Chapter 1:

An Introduction to
Macroeconomics

by
Ooi Soon Beng

McConnell, C.R., and Brue, S.L. (2017).

Economics: Principles, Problems and Policies,
21th Edition, Irwin McGraw-Hill.
After studying this chapter, you should be able to
understand:
 Key Macroeconomic Goals
 Gross Domestic Product
 Business Cycles
 Financial Investment versus Economic Investment
 Unemployment
 Inflation
 Balance of Payments, Exchange Rates and
Macroeconomic Policies (after mid term test)
Macroeconomics
 The Bible of Capitalism

The first modern

work of economics
began with the
publication of The
Wealth of Nations.

(1723-1790)
 Florence
Thompson, a
destitute pea
picker with her
children.

The iconic photograph of the Great Depression.

 The Great Depression

Macroeconomics
Modern
macroeconomics
only dates from the
Great Depression
(1929-1939).
John Maynard
Keynes’s book, The
General Theory of
Employment, Interest,
and Money, began
the subject.
(1883-1946)
Macroeconomics
(from Greek prefix
"makros" meaning
"large" +
"economics") is a
branch of economics
that examines the
economy as a whole.
Three widely agreed goals of macroeconomic
policy are:
1. Sustainable long-run economic growth
2. Reduce unemployment
3. Keep inflation low

Macroeconomics
The three primary measures used in
macroeconomics to assess the performance of
an economy are:
1) Economic growth rate
2) Unemployment rate
3) Inflation rate.

Macroeconomics
The economic growth rate is measured by:
[(Real GDP t  Real GDP t-1)  Real GDP t-1]  100.
[ ($188,061bn – $180,714bn) / $180,714bn ] x 100 = + 4.1%

Negative growth means the economy is shrinking.

Positive growth means the economy is expanding.

Macroeconomics
Nominal Gross Domestic Product (GDP) can be measured
in three ways.
 Aggregate output which is the value of the output of
final goods and services.
 Aggregate expenditure which is the total expenditure
on final goods and services, C + I + G + (X – M).
 Aggregate income which is the income paid out for the
use of resources, wages, interest, rent and profit.

Macroeconomics
Real GDP measures the total value of all final goods and
services produced within the borders of a country in a
given year, after adjusted for changes in the price level.

Nominal GDP measures the total value of all final goods

and services produced within the borders of a country in
a given year, at current market prices.

When calculating real GDP, prices are held constant. Only

changes in output are measured.
Macroeconomics
 Assume that in Year 1, an economy
produces 1,000 units of output and
they sell for $100 a unit, on average.

In Year 2, the economy produces the

same 1,000 units of output, and sells it
for $110 a unit, on average.

What happened to real GDP between

Year 1 and Year 2? Why?
Macroeconomics
1) USA 20,494,050 11) Russia 1,630,659
2) China 13,407,398 12) South Korea 1,619,424
3) Japan 4,971,929 13) Spain 1,425,865
4) Germany 4,000,386 14) Australia 1,418,275
5) UK 2,828,644 15) Mexico 1,223,359
6) France 2,775,252 16) Indonesia 1,022,454
7) India 2,716,746 17) Netherlands 912,899
8) Italy 2,072,201 18) Saudi Arabia 782,483
9) Brazil 1,868,184 19) Turkey 766,428
10) Canada 1,711,387 20) Switzerland 703,750
35) Malaysia 354,348
Source: IMF
1) China 25,270.07 11) Mexico 2,569.81
2) USA 20,494.05 12) Italy 2,397.41
3) India 10,505.28 13) Turkey 2,320.64
4) Japan 5,594.45 14) South Korea 2,138.24
5) Germany 4,356.35 15) Spain 1,864.11
6) Russia 4,168.88 16) Saudi Arabia 1,856.94
7) Indonesia 3,494.73 17) Canada 1,852.51
8) Brazil 3,365.34 18) Iran 1,749.43
9) UK 3,037.79 19) Australia 1,312.53
10) France 2,962.79 20) Thailand 1,310.57
26) Malaysia 1,002.06
Source: IMF
Nominal GDP differs from real GDP because:
A. Nominal GDP is based on constant prices
B. Real GDP is based on current prices
C. Real GDP is adjusted for changes in the price
level
D. Nominal GDP is adjusted for changes in the
price level

