CHAPTER 1

OVERVIEW
OF
MACROECONOMICS

SOURCES: MACROECONOMICS BY SAMUELSON

MACROECONOMICS, 9TH EDITION BY: STEPHEN L. SLAVI
MACROECONOMICS, 18TH EDITION BY: CAMPBELL R. MC CONNELL, BRUE,
AND FLYNN
INTRODUCTORY MACROECONOMICS BY CRISTOBAL PAGOSO

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 BASIC TERMS IN ECONOMICS
▪ Goods – anything which yields satisfaction to
someone
- it may be tangible when they are in the form
of material goods or commodities. They may also
be intangible in the form of services
- Tangible goods like shoes, books, and
umbrellas and intangible services like those
rendered by the doctor, the teacher, or the
painter are all used in the satisfaction of human
wants and needs

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 ECONOMIC RESOURCES
▪ The things which are needed to carry on the
production of goods and services are called
economic resources or factors of production
▪ These resources are land, labor, capital, and
entrepreneur
▪ They are the basic resources because they
constitute the basic needs in production
▪ They are the most basic tools used in the
production of goods and services

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 ECONOMIC RESOURCES
▪The three basic building blocks of
land, labor, and capital may be used
in different ways to produce
different goods and services, but
they still lie at the core of
production
▪ We will then look at the roles
played by technology and
entrepreneurs in putting these
factors of production to work
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 LAND
▪ Land refers to all-natural
resources, which are given by all
found in nature, and are,
therefore, not man-made
▪ This term includes the soil, river,
forests, and mineral deposits
▪ Land is an economic good
because it is scarce, and a price
has to be paid for it
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 LABOR
▪ Labor is any form of human effort exerted in
the production of goods and services
▪ People who work to repair tires, pilot
airplanes, teach children, or enforce laws are
all part of the economy’s labor
▪ People who would like to work but have not
found employment – who are unemployed –
are also considered part of the labor available
to the economy
▪ The supply of labor in a country is dependent
on its production and on the percentage of its
population that is willing to join the labor
force
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 CAPITAL
▪ Capital – is a factor of production that has been
produced for use in the production of other
goods and services. Office buildings,
machinery, and tools are examples of capital
▪ It refers to man-made goods used in the
production of goods and services
▪ Capital does not consist solely of physical
objects. Computer software used by business
firms or government agencies to produce goods
and services is capital.
▪ Capital may thus include physical goods and
intellectual discoveries

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 CAPITAL
Any resource is capital if it
satisfied two criteria:
1. The resource must have been
produced
2. The source can be used to
produce other goods and services
▪ One thing that is not considered
capital is money

