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Lets begin with a look at economics in general, and how macroeconomics fits into the overall
discipline. At the fundamental level, economics is almost
always concerned with some aspect of decision-making. The tools of economics enable systematic analysis
of how decisions are made, and provide criteria for evaluating the success or otherwise of
decisions. Decisions are important part of how society
operates, for economists, this is self evident. Because of an astute observation, made very
early in the history of Economics. Namely, that we live in a world of unlimited
wants and needs, but where the resources necessary to meet those wants and needs are finite.
Or to use the term preferred by economists Scarce. And it is this scarcity of resources
that mean decision making, in particular decisions
about how those scarce resources will be allocated among the competing needs, is a first order
important to the functioning of any society, or indeed any part of that society.
Think of your own decision making. Each day, you are called upon to make countless decisions.
These might range from decisions about what groceries to buy at the local store, how you
might spend your time today, should you apply for that new job, when and where will you
take your vacation this year and so on. Each and every one of the decisions you make
reflects the scarcity of the resources that are available to you. For example, your income,
or even the amount of time that you have available. You will need to make informed choices, weighing
up the pros and cons of each and every decision you make.
And you'll need to make the decisions that best meet your needs, or perhaps those of
your family, community, or your workplace. Economists regard this process of decision
making as being fundamental to how societies And the individuals making up those societies
operate. And so decision making is essential to almost
all analysis and economics. Economists study decision making across all
aspects of society. Sometimes economists are concerned with decision making at the level
of the individual or perhaps the individual firm or business.
Sometimes, the focus of analysis is the operation of individual markets and how decisions made
by many individuals and firms are coordinated in those markets.
Macroeconomics, as we will see, looks at decision making at an even higher level of aggregation.
Namely national economies and even the global economy.
In particular, how do all these decision taken by individuals, firms, and government influence
national economies and the global economies. Do the decisions that are taken produce the
best outcomes? Is there a role for government to influence
decision making and secure improved outcomes at the macroeconomic level? these are the
broad questions that macroeconomists consider. Throughout recorded history, different societies
have used different means to make decisions of about how to allocate their
scarce resources. Command economies, such as the former Soviet
Union for example, relied on decisions made by central planning agencies as to the uses
that scarce resources will be put. Market economies, in contrast, adopt a decentralized
approach, an approach in which the price system guides individual decision-making.
For example, suppose the demand for a particular commodity, outstrips its supply.
We would expect its price, relative to that of other commodities, will then increase.
In response, producers, attracted by the higher price, will shift resources towards that commodity.
Consumers discouraged by the higher price will shift their purchasing power towards
other commodities. The result, eventually, is the elimination
of the gap between demand and supply, a situation that economists call equilibrium.
Once in equilibrium, unless there is a fundamental change to market conditions.that would cause
the price to again change and producers can move to revise their decision.
The market will be at rest. The rising price has guided consumers and producers decisions
to secure a coordination of their respective decision making.
What consumers wish to purchase exactly matches what firms are prepared to produce.
When it's sometimes called the magic of markets achieve this coordination passes provide powerful
signals. Signals that secure market outcomes that ensure smooth process of coordinated
decision making a highly efficient way of dealing with the reality of scarce resources.
Economics is traditionally divided into 2 main subdisciplines. Microeconomics and Macroeconomics.
To some extent, the division is arbitrary. And there are clearly defined links between
the two. Particularly from microeconomics into macroeconomics.
And sometimes, certain topics are difficult to assign to one discipline as opposed
to the other. Nevertheless, most economists view themselves as working primarily in one
of these two disciplines. Microeconomic analysis emphasizes individual
units in the economy and how they interact through the medium of the market.
It is a powerful mode of analysis. To provide insight into the motivations and decision-making
of individual consumers and producers, the circumstances in which markets successfully
coordinate their actions, and mind you this doesn't always work, a thing we will come
back to, and the role government can play in addressing instances of market failure.
Here are some examples of what might be regarded as typical microeconomics questions.
