Introduction to macroeconomics Lecture 1 Introduction to

Introduction to macroeconomics

Lecture 1 Introduction to Macroeconomics Overview of macroeconomics The methodology and tools of macroeconomics Macroeconomic models Some important concepts in macroeconomic analysis

What is macroeconomics?

Macroeconomics, the study of the economy as a whole, addresses many topical issues, e. g. : What causes recessions? What is “government stimulus” and why might it help? How can problems in the housing market spread to the rest of the economy? What is the government budget deficit? How does it affect workers, consumers, businesses, and taxpayers? Why does the cost of living keep rising? Why are so many countries poor? What policies might help them grow out of poverty? What is the trade deficit? How does it affect the country’s well-being?

Definition of Economics All economic questions arise because we want more than we can get. Our inability to satisfy all our wants is called scarcity. Because we face scarcity, we must make choices. The choices we make depend on the incentives we face. An incentive is a reward that encourages an action or a penalty that discourages an action.

Definition of Economics is the social science that studies the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices. Economics distinguishes between: • Microeconomics • Macroeconomics

MICROECONOMICS Microeconomics is the study of choices that individuals and businesses make, the way those choices interact in markets, and the influence of governments.

MACROECONOMICS Macroeconomics is the study of the performance of the national and global economies.

Two Big Questions of Economics Two big questions summarize the scope of economics: • How do choices end up determining what, how, and for whom goods and services get produced? • When do choices made in the pursuit of selfinterest also promote the social interest?

WHAT, HOW, AND FOR WHOM? Goods and services are the objects that people value and produce to satisfy human wants. What? In Australia, agriculture accounts for 4 percent of total production, manufactured goods for 27 percent, and services for 70 percent. In China, agriculture accounts for 10 percent of total production, manufactured goods for 50 percent, and services for 40 percent.

How? Goods and services are produced by using productive resources that economists call factors of production. Factors of production are grouped into four categories: • Land • Labour • Capital • Entrepreneurship

The “gifts of nature” that we use to produce goods and services are land. The work time and work effort that people devote to producing goods and services is labour. The quality of labour depends on human capital, which is the knowledge and skill that people obtain from education, on-the-job training, and work experience. The tools, instruments, machines, buildings, and other constructions that businesses use to produce goods and services are capital. The human land labour resource that organizes land, labour, and capital is entrepreneurship.

For Whom? Who gets the goods and services depends on the incomes that people earn. 1. Land earns rent. 2. Labour earns wages. 3. Capital earns interest. 4. Entrepreneurship earns profit.

What Is Macroeconomics? Macroeconomics deals with questions related to the economy as a whole and/or with the behaviour of aggregate variables. Typical macroeconomic questions are: • What determines the wealth of nations? • What caused the Great Inflflation of the 1970 s? • What are the causes and cures of the 2008/09 global financial crisis? • What are the consequences of trade deficits and budget deficits?

The Macroeconomic Approach Macroeconomists have a general approach to study questions of interest: • Document the facts. • Collect data on the question of interest. • Develop a model. Models simplify the complicated real world into its most relevant elements. A model is useful if it has good predictive power. Economic models typically consist of systems of equations. A parameter is an input that is fixed over time, except when the model builder changes it for an experiment.

The Macroeconomic Approach A parameter is an input that is fixed over time, except when the model builder changes it for an experiment. An exogenous variable is an input that can change over time, but in a way that is completely determined ahead of time by the model builder. An endogenous variable is an outcome of the model – or something that is explained by the model. If a model has the same number of equations as unknowns, the model can be solved in equilibrium for the endogenous unknowns.

The Macroeconomic Approach Then… • Compare the predictions of the model with the original facts. • A successful model will make quantitative predictions of the correct magnitude. • Use the model to make other predictions that may be tested. • Change parameters in the model to experiment with howa change will affect the endogenous variables.

The Macroeconomic Approach

Positive Versus Normative Economics Positive economics is the study of what is Normative economics is the study of what should be The art of economics is using the knowledge of positive economics to achieve the goals determined in normative economics