Preface

It only seems like these macroeconomic notes are a textbook. That is what I keep telling myself. After each addition and revision based on feedback I receive from my students they get longer and longer, and better, I hope. My purpose is to use these notes as a supplement to my regular course and as the basis for the internet version of the same course. Because they are written to conform to HTML, they are not so nicely typeset. GIF graphs leave a lot to be desired. Tables are very time consuming to construct. Typos run amonk. And I get no respect.

So what do I want to accomplish? I hope that after viewing this course in its entirety one can turn on CNN or log into its web site and be able to have some understanding the business and economic events of the day. I also hope that one will be in a better position to analyze and critically examine political issues and proposals that have economic implications. After you are finished, you tell me if this has been accomplished.

For those of you who are preparing for a professional exam, good luck and I hope this material speeds you onto your goal. Let me know if there was something missing from these notes.

Thank you,

James Haischer

An Introduction

Why Study Macroeconomics?

Let me list some reasons why the study of economics and of macroeconomics in particular should be of interest to you.

One, macroeconomics can make a contribution to your understanding of your job environment. For example, business cycles affect product demand and product demand affects labor demand. Consequently there are goods times to ask for a raise and not so good times to ask for a raise. Anticipating changes in economic activity can aid in career planning. Knowing that there are product life cycles may enable you to more confidently pursue careers in companies that are producing hot products and services.

Secondly, understanding your businesses environment makes you a more valued employee, possibly putting you on a faster promotion track. Especially in the study of microeconomics, you will learn about the operation of individual product markets and how the competition is likely to behave. This will allow you to understand (and possibly devise better) product strategies.

Thirdly, macroeconomics builds a conceptual foundation for better personal financial planning. Understanding forces affecting stock and bond markets will help you make more informed investment decisions. Understanding the mechanics of growth will allow you to plan savings to achieve your future wealth targets necessary to retire in style.

Finally, macroeconomics provides a basis for better decision making at the voting booth. When the economy is running at full speed and another politican argues for a tax cut, you will realize the fallacy behind this. When another public works project is proposed such as a stadium supported by the arguments of economic impact and how good it will be for the community, you can cut through the fog to analyze who will really profit from it and who will really pay for it.

If you need other reasons, consider that you are a glutton for punishment but want to enjoy the intellectual challenges and rewards that the study of macroeconomics provides.

What is Macroeconomics?

Economics itself is defined as the study of how society allocates scarce resources but that definition ignores growth. A better definition of economics is the study of how we make choices, particularly, choices given constraints.

Macroeconomics looks at choices from the aggregate level, that is the national level. Macroeconomics concerns itself with the overall rationale for pricing and output decisions in an economy. When it ignores international trade it is called a closed economy, when it includes international trade it is called an open economy.

Society's Macroeconomic Goals

Let's piece together four goals of macroeconomics that society may demand. Number one, society desires full employment. Happy people are those that have a job. Happy people are happy voters. Parties in power like to keep voters employed. When the number of unemployed grows so does the number of potential revolutionaries.

Second, price stability is highly desirable. How happy would you be if the price of milk kept going up, on an hourly basis? High inflation also forces a change in government. As we will discuss, very often high inflation is caused by government. It was the deadly combination of high inflation and high unemployment that provided the conditions for Hitler's rise in Germany. Fifty five million people died in World War II. That alone should make economics an important discipline to study.

Third, economic growth is needed. On a personal level, most people want a better future than the present they enjoy today. Growth brings higher living standards, allows society to pay for environmental clean up and gives us optimism. On the international scene, growth brings a certain amount of power. Richer countries have more influence. If you are paying the bill for an international action then you want more say in how it is run. One of the dominating features in the twentieth century was the global depression after World War I. This started the battle for which political or economic philosophy that could attain economic stability; capitalism, fascism, communism, socialism, etc. The emphasis after the end of the Cold War is shifting to growth. Particularly after crisises in Asia, Russia, and in Latin America the search for the essential elements that are needed to ensure continued growth are being explored in economic research.

Lastly, external balance. Resources leaving and entering a country in the long run should equal. Many of the crisises in the last two decades have manifested themselves in the markets for foreign exchange, exports, imports and foreign investment. Governments have fallen or nearly fallen on the basis of a crisis that erupts first in the international sector. As the world today becomes more integrated it becomes increasingly important to understand international trade and finance.

Individuals

Society's macroeconomic goals mirror our own. We want a job, a nice income, upward mobility, etc. Yet how do we fit into the economic system? We play two roles, that of a consumer and that of a producer. We produce for income that is used to buy goods and services. If we lack a job, then we lack consumption. The economy has a circular flow, the earnings we collect from production are used to buy the products we built. The products we buy generate a demand for our labor services. What happens if we produce products that no one wants? The system has problems. Therefore, we have problems, we lose our job.

In analyzing individual economic behavior, there are two assumptions (assumptions based on observed behavior) that are made; one, individuals have bounded rationality, and two, individuals behave in their self-interest (sometimes called opportunitistic behavior).

Bounded rationality says that individuals have limits to their knowledge and in the ability to project consequences into the future. One reason many students are required to take economics classes, is to expand that ability to project consequences. For example, what are the consequences of large Federal government budget deficits?

When individuals are acting in their self-interest, they will make decisions to their benefit. Even actions that seem to be alutristic may provide a benefit to the giver in the form of personal gratification or the expectation of some type of future benefit (you scratch my back, I scratch your back). This is important in predicting outcomes in situations where behavior cannot be observed in the performance of work, or in the contracting for services.

To encourage performance of work to attain results, firms may require workers to adhere to certain work policies such as prompt attendance at work. In some instances, opportunitism will be a barrier to the market, particularly in the case where one party to a transaction has more information than another. This is called asymmetric informatoin and it provides a rationale for government intervention.

In this introduction to economics, these two individual attributes will have some impact on our discussions, mainly on economic policy implications and in our analysis of government operations.

Ultimately, in economics as in other disciplines, it is the behavior of the smaller units (here, individuals), that determine the direction of the larger units (society).