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CHAPTER 5
INTRODUCTION TO MACROECONOMICS
INTRODUCTION
To introduce students to macroeconomics in a natural and familiar way, the economy is compared to
the human body and parallels are drawn. The history of the U.S. economy is traced, using aggregate
supply and demand, and both demand-side economics and supply-side economics are discussed. The
chapter also conveys the difficulty of testing macroeconomic theories and includes a discussion of the
recession of 2007-2009.
CHAPTER OUTLINE
I. The National Economy: (Slides 3-9)
• Economy: the structure of economic life, or economic activity, in a community, a
region, a country, a group of countries, or the world.
• GDP (gross domestic product): The market value of all final goods and services
produced in the U.S. during a given period, usually a year.
A. What’s Special about the National Economy? Each country has its own “rules of
the game” (laws, regulations, customs, manners, and conventions).
B. The Human Body and the Economy: The economy, like the body: (1) consists of
many parts, each performing particular functions yet linked, (2) is continually
renewing itself and (3) involves circular flow through the system.
1. Flows and Stock Variables:
▪ Flow: A measure of an amount per unit of time.
▪ Stock: Amount measured at particular point in time.
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200 Chapter 5 Introduction to Macroeconomics
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Chapter 5 Introduction to Macroeconomics 201
of the economy was created. Prior to that time, macroeconomic policy was
based on the “laissez-faire” philosophy of Adam Smith.
B. The Age of Keynes: After the Great Depression to the Early 1970s
(Slides 30-35)
• Demand-side economics: Focused on how changes in aggregate demand
could promote full employment.
C. Stagflation: 1973 to 1980 (Slides 36-38)
• Stagflation: A contraction in the economy’s aggregate output, along
with inflation, or a rise in the economy’s price level.
D. Relatively Normal Times: 1980 to 2007 (Slides 39-43)
• Supply-side economics: Theorizes that lowering federal tax rates would
increase after-tax wages, which would provide an incentive to increase
the supply of labor and other resources.
• Output and employment grew nicely during the 1990s. The expanding
economy increased federal revenues enough to create a federal budget
surplus by the end of the decade. After achieving the longest expansion
on record, the U.S. economy slipped into recession aggravated by the
terrorist attacks of September 2001. The subsequent expansion lasted until
2007.
E. The Recession of 2007-2009 and Beyond (Slides 44-50)
• The economy went in recession in early 2008 because of falling home prices
and rising foreclosure rates. The collapse of a Wall Street bank in September
2008 panicked financial markets around the world, cutting investment and
consumption. Job losses were the worst since the Great Depression.
• Massive federal programs aimed at stabilizing the economy resulted in
gigantic federal deficits. Economic growth returned in the second half of
2009.
CONCLUSION
In a sense, macroeconomics is retrospective, always looking at recent developments for hints about
which model works best. Each new batch of information about the economy causes macroeconomists
to check their models. Macroeconomics often emphasizes what can go wrong with the economy.
Sagging output, high unemployment, and rising inflation capture much of the attention. But perhaps
the most important performance measure is economic growth.
CHAPTER SUMMARY
Macroeconomics focuses on the national economy. A standard measure of performance is the growth
of real gross domestic product, or real GDP, the value of all final goods and services produced in the
nation during the year.
The economy has two phases: periods of expansion and periods of contraction. No two business cycles
are the same. Before 1945, expansions averaged 29 months, and contractions 21 months. Since 1945,
expansions have averaged 57 months and contractions 11 months. Despite the Great Depression and
later recessions, the economy’s output has grown thirteenfold since 1929 and jobs have grown faster
than the population.
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202 Chapter 5 Introduction to Macroeconomics
The aggregate demand curve slopes downward, reflecting a negative, or inverse, relationship between
the price level and real GDP demanded. The aggregate supply curve slopes upward, reflecting a
positive, or direct, relationship between the price level and real GDP supplied. The intersection of the
two curves determines the economy’s real GDP and price level.
