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Chapter 6: Macroeconomics - The Big Picture

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Key Learning Objectives​

  • Understand the difference between macroeconomics and microeconomics.
  • Learn about business cycles and why policymakers try to reduce their severity.
  • Analyze how long-run economic growth affects a country’s standard of living.
  • Examine inflation and deflation, and why price stability is preferred.
  • Understand international macroeconomics and how economies interact through trade deficits and surpluses.

The Nature of Macroeconomics​

  • Macroeconomics studies the economy as a whole, focusing on aggregate outcomes like total employment, inflation, and national income.
  • Microeconomics focuses on individual decision-making by firms and consumers.
  • Macroeconomic outcomes are not simply the sum of microeconomic decisions.

Key Differences Between Micro and Macro Questions​

  • Micro: “Should I go to business school?” → Macro: “How many people are employed?”
  • Micro: “What salary does Google offer to an MBA?” → Macro: “What determines overall wage levels?”
  • Micro: “Should Citibank open a new office?” → Macro: “What determines global trade balances?”

Macroeconomics: The Whole is Greater Than the Sum of Its Parts​

  • Paradox of Thrift: If individuals cut spending to save money, overall demand falls, leading to economic downturns.
  • Individual behaviors don’t always translate into beneficial macroeconomic outcomes.

Macroeconomic Theory and Policy​

  • Pre-1930s Economic Thought: The economy was believed to be self-regulating, requiring minimal government intervention.
  • Post-1930s (Keynesian Economics): Economic downturns result from inadequate spending, and government policies (monetary & fiscal) can stabilize the economy.

Macroeconomic Policy Tools​

  1. Monetary Policy: Uses money supply adjustments to influence interest rates and spending.
  2. Fiscal Policy: Uses government spending and taxation to influence overall demand.

Historical Comparison​

  • Great Depression (1930s): Governments let the economy self-correct, worsening the slump.
  • Great Recession (2008): Governments cut interest rates, increased spending, and reduced taxes to stabilize the economy.

The Business Cycle​

  • Business Cycle: Alternates between recessions (downturns) and expansions (recoveries).
  • Recession: Period when output and employment decline.
  • Expansion: Period when output and employment rise.
  • Business Cycle Peak: Highest point before a recession.
  • Business Cycle Trough: Lowest point before an expansion.

Effects of Recessions​

  • Job losses, lower incomes, reduced corporate profits, and increased bankruptcies.
  • Policymakers aim to minimize recession frequency and severity.

Smoothing the Business Cycle​

  • Since the Great Depression, economists (Keynes, Friedman) have recommended policy interventions to stabilize the economy.

Long-Run Economic Growth​

  • Sustained upward trend in an economy’s output over time.
  • Increases the standard of living by expanding access to goods and services.
  • Historical Perspective:
    • Economic growth is a modern phenomenon (e.g., Britain in 1650 had similar wealth levels as two centuries earlier).
    • Growth rates vary across countries (e.g., the U.S. overtook Britain in economic wealth after 1875).

Inflation and Deflation​

  • Inflation: A rise in the overall price level.
  • Deflation: A fall in the overall price level.

Causes of Inflation and Deflation​

  • Inflation rises during booms and falls during downturns.
  • In the long run, inflation is primarily driven by money supply changes.

Economic Effects​

  • Inflation: Reduces cash value, discourages saving, and can lead to hyperinflation.
  • Deflation: Increases cash value, discourages spending/investment, and can deepen recessions.
  • Price Stability is preferred to avoid these extremes.

International Macroeconomics and Trade Balances​

  • The U.S. is an open economy, meaning it trades goods and services with other nations.
  • Trade Deficit: Imports exceed exports.
  • Trade Surplus: Exports exceed imports.

Determinants of Trade Balances​

  • Countries with high investment spending relative to savings run trade deficits.
  • Countries with low investment spending relative to savings run trade surpluses.

Practice Questions​

  1. If a country’s imports are $1.2 billion and exports are $1.3 billion, what is it running?
    Answer: Trade surplus.

  2. What policy uses taxes and government spending to influence the economy?
    Answer: Fiscal policy.

  3. If the economy is booming, what happens to inflation?
    Answer: It rises.