Roger Farmer _Macroeconomics

MACROECONOMICS

BY

Roger E. A. FarmerDepartment of Economics UCLA405 Hilgard AvenueLos Angeles CA 90024rfarmer@econ.ucla.eduSeptember, 97

©

Roger E. A. Farmer 1997. This is an incomplete and preliminary draft. You mayreproduce the material for personal use for a limited time only. Instructors may circulatethe material for classroom use after obtaining the written permission of the author.

MacroeconomicsbyRoger E. A. Farmer

Part 1: Introduction And Measurement

1.

What this Book is About2.

Measuring the Economy3.

Macroeconomic Facts

Part 2: The Classical Approach to Aggregate Demand and Supply

4.

The Theory of Aggregate Supply5.

Inflation and Aggregate Demand6.

Saving and Investment

Part 3: The Modern Approach to Aggregate Demand and Supply

7.

Unemployment and Labor Market Frictions8.

The Demand for Money9.

The Supply of Money10.

The IS-LM Model and Aggregate Demand11.

The Open Economy

Part 4: Dynamic Macroeconomics

12.

Debt, Deficits and Economic Dynamics13.

The Neoclassical Theory of Growth14.

The Endogenous Theory of Growth15.

Unemployment, Inflation and Growth16.

Expectations and Macroeconomics

Part 5: Conclusion

17.

What we Know and what we Don’t Know

Roger E. A. FarmerMacroeconomics, December, 97 2

What’s in Each Part?

Part 1: Introduction and Measurement

Part 1 consists of 3 chapters. Chapter 1 introduces three major questions that we will study inthe rest of the book. 1) Why has GDP per person grown at an average rate of 1.6% per yearsince 1890? 2) Why does GDP per person fluctuate around its trend growth rate? and 3) Whatcauses inflation? Chapter2 explains how we measure GDP and its component parts and it relatesthe measurement of GDP to the measurement of wealth. In this chapter you will learn to attachnumbers to the US and the world economies. How big is GDP? How wealthy is the averageAmerican? How large is the US economy relative to the rest of the world? Finally, chapter 3explains how economists measure economic time series. What are the regularities thatcharacterize business cycles and how can these regularities be quantified?

Part 2: The Classical Approach to Aggregate Demand and Supply

In Chapters 4, 5 and 6 we move from a

description

of data to an

explanation

of it. We will studya model of the complete economy, the

classical model,

that was developed over the course of ahundred and fifty years, beginning in the late eighteenth century and ending in the early part of the twentieth century. This model makes some strong simplifications that make it easy tounderstand. Although these simplifications are too simplistic for the classical model to captureall of the features of a modern industrial economy, the model is still useful to help us understandcertain features of the economy that are present in the more complete model that we will take uplater in the book.Chapter 4 deals with the labor market and the theory of aggregate supply. It is acomplete description of all of the features that determine output and employment in an economyoperating at full employment. Chapter 5 deals with the classical theory of inflation and inChapter 6 we will study the classical model of the capital markets. At the end of Part 2 you will

have gained an insight into the equilibrium method – the idea that demand equals supply in eachof several markets in the economy simultaneously. You will also learn how this method can beapplied to real world economic problems: the causes of business cycles, the cause of inflation incountries where inflation is very high, and the determination of savings and investment withapplications to current issues such as the aging of the population and the funding of socialsecurity.

Part 3: The Modern Approach to Aggregate Demand and Supply

Part 3 contains five chapters that go beyond the classical model to develop a more modernunderstanding of the theory of aggregate demand and supply. We begin, in Chapter 7, with twoalternative ways of understanding unemployment. We begin the chapter with a classicalperspective that views unemployment as the natural result of the fact that it is costly for firms tosearch for workers. The main idea here is that there is a

natural rate

of unemployment thatoccurs when no firm could profitably reduce unemployment by offering a lower wage or bysearching more intensively for the right employee. We proceed to model the Keynesian ideathat, for much of the time, unemployment may be either above or below this natural rate. Theidea that employment may differ from the natural rate is an important component of theKeynesian theory of aggregate supply.In Chapters 8, 9 and 10 you will study a modern approach to the theory of aggregatedemand. This approach is based on ideas from Keynes’ book

The General Theory of Employment Interest and Money

in which Keynes combined a theory of the demand for money

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