CH1

Macroeconomics is concerned with the overall performance of the economy.

It examines how total investment and consumption are determined, how central banks
manage money and interest rates, what causes international financial crises, nation growth /
stagnation.

3 problems of economic organizations:

 What commodities are produced and in what quantities?

 How are goods produced?
 For whom are goods produced?

(Inputs = factors of production) are commodities or services that are used to produce
goods and services. An economy uses its existing technology to combine inputs to
produce outputs.

3 categories of factors of production (inputs):

 Land —or, more generally, natural resources

 Labor consists of the human time spent in production
 Capital resources form the durable goods of an economy, produced in order to produce
yet other goods. Capital goods include machines, roads, computers, software, trucks,
steel mills, automobiles, washing machines, and buildings. As we will see later, the
accumulation of specialized capital goods is essential to the task of economic
development.
 CH19
2 central themes in Macroeconomics:

• The short-term fluctuations in output, employment, financial

conditions, and prices that we call the business cycle
• The longer-term trends in output and living standards known
as economic growth

 What are the sources of price inflation, and how can it be kept under control?

Price inflation is the sustained increase in the general price level of goods and services in an
economy over a period of time. There are several sources of price inflation, including:

1. Demand-pull inflation: This occurs when there is a sustained increase in demand for
goods and services that outpaces the ability of the economy to produce them, causing
prices to rise.
2. Cost-push inflation: This occurs when the costs of production, such as raw materials and
labor, increase, leading to higher prices for goods and services.
3. Monetary inflation: This occurs when the money supply in an economy increases too
rapidly, leading to a decline in the value of money and an increase in prices.
4. Built-in inflation: This occurs when expectations of future inflation become ingrained in
the economy, leading to rising prices even when there is no increase in demand or
production costs.

To keep inflation under control, central banks and governments can use a variety of tools,
including:

1. Monetary policy: The central bank can control the money supply by raising or lowering
interest rates, which can help to curb inflation.
2. Fiscal policy: The government can control spending and taxation to help regulate
demand in the economy and keep prices under control.
3. Price controls: The government can impose price controls on certain goods and services
to limit the increase in prices.
4. Increased production: The government and businesses can invest in increasing the
production of goods and services to help meet demand and keep prices from rising too
rapidly.
  How can a nation increase its rate of economic growth?

Economic growth refers to an increase in a country's production of goods and services over a
period of time. There are several ways that a nation can increase its rate of economic growth,
including:

1. Investment in physical capital: Investing in infrastructure, machinery, and equipment can

help increase productivity and economic growth.
2. Investment in human capital: Investing in education and training can help increase the
skills and knowledge of the workforce, leading to increased productivity and economic
growth.
3. Innovation and technological advancements: Encouraging and supporting research and
development can lead to new products, processes, and technologies, boosting economic
growth.
4. Trade and globalization: Openness to trade and investment can bring in new ideas,
capital, and technologies, leading to increased economic growth.
5. Deregulation and economic reform: Reducing red tape and removing barriers to entry in
industries can increase competition, spur innovation, and promote economic growth.
6. Fiscal policy: The government can use fiscal policy to stimulate demand in the economy
by increasing government spending or cutting taxes, which can boost economic growth.
7. Monetary policy: The central bank can use monetary policy to regulate the money
supply and control interest rates, which can impact economic growth.

It is important to note that the specific steps that a nation can take to increase its rate of
economic growth will depend on its individual circumstances and needs. Additionally, some
measures to boost economic growth, such as increased government spending, can have
negative side effects, such as increased debt or inflation. The best approach will depend on the
specific conditions and needs of a nation, and a careful balance must be struck between
promoting economic growth and maintaining stability and sustainability in the long term.

Key factors in long-term economic growth include:

 reliance on well-regulated private markets for most economic activity
 stable macroeconomic policy
 high rates of saving and investment
 openness to international trade
 accountable and noncorrupt governing institutions

The most comprehensive measure of total output in the economy is the GDP, it’s the measure
of the market value of all final goods and services.
Potential GDP represents the maximum sustainable level of output that the economy can
produce.

 When real output > potential output what happens to inflation?

There is an increase in demand for goods and services. This increased demand puts upward
pressure on prices, causing inflation.

 economy is operating above its capacity and there is an increase in demand for goods and
services relative to the available supply. As a result, prices for goods and services tend to rise,
which is a hallmark of inflation.

increase in demand = low unemployment

Because companies produce more, which increases demand for labor.
This increase in demand for labor can lead to new job creation.

 How to fix?

In order to combat inflation in this situation, central banks or governments may take steps to
reduce demand by raising interest rates, decreasing government spending, or increasing taxes.

 When potential output > real output what happens to inflation?

There is a decrease in demand for goods and services. This decrease in demand puts
downward pressure on prices, causing deflation.

economy is operating below its capacity and there is a decrease in demand for goods and
services relative to the available supply. As a result, prices for goods and services tend to fall,
which is a hallmark of deflation.

decrease in demand = high unemployment

Because companies produce less, which decreases demand for labor.
This reduction in demand for labor can lead to job losses, reduced hours for workers, or a
slowdown in hiring.

 How to fix?