Macroeconomics
Real GDP is preferred to nominal GDP as a measure of
economic performance because:
A. nominal GDP uses current prices and thus may over-
or understate true changes in output.
B. nominal GDP only includes goods and excludes
services.
C. nominal GDP is not adjusted for population changes.
D. real GDP accounts for changes in the quality of goods
and services produced.
Macroeconomics
If the prices of all goods and services rose, but the
quantity produced remained unchanged, what would
happen to nominal and real GDP?
A. nominal and real GDP would both rise.
B. nominal and real GDP would both be unchanged.
C. real GDP would rise, but nominal GDP would be
unchanged.
D. nominal GDP would rise, but real GDP would be
unchanged.
Macroeconomics
 A business cycle is the periodic, but irregular up-
and-down movement in economic activity measured
by fluctuations in real GDP.
Every business cycle has two phases:
1. A contraction
2. An expansion
and two turning points:
3. A peak
4. A trough
Macroeconomics
A peak is the upper turning point, the end of an
expansion and the beginning of a recession.

A trough is the lower turning point, the end of a

recession and the start of an expansion.

A contraction is a period during which real GDP

decreases for at least two successive quarters.

An expansion is a period during which real GDP

increases.
Macroeconomics
The business cycle depicts:
A. fluctuations in the general price level.
B. the phases a business goes through from
when it first opens to when it finally closes.
C. the evolution of technology over time.
D. short-run fluctuations in output and
employment.

Macroeconomics
What is the difference
between a slowdown
in economic growth
and a recession?
Financial Investment captures what ordinary people
mean when they say investment. It includes the
purchase of assets like stocks, bonds, or real estate
in the hope of reaping a financial gain.
Economic Investment only includes money spent
purchasing newly created capital goods such as
machinery, tools, factories, and warehouses. This is
what economists mean when they refer to
investment.
Macroeconomics
What is the difference between financial investment and
economic investment?
A. There is no difference between the two.
B. Financial investment refers to the purchase of financial
assets only; economic investment refers to the purchase
of any new or used capital goods.
C. Economic investment is adjusted for inflation; financial
investment is not.
D. Financial investment refers to the purchase of assets for
financial gain; economic investment refers to the
purchase of newly created capital goods.
Macroeconomics
 Which of the following would an economist consider
to be investment?
A. Boeing building a new factory
B. Oprah buying a $10 million home from a fellow
celebrity
C. A stockbroker buying 1000 shares of Starbucks
stock
D. All of the above

Macroeconomics
Which of the following is an example of economic
investment?
A. Volvo buys an old factory building from
General Motors.
B. Nike buys a new machine that increases shoe
production.
C. Bill Gates buys shares of stock in IBM.
D. Warren Buffet buys U.S. savings bonds.
Macroeconomics
 Employment is a state in which people have jobs.

Are you
unemployed?
Unemployment
is a state in
which people
who are available
for work, willing
to work and have
made an effort to
find work, don’t
have jobs.
The labour force is the total number of people in
the country who are employed and unemployed.

The labor force does not include the jobless who are
not looking for work.

The unemployment rate is the percentage of the

people who are unemployed in the labour force, or

Unemployment rate = unemployed people x 100

labour force
Macroeconomics
 Assuming the total population
is 200 million, the labor force
is 100 million and 92 million
workers are employed, the
unemployment rate is
___________ .

Macroeconomics
1) Frictional unemployment is a temporary condition.
This unemployment occurs when an individual is out
of his current job, takes a break, before starts another
job.

2) Structural unemployment occurs due to the

structural changes within an economy that causes a
mismatch of skilled workers and occupational
vacancies. Some of the causes are geographical
immobility, occupational immobility and
technological change.
Macroeconomics
3) Cyclical unemployment occurs when there is an
economic recession. When the aggregate demand for
goods and services decreases, the demand for labor
also decreases.

4) Seasonal unemployment occurs due to the seasonal

nature of the job. The industries that are affected by
seasonal unemployment are hospitality, tourism
industries, the fruit picking and the catering
industries.
Macroeconomics
5) Classical or real-wage unemployment occurs
when real wages are set above the market-clearing
wage, causing the number of job-seekers to
exceed the number of vacancies.
The high real wages could be due to powerful trade
unions and minimum wages.
Classical unemployment is more likely to occur
during deflation when prices are falling.

