods and services equals potential output and the prices and inflation are determined by fluctuations in demand.
In short run, fluctuations in demand determine how much of the available capacity is used and thus the level of output and unemployment.
- In contrast to long run, in short-run, prices are relatively fixed and output is a variable.
There are various opinions among Economists on what should be chosen as the time frame for each step.

We ignore recessions and booms are related short-run fluctuations in employments of people and other resources. This is proper since over a large time span, these tend to average.

The economy with fixed productive capacity

The aggregate supply curve depicts, for each given price level, the quantity of output firms are willing to supply. The level of aggregate supply is the amount of output the economy can produce given the resources and technology available.
The position of the aggregate supply curve depends on the productive capacity of the economy.
The aggregate demand curve depicts, for each given price level, the level of output at which the goods market and money market are simultaneously in equilibrium. The level of aggregate demand is the total demand for goods to consume, for new investment, for goods purchased by the government, and for net goods to be exported abroad.
The position of the aggregate demand curve depicts on monetary and fiscal policy and also on consumer confidence.
In long run, the aggregate supply curve is vertical.
In the long run, the output is determined by aggregate supply alone and prices are determined by both aggregate supply and aggregate demand.
Very high inflation rates—episodes of rapid increases in overall price level—are always due to changes in aggregate demand.

In a short run, the aggregate supply curve is flat.
Thus the prices remain fixed. Output, in contrast, can take any value. The underlying assumption is that the level of output does not affect the price level.
We study aggregate demand because, in the short run aggregate demand determines the output and therefore unemployment.

The medium run represents the situation in which transition between long run and short run happens.

The growth rate of an economy is the rate at which the gross domestic product (GDP) is increasing.
The GDP can grow for the following reasons

The available amount of resources in the economy changes. Principal resources are capital and labour. The capital consists of things like buildings and machines.
The efficiency of factors of production changes. Efficiency improvements are called productivity increases. Productivity increases results from changes in knowledge, people learning through experience, et cetera.

Huge inflations have one cause: great outward sweeps of the aggregate demand curve caused by the government’s printing of too much money.
Big changes over short life spans in the level of economic activity and thus unemployment is explained by short-run aggregate supply-aggregate demand model.

The business cycle is more or less regular pattern of expansion (recovery) and contraction (recession) in economic activity around the path of trend growth.
The trend path of the GDP is the path GDP would take if factors of production were fully employed.
In economic terms, there is full employment of labor when everyone who wants a job can find one within reasonable amount of time.
The output gap measures the gap between actual output and the output the economy would produce at full employment given the existing resources. Full employment is also called potential output. Output gap \(\equiv\) Actual output \(-\) Potential output.