I stress the field is much broader than this, encompassing virtually all aspects of individual
decision-making, and the complex interactions that exist between individuals and the economic
institutions such as the market. That have evolved through time. With a limited
budget, how should members of an individual household organize spending across goods and
services? Given market conditions, how does a firm choose how much to produce? Will prices
coordinate household spending and firms' production in a way that best allocates society's scarce
resources. Macroeconomics in contrast and as the name
suggests, shifts the emphasis away from the individual towards the aggregate.
The name itself is derived from the Greek word macros, meaning large. As a generalization,
one can think of macroeconomics as dealing with economic outcomes at the label of national
economies and the global economy. However, the distinction between microeconomics
and macroeconomics is not quite as stark as I had portrayed it. Many of the important
analytical breakthroughs in macroeconomics, particularly in recent times, have come about
by considering how the decision making of individual units in the economy aggregate
up to affect economic outcomes at the larger scale.
An important part of modern macroeconomics is to consider what's known as its microeconomic
foundations. And whilst this course will be devoted to macroeconomics, you will, by necessity,
learn some microeconomics along the way. Here are some examples of questions studied by
macroeconomists. Indeed, it is precisely these questions that we are going to answer in this
course. What factors determine how much output a nation produces?
Why do recessions occur? Why do different economies have different rates of inflation?
What roles do monetary and fiscal policy play in managing the economy?
And what are the sources of a nation's long run growth? Let me return briefly to the market
mechanism and to two of the most important concepts in economics. What are known as the
fundamental theorems of welfare economics. The reason for having to look at this, is
to place the study of macroeconomics into some context.
For many of the nine problems studied by macro economists occur because of a break down in
these fundamental theorems as they apply to the real world. The first fundamental theorem
states that under ideal conditions decentralized decision making conducted through the meaning
of the market. Will lead to what is known as an optimal,
that is, the best possible allocation of resources. Economists are very precise when talking about
optimal outcomes. What is meant by optimal is a situation in which there exists no possible
way of reallocating resources that would make any one individual better off.
Without harming at least one individual. One can think of this as the no free lunch principle.
When optimality has been achieved, one can't improve a welfare of any single person, without
harming at least one other person. However if optimality has not been achieved, then
unambiguous improvements in welfare can be achieved. People can be made better off through
a reallocation of resources, without harming anyone. The first fundamental theorem which
has a most elegant mathematical proof, states that decentralized decision making in response
to price signals, and under certain ideal conditions, yields an optimal outcome.
This outcome is often known as Pareto optimality. [SOUND] The name is based on the great
Italian economist Wilfrado Pareto, who died in 1923. And he was the first scholar to consider
optimality in these terms. You'll often here the term Pareto optimality in all branches
of economics. The second fundamental theorem is slightly more technical. And states that
there will always be a market deterrent outcome. That will support any Pareto efficient allocation.
The Fundamental Welfare Theorems are an important intellectual foundation for economists' general
view that market-determined resource allocation can produce highly desirable outcomes. And
in a variety of situations, we can see this to be true, but not in all situations. And
whilst microeconomics for example do indeed spend a great deal of their time analyzing
cases where the fundamental theorems do not hold.
In macroeconomics, the breakdown of the theorems is particularly important.
We can see this in the work of Keynes, who was writing at the time of the Great Depression.
Whilst cataclysmic events, like the Great Depression and the more recent global financial
crisis, are extraordinarily complex and most certainly not amenable to simple explanations
based on one or two key factors, for many macro economists, these represent radical
departures from the world of the fundamental welfare theorems. A great deal of macroeconomics
is concerned with instances where market based economies do not allocate resources efficiently
at the aggregate level. An important qualification before we go any further. Macroeconomics is
by no means a settled discipline where there is complete consensus amongst scholars.
Many of my colleagues would take issue with my view of macro economics, that it deals
with instances of pronounced market failure. In fact, a great deal of extremely useful
and powerful macro economic analysis can be under taken viewing aggregate outcomes as
optimal market-based responses to the external environment.
Even what we call recessions may represent, in some sense, optimal market-based adjustments
in response to events like A hike in oil prices or increased uncertainty about the future.