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 CAPITAL
▪A firm cannot use money directly to
produce other goods, so money does
not satisfy the second criterion for
capital
▪Firms can, however, use the money to
acquire capital
▪Money is a form of financial capital
▪Financial capital includes money and
other “paper” assets (such as stocks
and bonds) that represent claims for
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 ENTREPRENEUR
▪ The entrepreneur is not presented as a
separate factor of production, but it is
classified as a part of labor
▪ However, the entrepreneur does a
special type of work and is, therefore, not
ordinary labor
▪ He is the person who combines the
other economic resources for use in the
production of goods and services
▪ He decides on the combination of land,
labor, and capital to be used in
production
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 ENTREPRENEUR
▪ The entrepreneur is not presented as a
separate factor of production, but it is
classified as a part of labor
▪ However, the entrepreneur does a
special type of work and is, therefore, not
ordinary labor
▪ He is the person who combines the
other economic resources for use in the
production of goods and services
▪ He decides on the combination of land,
labor, and capital to be used in
production
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 TECHNOLOGY AND THE ENTREPRENEUR
▪ An entrepreneur is a person who, operating
within the context of a market economy, seeks
to earn profits by finding new ways to organize
factors of production. In non-market economies,
the role of the entrepreneur is played by
bureaucrats and other decision-makers who
respond to incentives other than profit to guide
their choices about resource allocation
decisions
▪ The interplay of entrepreneurs and technology
affects all our lives. Entrepreneurs put new
technologies to work every day, changing the
way factors of production are used
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 TYPES OF ECONOMIC SYSTEM:
TRADITIONAL, MARKET, AND COMMAND ECONOMIES
▪ Traditional economy – this is basically a
subsistence economy. A family produces
everything that it consumes. Decisions on
what, how, and for whom to produce are
made by referring to the traditional manner
of doing things
▪ Production is carried on in the methods used
by the forefathers and is therefore very
primitive. This type of economic system is
very backward since it does not allow for
change
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 TYPES OF ECONOMIC SYSTEM:
TRADITIONAL, MARKET, AND COMMAND ECONOMIES
▪ Market economy – is one in which individuals &
private firms make the major decisions about
production & consumption. A system price, of markets,
profits & losses, of incentives & rewards, determines
what, how, and for whom. Firms produce the
commodities that yield the highest profits (the what)
by the techniques of production that are least costly
(the how). Consumption is determined by individuals’
decisions about how to spend the wages & property
ownership (the for whom)
▪ Laissez-faire – the extreme case of a market economy,
in which the government keeps its hands off economic
decisions, is called a laissez-faire
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▪ Command economy – is one in which the
government makes all important decisions about
production and distribution. In a command
economy, such as the one which operated in the
Soviet Union during most of the twentieth century,
the government owns most of the means of
production (land & capital); it also owns & directs
the operations of most workers & tells them how
to do their jobs; & it decides how the output of the
society is to be divided among different goods &
services
▪ No contemporary (modern) society falls
completely into either of these polar categories.
Rather, all societies are mixed economies. There
has never been a 100 percent market economy
(although nineteenth-century England came
close).
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 OPPORTUNITY COST
▪ Opportunity cost is the value or benefit of the next best
alternative given up when making a choice.
▪ When one makes a choice, there is always an alternative
that has to be given up. A producer who decides to
produce shoes gives up other goods that could be
produced with the same resources
▪ A student who buys a book with his limited allowance
gives up the chance of eating out or watching a movie
▪ An M.A. graduate who decides to teach, gives up the
salary he would have earned had he worked in a big firm
like San Miguel Corporation
▪ The values of these alternatives given up are referred to as
opportunity costs
▪ When we make a decision to buy Good A, we are in effect,
making the decision not to buy Good B
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 SOCIETY’S TECHNOLOGICAL POSSIBILITIES
▪ Each economy has a stock of limited resources –
labor, technical knowledge, factories & tools, land,
and energy. In deciding what and how things should
be produced, the economy is deciding how to
allocate its resources among the thousands of
different possible commodities & services
▪ Faced with the undeniable fact that goods are
scarce relative to wants, an economy must decide
how to cope with limited resources. It must choose
among different potential bundles of goods (the
what), select from different techniques of
production (the how), & decide in the end who will
consume the goods (the for whom)
▪ To answer three questions, every society must make
choices about the economy’s inputs & outputs
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▪ Inputs (factors of production) – are
commodities or services that are used to
produce goods & services. An economy uses its
existing technology to combine inputs to
produce outputs. Another term for inputs is
factors of production
▪ Outputs – are various useful goods or services
that result from the production process and are
either consumed or employed in further
production. Example: production of pizza

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 3 BROAD CATEGORIES OF INPUTS
▪ Land – or, more generally, natural resources – represents
the gift of nature to our production processes. It consists
of the land used for farming or for underpinning houses,
factories, & roads; the energy resources that fuel our
cars & heat our homes; & the non-energy resources like
copper & iron ore & sand. Natural resources also include
clean air & drinkable water
▪ Labor – consists of the human time spent in production –
working in automobile factories, tilling the land,
teaching school, or baking pizzas
▪ Capital – resources form the durable goods of an
economy, produced in order to produce yet other goods.
Capital goods include machines, roads, computers,
hammers, trucks, steel mills, automobiles, washing
machines, & buildings
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 PRODUCTION-POSSIBILITY FRONTIER (PPF)
▪ PPF shows the maximum amounts of production that can be
obtained by an economy, given its technological knowledge &
quantity of inputs available. The PPF represents the menu of
goods & services available to society
▪ Example: the butter & guns
▪ These are two extreme possibilities. In between are many
others. If we are willing to give up some butter, we can have
some guns. If we are willing to give up still more butter, we can
have still more guns
▪ The frontier in the next slide shows the schedule along which
society can choose to substitute guns for butter. It assumes a
given state of technology & a given quantity of inputs. Points
outside the frontier (such as point I) are infeasible or
unattainable. Any point inside the curve, such as U, indicates
that the economy has not attained productive efficiency, as is
the case, for instance, when unemployment is high during
severe business cycles
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 A SMOOTH CURVE CONNECTS THE PLOTTED POINT OF THE
NUMERICAL PRODUCTION POSSIBILITIES

