CHAPTER SIX: FUNDAMENTAL CONCEPTS TO MACROECONOMICS

 6.1. What Macroeconomics is about?

 Why have some countries experienced rapid
growth in incomes over the past century while
others stay mired in poverty?
 Why do some countries have high rates of
inflation while others maintain stable prices?
 Why do all countries experience recessions and
depressions and how can government policy reduce
the frequency and severity of these episodes?

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 Macroeconomics-is a branch of economic analysis

concerned with the structure, performance and behavior
of the economy as a whole and sub aggregates of the
economy.
 It deals with aggregate units of national economy such
as total output of goods and services (GDP), general
price level (inflation), national
employment/unemployment and international
transactions(balance of payments), population growth,
Economic growth, Money & Banking, Output, and
Business Cycle.
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 6.2. Macroeconomic Goals, policies and Instruments
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 Macroeconomic Goals
 These include:
 Attain full employment /low unemployment
 Achieve stable price/low inflation with in free market:
Rapid price changes lead to economic inefficiency
 Sustainable economic growth : The ultimate objective of
economic activity is to provide the goods and services
that the population desires.

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6.2.1. Macroeconomic Policies and policy Instruments

 A policy instrument is an economic variable under the
control of government that can affect one or more of
the macroeconomic goals. It includes:
1. Fiscal Policy: is concerned with the composition of and
changes in the level of government expenditure and
taxation.
2. Monetary Policy: is defined as the measures taken by
the government and the central banks to control the
quantity of money which in turn influence the cost of
borrowing (i.e. the rate of interest) and availability of
credit and liquidity in the economy there by affecting
the over all demand for and supply of money.

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3. Exchange rate policy: refers to government and
the central bank intervention in the foreign
exchange markets to influence the level and
direction of the external value of a country’s
currency.
 Exchange rate represents the price of own

currency in terms of the currency of other nation.

 For example , Ethiopian birr in terms of

American dollar.

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4. International Trade Policy: measures taken by
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the government, in addition to the exchange rate
policy, to influence the magnitude and direction of
foreign trade (….. Net export, trade surplus, trade
deficit)
 Like correction of Balance of payment (BoP)

problems, export subsidies, tariffs on imports,

import quotas etc.

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5. Price and income policies: refers to the direct
7 intervention by government in the working of a
market economy concerned with the setting of prices
for goods and services and wage settlements. These
policies have two major aims
 Control of general inflation

 Protection of wages

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6. Employment Policy: is concerned with
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government efforts to create jobs and thereby
reduce unemployment.
 The policy may be implemented either
indirectly, via stimulation of aggregate demand
in the economy, or directly through supply-side
measures such as job creation schemes and the
provision of training programmes; like MSEs

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 6.4. Major macroeconomic problems
6.4.1. Unemployment, Inflation and Business Cycle
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 Unemployment:
 The labor force is defined as the sum of the employed and unemployed.
 The labor-force participation rate is the percentage of the adult population
who are in the labor force.
Labor-force participation rate = Labor force_____ x 100
Adult population
 Unemployment rate is defined as the percentage of the labor force that is
unemployed, measures the fraction of the labor force that is looking for
but cannot find the work.
 A person is said to be unemployed if he/she is within the working age
group and actively searching for a job but couldn’t get a job.
Unemployment rate = Number of unemployed x 100
Total labor force
, At a given period of time
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 Types of Unemployment
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 Economists define 4 different types of
unemployment:
 Seasonal unemployment,

 Frictional unemployment,

 Structural unemployment, and

 Cyclical unemployment.

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 Seasonal unemployment: this type of
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unemployment happens due to seasonal variations
in the demand for labor.
 Example: farmers, construction workers, etc faces
seasonal unemployment.
 Frictional unemployment: occurs when workers are
engaged in voluntary job search. For this reason, it is
sometimes referred to as "search unemployment.“
 Workers searching for their first jobs or who have
quit their jobs to try to find a better one are
considered to be frictionally unemployed.
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 Structural unemployment: Some workers lose their jobs
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because of technological change or changes in the demand for
final output. This situation reduce the demand for labor in a
particular job type.

 Structural unemployment can persist if the job skills of those

who lost their jobs do not necessarily match the skills required
in the new jobs that are open.

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 Cyclical unemployment: happen when the
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economy faces recession. That is, some labor force
lose their jobs because of the general decline in the
economy.
 One of the main objectives of macroeconomic
policy is to keep the level of cyclical
unemployment as close to zero as possible.

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 Inflation
 The rate of inflation measures changes in the level of prices.
It denotes the rate of growth or decline of the price level from
one year to the next.
 Theories: (Causes/ sources of Inflation)
 Cost-push inflation: occurs as a result of increases in
production costs.
 Example: the inflation that resulted from rising energy prices
 Demand-pull inflation: is caused by an increase
in the demand for output.
 Aggregate Demand Aggregate Supply Demand
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o Measure of Inflation
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 When prices of almost everything increase, we can say
there is inflation; consequently the cost of living also
increases.
 But how exactly is the inflation rate measured?
 Inflation Rate (year t) =
price level at (t) - price level at (t-1) x 100
price level at (t-1)

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o Inflation or deflation:
 An inflation occurs when the level of price is
growing (the rate of inflation is positive).
 A deflation denotes that the level of price
declines (the rate of inflation is negative).
 A disinflation is a decrease in the rate of
inflation. The slowing of the rate of inflation per
unit of time.

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 Business Cycle
 Market economies experience fluctuations in real
GDP and employment over time. These
fluctuations are referred to as the business cycle.
A recession is said to occur when real GDP falls
(typically economists only say that a recession has
occurred if real GDP has fallen for two consecutive
quarters).
*Hard times for many people
*A major political concern

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 An expansion occurs when output is rising. The

graph below depicts the stages of a simple business
cycle.
 The peak of the cycle is the point at which an
expansion ends and a recession begins.
 Trough is a point where a recession ends and an
expansion begins at the business cycle.
 A very severe recession is called a depression. Such
situation experienced during the 1930s.
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