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An Introduction to Macroeconomics

An Introduction to Macroeconomics

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Published by Fernan Ada Santos

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Published by: Fernan Ada Santos on Nov 27, 2012
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OVERVIEW OF MACROECONOMICSAn Introduction to Macroeconomics
Macroeconomics
studies the behavior of the economy as a whole. It is primarily concerned with twotopics: long-run economic growth and the short-run fluctuations in output and employment that areoften referred to as the
business cycle
.
Performance and Policy
Real GDP
or real gross domestic product, measures the value of final goods and services producedwithin the borders of a given country during a given period of time, typically a year. To get real GDP,government statisticians, first calculate
nominal GDP
, which totals the dollar value of all goods andservices produced within the borders of a given country using their current prices during the year thatthey were produced
Unemployment
is the state a person is in if he or she cannot get a job despite being willing to work andactively seeking work. High rates of unemployment are undesirable because they indicate that a nationis not using a large fraction of its most important resource-the talents and skills of its people.
Inflation
is an increase in the overall level of prices. This can be problematic for several reasons. First, a
person’s standard of living fall. Along the same lines, a surprise jump in inflation reduces the purchasingpower of people’s savings.
 
Modern Economic Growth
Modern Economic Growth
(in which output per person rises) under modern economic growth, theannual increase in output per person is often not large, perhaps 2 percent per year in countries such asEngland that were the first to industrialize. But when compounded over time, an annual growth rate of 2percent adds up very rapidly.
Savings, Investment, and Choosing between Present and Future Consumption
Savings
are generated when current consumption is less than current output (or when current spendingis less than current income)
Investment
happens when resources are devoted to increasing future output.
Financial Investment
captures what ordinary people mean when they say investment, namely the purchase of assets likestocks, bonds, and real estate in the hope of reaping a financial gain.
Economic Investment
has to dowith the creation and expansion of business enterprises. Specifically, economic investment only includesmoney spent purchasing newly created capital goods such as machinery, tools, factories, andwarehouses.
 
Banks and Other Financial Institutions
Banks and Other Financial Institutions
help to convert saving into investment by taking the savingsgenerated by households and lending it to businesses that with to make investment. Macroeconomicsdevotes considerable attention to money, banking, and financial institutions because a well-functioningfinancial system helps to promote economic growth and stability by encouraging savings and byproperly directing that savings into the most productive possible investments.
Uncertainty, Expectations, and Shocks
Expectations
have an important effect on the economy for two reasons. First, if people and businessesare more positive about the future, they will save and invest more. Second, individuals and firms mustmake adjustments to shocks-situations in which expectations are unmet and the future does not turnout the way people were expecting.Firms are often forced to cope with
shocks-
situations in which they were expecting one thing to happenbut then something else happened.
Demand Shocks
are unexpected change in the demand for goodsand services.
Supply Shocks
are unexpected changes in the supply of goods and services. In particularshocks often imply situations where the quantity supplied of a given good or service does not equal thequantity demanded of that good or service.
Basic Macroeconomic Relationship
The income-consumption and Income-saving relationship
Other things equal, there is a direct (positive) relationship between income and consumptionand income and saving. The consumption and saving schedules show the various amounts thathouseholds intend to consume and save at the various income and output levels, assuming a fixed pricelevel.
The Consumption Schedule
It reflects the direct consumption-disposable income relationship suggested by the data and it isconsistent with many household budget studies. In the aggregate, households increase their spending astheir disposable income rises and spend a larger proportion of a small sisposable income than of a largedisposable income
The Saving Schedule
It is relatively easy to derive a saving schedule. Because saving equals disposable income lessconsumption, we need only subtract consumption form disposable income to find the amount saved ateach DI. The
break-even income
is the income level at which household plan to consume their entireincomes.
 
Average and Marginal Propensities
The average propensities to consume and save show the fractions of any total income that areconsumed and saved; APC + APS = 1. The marginal propensities to consume and save show the fractionsof any change in total income that are consumed and saved; MPC + MPS = 1
Non-income Determinants of Consumption
 
Wealth
Households build wealth by saving money out of current income. The point of buildingwealth is to increase consumption possibilities. Events sometimes suddenly boost the value of existing wealth. When this happens, households ten to increase their spending and reduce theirsaving. This so-called
wealth effect
shifts the consumption schedule upward and the savingschedule downward.
 
Borrowing
 When a household borrows, it can increase current consumption beyond what would bepossible if its spending were limited to its disposable income. By allowing households to spendmore, borrowing shifts the current consumption schedule upward.
 
Expectations
 Household expectations about future prices and income may affect current spendingand saving. For example, expectations of rising prices tomorrow may trigger more spending andless saving today. Thus, the current consumption schedule shifts up and the current savingschedule shifts down.
 
Real Interest Rates
 When real interest rates fall, households tend to borrow more, consume more, and saveless. A lower interest rate also diminishes the incentive to save because of the reduced interest
“payment” to the saver. At best, lower interest rates shift the consumption schedule slightly
upward and the saving schedule slightly downward. Higher interest rates do the opposite.
Other Important Considerations
 
Switching to real GDP
Economists change their focus from the relationship between consumption anddisposable income to the relationship between consumption and real domes output
 
Changes along schedules
The movement from one point to another on a consumption schedule is a change in theamount consumed and is solely caused a change in real GDP

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