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 BRANCHES OF ECONOMICS
▪ Microeconomics – the branch of economics
which today is concerned with the behavior of
individual entities such as markets, firms, and
households
▪ Adam Smith is usually considered the founder
of the field of microeconomics. In the Wealth of
Nations (1776), smith considered how
individual prices are set, studied the
determination of prices of land, labor, & capital,
& inquired into the strengths & weaknesses of
the market mechanism. Most important, he
identified the remarkable efficiency properties
of markets & saw that economic benefit comes
from the self-interested actions of individuals
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▪ Macroeconomics – is concerned with the overall
performance of the economy
▪ Macroeconomics did not even exist in its modern
form until 1936 when John Maynard Keynes
published his revolutionary General Theory of
Employment, Interest, & Money. In his new theory,
Keynes developed an analysis of what causes
business cycles, with alternating spells of high
unemployment & high inflation
▪ Macroeconomics examines a wide variety of
areas, such as how total investment & consumption
are determined, how central banks manage money
& interest rates, what causes international financial
crises, & why some nations rapidly while others
stagnate
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 B. THE 3 PROBLEMS OF ECONOMIC
ORGANIZATION

▪ 1. What commodities are produced and in

what quantities? A society must
determine how much of each of the many
possible goods and services it will make
& when they will be produced. Will we
produce pizzas or shirts today? Will we
use scarce resources to produce many
consumption goods (like pizzas)?

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▪ 2. How are goods produced? A society must
determine who will do the production, with
what resources, and what production
techniques they will use. Who farms & who
teaches? Will factories be run by people or
robots?
▪ 3. For whom are goods produced? Who gets
to eat the fruit of economic activity? Is the
distribution of income & wealth fair &
equitable? How is the national product
divided among different households?

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HOW TO SOLVE THE 3 ECONOMIC PROBLEMS
▪ 1. Increasing efficiency – by promoting
competition, curbing externalities like
pollution, and providing public goods
▪ 2. Promoting equity by using tax and
expenditure programs to redistribute income
toward particular groups
▪ 3. Fostering macroeconomic stability and
growth – reducing unemployment and
inflation (rising prices) while encouraging
economic growth – through fiscal policy and
monetary regulation

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A. KEY CONCEPTS OF MACROECONOMICS
▪ The 1930s marked the first stirrings of the
science of macroeconomics, founded by
John Maynard Keynes as he tried to
understand the economic mechanism that
produced the Great Depression
▪ The U.S. Congress formally proclaimed
federal responsibility for macroeconomic
performance. It enacted the landmark
Employment Act of 1946, which stated:

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▪ Macroeconomics is the study of the
behavior of the economy as a whole. It
examines the forces that affect many firms,
consumers, and workers at the same time
▪ Two central themes will run through our
survey of macroeconomics: (1) the short-
term fluctuations in output, employment,
and prices that we call the business cycle
and (2) the longer-term trends in output
and living standards known as economic
growth

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A. KEY CONCEPTS OF MACROECONOMICS
▪ The 1930s marked the first stirrings of the
science of macroeconomics, founded by
John Maynard Keynes as he tried to
understand the economic mechanism that
produced the Great Depression
▪ The U.S. Congress formally proclaimed
federal responsibility for macroeconomic
performance. It enacted the landmark
Employment Act of 1946, which stated:

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▪ Why do output and employment sometimes fall,
and how can unemployment be reduced?
▪ One key goal of macroeconomic policy has
been to use monetary and fiscal policy to
reduce the severity (cruelty) of business
cycle downturns and unemployment. From
time-to-time countries experience high
unemployment that persists for long periods,
sometimes as long as a decade

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▪ What are the sources of price inflation, and
how can it be kept under control? A market
economy uses prices as a yardstick (index) to
measure economic values and conduct
business
▪ How can a nation increase its rate of economic
growth? Above all, macroeconomics is
concerned with economic growth, which refers
to the growth in the productive potential of an
economy. An economy’s productive potential is
the central factor in determining the growth in
its real wages and living standards