In order to boost economic growth in this situation, central banks or governments may take
steps to increase demand, such as lowering interest rates, increasing government spending, or
cutting taxes.
Potential GDP tends to grow steadily because inputs like labor and capital and the level of
technology change slowly over time. By contrast, real GDP is subject to large business-cycle
swings if spending patterns change sharply.

Potential Gross Domestic Product (GDP) refers to the maximum level of production that an
economy can sustain without leading to an increase in inflation. It represents the level of output
that an economy can produce if all its resources, including labor and capital, are utilized
efficiently. Potential GDP is typically estimated by economists and can be used to determine the
potential growth rate of an economy over the long term.
Nominal Gross Domestic Product (GDP), on the other hand, refers to the total value of all goods
and services produced within an economy in current market prices. Nominal GDP takes into
account changes in both the prices of goods and services and the quantity of goods and services
produced.
The difference between potential GDP and nominal GDP is that potential GDP is a measure of an
economy's productive capacity, while nominal GDP is a measure of an economy's actual
production. Potential GDP provides a benchmark for what an economy is capable of producing,
while nominal GDP provides an estimate of what an economy is actually producing.
In general, when an economy is operating below its potential GDP, there is room for economic
growth without generating inflationary pressures. When an economy is operating above its
potential GDP, there may be inflationary pressures as demand for goods and services outpaces
the economy's ability to supply them. Understanding the difference between potential GDP and
nominal GDP is important for analyzing the health and potential of an economy, as well as for
making informed decisions about economic policy.

Real Gross Domestic Product (GDP) and Nominal Gross Domestic Product (GDP) are two
different measures of a country's economic output.
Real GDP is a measure of a country's economic output that takes into account the effects of
inflation. It is adjusted for price changes and is expressed in constant prices. This means that the
value of real GDP is a more accurate representation of a country's economic output as it
accounts for changes in the purchasing power of money.
Nominal GDP, on the other hand, is the value of economic output measured in current prices,
without any adjustment for inflation. This means that it does not account for changes in the
purchasing power of money, and therefore may overstate the true increase in economic activity.
In summary, Real GDP provides a more accurate picture of a country's economic growth, while
Nominal GDP is a measure of economic output in current prices.

Real Gross Domestic Product (GDP) and Nominal Gross Domestic Product (GDP) are two
different measures of a country's economic output.
Real GDP is a measure of a country's economic output that takes into account the effects of
inflation. It is adjusted for price changes and is expressed in constant prices. This means that the
value of real GDP is a more accurate representation of a country's economic output as it
accounts for changes in the purchasing power of money.
Nominal GDP, on the other hand, is the value of economic output measured in current prices,
without any adjustment for inflation. This means that it does not account for changes in the
purchasing power of money, and therefore may overstate the true increase in economic activity.
In summary, Real GDP provides a more accurate picture of a country's economic growth, while
Nominal GDP is a measure of economic output in current prices.

Real output and potential output are related concepts, but they are not the same as real and
potential Gross Domestic Product (GDP).
Real output is the actual output of goods and services produced by an economy, while potential
output is the maximum level of output that an economy can produce without generating
inflation. Real output can be less than or equal to potential output, but it cannot be greater.
On the other hand, real GDP is the value of economic output measured in constant prices,
adjusted for inflation, while nominal GDP is the value of economic output measured in current
prices, without any adjustment for inflation.
In summary, real output and potential output are related to the production of goods and
services within an economy, while real GDP and nominal GDP are measures of the value of the
economic output.

Real output cannot be greater than potential output because if real output exceeds potential
output, it would put upward pressure on prices and lead to inflation. In other words, if an
economy produces more goods and services than it is capable of producing without generating
inflation, then the excess demand for goods and services will drive up prices.
When the economy is producing at its potential output, all factors of production, including labor
and capital, are being utilized efficiently and at full capacity. If the economy produces beyond
this level, then resources become scarce, leading to an increase in prices as firms compete for
these scarce resources. This can cause a spiral of rising prices, reducing the purchasing power of
money and leading to inflation.
Therefore, to maintain stable prices and avoid inflation, real output must remain less than or
equal to potential output.

Recession: period of a significant decline in total output, income, and employment, usually
lasting more than a few months and marked by widespread contractions in many sectors of the
economy.
Depression: severe and protracted downturn. Output can be temporarily above its potential
during booms and wartime as capacity limits are strained, but the high utilization rates may
bring rising inflation and are usually ended by monetary or fiscal policy.

Recessions are just milder and shorter depressions.

Deflation: prices decline (which means that the rate of inflation is negative).
Hyperinflation: a rise in the price level of a thousand or a million percent a year.

Policy Instrument: is an economic variable under the control of the government that can affect
one or more of the macroeconomic goals.
Policy Instruments

Fiscal Policy Monetary Policy

• By changing monetary, fiscal, and other policies, governments can avoid the worst excesses of
the business cycle or increase the growth rate of potential output.

Fiscal policy denotes the use of taxes and government expenditures.

Government expenditures come in two distinct forms: government purchases & government
transfer payments

The second major instrument of macroeconomic policy is monetary policy, which the
government conducts by managing the nation’s money, credit, and banking system.