3. Lesson Objectives
• By the end of this lesson you must be able to;
– Define Macroeconomics
– Explain macroeconomic objectives
– Justify the learning of macroeconomics
– Define economic models
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AAE 321: Macroeconomic Theory
5. Economics and its Branches
• Economics is the study of how limited resources are allocated or distributed
among the people in order to satisfy their wants.
• It is a social science that studies efficient allocation of scarce resources
among competing alternative uses in order to maximise satisfaction.
• Think of human wants as being all the goods and services that individuals
desire that enhances the quality of life.
• Since we can always think of ways to improve our well-being with more or
better goods and services, our wants are unlimited
• Economics has two main branches called microeconomics and
macroeconomics.
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6. Microeconomics
• The prefix micro is derived from the Greek word mikros, which means
“small.”
• Microeconomics is the study of how individual economic decision makers
(households or firms) make their decisions and how they interact in the
market place.
• Microeconomics examines the economic behavior of individual economic
decision units, such as a consumer or a firm, as well as groups of economic
agents, such as households or industries.
• It also analyzes the behavior of individual households, industries, markets,
labor unions, or trade associations.
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7. Macroeconomics
• The prefix macro comes from the Greek word makros, which
means “large.”
• Macroeconomics is the study of economy wide phenomena.
• Macroeconomics examines either the economy as a whole or its
basic subdivisions or aggregates, such as the government,
household, and business sectors.
• An aggregate is a collection of specific economic units treated as if
they were one unit.
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8. Differences
AAE 321: Macroeconomic Theory
Microeconomics Macroeconomics
Study of individual economic units
of an economy
Study of economy as a whole and its
aggregates
Deals with Individual Income,
Individual prices, Individual output
Deals with aggregates like national Income,
general price level, national output
Solve the central problem of ‘what,
how and for whom’ to produce
Solve the central problem of full
employment of resources in the economy
Price is the main determinant of
micro- economic problems
Income is the major determinant of
macroeconomic problems.
8
9. Macroeconomics and Microeconomics
Microeconomics and macroeconomics are also related.
• Economy wide events arise from the interaction of many individual
decisions.
– The national output studied in macroeconomics arises from decisions
made by individual producers.
• Macroeconomic environment influences decisions made at micro level.
– High inflation might reduce household demand for goods and services.
• Macroeconomists use many of the tools of microeconomics.
– This is because macroeconomic events arise from many microeconomic interactions.
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11. Macroeconomics Variables
• In analyzing various economic problems, macroeconomists speaks of such
economic measures as
Total output,
Unemployment,
The general level of prices.
Balance of payment
Aggregate expenditures,
Exchange rate,
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12. Macroeconomic Objectives
• Broadly, the objective of macroeconomic policies is to maximize the level
and growth of national income to raise the utility and standard of living of
participants in the economy.
• There are also a number of secondary objectives which include
– Sustainable economic growth and economic development
– Full employment
– Price stability
– Balance of payments equilibrium and exchange rate stability
– Increasing productivity
– Equitable distribution of income and wealth
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13. Economic Growth
• Sustainable economic growth rate of growth which allows an increase in
living standards without undue structural and environmental difficulties.
• Sustainable Economic Development is the economic development that
meets the needs of the present generation without compromising the
ability of the future generations to meet their own needs.
• There are three major’ sources of economic growth,
– The growth of the labour force,
– Capital formation
– Technological progress.
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14. Full Employment
• Unemployment refers to involuntary idleness of mainly labour force and
other productive resources.
• Where those who are able and willing to have a job can get one, given that
there will be a certain amount of frictional, seasonal and structural
unemployment (referred to as the natural rate of unemployment).
• Full employment does not necessarily means zero unemployment rate.
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15. • Price stability is when prices remain largely the same, and there is no rapid
inflation or deflation.
• Inflation refers to a sustained rise in the general price level in an economy
over a given time period. It is a good measure of 'price stability'.
• Price stability is not necessarily the same as zero inflation, but instead steady
levels of low-moderate inflation is often regarded as ideal and zero inflation is
often undesirable in an economy.
• It is worth noting that prices of some goods and services often fall as a result
of productivity improvements during periods of inflation, as inflation is only a
measure of general price levels.
Price Stability
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16. • The balance of payments is a record of a country’s financial transactions
with the rest of the world.
• It is composed of three accounts
i. Current account: This measures trade balance.
ii. Capital account: it measure financial transactions that do not affect a country’s
income, production and savings. Eg trademarks and copyrights.
iii. Financial account. It measure changes in domestic ownership of foreign assets and
foreign ownership of domestic assets.
• Balance of payments equilibrium or external balance occurs when induced
balance of payments transactions are zero.
AAE 321: Macroeconomic Theory
Balance of Payment Rate equilibrium
16
17. Exchange Rate Stability
• Exchange rate is the amount of foreign currency required to purchase one
unit of the domestic currency.
• Depreciation of the currency makes imports to become expensive but
makes domestic goods and services cheaper to foreign consumers while
appreciation makes lowers the nominal price of imports while making
exports expensive.
• The foreign exchange rate should be stable as far as possible.