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OBJECTIVES AND INSTRUMENTS OF
MACROECONOMICS
▪ Objectives:

a. Output: High level and rapid growth of output

b. Employment: High level of employment with
low involuntary unemployment
c. Price-level stability

▪ Instruments:
a. Monetary policy: Controlling the money
supply to determine interest rates
b. Fiscal policy: Government expenditures
Taxation

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▪ Output. The ultimate objective of economic
activity is to provide the goods and services that
the population desires. What could be more
important for an economy than to produce
ample shelter, food, education, and recreation
for its people?
▪ The most comprehensive measure of the total
output in an economy is the gross domestic
product (GDP). GDP is the measure of the market
value of all final goods and services – beers,
cars, rock concerts, and so on – produced in a
country during a year

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▪ There are two ways to measure GDP:
▪ Nominal GDP is measured in actual market
prices.
▪ Real GDP is calculated in constant or invariant
prices (where we measure the number of cars
times the prices of cars in a given year such as
2022)
▪ Potential GDP represents the maximum
sustainable level of output that the economy
can produce.
▪ When an economy is operating at its potential,
there are high levels of utilization of the labor
force and the capital stock
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▪ When output rises above potential output, price
inflation tends to rise, while if it’s below the
potential level of output, it leads to high
unemployment
▪ Potential output is determined by the
economy’s productive capacity, which depends
upon the inputs available (capital, labor, land,
etc.) and the economy’s technological
efficiency.
▪ Potential GDP tends to grow steadily because
inputs like labor and capital and the level of
technology change quite slowly over time.

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▪ High employment, low unemployment. Of all
the macroeconomic indicators, employment and
unemployment are most directly felt by
individuals.
▪ People want – high-paying jobs without searching
or waiting too long, and they want to have job
security and good benefits.
▪ In macroeconomic terms, these are the objectives
of high employment
▪ The labor force includes all employed persons and
those unemployed individuals who are seeking
jobs.
▪ It excludes those without work or who are not
looking for jobs
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▪ The unemployment rate tends to reflect
the state of the business cycle:
When output is falling, the demand for
labor falls, and the unemployment rate
rises.
▪ Price stability. The third macroeconomic
objective is to maintain price stability.
This term means that the overall price
level is either unchanged or rising very
slowly

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▪ To track prices, government statisticians
construct price indexes or measures of the
overall price level.
▪ An important example is the consumer price
index (CPI), which measures the average price
of goods and services bought by consumers
▪ Economists measure price stability by looking
at the inflation rate, or rate of inflation.
▪ The inflation rate is the percentage change in
the overall level of prices from one year to the
next.

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▪ A deflation occurs when prices decline
(which means that the rate of inflation is
negative). At the other extreme is
hyperinflation, a rise in the price level of a
thousand or a million percent a year
▪ Price stability is important because a
smoothly functioning market system
requires that prices accurately and easily
convey information about relative scarcities

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▪ Most nations seek the golden mean of stable
or slowly rising prices as the best way of
encouraging the price system to function
efficiently
▪ The goals of macroeconomic policy are:
a. A high and growing level of national
output
b. High employment with low
unemployment
c. A stable or gently rising price level

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 THE TOOLS OF MACROECONOMIC POLICY
▪ Put yourself in the shoes of the chief economist
advising the government. Unemployment is
rising and GDP is falling. Or perhaps
productivity growth has declined, and you wish
to increase potential output growth.
▪ Or your country has a balance-of-payments
crisis, with a large trade deficit and an attack on
the currency. What policies will help reduce
inflation or unemployment, speed economic
growth, or correct a trade imbalance?

