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After studying this chapter you will be able to

Describe the origins and issues of macroeconomics

Describe the trends and fluctuations in economic growth
and explain the benefits and costs of economic growth
Describe the trends and fluctuations in unemployment
and explain why unemployment is a problem
Describe the trends and fluctuations in inflation and the
value of the dollar and explain why inflation is a problem
Describe the trends and fluctuations in surpluses,
deficits, and debts and explain why they matter
Identify the macroeconomic policy challenges and list the
tools available for meeting them
Macroeconomics is the study of employment,
output, and prices in a decentralized, market
Macroeconomic is the study of aggregate
behavior of economic aggregates, such as level
of output, price level, and growth of output.
Macroeconomic measuresreal output (real
GDP), price level (GDP deflator), inflation rate
and the growth of real output.
What Will Your World Be Like?
Will tomorrows world be more prosperous than today?
Will jobs be plentiful?
Will the cost of living be stable?
Will the governments and the nations deficit continue to
What macroeconomic policy tools does the government
have to steer the course of the economy?
Origins and Issues of Macroeconomics
Economists began to study economic growth, inflation,
and international payments during the 1750s.
Modern macroeconomics dates from the Great
Depression, a decade (1929-1939) of high unemployment
and stagnant production throughout the world economy.
John Maynard Keynes book, The General Theory of
Employment, Interest, and Money, began the subject.

Some Great Depression Statistics
Worst points:
In October 1929, stock market collapsed loosing more
than 1/3
of its value in two weeks.
1933 was the worst year of Great Depression:
US GDP in 1933 was 70% of 1929
Unemployment rate was 3.2% in 1929 which
increased to 25% in 1933
Wage rates fell from 57 cents an hour in 1929 to 44
cents an hour.
Good points:
Price level also fell by a larger percentage, so real
wages of workers with jobs became better.

Origins and Issues of Macroeconomics
Short-Term Versus Long-Term Goals
Keynes focused on the short-termon unemployment
and lost production.
In the long run, said Keynes, were all dead.
During the 1970s and 1980s, macroeconomists became
more concerned about the long-terminflation and
economic growth.
Economic Growth and Fluctuations
Economic growth is the expansion of the economys
production possibilitiesan outward shifting PPF.
We measure economic growth by the increase in real
Real GDP (real gross domestic product) is the value of the
total production of all the nations farms (i.e. agriculture)
factories (i.e. industry) and shops and offices (i.e.
services) measured in the prices of a single year.

Economic growth in Pakistan
Year (avg. annual %) Growth rate
1960s 6.8
1970s 4.8
1980s 6.5
1990s 4.6
2000s 4.7
2007-08 3.7
2008-09 1.7
2009-10 3.1
2010-11 3.0
2011-12 3.7
Comparing Economic Growth in Pakistan
Economic Growth and Fluctuations
Economic Growth in the
United States
Figure 20.1 shows real
GDP in the United States
from 1960 to 2005.
The figure highlights:
Growth of potential GDP
Fluctuations of real GDP
around potential GDP
Economic Growth and Fluctuations
Growth of Potential GDP
Potential GDP is the value
of production when all the
economys labor, capital,
land, and entrepreneurial
ability are fully employed.
During the 1970s, the
growth of output per person
in the U.S. sloweda
phenomenon called the
productivity growth
Economic Growth and Fluctuations
Fluctuations of Real GDP
Around Trend
Real GDP fluctuates
around potential GDP in a
business cyclea
periodic but irregular up-
and-down movement in
Economic Growth and Fluctuations
Every business cycle has two phases:
1. A recession
2. An expansion
and two turning points:
1. A peak
2. A trough
Figure 20.2 on the next slide illustrates these features of
the business cycle.
Economic Growth and Fluctuations
Most recent business cycle in the United Staes
Economic Growth and Fluctuations
A recession is a period during which real GDP
An expansion is a period during which real GDP

