CHAPTER ONE

INTRODUCTION
1. What Macroeconomics is about ?
Definition:
 Macroeconomics is the study of the structure and performance
of national economies and of the policies that governments use
to try to affect economic performance.
 Its is the study of the economy as a whole. Macroeconomics
aims in answering several questions which includes:
 What determines a nation's long-run economic growth?
 What causes a nation's economic activity to fluctuate?
 What causes unemployment?
 What causes prices to rise?
 Can government policies be used to improve a nation's economic
performance?
 … cont’d
 Macroeconomics is a policy-oriented part of economics. The
subject matter of macro-economics includes factors that
determines both the level of macro economic variables such as:
• total output,
• aggregate price level,
• employment and unemployment,
• interest rates, wage rates
• foreign exchange rates and
• how the variables are change over time.
 Macroeconomics focuses on the economic behavior and policies
that affect consumption and investment, trade balance, the
determinants of changes in wages and prices, monetary and fiscal
policies, the money stock, government budget, interest rate, and
national debt.
 
 1.2 Basic Concepts and Methods of Macroeconomic
Analysis
o The major macro economic variables are:
Output, unemployment, and Inflation.
 Output: Is the production of goods and services or
the national income of the country.
 Inflation: is a sustained increase in the general
price level of goods and services in an economy
over a period of time.
 Unemployment: is a term referring to
individuals who are employable (in the labor
force) and seeking a job but are unable to
find a job. 
 …

Methods in Macroeconomics (Economics in general)

 Positive economics: An approach to economics that
seeks to understand behavior and the operation of
systems without making judgments. It describes what
exists and how it works. It’s mainly concerned with
the answering “ What was? What is? And what will be?”

 Normative economics: An approach to economics

that analyzes outcomes of economic behavior,
evaluates them as good or bad, and may prescribe
courses of action. Also called policy economics. It’s
mainly concerned with the answering “ What must be
done or what ought be ?
 …
 Economic theory: A statement or set of related statements
about cause and effect, action and reaction.

 Model: A formal statement of a theory, usually a mathematical

statement of a presumed relationship between two or more
variables.

 Variable: A measure that can change from time to time or

from observation to observation.

 Ceteris paribus, or all else equal A device used to analyze the

relationship between two variables while the values of other
variables are held unchanged.
 Empirical economics : The collection and use of data to test
economic theories.
 Economic policy

Criteria for judging economic outcomes:

1. Efficiency
2. Equity
3. Growth
4. Stability
 Efficiency: in economics, allocative and technical efficiency. An efficient
economy is one that produces what people want at the least possible cost.

 Equity: Fairness.
 Economic growth: An increase in the total output of an
economy.
 Stability: A condition in which national output is growing
steadily, with low inflation and full employment of resources.
 1.3 Macroeconomic Goals and Instruments
 Basic macroeconomic goals include,
 Stable price
 Low level of unemployment and
 Economic growth
 Instruments through which government tries to
pursue these goals fall into the following main
categories. Namely:
 Fiscal policy and
 Monetary policy
 Income policy
 1.4 The State of Macroeconomics: Evolution and Recent
Developments
 Macroeconomics evolves with the evolution of the
economy and macroeconomic theories change over
time.
 Macroeconomic theories keep on changing because of
major economic events such as;
• The 1930s great depression (1923-33)
• The great inflation of the year 1970s bringing in focus
problems with the prevailing theory.
 Different schools of thoughts emerged since the
publication of Keynes’ General Theory in 1936.
• The reason is that there is disagreement among
economists mainly on the way how theories are applied
to a specific problem, instead of on theories themselves.
 Cont…

 There have been two main intellectual traditions in

macroeconomics
 One school of thought believes that markets work best if left
to themselves;
 The other believes that government intervention can
significantly improve the operation of the economy.
 The 1770s economists believe that market should be
free and there should not be government intervention.

 In the 1960s, the debate on these questions involved

Keynesians, including Franco Modigliani and James
Tobin, on one side, and monetarists, led by Milton
Friedman, on the other.
 Cont…

 In the 1970s, much debate on the same issues brought a

new group- the new classical macroeconomists, who by
and large replaced the monetarists in keeping up the
argument against using active government policies to
try to improve economic performance.

 On the other side are the new Keynesians; they may not
share many of the detailed belief of Keynesians three or
four decades ago, except the belief that government
policy can help the economy perform better.
 … cont’d
 Accordingly we will see three school of thoughts in
Macroeconomics, namely;

1. Classical macroeconomists (1776 – 1870).

 In this period the distinction between micro and macro was
not clear.
 The ruling principle was the invisible hand coined by
Alfred Marshall.
 Emphasis the optimization of private economic actors
 Laissez fair: No need to manage the economy-just leave it
for the mercy of the market mechanism
 Adam Smith, David Recardo, Say, A. Malthus, J. Mill …
etc were among the prominent classical economists
2. Neo classical macroeconomists (1870 – 1936.)
 Basically the neoclassical school is not different from
the classical school.
 The main distinction is the tool of analysis, such as the
marginal analysis.
 It  is an approach to economics focusing on the
determination of goods, outputs, and
income distribution in markets through supply and
demand.
 This determination is often mediated through a
hypothesized maximization of utility by income-
constrained individuals and of profits by firms facing
production costs and employing available information
and factors of production, in accordance with rational
choice theory
 … cont’d
3. Keynesian Macroeconomists: (1936 – 1970s. )
The main thesis of the Keynesian stream is that the economy
is subjected to failure so that it may not achieve full
employment level. Thus, government intervention is inevitable.
Keynesian economics is based on two main ideas.
• First, aggregate demand is primary cause of a short-
run economic event like a recession.
• Second, wages and prices can be sticky, and so, in
an economic downturn, unemployment can result.
Keynes believes that during recessions there should be
monetary expansion. But he worried that even this might
sometimes not be enough, particularly if a recession had been
allowed to get out of hand and become a true depression
 … cont’d
3. Keynesian Macroeconomists: (1936 – 1970s. )
Once the economy is deeply depressed, households and
especially firms may be unwilling to increase spending no
matter how much cash they have; they may simply add any
monetary expansion to their hoarding. Such a situation, in
which monetary policy has become ineffective, has come to be
known as a “liquidity trap”.
In such a case, the government has to do what the private
sector will not: spend. When monetary expansion is ineffective,
fiscal expansion must take its place. Such a fiscal expansion can
break the vicious circle of low spending and low incomes and
 1970s – present.
 There is no dominant school of thought of
macroeconomics.
 As a conclusion, there have been two views in
macroeconomics as mentioned earlier.
 first thought believes that government
intervention can significantly improve the
operation of the economy;
 While second believes that markets work best if
left to themselves