The Great Depression and earlier depressions prompted John Maynard Keynes to argue that the
economy is unstable, largely because business investment is erratic. Keynes did not believe that
contractions were self-correcting. He argued that whenever aggregate demand sagged, the federal
government should spend more or tax less to stimulate aggregate demand. His demand-side policies
dominated macroeconomic thinking between World War II and the later 1960s.
During the 1970s, higher oil prices and global crop failures reduced aggregate supply. The result was
stagflation, the troublesome combination of declining real GDP and rising inflation. Demand-side
policies appeared less effective in an economy suffering from a reduction in aggregate supply because
stimulating aggregate demand would worsen inflation.
Supply-side tax cuts in the early 1980s were aimed at increasing aggregate supply, thereby increasing
output while dampening inflation. Output and employment grew nicely during the 1980s, but federal
spending increased faster than federal tax revenue, resulting in budget deficits that grew into the 1990s.
Output and employment grew nicely during the 1990s. The expanding economy increased federal
revenues enough to create a federal budget surplus by the end of the decade. But after the longest
expansion on record, the economy experienced an eight-month recession in 2001. The economy started
growing again, and the expansion lasted until the end of 2007.
The economy went in recession in early 2008 because of falling home prices and rising foreclosure
rates. The collapse of a Wall Street bank in September 2008 panicked financial markets around the
world, cutting investment and consumption. Job losses were the worst since the Great Depression.
Massive federal programs aimed at stabilizing the economy resulted in gigantic federal deficits.
Economic growth returned in the second half of 2009.
TEACHING POINTS
1. It may be useful to point out to students here that the reasons for the negative and positive slopes
of the demand and supply curves of individual goods do not apply in dealing with the AS and AD
curves. For example, holding “other prices” and “money income” constant is not appropriate in
construction of the AD curve, and aggregate suppliers may be neither willing nor able to offer
more output when the aggregate price level increases.
2. A short time series will show that the U.S. economy did not really have a serious fall in income
until 1931. The low point was reached in 1933 during a period of terrific monetary contraction.
Many people mistakenly believe that the economy rose continually after that point in time (owing
to FDR’s New Deal). However, the economy turned down again in 1938, although the drop was
not as deep as the one that occurred in 1933. After 1938 the economy rose steadily as a result of
the military spending that began at that time.
3. Some students may think that study of the Great Depression is akin to the study of dinosaurs.
However, many have noted parallels between recent times ("The Great Recession") and the Great
Depression, especially as relates to the dramatic rises and falls in the stock market.
4. The purpose of introducing AS-AD in this chapter is to provide the student a sense of the two sides
to macroeconomics: supply and demand. It capsulizes national income determination and the
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Chapter 5 Introduction to Macroeconomics 203
determination of the price level in a heuristic way. Nevertheless, it can be troublesome explaining
why a lower price level increases the quantity of aggregate output demanded (certainly not because
of a decrease in the demand for substitute goods). A drop in the price level, holding all else
constant, makes money balances more valuable, thus giving rise to greater demand for output.
5. You may wish to ask the students how the AS and AD curves would shift in each of the
following situations: (1) government spending increases, (2) consumer confidence improves, (3)
personal tax rates are cut, and (4) the aggregate price level changes (not shifting either curve).
6. Send students to websites like the Bureau of Economic Analysis or the Economic Report of the
President to find out what has happened to the macroeconomy since the recession of 2007-2009.
Each national economy has its own rules of the game, that is, its own laws, regulations, customs,
and conventions for conducting economic activity. U.S. gross domestic product provides a
measure of the performance of the national economy and of how it interacts with the rest of the
world.
2. (The Human Body and the U.S. Economy) Based on your own experiences, extend the list of
analogies between the human body and the economy as outlined in this chapter. Then determine
which variables in your list are stocks and which are flows.