Economic Growth and Fluctuations
Figure 20.3 shows the long-term growth trend and cycles.
Economic Growth and Fluctuations
Economic Growth
Around the World
Figure 20.4(a) compares
the growth rate of real
GDP per person in the
United States with that for
the rest of the world as a
Economic Growth and Fluctuations
Figure 20.4(b) compares
economic growth in the
United States with that in
other countries and
regions from 1996 to
Among the advanced
economies, Japan has
grown slowest and the
newly industrialized Asian
economies have grown
Economic Growth and Fluctuations
Among the developing
economies, Central and
South America have
grown slowest and Asia
has grown fastest.
The world has grown a bit
faster than the United
The Lucas Wedge and Okun Gap
How costly are the growth slowdown and the lost
output over the business cycle?
To answer that question we measure:
The Lucas wedge
The Okun gap

Economic Growth and Fluctuations
The Lucas Wedge
The Lucas wedge is the
accumulated loss of
output from the
productivity growth
slowdown of the 1970s .
Figure 20.5(a) shows
that the Lucas wedge is
$72 trillion or 6.5 times
the real GDP in 2005.
Economic Growth and Fluctuations
The Okun Gap
Real GDP minus
potential GDP is the
output gap.
A negative output gap
is called an Okun gap.
Figure 20.5(b) shows
the Okun gap from
recessions since 1973
is $3.3 trillion or about
30 percent of real GDP
in 2005.
Economic Growth and Fluctuations
Benefits of Economic Growth
The Lucas wedge is a measure of the dollar/Rupee value
of lost real GDP if the growth rate slows. This cost
translates into real goods and services.
A high economic growth rate brings:
Higher per capita income and hence higher standard of
living and more to consume,
Low unemployment rate (i.e. high employment rate)
Better health and education facilities, cleaner water,
cleaner cities,
More spending on R & D (Think more)
Economic Growth and Fluctuations
The cost of low economic growth
The costs of lower economic growth are many, such as:
Lower per capita income and hence lower standard of
Lower per capita consumption of goods and services,
Less health care for the poor and elderly,
Less cancer and AIDS research,
Worse infrastructure such as roads, bridges, and
communication system, and
Less to spend on basic education, clean air, more trees,
and cleaner water.
(add more)
The cost of fast economic growth

But fast growth is also costly.
Its main cost is forgone current consumption
To sustain growth, resources must be allocated to
advancing technology and accumulating capital rather
than to current consumption.
Fast economic growth may also bring higher inflation.
(Think more)
Jobs and Unemployment
In 2006, 143 million people in the United States had jobs.
This number is 16 million more than in 1996 and 33 million
more than in 1986.
But the pace of job creation fluctuates.
During the recession, the number of jobs shrinks.
During the 19901991 recession, more than 1 million jobs
were lost and during the 2001 recession, 2 million jobs
Jobs and unemployment in Pakistan
(civilian labor force)
2007-08 2008-09 2010
Labor force (ml.) 51.8 53.7
Employed (ml.) 49.1 50.8
Unemployed (ml.) 2.7 2.9

