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Macroeconomics is the study of the economy as a whole. When macroeconomists address economic problems and challenges, they consider broad trends throughout the economy. In economics, models demonstrate the relationship between important variables. Their simplicity allows economists to focus on one change at a time, using the ceteris paribus assumption that other conditions remain the same. The production possibility curve demonstrates the maximum amount of output that an economy may produce, given the current level of economic resources and production technology. In addition to more economic resources and technological advancements, comparative advantage and trade lead to an outward shift in the production possibility curve. Capitalism serves as the most important economic system. It exerts power and influence over the process of resource allocation. In a capitalist system, markets establish economic incentives, thus determining an economy’s exchange and industrial organization.

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No chapter abstract available.

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Markets and institutions influence macroeconomic outcomes. Business cycles are periods of economic expansion and contraction. Business cycles measure short-run fluctuations in aggregate economic activity. The four phases of the business cycle are expansion, peak, contraction, and trough. National income accounts measure economic activity. The circular flow diagram demonstrates spending and income. In the circular flow, firms and households interact in the product and resource markets. Gross Domestic Product is the total market value of goods and services produced in the economy in a given year. Economists measure GDP with spending or income. With the spending approach, GDP consists of the spending from household consumption, business investment, government purchases, and net exports. The income approach involves adding up the income earned by the factors of production, then adjusting it to fully account for GDP. The calculation of nominal GDP requires the multiplication of the quantity of output and the prices of output in a specific year. Real GDP is the value of final goods and services, measured in constant prices. But real GDP per capita is not equivalent to quality of life or human well-being, as measured by an individual’s perception of their position in society.

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Employment statistics serve as macroeconomic indicators. The labor market includes the individuals who supply their labor services and the businesses that hire workers. The labor force includes the people in the economy who are working or actively seeking jobs. The unemployment rate is calculated by dividing the number of people who are unemployed by the labor force. The employment-to-population ratio is the percentage of the population that is employed. In the United States, the Department of Labor and Census Bureau surveys households, firms, and government agencies to determine changes in employment. Because the surveys provide monthly data, they determine the employment trends for the macroeconomy. The labor force participation rate provides the percentage of individuals of the working age population who achieve employment status or are actively seeking jobs. The surveys struggle to identify chronically underemployed individuals who are discouraged and frustrated with their job opportunities. A discouraged worker does not actively look for a job but prefers to work. Underemployment exists when the positions of individuals do not utilize their education, experience, or skills to their fullest extent. Full employment is equivalent to the natural rate of unemployment when unemployment is frictional and structural but cyclical is equal to zero. Several reasons exist for structural unemployment, including efficiency wages, fundamental changes in the economy, labor unions, and minimum wages.

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Inflation is an increase in the price level. During the coronavirus pandemic, global supply chain problems led to a decrease in market supply. An increase in federal government spending sent money to households, leading to an increase in market demand. Together, the market factors led to a historically high rate of inflation. The price index is the weighted average of prices in a market basket of goods and services. A market basket includes a set of items that are typically bought and sold. The Consumer Price Index demonstrates how the cost of items purchased by the typical urban consumer changes over time, relative to a base period. The inflation rate is the annual percentage change in the price index. The set of goods and services that are typically bought and sold by consumers is part of a market basket. The CPI uses a market basket to track changes in the price level. When the CPI increases, inflation occurs. When the CPI decreases, deflation occurs, a general decrease in the price level. Economists focus on core inflation as the change in the cost of goods and services, but they exclude the output from the energy and food sectors. The reason is that energy and food prices are more volatile. In addition to the CPI, economists use other measures to track price changes, including the Personal Consumption Expenditures Index, Producer Price Index, and GDP deflator. When the inflation rate is relatively high, it imposes three types of costs on the economy: menu costs, shoe-leather costs, and unit-of-account costs. Inflation may become a self-fulfilling prophecy. An expectation of higher prices may cause the inflation rate to rise.

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No chapter abstract available.

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Economic growth means an increase in the production of output. Economic growth plays an important role by helping to increase the standard of living. Economists measure the change in a country’s standard of living by calculating the ratio of the growth of real GDP per capita to population growth. In the short run, economic growth occurs when the economy uses existing but underutilized resources. In the long run, the economy expands its productive capacity and achieves economic growth by increasing its economic resources or using existing resources more productively. The production function demonstrates how economic resource inputs are converted into output. Economic growth requires productivity gains. The level of productivity refers to the extent to which economic resources contribute to a given level of output. The most common measure of productivity is labor productivity, a ratio of the economy’s total output to the number of hours worked. Economic growth occurs with an increase in the level of land and natural resources, human capital, and physical capital. Total factor productivity also contributes to economic growth, the factors that influence the effectiveness of economic resources. Government spending contributes to the process of economic growth. The intangible capital refers to the knowledge-based, nonphysical assets that contribute to production. It is the productive capital that lacks a physical presence.