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▪ Governments have certain instruments that
they can use to affect macroeconomic
activity.
▪ A policy instrument is an economic variable
under the control of the government that can
affect one or more macroeconomic goals.
▪ By changing monetary, fiscal, and other
policies, governments can avoid the worst
excesses of the business cycle or increase
the growth rate of potential output

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▪ Fiscal policy. Fiscal policy denotes the use of
taxes and government expenditures.
▪ Government expenditures come in two distinct
forms.
▪ First, there are government purchases. These
comprise spending o goods and services –
purchases of tanks, construction of roads,
salaries for judges, and so forth.
▪ In addition, there are government transfer
payments, which boost the incomes of targeted
groups such as the elderly or the unemployed.
▪ From a macroeconomic perspective,
government expenditures also affect the
overall spending in the economy and thereby
influence the level of GDP
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▪ The 2nd part of fiscal policy is the taxation
▪ It affects the overall economy in two ways.
▪ 1. Taxes affect people’s incomes. By leaving
households with more or less disposable or
spendable income, taxes tend to affect the amount
people spend on goods and services as well as
the amount of private savings. Private
consumption and saving have important effects on
investment and output in the short-run and long
run
▪ 2. Taxes affect the prices of goods and factors of
production and thereby affect incentives and
behavior

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▪ Monetary policy. The second major instrument of
macroeconomic policy is monetary policy, which
the government conducts by managing the
nation’s money, credit, and banking system
▪ How does such a minor thing as the money supply
have such a large impact on macroeconomic
activity?
▪ By changing the money supply, the Government
Reserve can influence many financial and
economic variables, such as interest rates, stock
prices, housing prices, and foreign exchange
rates
▪ The exact nature of the monetary policy is one of
the most important areas of macroeconomics
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 SUMMARY
▪ A nation has two major kinds of policies that can
be used to pursue its macroeconomic goals –
fiscal policy and monetary policy
▪ 1. A fiscal policy consists of government
expenditure and taxation. Government
expenditure influences the relative size of
collective spending and private consumption.
Fiscal policy is primarily employed today to
affect long-term economic growth through its
impact o national saving and on incentives to
work and save

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▪ 2. Monetary policy, conducted by the
central bank, determines the money supply
ad financial conditions. Changes in the
money supply move interest rates up or
down and affect spending in sectors such as
business investment, housing, and foreign
trade. Monetary policy has a important
effect o both actual GDP ad potential GDP

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 2 MAJOR AREAS OF CONCERN IN
INTERNATIONAL TRADE
▪ 1. Trade policies – consist of tariffs, quotas,
and other regulations that restrict or
encourage imports and exports. Most trade
policies have little effect on macroeconomic
performance, but from time to time, as was
the case in the 1930s, restrictions on
international trade are so severe (strict) that
they cause major economic dislocations,
inflations, or recessions

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▪ 2. The second set of policies is international
financial management. A country’s
international trade is influenced by its foreign
exchange rate, which represents the price of its
own currency in terms of the currencies of
other nations. Particularly in small open
economies, managing the exchange rate is the
single most important macroeconomic policy

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▪ The international economy is an intricate
(complex) web of trading and financial
connections among countries. When the
international economic system runs smoothly,
it contributes to rapid economic growth; when
trading systems break down, production and
income suffer throughout the world.
Countries, therefore, consider the impacts of
trade policies and international financial
policies on their domestic objectives of
output, employment, and price stability

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B. AGGREGATE SUPPLY AND DEMAND
▪ Aggregate supply refers to the total quantity of
goods and services that the nation’s business
willingly produces and sells in a given period.
Aggregate supply (often written as AS)
depends upon the price level, the productive
capacity of the economy, and the level of costs
▪ Aggregate demand. It represents what
everyone in the economy – consumers,
businesses, foreigners, and governments –
would buy at different aggregate price levels
(with other factors affecting aggregate demand
held constant)
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 MACROECONOMIC EQUILIBRIUM
▪ We now see how aggregate output and the price
level adjust or equilibrate to bring aggregate
supply and aggregate demand into balance.
That is, we use the AS and AD concepts to see
how equilibrium values of price and quantity
are determined or to find the P and Q that
satisfy the buyers and sellers all taken together
▪ Macroeconomic equilibrium is a combination of
overall price and quantity at which all buyers
and sellers are satisfied with their purchases,
sales, and prices

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MACROECONOMIC EQUILIBRIUM

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THE ROLE OF ECONOMIC POLICY
▪ The striking change over the twentieth
century was the discovery and
application of macroeconomics, along
with a good appreciation of the role and
limitations of monetary and fiscal policy.
▪ The application of fiscal policy, and
especially monetary policy, helped
lower unemployment and provided
largely stable prices over the last two
decades

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