Principles of Macroeconomics Overview of Macroeconomics

Assoc Prof, PhD Nguyen Thi Thuy VINH

Foreign Trade University

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Recall,…what is economics?
Why should you study of economics?
 Economics is concerned with the way scarce resources
• it will help you understand the world in which are allocated among alternative uses to satisfy human
you live; wants.
• it will make you to become a more clever Resources are scarce > < Human wants is unlimited
participant in the economy;
 The three questions of any economy are:
• it will give you a better understanding of both What to produce?
the potential and the limits of economic policy.
How to produce it?
For whom to produce it?

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 Recall,…what is economics?
• In a command economy, the government or central
planning decides all three answers.
• In a market economy, the producers decide what and
how and the consumers (based on prices and their
demand) decide for whom by buying the products.
• In mixed economy, both private and public sectors
work together to solve economic problems.
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Recall,…what is economics?
 Ten Principles of Economics
• How the Economy as a Whole Works
(9) Prices rise when the government prints too much
money
• Inflation is an increase in the overall level of prices in
the economy.
• One cause of inflation is the growth in the quantity of
money.
• When the government creates large quantities of
money, the value of the money falls.
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Recall,…what is economics?
 Ten Principles of Economics
• How the Economy as a Whole Works
(8) A country’s standard of living depends on its
ability to produce goods and services
• Almost all variations in living standards are explained
by differences in countries’ productivities.
• Productivity is the amount of goods and services
produced from each hour of a worker’s time.
Recall,…what is economics?
 Ten Principles of Economics
• How the Economy as a Whole Works
(10) Society faces a short-run trade-off between
inflation and unemployment
• The Phillips Curve illustrates the tradeoff between
inflation and unemployment:
Inflation   Unemployment 
It’s a short-run tradeoff!
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 Recall,….the methodology of economics Recall,….the methodology of economics
Economists play two roles:
Observe to identify problem
1. Scientists: try to explain the world
2. Policy advisors: try to improve it
 Economists employ the scientific method, Develop a model based on
Observation  Theory and …  More Observation simplified assumptions

- Uses abstract models to help explain how a

complex, real world operates. Collect data, test model,
- Develops theories, collects, and analyzes data to and formulate a conclusion
evaluate the theories.
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Recall,….the methodology of economics Recall,….the methodology of economics

 Economic Models
 The Role of Assumptions
…are simplified versions of a more complex reality
• Economists make assumptions in order to make the - irrelevant details are stripped away
world easier to understand.
…are used to
• The art in scientific thinking is deciding which
- show relationships between variables
assumptions to make.
- explain the economy’s behavior
• Economists use different assumptions to answer - devise policies to improve economic performance
different questions.

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 Recall,….the methodology of economics
 Economic Models
Economists use models to study economic issues.
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Supply and Demand for new cars
• shows how various events affect price and quantity of
cars
• assumes the market is competitive: each buyer and
seller is too small to affect the market price
Variables
Qd = quantity of cars that buyers demand
Qs = quantity that producers supply
P = price of new cars
Y = aggregate income
Ps = price of steel (an input)
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Recall,….the methodology of economics
 Economic Models
• Basic economic models:
- Demand and Supply
- The Circular Flow Diagram
- The Production Possibilities Frontier
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Recall,…Endogenous vs. Exogenous variables
• The values of endogenous variables are determined
in the model.
• The values of exogenous variables are determined
outside the model:
the model takes their values & behavior as given.
• In the model of supply & demand for cars,
endogenous:
exogenous:
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 The Circular-Flow Diagram
Households:
• a visual model of the economy, shows how money  Own the factors of production,
flow through markets among households and firms sell/rent them to firms for income
 Buy and consume goods & services
• Two types of “actors”:
– households
Firms Households
– firms
• Two markets: Firms:
– the market for goods and services  Buy/hire factors of production,
– the market for “factors of production” use them to produce goods and
services
 Sell goods & services
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FIGURE 1: The Circular-Flow Diagram