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This chapter explains how the economy coordinates savings and investment, and how this coordination contributes to economic growth. In the long run, saving and investment facilitate higher levels of production. The investments in equipment and machines for firms and education and training for workers increase productivity and the quantity of output per worker. But firms may need to secure financing. They may borrow from an investor or the financial system. For the economy as a whole, the financial system channels money from savers to borrowers. With direct finance (through financial markets) and indirect finance (through financial intermediaries), the financial system facilitates financial exchange. The decision to save money means the deferral of current consumption in order to increase future consumption. The expenditure on investment opportunities is undertaken with the expectation of profit. The model of the market for loanable funds describes the processes of saving, investment, the real interest rate, the quantity of loanable funds, and what happens to equilibrium when market conditions change.

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No chapter abstract available.

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Throughout history, money has taken different forms. Today, electronic money is the best modern example of fiat money, which is money without intrinsic value but is classified as legal tender by the government. In the economy, money assumes specific functions, making it unique as a commodity, serving as a medium of exchange, store of value, and unit of account. The narrowest definition of the money supply is M1. The measure M2 is broader. Checking accounts allow banks and other financial institutions to create money by making loans to economic agents. The key is the existence of fractional reserve banking, which means banks are required to keep a fraction of the deposits in reserve. They can lend the rest. By expanding or reducing loan activity, the banking system alters the money supply according to the money multiplier. But individual banks create money by lending their excess reserves, the funds held by banks that exceed the minimum reserve requirement. Although the banking system creates money and facilitates economic growth, several factors constrain the process. Digital currency, an example of fiat money, facilitates an electronic form of exchange. The types of digital currency are central bank digital currency, cryptocurrency, stablecoins, and virtual currency.

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Inflation, a general increase in the price level, seems like a natural economic phenomenon. But economies also experience periods of deflation. The classical theory of inflation posits a direct association between monetary growth and the price level. While the price level (P) measures the price of goods and services in terms of money, 1/P measures the value of money in terms of goods and services. When the price level increases, the value of money decreases. The central bank and the banking system determine the supply of money. The demand for money is a function of the level of wealth that economic agents want to hold in liquid form. A market equilibrium exists when supply is in balance with demand. With the quantity theory of money, the quantity of money times the velocity of money equals the price level times the level of output. The quantity theory leads to the neutrality of money: in the long run, changes in the money supply alter the price level, but not real variables in the economy, such as employment and output. When the central bank injects money into the economy, economists determine the velocity of money, which is the annual amount the average dollar changes hands. In the long term, when the central bank increases the rate of growth of the money supply, both the inflation rate and nominal interest rate rise. The link between the change in the inflation rate and nominal interest rate is known as the Fisher effect.

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No chapter abstract available.

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Say’s Law states that “supply creates its own demand.” In macroeconomics, understanding the power of spending and how it multiplies income and output serves as an important issue. The goal of government spending programs is to put money in the hands of economic agents, including households and businesses. Consumption is a function of disposable income, the income left over after the payment of taxes. Households allocate their income to consumption and saving. The average propensity to consume, which equals consumption divided by income, is a measure of how much income the individual allocates for the purpose of consumption. The average propensity to save, which equals saving divided by income, is a measure of how much income the individual allocates for the purpose of saving. The marginal propensity to consume, which equals the change in consumption divided by the change in income, demonstrates how much households want to spend when their income rises or falls. The marginal propensity to save, which equals the change in savings divided by the change in income, demonstrates how much households want to save when their income rises or falls. The multiplier effect means that an initial change in spending leads to a larger change in aggregate output and income.

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The downward-sloping aggregate demand curve shows the amount of output (real GDP) that consumers want to purchase at different price levels. The shape of the AD curve is the same as the demand curve for individual goods and services. At all price levels, the AS curve shows how much output firms produce and sell. Unlike the AD curve, the shape of the AS curve depends on the time horizon. The long-run aggregate supply curve is vertical. But the short-run aggregate supply curve slopes upward. The macroeconomic equilibrium occurs at the intersection between aggregate demand and short-run aggregate supply. But the economy may establish an equilibrium level of production at a point that differs from full employment. A recessionary gap occurs when the equilibrium level of production is less than the full-employment level of production. An inflationary GDP gap occurs when the equilibrium level of production is greater than the full-employment level of production. If the equilibrium level of real GDP differs from full employment, a macro failure exists. Market participants alter their spending behavior, shifting AD leftward or rightward.