Macroeconomics
High rates of unemployment are undesirable.
1. Causes an immediate loss of
production.
2. Causes lost of human capital,
which seriously hurts the
person’s future job prospects.
3. Causes social problems such
as crime, political unrest,
depression, heart disease,
etc.
Why are high rates of unemployment of concern to
economists?
A. Higher rates of unemployment are linked to higher
crime rates and other social problems.
B. A larger fraction of the nation's labor resource is going
unutilized.
C. There is lost output that could have been produced if
the unemployed had been working.
D. All of the above are reasons why economists are
concerned about high unemployment rates.
Macroeconomics
Inflation is a persistent
increase in the general
price level of goods and
services.
The annual percentage
change in a Consumer
Price Index (CPI) is used
as a measure of
inflation.
Macroeconomics
If exactly one year ago, the CPI was 178 and
today the CPI is 185, then the inflation rate is:
(185 - 178) / 178) x 100
= (7 / 178) x 100
= 0.0393 x 100
= 3.93%

Macroeconomics
1) Creeping or mild inflation is when prices rise 3% a
year or less. Mild inflation is good because it drives
economic expansion.

2) Walking inflation is between 3-10% a year. It is

harmful to the economy because it heats up
economic growth too fast. People start to buy more
than they need, just to avoid paying more in the
future.

Macroeconomics
3) Galloping inflation rises to 10% or greater. It wreaks
havoc on the economy. Money loses value so fast that
business and employee income can't keep up with
costs and prices. Foreign investors avoid the country,
depriving it of needed capital.

4) Hyperinflation is when the prices skyrocketed .

Hyperinflation occurred when the government printed
money recklessly to pay for war. Examples include
Germany in the 1920s and Zimbabwe in the 2000s.
Macroeconomics
5) Stagflation occurs when economic growth is
stagnant or weak, but there still is price inflation.
Stagflation got its name around 1973 - 1975 when
there were six quarters of shrinking GDP growth.
But, inflation tripled to 9.6% in 1973 and remained
10-12% around 1974-1975.

Macroeconomics
Many consider demand-pull and cost-push to be types of
inflation, but they are actually causes of inflation
Demand-pull inflation occurs when demand for a good or
service increases but resources are near full employment.
Prices will increase, creating inflation.
Cost-push inflation occurs when the cost of producing
rises and the increase is passed on to consumers. The cost
of production can rise because of rising labor costs, cost of
imported raw materials and natural calamities.

Macroeconomics
Inflation is a problem because:
1. They redistribute income in arbitrary ways.
Gainers would be employers, debtors and
shareholders. Losers would be employees,
creditors and debenture holders.
2. Eliminating inflation is costly because it brings
a period of high unemployment.
3. A high inflation rate diverts resources from
productive activities to speculative activities.
Macroeconomics
4. In the case of a
hyperinflation,
it brings
economic chaos
and social
disruption.
5. Inflation
reduces
purchasing
power and
standard of
living. Hyperinflation in Germany in 1923.
 Zimbabwe's inflation is
estimated at 6.5
sextillion percent in
Macroeconomics mid-November 2008.
Suppose a family's income increases by 5% at the
same time that inflation is 6%. Then
A. the family's standard of living will increase
B. the family's standard of living will not change
C. the family's standard of living is not affected by
inflation
D. the family's standard of living will fall

Macroeconomics
Which is more miserable: inflation or
unemployment?
Why are economists concerned about inflation?
A. Inflation generally causes unemployment rates to
rise.
B. Real GDP is necessarily falling when there is
inflation.
C. Inflation lowers the standard of living for people
whose income does not increase as fast as the
price level.
D. Inflation increases the value of peoples' saving and
encourages overspending on goods and services.
Macroeconomics
Historically, inflation and unemployment have
maintained an inverse relationship, as
represented by the Phillips curve.
Higher inflation is associated with lower
unemployment and vice versa.
The inverse relationship between unemployment and
inflation is depicted as a downward sloping Phillips
curve.
Phillips curve was first
described in 1958 by
Alban William Phillips
(1914 – 1975), a New
Zealand economist.
His study outlined the
relationship between
wage and unemployment
between 1861 and 1957 in
the UK.
The Phillips curve was a concept used to guide
macroeconomic policy in the 20th century.
The curve implied that policymakers could maintain a
lower unemployment rate forever, as long as they
were willing accept higher inflation rate.