The Production Possibilities Frontier (PPF)
Revenue Spending
Markets for
Goods & • a graph that shows the combinations of
G&S G&S
sold Services two goods the economy can possibly produce given
bought
the available resources and the available technology
• Example:
Firms Households – Two goods: computers and wheat
– One resource: labor (measured in hours)
Factors of Labor, land,
– Economy has 50,000 labor hours per month available
production Markets for capital for production.
Factors of
Wages, rent, Production Income
interest or profit
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 PPF Example PPF Example
• Producing one computer requires 100 hours labor.
Wheat
• Producing one ton of wheat requires 10 hours labor. Point Production
(tons)
on Com-
Employment of 6,000
Production graph puters Wheat E
labor hours 5,000
A 500 0 D
Computers Wheat Computers Wheat 4,000 G
B 400 1,000
3,000 C
A 50,000 0 500 0 F
C 250 2,500
2,000
B 40,000 10,000 400 1,000 D 100 4,000 B
1,000
C 25,000 25,000 250 2,500 E 0 5,000 A
0
D 10,000 40,000 100 4,000 0 100 200 300 400 500 600
Computers
E 0 50,000 0 5,000
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PPF Example Economic Growth and the PPF

Points on the PPF (like A – E) With additional Wheat
Economic
resources or an (tons)
– possible 6,000 growth shifts
improvement in
– efficient: all resources are fully utilized the PPF
technology, 5,000 outward.
the economy can
Points under the PPF (like F) produce more
4,000
– possible computers, 3,000
– not efficient: some resources underutilized more wheat, 2,000
(e.g., workers unemployed, factories idle) or any combination in 1,000

Points above the PPF (like G) between. 0

0 100 200 300 400 500 600
– not possible
Computers

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 I– What is Macroeconomics?
Economics is divided into two subfields:
- Microeconomics studies how households and firms
make decisions and how they interact in markets.
- Macroeconomics is concerned with the behavior of the
economy as a whole – with booms and recessions,
economic growth, inflation, unemployment, the balance
of payment, and exchange rate.
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I– What is Macroeconomics?
For examples,
• What causes recessions? What is “government
stimulus” and why might it help?
• Why does the cost of living keep rising?
• Why are so many countries poor? What policies
might help them grow out of poverty?
• What is the government budget deficit?
How does it affect workers, consumers, businesses,
and taxpayers?
• What is the trade deficit? How does it affect the
country’s well-being?
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II- Basic Model of Macroeconomics

The use of multiple models
Exogenous Macroeconomics Endogenous
Variables Models Variables • No one model can address all the issues we care
(AS x AD) about.
• E.g., our supply-demand model of the car market…
Variables that a model Variables that a model
takes as given tries to explain – can tell us how a fall in aggregate income affects
price & quantity of cars.
Output, economic growth – cannot tell us why aggregate income falls.
Non- Economic
economic factors Inflation rate
factors
Unemployment rate
Economic
policies
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 The use of multiple models
• So we will learn different models for studying
different issues (e.g., unemployment, inflation, long-
run growth).
• For each new model, you should keep track of
– its assumptions
– which variables are endogenous,
which are exogenous
– the questions it can help us understand,
those it cannot
Assumption of Prices: flexible vs. sticky
• Market clearing: An assumption that prices are
flexible, adjust to equate supply and demand.
• In the short run, many prices are sticky –
adjust sluggishly in response to changes in supply or
demand. For example:
– many labor contracts fix the nominal wage for a
year or longer
– many magazine publishers change prices only once
every 3-4 years

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Assumption of Prices: flexible vs. sticky

• The economy’s behavior depends partly on whether

prices are sticky or flexible:
– If prices sticky (short run),
demand may not equal supply, which explains:
• unemployment (excess supply of labor)
• why firms cannot always sell all the goods
they produce
– If prices flexible (long run), markets clear and
economy behaves very differently

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