Chapter 6 - Macroeconomics: The Big Picture

WHAT YOU WILL LEARN IN THIS CHAPTER

 What is the difference between macroeconomics and microeconomics?

 What are business cycles and why do policy makers try to diminish their severity?

 How does long-run economic growth determine a country’s standard of living?

 What are inflation and deflation, and why is price stability preferred?

 Why does international macroeconomics matter, and how do economies interact through trade
deficits and trade surpluses?

THE NATURE OF MACROECONOMICS

• Macroeconomics differs from microeconomics by focusing on the behaviour of the economy as

• Microeconomics focuses on decisions made by individuals and firms.

• Macroeconomics examines the actions of all the individuals and all the firms in the economy.

TABLE 6-1 Microeconomic versus Macroeconomic Questions

MACROECONOMICS: THE WHOLE IS GREATER THAN THE SUM OF ITS PARTS

• Macroeconomic questions can’t be answered simply by adding up microeconomic answers.

• Consider, for example, the paradox of thrift. When people are worried about economic hard
times, they prepare by cutting their spending. This reduction in spending depresses the
economy, and businesses react by laying off workers.

• As a result, people end up worse off than if they hadn’t cut their spending. Seemingly virtuous
behaviour—saving more—harms everyone.

• The combined effect of individual decisions can have results that are different from what any
one individual intended. The behaviour of the macroeconomy is greater than the sum of
individual actions and market outcomes.

MACROECONOMICS: THEORY AND POLICY

• Pre-1930s economics: the economy is self-regulating. Problems such as unemployment would

• Post-1930s Keynesian economics: a depressed economy is the result of inadequate spending.

• Monetary policy uses changes in the quantity of money to alter interest rates, which in turn
affect the level of overall spending.
 • Fiscal policy uses changes in taxes and government spending to affect overall spending.

• John Maynard Keynes established the idea that managing the economy is a government
responsility.

COMPARING THE GREAT RECESSION TO THE GREAT DEPRESSION

• The Great Depression: policy makers let the slump run its course.

• The Great Recession: policy makers slashed interest rates, increased spending, and cut taxes—
governments helped avoid a global economic catastrophe.

THE BUSINESS CYCLE

• Recessions (contractions): periods of economic downturn when output and employment are
falling

• Expansions (recoveries): periods of economic upturn when output and employment are rising

• Business cycle: the short-run alternation between recessions and expansions

Fig. 6-2 CHARTING THE BUSINESS CYCLE

• The point at which the economy turns from expansion to recession is a business-cycle peak.

• The point at which the economy turns from recession to expansion is a business-cycle trough.

THE PAIN OF RECESSION

• Recessions cause many people to lose their jobs and make it hard to find new ones.

• Recessions reduce the standard of living, increase poverty, cut corporate profits, and result in
bankruptcies of many small businesses.

• Can anything be done to reduce the frequency and severity of recessions?

TAMING THE BUSINESS CYCLE

• Modern macroeconomics largely came into being as a response to the recession of 1929–1933.
 • According to John Maynard Keynes and Milton Friedman, policy makers should try to “smooth
out” the business cycle. They haven’t been completely successful but have helped make the
economy more stable.

LONG-RUN ECONOMIC GROWTH

• Long-run economic growth is the sustained upward trend in the economy’s output over time.

• It reflects one of our basic principles of economics: increases in the economy’s potential lead to
economic growth over time.

• Long-run economic growth is a modern invention. Britain, for example, wasn’t any richer in 1650
than it was two centuries earlier.

• Countries don’t necessarily grow at the same rate. Britain was once substantially richer than
Canada, but it was overtaken by the rapidly growing Canada after 1950.

INFLATION AND DEFLATION

• A rise in the overall level of prices is inflation.

• A fall in the overall level of prices is deflation.

THE CAUSES OF INFLATION AND DEFLATION

• Can we just add up supplies and demands in all the markets to find out what happens to prices?

• No, because supply and demand can only explain why a good or service becomes more
expensive relative to other goods and services.

• In the short run, movements in inflation are closely related to the business cycle.

a) When the economy is depressed and jobs are hard to find, inflation tends to fall.

b) When the economy is booming, inflation tends to rise.

• In the long run, the overall level of prices is mainly determined by changes in the money supply.

THE PAIN OF INFLATION AND DEFLATION

• Both inflation and deflation are problematic.

a) Inflation discourages people from holding onto cash (because cash loses value if prices
are rising). In extreme cases, people stop using cash altogether.

b) Deflation can cause the reverse problem. Since cash gains value if the price level is
falling, holding onto it is more attractive than investing in new factories and other
productive assets. This can deepen a recession.

c) The economy has price stability when the overall level of prices changes slowly.

d) Economists view price stability as a desirable goal. From the 1990s to the present, it has
been achieved.
INTERNATIONAL IMBALANCES

• Canada is an open economy: it trades goods and services with other countries.

• In 2019, Canada ran a big trade deficit when the country imported more than it exported.

• Trade deficit: the value of goods and services bought from foreigners is more than the value of
goods and services sold to them.

• Trade surplus: the value of goods and services bought from foreigners is less than the value of
the goods and services sold to them.

• Are the Canadian trade deficits a sign that something is wrong with the economy?

• In a later chapter we’ll learn the surprising answer: the determinants of the overall balance
between exports and imports lie in decisions about savings and investment spending.

• Countries with high investment spending relative to savings run trade deficits; countries with
low investment spending relative to savings run trade surpluses.x