HAWASSA UNIVERSITY

College Of Business And Economics

Macro Economics

By Hiwot D.A.
 CHAPTER ONE
1. Introduction

Economics is a science of choice.

Economics study efficient resource allocation to produce
maximum output.
Microeconomics and Macroeconomics
Microeconomics; focuses in the analyses of the behaviour
of individual economic actors (markets, households and
business firms).
 Macroeconomics deals with issues relating to the
structure, performance and behaviour of the economy as a
whole.
 MACROECONOMICS
Why macroeconomics?
Macroeconomic performance of a country is directly
related to the lives and welfare of its citizen.
 An economy that has successful macroeconomic
management should experience low unemployment and
inflation, and steady and sustained economic growth.
In contrast, in a country where there is macroeconomic
mismanagement, we will observe an adverse impact on
the living standards and employment opportunities of the
citizens of that country.
Why are there recessions? Can the government do anything
Macroeconomic Concerns

to combat recessions? Should it?

Why are so many countries, including Ethiopia, poor? What
policies might help them grow out of poverty?
Why does the cost of living keep rising in Ethiopia in recent
years or why inflation has soared?
 why are millions of people unemployed even when the
economy is registering successive growth or why some new
graduates from universities couldn’t find a job?
 Why do Ethiopia and other LDCs have such a huge trade
deficit?
What is the government budget deficit? How does it affect
the economy?
 Macroeconomic Tools

Theories and Models

Economic theories are developed to explain the observed
phenomena in terms of a set of basic assumptions and
rules.
Economic models are simplified versions of a more
complex reality.
 show the key relationships among economic variables.
 models have three aspects story, mathematical expression
and graphical representation.
 Models have two kinds of variables: endogenous
variables and exogenous variables.
 Flexible Versus Sticky Prices
A key feature of a macroeconomic model is whether it
assumes that prices are flexible or sticky.
The economy’s behaviour depends partly on whether
prices are sticky or flexible.
Economists normally presume that the price of a good or
a service moves quickly to bring quantity supplied and
quantity demanded into balance.
This assumption is called market clearing: an assumption
that prices are flexible, adjust to equate supply and
demand.
However, many wages and prices adjust slowly (in the
short run).
 2. The State of Macroeconomics:
Its Evolution and Developments
The birth of modern macroeconomics is attributed to
John Maynard Keynes and his General Theory of
Employment, Interest and Money published in 1936.
There are a wide variety of schools of thought in
economics in general, and macroeconomics in particular.
The real dividing issues between macroeconomists can be
broadly stated as:
Can the government influence the outcome of the economic
process? and
Should the government influence the economic process?
 A. Classical Economists:
Adam Smith, David Hume, David Ricardo, John Stuart Mill, Knut
Wicksell and Irving Fisher.
No sharp distinction between microeconomics and
macroeconomics
 Assumptions
The economy is self-regulating mechanism
 Wages, prices, and interest rates are flexible.
 Say’s law- the dictum, “supply creates its own demand”
 full employment (vertical aggregate supply).
Classical dichotomy
Neutrality of money
 The policy implications of classical view is that of Laissez-
faire-”leave it alone”
 B. The Keynesians
It is a result of great depression/great crash.
Keynesian economics is short run economics.
Assumption
price and wage inflexibility
Upward sloping supply curve
There is no full employment

Policy implications; Active government intervention

through fiscal policy.
For Keynes, monetary policy, is ineffective because the
additional money absorbed by investors with no effect on
the interest rate.
 C. Neo Classical Synthesis/Neo Keynesian synthesis
Virtually all economists in 1950s and 1960s except Milton
Friedman
Paul Samuelson, James Tobin, Franco Modigliani, Robert
Solow
 The neo classical synthesizers state that the economy is
“Keynesian” in the short run but “classical” in the long run.

Policy view: Both monetary and fiscal policy can affect the
economy in the short run and presume the government should
pursue a counter-cyclical policy.
•
 D. Monetarists
 Milton Friedman and his “Chicago boys”
 The roots of monetarism emanated from the “quantity theory of
money” M = kPY
 Where, M= is money supply, P= price level, Y = real output and 1/k
= V is velocity of circulation of money, which is assumed as stable
 Assumption
 Prices and wages are relatively flexible
 Philips curve does not hold in the long run
 Money supply in the short run determine Nominal GDP, in the long
run by price
inflation is always and everywhere a monetary phenomenon.
 Policy Implications; For monetarists, fiscal policy is “irrelevant” .
Monetary policy is potent but policy makers make timing errors (“long and
variable lags”) and may exacerbate the cycle. Thus, there should be constant
money growth rule.
 E. New Classical Economists
 Robert Lucas, Robert Barro, Thomas Sargent, Neil Wallace, Edward
Prescott
 Are called fresh water economists
 Emerged during the 1970s as natural successors to the classical
economists.
 Assumption
 Economic agents make optimal decisions
 Expectations are rational
 Markets clear continuously
 New Classicals claim that all the fluctuations that we observe in the
economy are due not to nominal rigidities as Keynesians claim but are
due to rational agents responding to the incentives as the observe them.
 RBC
 Policy implication; only unanticipated monetary surprises can
temporarily affect real variables
 F. Supply Siders
Arthur Laffer, Robert Mundell
They were radical conservatives with strong distrust of “the
government” and emphasize on distorting aspects of taxation.
Major contribution of the supply siders was the so called
Laffer curve, which shows that high tax rates shrink the tax
base because they reduce economic activity.

Policy Advice:
Cut tax rates and then stimulate the economy. They argued that
there was no need to cut government spending, tax cut would
pay for itself.
 G. New Keynesian Economists
Edmund Phelps, Stanley Fischer, John Taylor, Olivier-Jean
Blanchard, Greg Mankiw, Lawrence summers, George Akerlof,
David Romer, Janet Yellen, Ben Bernanke, Joseph Stiglitz…
They are also called ‘Saltwater’ economists.
 Assumptions
Price and wage rigidity
Imperfect competition,
Incomplete markets,
Failures, and
Credit market imperfections
 Policy advocacy; the government can and should intervene in
the macro economy.