Unemployment rate:
Total 5.2 5.5 15
Rural 4.7 4.7
Urban 6.3 7.1

Jobs and Unemployment
Not everyone who wants a job can find one.
On an average day in a normal year, 7 million people in
the United States are unemployed.
In a recession, the number is larger. For example, in 1990-
1991 recession, 9 million people were looking for jobs.
The unemployment rate is the number of unemployed
people expressed as a percentage of all the people who
have jobs or are looking for one.
Jobs and Unemployment
The unemployment rate is not a perfect measure of the
underutilization of labor. For two reasons:
The unemployment rate
1. Excludes people who are so discouraged that they
have given up looking for jobs.
2. Measures unemployed people rather than unemployed
labor hours. So it does not tell us about the number of
part-time workers who want full-time jobs.
Jobs and Unemployment
Unemployment in in United States
Figure 20.6 shows the unemployment rate from 1926 to
Jobs and Unemployment
During the 1930s, the unemployment rate hit 25 percent.
Jobs and Unemployment
The lowest rate occurred during World War II at 1.2 percent.
Jobs and Unemployment
During recent recessions, the unemployment rate increased
but was not as high as in the Great Depression.
Jobs and Unemployment
The unemployment rate is never zero. Since World War II, it
has averaged 5 percent.
Jobs and Unemployment
Unemployment Around
the World
Figure 20.7 compares the
unemployment rate in the
United States with those
in Japan, Western
Europe, and Canada.
The U.S. unemployment
rate has been lower than
that in Western Europe
and Canada but higher
than that in Japan.
Jobs and Unemployment
The cycle in unemployment
in Canada is similar to that
in the United States.
The cycle in unemployment
in Western European is out
of phase with that in the
United States.
Unemployment in Japan
has drifted upwards since
the mid-1990s.
Jobs and Unemployment
Why Unemployment Is a Problem
Unemployment is a serious economic, social, and
personal problem for two main reasons:
Lost production and incomes
Lost human capital
The loss of a job brings an immediate loss of income and
productiona temporary problem.
A prolonged spell of unemployment can bring permanent
damage through the loss of human capital.
We measure the level of pricesthe price level as the
average of the prices that people pay for all the goods and
services that they buy.
The Consumer Price Indexthe CPIis a common
measure of the price level.
We measure the inflation rate as the percentage change
in the price level.
Inflation arises when the price level is rising persistently.
If the price level is falling, inflation is negative and we have
Inflation in Pakistan and Other Countries
Years: Pakistan World USA Japan C8hina India
1972-73 30
1973-74 27
2005 9.3 3.7 3.4 - 0.3 1.8 4.2 2.2
2006 7.9 3.6 3.2 0.3 1.5 6.2 2.2
2007 7.8 4.0 2.9 0.0 4.8 6.4 2.1
2008 12.0 6.0 3.8 1.4 5.9 8.3 3.3
2009 20.8 2.4 -0.3 -1.4 -0.7 10.9 0.4
2010 11.7 3.7 2.1 -1.4 5.0 13.2 1.8
2011 13.7
2012 11.01

Inflation and the Dollar
Was low in
the 1960s.
Increased in
the 1970s
and early
Fell during
the 1980s
and 1990s.
after 2002.
Inflation in the United States
Inflation and the Dollar
Inflation Around the
Figure 20.9(a) shows the
inflation rate in the United
States compared with that
in other industrial
U.S. inflation is similar to
that in other industrial
Inflation and the Dollar
Figure 20.9(b) shows the
inflation rate in industrial
countries has been much
lower than that in
developing countries.
The most serious type of inflation is hyperinflationan
inflation rate that exceeds 50 percent a month.
Why Inflation is a Problem
Inflation is a problem for many reasons, but the main one
is that once it takes hold, it is unpredictable.
Unpredictable inflation is a problem because it
Redistributes income and wealth
Diverts resources from production
Unpredictable changes in the inflation rate redistribute
income in arbitrary ways between employers and workers
and between borrowers and lenders.
A high inflation rate is a problem because it diverts
resources from productive activities to inflation forecasting.
From a social perspective, this waste of resources is a
cost of inflation.
Eradicating inflation is costly because it brings a period of
greater than average unemployment.
Inflation and the Rupee/Dollar
The Value of the Pak Rupee/Dollar
The value of the Pak Rupee/U.S. dollar in terms of other
currencies is called the exchange ratea measure of
how much your Rupee/dollar will buy in other parts of the
An example is the number of Rupees that 1 U.s dollar will
buy or the number of pesos that 1 U.S. dollar will buy.

