Macroeconomics 2HH3Chapter 1Introduction and Measurement Issues

is the study of the behaviour of large collections of economicsagents

it analyzes issues associated with long-run growth and businesscycles

long-run growth is the icnrease productivitecapacity and average standard of loving

business cycles are the short-run fluctuations in aggregateeconomic activity

microeconomics is concerned with the choices of economic agentssuch as households and firms

macroeconomics is concerned with the overal effects oneconomies of the choices that these economic agents make

important issues in macroeconomics are

why are some countries rich and otherrs are so poor

why are most canadadians so much better off than their parentsand grandparents

why are there fluctuations in aggregate economic activity

why is there unemployment

gross domestic product (GDP) is a measure of aggregate economic activity

real gdp is optained by adjusting GDP for inflation and population growth

growth fluctuations

called business cycles

Most notible

Great depression

World War II

Growth Measurement

THE PRODUCTIVITY SLOWDOWN

GOVERNMENT INCOME, GOVERNMENTOUTLAYS, AND THE GOVERNMENT DEFICIT

INFLATION

INTEREST RATES

ENERGY PRICES AND MACROECONOMICACTIVITY

TRADE AND THE TWIN DEFICITS

UNEMPLOYMENT

Figure 1.1

Per Capita Real GDP for Canada1926 - 2004

shows

sustained growth in per capitaread GDP

growth fluctuations

economic model

a description of consumers and firms,their objectives and constraints, andhow they interact

long-run growth

the increase in a nation's productive capacity andaverage standard of living that occurs over a longperiod of time

business cycles

short-run ups and downs, or booms and recessions,in aggregate economic activity

gross domestic product (GDP)

the quantity of goods and services producedwithin a country's borders during some specifiedperiod of time

trend

the smooth growth path around which an economicvariable cycle

models

artificial devices that can replicate the behaviourof real systems

optimize

the process by which economic agents (firms and consumers)do the best they can given the constrains they face

equilibrium

the situation in an economy when the actions of allall the consumers and firms are consistent

competitive equilibrium

equilibrium in which firms and households areassumed to be pricetakers, and market pricesare such taht the quantity supplied equals thequantity supplied equals the quantity demandedin each market economy

rational expectations revolution

macroeconomics movement that occured in the 1970'sintroducing more microeconomics into macroeconomics

Lucas critique

the idea that macroeconomic policy analysis can be donein a sensible way only if microeconomic behaviour is taken seriously

endogenous growth models

models that describe the economic mechanism determingthe rate of economic growth

money surprise theory

this theory, developed by Milton Friedman and RobertLucas, monetary factors are the primary cause of businesscycles, and the government should not be active in smoothingcycles

real business cycle theory

this theory, initiated by Finn Kydland and Edward Prescott,implies that business cycles are caused primaraly by shocksto technology and that the government should play a passiverole over the business cycle

Keynesian coordinationfailure theory

a modern incarnation of Keynesian business cycle theory positingthat business cycles are caused by self-fulfilling waves of optimismand pesimism, which may be countered with government policy

Keynesian

describes macroeconomists who are folloers of J.M. Keynes andwho see an active role in government in smoothing businesscycles

inflation

the rate of change in the average level of prices over time

Bank of Canada

The central bank of Canada

search theory

theory that explains unemployment in terms of the costs ofsearching for job offers

efficiency wage theory

Theory positing that workers are unemployed because ofan excess supply of labour brought about when firms payhigh wages to induce their workers not to shirk

Phillips Curve

a positive relationship between the devation of aggregate outputfrom trend and the inflation rate

productivity slowdown

the period of low productivity growth occuring from the early1970's until the mid- 1980's

crowding-out

the process by which government spending reduces privatesector expentitures on investment and consumption

government surplus

the difference between taxes and government spending

government saving

identical to the government surplus

government deficit

the negative of government surplus

Ricardian equivalence theorem

theory asserting that a change in taxation by the governmenthas no effect

price level

the average level of prices

nominal interest rate

the interest rate in money terms

real interest rate

approximately equal to the nominal interest rate minusthe expected rate of inflation

current account surplus

exports minus imports plus net factor payments to domesticresidents from abroad

net exports

exports of goods and services minus imports of goods and services

net factor payments

these are the payments recieved by domestic factors of productionfrom abroad, minus the payments to foriegn factors of production fromdomestic sources

current account deficit

situation in which the current account surplus is negative

twin deficits

the phenomenon by which a government deficit (surplus) is reflected in acurrent account deficit (surplus)

1.