In 1970s, the world suffered stagflation . There were

high levels of both inflation and unemployment.
The stagflation in 1970s violated the Phillips curve and
led economists to add the role of expectations in the
relationship between unemployment and inflation.
Why long run Phillips curve is vertical:
Say the current inflation rate is 3% and the natural rate
of unemployment is 4%.
If the government pursues expansionary policy to cut
unemployment rate to 3%, the higher aggregate
demand will push the inflation rate to 5% in the short
run.
Firms do not suffer from “money illusion”. They
realize that inflation has risen and hire more workers
because real wage has fallen.
Real wage = Nominal wage/Price
On the other hand, workers suffer from ‘money
illusion’. They fail to anticipate that inflation rate has
risen and real wage has fallen. They continue to offer
labor services demanded by the firms.
This results in tradeoff between unemployment and
inflation in the short run.
But, this tradeoff does not hold in the long run because
workers will recover from money illusion and adjust their
expectations about future inflation based on current
inflation and unemployment.
Workers will then demand for higher money wage to
restore their real wage to the old level.
With real wage restored to the old level, firms will fire
workers and unemployment rate returns back to 4%.
In the long run, only inflation is rising and
unemployment remains at the natural rate of
unemployment. This explains why the Phillips Curve is
vertical in the long run.
An increase in
expected inflation
shifts the short-run
Phillips curve
upward.
In the long run,
Phillips curve is a
vertical line at the
natural
unemployment rate
while inflation
keeps on rising.
The Phillips curve shows the relationship between
inflation and what?
A. The balance of trade
B. The rate of growth in an economy
C. The rate of price increases
D. Unemployment

Macroeconomics
In the short run unemployment may fall below the
natural rate of unemployment if:
A. Nominal wages have risen less than inflation
B. Nominal wages have risen at the same rate as
inflation
C. Nominal wages have risen more than inflation
D. Nominal wages have risen less than
unemployment
Macroeconomics
According to the Phillips curve, unemployment will
return to the natural rate when:
A. Nominal wages are equal to expected wages
B. Real wages are back at long-run equilibrium level
C. Nominal wages are growing faster than inflation
D. Inflation is higher than the growth of nominal
wages

Macroeconomics
Balance of payments account is an accounting record of
all monetary transactions between a country and the rest
of the world.

Balance of payments
consists of 3
accounts:
 Current Account
 Capital and
Financial Account
 Official Reserves
Account
Current account records payments for imports
of goods and service, and receipts from exports
of goods and services.
Capital and financial account records foreign
investment in the country minus investments
abroad by local residents.
The official reserves are the foreign currencies
owned by the central bank.
Macroeconomics
The foreign exchange market is the market in which the
currency of one country is exchanged for the currency of
another.

The price at which one

currency exchanges for
another is called a foreign
exchange rate.
 RM3.00 = USD1.00 –
indirect quotation
 USD0.33 to RM1.00 –
direct quotation
Currency depreciation is the fall in the value of the
currency in terms of another currency.
Currency appreciation is the rise in value of the
currency in terms of another currency.
Example:
Today: RM3.15 = USD1
Next week: RM3.10 = USD1 (RM appreciates)
Next week: RM3.20 = USD1 (RM depreciates)
Macroeconomics
Two broad groups of macroeconomic policy
tools are :
1. Fiscal policy involves making changes in
government spending and tax rates.
2. Monetary policy involves changing quantity
of money and the interest rates.

Macroeconomics
Fiscal Policy

An expansionary fiscal policy increases government

spending and reduces taxes, causing budget deficit.

A contractionary fiscal policy reduces government

spending and increases taxes, causing budget surplus.

Macroeconomics
Monetary Policy
An expansionary monetary policy increases
supply of money and lowers the interest rate.
A restrictive monetary policy decreases supply
of money and increases the interest rate.

Macroeconomics