Answers will vary. Students could describe parallels between the food that the body needs for
energy and growth with the savings that an economy must generate to fuel investment and
economic growth. Food and savings are examples of flow variables, are measured over a period
of time. When a body is weighed, a human has an objective idea of his or her size at a certain
point in time. When the government measures the inventory of the economy, the economy has a
measure of its size at a particular point in time. Weight and inventory are examples of stock
variables.
3. (Stocks and Flows) Differentiate between stock and flow variables. Give an example of each.
Stock variables are measures at a given point in time such as height, weight, checking account
balance. Flow variables measure something over an interval such as annual income, monthly
budget.
4. (Economic Fluctuations) Describe fluctuations in economy activity over time. Because economic
activity fluctuates, how is long-term growth possible?
The economy moves through periods of expansion and periods of contraction. Contractions
include recessions in which total output and employment decline over a six-month period and
more serious depressions in which sharp reductions occur in output and employment that last
more than a year. The end of a contraction is marked by the trough, or lowest point. After the
trough, the economy enters an expansion period in which total output increases until the economy
reaches its peak.
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204 Chapter 5 Introduction to Macroeconomics
The economy grows over time. This is possible because the growth during expansions more
than offsets the decline during recessions. In fact, expansions and contractions are measured as
movements above and below the long-term trend line.
5. (Economic Fluctuations) Why doesn’t the National Bureau of Economic Research identify the
turning points in economic activity until months or even a year after they occur?
The economy does not move smoothly through recessions and expansions. Throughout each year,
the economy goes through seasonal fluctuations, for example, the tourist industry in Colorado
expands during the winter months. In addition, the economy experiences random disturbances,
such as the impact due to hurricanes or earthquakes. The NBER must wait to determine whether
a change in the direction of the economy is sustained in order to distinguish the impact of
seasonal fluctuations and random disturbances and the movement into a recession or expansion.
6. (The Great Recession) The recession of 2007-2009 was made worse by a global financial crisis.
Show the effect of the Great Recession on the economy by shifting aggregate demand and/or
aggregate supply curves as appropriate.
7. (Leading Economic Indicators) Define leading economic indicators and give some examples.
You may wish to take a look at The Conference Board’s index of leading economic indicators
at http://www.conference-board.org/data/.
Leading economic indicators are economic statistics that change prior to a change in the overall
economy. That is, they turn downward before a recession and upward before an expansion, thus
pointing to the future direction of the overall economy. Examples include orders for machinery
and equipment, the stock market index, consumer confidence, and household spending on durable
goods.
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Chapter 5 Introduction to Macroeconomics 205
8. (Aggregate Demand and Aggregate Supply) Why does a decrease of the aggregate demand curve
result in less employment, given an aggregate supply curve?
When aggregate demand decreases along a fixed aggregate supply curve, both the price level
and the output level drop. As aggregate output declines, fewer workers are needed and
unemployment rises.
9. (Aggregate Demand and Aggregate Supply) Is it possible for the price level to fall while
production and employment both rise? If it is possible, how could this happen? If it is not
possible, explain why not.
Yes, this could occur if aggregate supply and aggregate demand increased. Both curves would
shift to the right, but the aggregate supply curve would shift more than the aggregate demand
curve. This would force down the price level while increasing production. Increased production
and a lower price level would also occur if aggregate supply increased along a fixed demand
curve.
10. (Aggregate Demand Curve) Describe the relationship illustrated by the aggregate demand curve.
Why does this relationship exist?
Aggregate demand describes an inverse relationship between the average price level of all goods
and services and the total quantities of goods and services demanded throughout the entire
economy. The quantity of aggregate output demanded depends in part on household wealth. An
increase in the price level decreases the purchasing power of bank accounts and currency. Thus,
households are poorer when the price level increases, so they decrease the quantity of aggregate
output demanded.
11. (Demand-Side Economics) What is the relationship between demand-side economics and the
federal budget deficit?
Demand-side economics focuses on the ability of the government to affect aggregate demand and
thus promote full employment. During periods of unemployment, demand-side economics
recommends that the federal government expand aggregate demand by increasing government
spending and/or cutting taxes. This is likely to result in budget deficits, when government
expenditures exceed government tax revenues.