What are the primary defining characteristics ofmacroeconomics

Macroeconomics is the study of the behaviour oflarge collections of economic agents

the aggregate behaviour of consumers, firms, and governments

the overall level of economic activity in individual contries

and the economic interactions among nations

2.

What makes macroeconomics different from microeconomics

microeconmists study the behaviour of individual households and firms

the economy as a whole is comprised of a large numberof households and firms

What do they have in common

as a result, interactions at the aggregate leve are theresult of decisions of individul households and firms

3.

How much richer was the average Canadian in 2004than in 1926

In 2004 the average canadiant was more then five times richer thenshe was in 1926

the average income for a canadian in 1926 was $6700 in 1997 dollarscompared with $35000 in 2004 based on 1997 dollars

4.

what are two striking business cycle events in Canadaduring the last 80 years

The Great Depression of the 1930's

World War 2

5.

List six fundamental macroeconomic questions

What causes sustained economic growth?

Could economic growth continue indefinitely,

or is there some limit to growth

what causes business cycles

Could the dramatic decrease and increase in economic growth thatoccured during the Great Depression and WWII be repeated

Should governments act to smooth business cycles

6.

In a graph of the natural logarithm of an economictime series, what does the slope of the graph represent

the slope represents the growth rate

7.

what is the difference between the trend and the business cyclecomponent of an economic time series

the trend in a series is a smooth curve fit to the data.

the business cycle component is equal to teh actual series valuesminus the trend values

8.

explain why eperimentation is diffucult in macroeconomics

experimentation may cause significant irreparable hard to a largenumber of people

9.

why should a macroeconmic model be simple

a model must be simple to capture the essential features of the worldthat are relevant to problems at hand

10

should a macroeconomic model be an exact descriptionof the world

no

Explain why or why not

exact descriptions of reality are too complicateto provide useful results

11.

What are the five elements that make up the basic structure of amacroeconomic model

the consumers and firms that interact in the economy

the set of goods that consumers wish to consume

consumers preferences over goods

the technology available to firms for producing goods

the resources available

12.

why can macroeconomic models be useful?

macroeconomic models help us answer questions about how theeconomy behaves

how do we determine whether or not they are useful?

Models are useful if they reasonably and accurately explainthe phenomenon of interest

13.

explain why a macroeconomic model should be built frommicroeconomic principles

macroeconomics is the result of many microeconomic decisions

to answer policy questions, we need to know whether a propsed policychange is likely to affect the behaviour of the individual decion maker

14.

what are the 4 theories of the business cycle that wewill study

Keynesian sticky wage model

money suprise theory

real business cycle theory

keynesian coordination failure theory

15.

what are two possible causes of the productivity slowdown

total factor productivity continued to rise, but was imprecisely measured

time was required for the economy to adjust to new technology

16.

what is the principle effect of the productivityslow down

and increase in government spending consumes resources that mightotherwise be used by the private sector

17.

why might a decrease in taxes have no effect

holding government spending fixed, a cut in taxes todaymight be offset by a tax incrase in the future

such a policy change should not affect private decisions topurchase goods and services

18.

what is the cause of inflation in the long run

the cause of inflation is excessive growth in the money supply

19.

explain the difference between the nominal interest rateand the real interest rate

the nominal interest rate expresses dollar interest payments as a percentageof the amount borrowed

the real interest rate measures that amount of purchasing power thatwill be required to pay of the loan

expected real interest rate is approximately equal to the nominal interestrate minus the expected rate of inflation

20.

what effect does an increase in the relative price of energy have onaggregate economic activity

changes in realtive price of energy affecct the relative prices of inputs into the production process

when energy prices rise, producers must subsitute other factors of production for the higher priced energy

such an adjustment typically reduces the level of aggregate production in the economy

21.

how are government surpluses and the current accountsurplus connected

for the given amounts of domestic production and spending, government deficits much be finance by borrowing from abroad

total borrowing from abroad is equal to the current account deficit

therefore, if the government budget deficit increases, the current accountbudget deficit automatically increases by the same amount, unless there issome offset due to changes in domestic prodcution or spending

22.

what are four factors that determine the quantity of unemployment

the level of aggragate economic activity

the structure of the population

governement intervention

sectoral shifts