Chapter 4

On Overview of Macroeconomics
 1. The Origin of
Macroeconomics
• Great Depression (1930’s)
• Failure of classical economics
• Keynesian economics
– Flexible wages and prices
– Emphasis on spending

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 2. A Historical Sketch of
Macroeconomics
• Modern macroeconomic theory
owes its origin to John Maynard
Keynes
• Invisible hand: a term used by
Adam Smith to describe the market
mechanism.
• The Great Depression: a period of
severe economic slow down lasting
for 10 years (1929 – 1939).

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 3. Classical Economics
• Classical economic models: pre-
Keynesian economic models that
emphasized the market forces of S
and D.
 4. Classical Economics
• Classical economists argued that if
there is unemployment, it would
reduce the wage rate, resulting in
the unemployed workers being
employed.
• Classical economics could not explain
the Great Depression.

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5. Keynesian Economics
• Keynesian macroeconomics:
emphasizes total spending as the
main determinant of the level of
income and employment.
• Fiscal policy: the use of
government spending and taxes
to regulate economic activity.

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5-1: Keynesian Economics
• Keynesian economics: a theory based
on the premise that total output is
determined by total spending.

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6. Development in Macroeconomics
since the 1970s
• The influence of Keynesian economics
declined in the 1970s
• Stagflation: an economic situation
characterized by high inflation and high
unemployment.
• Supply side: the production side of the
economy.
• New Classical economists: economists who
emphasize wage and price flexibility.

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 7. Development in
Macroeconomics since the
1970s
• New Keynesian economists:
economists who emphasize wage
and price inflexibility.

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 8. Importance of
Macroeconomics(1)
• It deals with issues that affect
standard of living and cost of living.
• Macroeconomic policy: action taken
by the government to achieve
economic objectives .

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 Importance of
Macroeconomics(2)
• Monetary policy: action taken by the
central bank to change the supply of
money and the rate of interest.
• Incomes policy: action taken by the
government to control wages and
prices.

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 Usefulness of Macro to
Business Decision Making
(3)
• Macroeconomic variables could
affect the profits of firms.
– When the economy is growing, the
demand for its goods and services is
high.
– When the economy is declining, the
demand for goods and services is low.

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9. Circular Flow Model

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Circular Flow Model-1
HOUSEHOLDS:
• Assumed to maximize satisfaction.
• Sell labour services and other
resources to firms.
• Invest in firms by purchasing stocks
and lend to firms by buying bonds.
• Some work for governments.
• Some purchase government bonds.

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 Circular Flow Model -2
HOUSEHOLDS:
• Receive wages, rent, interest, and
dividends from firms and governments.
• Some receive transfer payments
• Transfer payments: payments that do
not represent compensation for goods
and services.
• Pay taxes to the government.

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 Circular Flow Model-3
FIRMS
• Assumed to maximize profits
• Buy labour services and other resources
from households.
• Sell stocks and bonds to households.
• Some sell goods or services to
households and governments.
• Pay taxes to the government.

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 Circular Flow Model-4
GOVERNMENTS:
• Provide services to households and
firms.
• Buy labour services from households.
• Sell bonds to households and firms.
• Collect taxes from households and
firms.
• Expenditure ≡ income

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 10. Behaviour of the
Canadian Economy-1
• GDP: the value of all the goods and
services produced in a country during
a period.
– Fluctuates considerably
• Unemployment rate: the number of
people unemployed expressed as a
percentage of the labour force.
– If it is high, the economy is not operating
at its potential.
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 Behaviour of the
Canadian Economy-2
• The consumer price index (CPI): an
index that measures the level of
prices of consumer goods and
services.
– Could be used to estimate the rate of
inflation.
– The rate of inflation has been relatively
low since the 1990s.

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