Surpluses, Deficits, and Debts
Figure 20.10 shows the
U.S. dollar exchange rate.
When value of the dollar
decreases, the U.S. dollar
depreciates against other
When value of the dollar
increases, the U.S. dollar
appreciates against other
Inflation and Pak Rupee/ U.S. Dollar
Why the Exchange Rate Matters
When Pak Rupee appreciate, Pak consumers pay less for
imported goods.
But the higher Rupee makes it harder for Pak producers to
compete in foreign markets. Similarly, a higher dollar hurts
U.S producers.
When the Pak Rupee depreciates, the Pak consumers pay
more for imported goods. So a lower Rupee hurts
But the lower Rupee makes it easier for Pak producers to
compete in foreign markets.
Surpluses, Deficits, and Debts
Government Budget Balance
If a government collects more in taxes than it spends, it
has a government budget surplus (T G)

If a government spends more than it collects in taxes, it
has a government budget deficit (G T)
Surpluses, Deficits, and Debts
Figure 20.11(a) shows
the U.S. federal
government budget
balance from 1960 to
The budget deficit as a
percentage of GDP
increases in recessions
and shrinks in expansions
In 1998, a budget surplus
emerged, but the budget
deficit reappeared in
Surpluses, Deficits, and Debts
International Surplus and Deficit
If a nation imports more than it exports, it has an
international deficit.
If a nation exports more than it imports, it has an
international surplus.
The balance on the current account equals Pak exports
minus Pak imports but also takes into account interest
payments paid to and received from the rest of the world.
Surpluses, Deficits, and Debts
Figure 20.11(b) shows
the U.S. current account
balance from 1960 to
During the 1980s
expansion, a large deficit
appeared but it almost
disappeared during the
19901991 recession.
The current account
deficit in 2005 was 6.3
percent of GDP.
Surpluses, Deficits, and Debts
Deficits Bring Debts
A debt is the amount that is owed.
When a government or a nation has a deficit, its debt
A governments or a nations debt equals the sum of all
past deficits minus past surpluses.
A governments debt is called national debt.
Pakistan National Debt

Outstanding domestic debt = Rs. 6 Trillion (30-06-11)

Total External Debt = $ 61.8 billion (30-06-11)

Total Debt (domestic and external) Rs. 11.5 Trillion
Pakistan debt per person = Rs. About 34,000/00
(US debt per person in 2006 $ 28,140)


(Source: SBP)
Surpluses, Deficits, and Debts
Figure 20.12(a) shows
the U.S. government
debt from 1945 to 2005.
Budget surpluses and
rapid economic growth
shrink the debt.
Budget deficits and
slower economic growth
swelled the debt.
Surpluses, Deficits, and Debts
Figure 20.12(b) shows
the U.S. international
debt from 1975 to 2005.
Until 1986, the United
States was a net lender
to the world.
But with increased
deficits, the United
States is now a net
borrower from the world.
Macroeconomic Policy Challenges
and Tools
Classical and Keynesian Views about macroeconomy
Economists views fall into two broad schools:
Classical view: The economy behaves best if the
government leaves people free to pursue their own self-
interest. Attempts by the government to improve
macroeconomic performance will not succeed.
Keynesian view: The economy behaves badly if left alone
and that government action is needed to achieve and
maintain full employment.
Macroeconomic Policy Challenges
and Tools
Five widely agreed policy challenges for macroeconomics
are to:
1. Boost economic growth
2. Keep inflation low
3. Stabilize the business cycle
4. Reduce unemployment to achieve full employment
5. Reduce government deficit (Fiscal deficit)
6. Reduce international deficit (BOT, BOP)
Macroeconomic Policy Challenges
and Tools
Two broad groups of macroeconomic policy tools are:
Fiscal policymaking changes in tax rates and
government spending
Monetary policychanging interest rates and changing
the amount of money in the economy
The government conducts fiscal policy.
The Central Bank (State Bank of Pakistan/Federal
Reserve System-FED) conducts monetary policy.