• This is what one may call it external stability in price.
• Excessive importation erodes value of the domestic currency.
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18. Increasing Productivity
• Increase in productivity implies more output per unit of labour
per hour.
• Also, since labor is but one of many inputs to produce goods and
services, it could also be described as output per unit of factor
inputs per hour.
• Technological advancement is key for achievement of this
objective.
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20. Why learn macroeconomics?
1. The macroeconomy affects society’s well-being.
– For example: each one-point increase in the unemployment rate in the
US is associated with:
• 920 more suicides
• 650 more homicides
• 4000 more people admitted to state mental institutions
• 3300 more people sent to state prisons
• 37,000 more deaths
• increases in domestic
AAE 321: Macroeconomic Theory
20
21. Why learn macroeconomics?
2. The macroeconomy affects well-being of individuals.
Unemployment and earnings growth
-3
-2
-1
0
1
2
3
4
5
1965 1970 1975 1980 1985 1990 1995 2000 2005
-7
-5
-3
-1
1
3
5
unemployment rate inflation-adjusted mean wage (right scale)
change
from
12
mos
earlier
percent
change
from
12
mos
earlier
AAE 321: Macroeconomic Theory
21
22. Why learn macroeconomics?
2. The macroeconomy affects well-being of individuals.
Interest rates and mortgage payments
For a $150,000 30-year mortgage:
$9,888
$824
5.21%
$11,520
$960
6.63%
6/21/02
annual
payment
monthly
payment
actual rate on
30-year
mortgage
date
6/20/03
AAE 321: Macroeconomic Theory
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23. Why learn macroeconomics?
3. Macroeconomics affects politics and current events.
• Performance of an economy has a baring on popularity of
national political leaders.
• Although the job of making economic policy falls to world
leaders, the job of explaining how the economy as a whole
works falls to macroeconomists.
• In developed societies politicians are put in power or
removed from power on the basis of economic performance
of their country.
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24. USA politics and macro economy
Every era has its own economic problems.
• In the 1970s, Presidents Richard Nixon, Gerald Ford, and Jimmy Carter all
wrestled in vain with a rising rate of inflation.
• In the 1980s, inflation subsided, but Presidents Ronald Reagan and George
Bush presided over large federal budget deficits.
• In the 1990s, with President Bill Clinton in the Oval Office, the budget
deficit shrank and even turned into a budget surplus, but federal taxes as a
share of national income reached a historic high.
• So it was no surprise that when President George W. Bush moved into the
White House in 2001, he put a tax cut high on his agenda.
When the economy is doing poorly, people change governing the party.
AAE 321: Macroeconomic Theory
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26. Economic models
• Economic models illustrate, often in mathematical terms, the
relationships among the variables.
• They are simplified versions of a more complex reality
irrelevant details are stripped away
• Models are used to
show relationships between variables
explain the economy’s behavior
devise policies to improve economic performance
AAE 321: Macroeconomic Theory
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27. Economic models
• To understand the economy, economists use models—theories that simplify
reality in order to reveal how exogenous variables influence endogenous
variables.
• Models may lead to incorrect conclusions if they assume away features of
the economy that are crucial to the issue at hand.
• Economic modeling therefore requires care and common sense.
• The art in the science of economics is in judging whether a model captures
the important economic relationships for the matter at hand.
• Because no single model can answer all questions, macroeconomists use
different models to look at different issues.
AAE 321: Macroeconomic Theory
27
28. Example of a model
• AD-AS Model
• IS-LM model
• Mundell Flemmings Model
AAE 321: Macroeconomic Theory
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29. Endogenous and Exogenous Variables
• The values of endogenous variables are determined in the model.
• The values of exogenous variables are determined outside the model.
• The model takes values & behavior of exogenous variables as given.
In the model of supply & demand for cars,
𝑄𝑑 = 𝐷 𝑃, 𝑌
𝑄𝑠 = 𝑆(𝑃, 𝑃𝑠)
endogenous: , ,
d s
P Q Q
exogenous: , s
Y P
AAE 321: Macroeconomic Theory
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30. Endogenous and Exogenous Variables
• It is easiest to consider what a macro-econometric model is like by
considering a simple example.
• The following is a simple multiplier model. Ct is consumption, It is
investment, Yt is total income or GDP, Gt is government spending, and rt is
the interest rate. The t subscripts refer to period t.
(1) Ct = a1 + a2Yt + et
(2) It = b1 + b2rt + ut
(3) Yt = Ct + It + Gt
• Identify endogenous and exogenous variables
AAE 321: Macroeconomic Theory
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31. Topic Review Exercise
• Analyse branches of economics.
• How would you ensure that economic models give useful
results with adequate accuracy?
• Discuss any four macroeconomic objectives.
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AAE 321: Macroeconomic Theory
32. Conclusion
• In this lesson you have defined economics and its branches.
• You have also explained macroeconomic variables and
objectives.
• At the end of the lesson you have learnt that economists use
models as simplified presentation of complex reality.
• In the next lesson you will learn about macroeconomic data.
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AAE 321: Macroeconomic Theory