12. (Stagflation) What were some of the causes of the stagflations of 1973 and 1979? In what ways
were these episodes of stagflation different from the Great Depression of the 1930s?
In 1973, crop failures around the world caused grain prices to rise substantially. At the same
time, OPEC raised oil prices sharply. These two events combined to reduce aggregate supply,
causing the price level to rise while output and employment fell. In 1979, oil prices again rose
sharply, and aggregate supply dropped.
In contrast, the Great Depression occurred with a significant drop in aggregate demand.
Therefore, while output and employment fell, prices dropped—unlike the price increases that
come with stagflation. In addition, the Great Depression lasted much longer and caused a much
greater drop in output and employment.
13. (Recession of 2007-2009) How did the recession of 2007-2009 affect the economy?
Employment fell by 8.4 million jobs. The federal budget deficit tripled from $408 billion to $1.4
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206 Chapter 5 Introduction to Macroeconomics
14. (CaseStudy: Eight Decades of Real GDP and Price Levels) The price level grew slightly faster
than real GDP between 1947 and 2011. Does this mean that the rising price level masked an
actual decline in output? Why or why not?
No, there was an actual increase in aggregate output between 1947 and 2011. Real GDP figures
are adjusted already for any increases in the price level. The fact that the price level increased
so much faster means that nominal GDP grew at a much faster rate than real GDP.
15. (Aggregate Demand and Supply) Review the information on demand and supply curves in
Chapter 4. How do the aggregate demand and aggregate supply curves presented in this chapter
differ from the market curves of Chapter 4?
The demand and supply curves in Chapter 4 describe the relationship between the price of an
individual product or product category, such as textbooks or food, and the quantities of that
individual item demanded and supplied. Aggregate demand and aggregate supply describe the
relationship between the average price level of all goods and services and the total quantities of
goods and services demanded and supplied throughout the entire economy.
16. (Aggregate Demand and Supply) Determine whether each of the following would cause a shift
of the aggregate demand curve, a shift of the aggregate supply curve, neither, or both. Which
curve would shift, and in which direction? What happens to aggregate output and the price level
in each case?
a. The price level changes
b. Consumer confidence declines
c. The supply of resources increases
d. The wage rate increases
a. Neither curve would shift. A change in the price level would cause a movement along the curves.
b. Aggregate demand shifts left because less consumer confidence reduces the aggregate output
demanded at each price level. Therefore, both aggregate output and the price level fall.
c. Aggregate supply shifts right. There is an increase in the aggregate output supplied at each price
level. Therefore, aggregate output increases and the price level falls.
d. Aggregate supply shifts left as the costs of production have risen. Therefore, aggregate output falls
and the price level rises..
17. (Supply-Side Economics) One supply-side measure introduced by the Reagan administration was
a cut in income tax rates. Use an aggregate demand/aggregate supply diagram to show what effect
was intended. What might happen if such a tax cut also shifted the aggregate demand curve?
Lower tax rates were intended to increase after-tax earnings and thus increase incentives for
resource owners to provide labor and capital. The resulting rightward shift in aggregate supply
would increase aggregate output and lower the price level. The increase in after-tax earnings
would also increase aggregate demand, which would increase aggregate output and raise the
price level. The overall impact on the price level would depend on the relative sizes of the shifts
in the aggregate supply and the aggregate demand.
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you’re the whitest bunch that I ever traveled with—all but Nat Silmore and
his pair of black sheep.”
The last night came, and the camp paraphernalia was pretty well packed
up. Mr. Bartlett had made arrangements for the wagons to be on hand early
on the following morning to haul the camp material down to the railroad,
where it could be put aboard the same train which Mr. Holwell had taken,
coming along about ten o’clock.
Although they had certainly had a wonderfully fine time of it,
apparently nobody seemed sorry because they were about to start back to
Cliffwood. Home yearnings had commenced to be felt of late, and some of
the boys could hardly wait for the dawn to break. Indeed, the last night in
camp promised to be about as sleepless as the first had been, judging from
their excitement.