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No chapter abstract available.

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Fiscal policy is the use of government expenditure (spending) and revenue collection (taxation) to alter economic activity. The government may implement two types of policy, depending on economic circumstances: expansionary fiscal policy, to fight recessions; and contractionary fiscal policy, to fight inflation. While the former stimulates economic activity, the latter slows the rate of economic growth. Government outlays include both spending and transfer payments. Three types of government outlays exist: discretionary spending, mandatory outlays, and interest payments. An increase in government spending in areas such as education and highways, higher transfer payments for unemployment benefits and medical care, or lower taxes, serve as expansionary fiscal policy, causing the AD curve to shift to the right. With a reduction in G, decrease in transfer payments, or increase in T, AD shifts to the left. By implementing supply-side fiscal policy, the government focuses on long-run economic growth. The use of the government budget to alter economic activity means that government expenditures and receipts will not always be equal. The government may experience a budget deficit or a budget surplus. Annual budget deficits lead to the accumulation of government debt.

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The central bank controls monetary policy, which means adjusting the economy’s money supply, interest rates, and availability of credit. The twin goals of central banks are a low and stable price level and low unemployment. When the economy is booming but the rate of inflation is rising, the central bank may implement a contractionary monetary policy that slows the economy and reduces the rate of inflation. When the economy is slumping, the central bank may implement an expansionary monetary policy that stimulates the economy and reduces the unemployment rate. The central banks of industrialized economies have three tools of monetary policy to control the money supply: reserve requirement, discount rate, open market operations. When the central bank increases the money supply, the interest rate decreases. When the central bank decreases the money supply, the interest rate increases. The central bank often views the interest rate, rather than the money supply, as an important policy target. The federal funds rate is the interest rate that commercial banks charge each other for overnight loans that are used as reserves. The European Central Bank oversees the Eurozone. The Federal Reserve System serves as the central bank of the United States.

Pages: 40

No chapter abstract available.

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Economic agents around the world conduct business with each other because they expect to achieve economic gains. At the country level, imports are goods and services purchased from foreign sellers. Exports, the goods and services sold to foreign buyers, also vary according to a country’s economic conditions and consumer characteristics. At the macroeconomic level, a difference exists between a country’s balance of trade and level of trade. The balance of trade is the difference between the value of exports and imports. A trade surplus exists when exports are greater than imports. The level of trade measures an economy’s exports as a percentage of GDP. The last decades of the twentieth century and early decades of the twenty-first century experienced an expansion of global supply chains in international locations. The growth in global supply chains is a function of international trade flows and the process of globalization, which is the growing interdependence of the world’s economies. The motivation to trade is important in the analysis of international economics, because many countries export some of the same products that they import. If a country produces specific goods or services at a lower domestic opportunity cost than a trading partner, it has comparative advantage with those forms of output. The idea is that a country should specialize in the output that is relatively more efficient. While comparative advantage forms the basis for trade, the terms of trade refers to the rate at which goods are exchanged. Trade agreements boost the volume of trade, make the international sector more predictable and transparent, and increase the variety of goods and services in the marketplace. Protectionism means that countries shield their domestic industries from foreign competition. The trade policy of a country includes the laws and regulations that govern trade flows. When a country wants to restrict trade, it may implement different trade policies, including export subsidies, import quotas, tariffs, and voluntary export restraints.

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An exchange rate is the price of one currency in terms of another currency. Currencies fluctuate in the marketplace, according to supply and demand conditions. If the demand for a currency rises, it appreciates, increasing in value. If the demand for a currency falls, it depreciates, decreasing in value. Exchange rates are important in international economics because they determine the prices of exports and imports. A currency depreciation decreases the price of domestic output to foreign buyers, increasing exports. A currency appreciation increases the price of domestic output to foreign buyers, decreasing exports. The foreign exchange market determines the exchange rates between currencies. The spot exchange rate that exists at a moment in time is the market equilibrium, the point at which the market balances. When an exchange rate changes in value in the market, it is known as a freely fluctuating exchange rate or a floating exchange rate. Changes in the supply of or demand for foreign exchange determine whether a currency appreciates or depreciates. Given the impact of changes in the exchange rate on trade flows, governments often intervene in the foreign exchange market to stabilize the exchange rate. Most countries implement floating exchange rates. The value of the currencies change according to the forces of supply and demand. Given the impact of changes in the exchange rate on trade flows, governments often intervene in the foreign exchange market to stabilize the exchange rate.

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absolute advantage the ability to produce more output using the same economic resources