All through their stay keen rivalry had continued between those who
were entered for the various prizes. The result would not be known until
Mr. Bartlett and the physical director could have a chance to count up the
scores and announce results. This, of course, served to keep the interest of
the contestants at fever heat.
There was also the interest in the plan aided and abetted by Mr. Bartlett,
who contributed liberally toward raising a certain sum. This was presented
to the genial cook, whose good nature had endured through the entire
stretch of camp life.
Mr. Bartlett made the presentation, heartily applauded by the boys.
“Here’s ten dollars we’ve chipped in, Sunny Jim,” he said to the
astonished cook, whose eyes danced with pleasure. “We want you to buy
the best watch you can find in Cliffwood for the money. Every time you
look at it think of Camp Russabaga. And I voice the sentiments of every
boy here when I say we hope to have you cook for us again next summer.
Give Jim three cheers, lads, for he deserves well of us.”
That was one of the proudest moments of Sunny Jim’s life, though he
had lost his voice apparently, so that he could only stand, nod his woolly
head violently and grin.
We shall hope to meet Dick and his many friends again in the pages of
another volume. That the seed of his prophecy regarding the brightening of
Cliffwood’s skies in the matter of athletic sports among the younger
element was not doomed to fall by the roadside, or among thorns that would
choke it, can be guessed from the title of our next book, which will be
called “The Y. M. C. A. Boys at Football; Or, Lively Doings On and Off the
Gridiron.”
All of the lads were up before daylight on the last morning on Bass
Island. The tents came down and were hastily packed, while breakfast was
being prepared. Indeed, a trip across with both boats had been made before
the campers sat down to the morning meal.
“It’s our last breakfast on Bass Island, boys,” said Mr. Bartlett, looking
around at the circle of eager faces; “and if I know what I’m talking about
we’ll all remember for many a day the great times we’ve had up here. We
hope we shall have good luck in developing and printing the pictures,
because they’ll illustrate our story about the gorilla. And last, but not least,
we’re glad to know that little Josh Jones is well on the road to recovery.
When we get all the stuff over to the mainland we’ll stand around and give
dear old Bass Island one last jolly cheer. Then it’s home for us. Now hurry
and finish, for we ought to start before long.”
With this last glimpse of the Y. M. C. A. Boys we will draw the curtain
and say good-bye.
THE END
THE Y. M. C. A. BOYS SERIES
By BROOKS HENDERLEY
12mo. Cloth. Illustrated. Price per volume, 60 cents, postpaid.
Telling how the boys of Cliffwood were a wild set and how, on
Hallowe’en, they turned the home town topsy-turvy. This led to an
organization of a boys’ department in the local Y. M. C. A. When the
lads realized what was being done for them, they joined in the
movement with vigor and did all they could to help the good cause.
To raise funds they gave a minstrel show and other entertainments,
and a number of them did their best to win a gold medal offered by a
local minister who was greatly interested in the work of upbuilding
youthful character.
In this tale the scene is shifted to the seashore, where the boys
are having a vacation for the summer. Encouraged by the
temperance work done in their home town, they join a local crusade
to close the various drinking and gambling houses. They fall in with
another lad, the son of a well-known drunkard of the summer resort,
and do all they can to aid him. A good, clean-cut boys’ story, full of
life and action, not at all preachy, but teaching the best of morals.
By CLARENCE YOUNG
12mo. Illustrated. Price per volume, 60 cents, postpaid.
Fresh from their adventures in their automobile, their motor boat and
their airship, the youths are sent to college to complete their interrupted
education. Some boys at the institution of learning have heard much about
our heroes, and so conclude that the Motor Boys will try to run everything
to suit themselves.
A plot is formed to keep our heroes entirely in the background and not
let them participate in athletics and other contests. How the Motor Boys
forged to the front and made warm friends of their rivals makes unusually
interesting reading.
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