These approaches to macroeconomics, sometimes labeled neo classical macroeconomics or real
business cycle theory, have provided much insight into he dynamic behavior of modern
economies. These models are quite complex, and while
worthy of study, will not be pursued in this course.
Here, the emphasis will be in the macro-economic tradition that has its beginnings in the work
of Keynes, which see many macro economic outcomes as becoming instances of market folio where
there is scope for carefully designed macroeconomic policies to achieve better outcomes.
As we have seen during the global financial crisis, this view of the macroeconomy is one
widely held by governments across the world. Understanding government responses to the
global financial crisis is achieved. To a large extent by understanding this Keynesian
tradition. This slide reproduces one of the most famous quotes from Keynes' great work,
The General Theory of Employment, Interest and Money.
Keynes' argument was based around the hypothesis that optimal resource allocation.
Achieved through decision making in response to market based price signals was a special
case of a more general way of thinking about the economy. In this general model of the
economy equilibrium at the macroeconomic level can be consistent with a situation in which
there is unemployed labor. And businesses are working at less than full capacity. Whilst
in equilibrium, that is the economy is at rest, this cannot be optimal in the pareto
sense. For example, providing work for an unemployed person need not harm anyone else.
This is the essence of the Keynetian approach to government management of the macroeconomy.
Namely there is a role for government to secure improved macro-economic outcome. This view
forms the basis for governments response to the global financial crisis. The key is careful
management of the economy. Recognizing there are limits to what governments
can achieve. And government policies designed to support an economy during a period of recession
can cause problems for economies later. A theme being played out in a number of countries
at the moment. As well as outlining the internet, intellectual foundations to the government's
response to events like the global financial crisis, we will in this course think carefully
about the wider implications of such policies. [SOUND] Let me now begin to outline three
key themes in macroeconomics that'll form the basis of our course.
The first I've called indicators and performance. What do macroeconomists look at to decide
the quality of an economy's performance? As you will see in this course, a great deal
of macroeconomic analysis Is designed to understand the factors that influence a nation's gross
domestic product, or GDP. And we will devote our second lecture to understanding
what GDP actually measures and why it is such an important concept. For now, it is enough
to think of GDP as a measure of goods and services produced in an economy. Over a particular
time period. It's actually a much more subtle concept than that, but we will consider this
in more detail in lecture two. The chart shown here is gross domestic product for the United
States. No matter which country you live in, you'll be able to find similar data that relate
to your location. These data are routinely published in country's national accounts,
usually prepared by the official government statistical agency.
I want to draw your attention to two features of the GDP data. First is its long run upward
trend. In general, over long periods of time, economies are able to produce more goods and
services than was previously the case. And this has been a defining characteristic of
most, if not all, economies since the industrial revolution. We will look in this course of
some of the key ideas macroeconomists have developed to understand why GDP increases
in this way over the long run. This is the subject matter of what is called growth economics.
An important branch of macroeconomics and an area with some of the most exciting recent
developments in the discipline have occurred. Second feature, as apparent from the GDP data,
is that there are occasional interruptions to this long run growth. In the chart, these
are shown by the shaded areas. And they represent recessions. Why long run
growth is interrupted in this way is the key question addressed by business cycle analysis.
It was this question that Keynes addressed in his general theory. And it is this question
that has been front and center of the minds of macroeconomists. Ever since the publication
of the general theory. We will be spending a lot of our time thinking about exactly this
issue. Another important indicator of macroeconomic performance is the rate of inflation.
The rate at which the general level of prices in the economy is changing. This chart shows
the United States inflation rate since the late 1940s. The historical pattern of inflation
in the U.S. is very similar to that of a great many other countries. Highly variable in the
1950s. Gradually increasing in the 1960s. Remaining stubbornly high in the 1970s. Thereafter,
gradually falling, and being, for the most part, far less volatile. There is one other
feature of the inflation data I wish to draw your attention to. Because we will return
to this in some detail. This is the tendency for the inflation rate
to fall, during periods of recession. This suggests a theme that we will explore in this
course, the interrelationship that exist between GDP, and macroeconomic performance more generally.
And inflation. Another important key indicator of an economy's performance is its rate of
unemployment. The chart shows a key characteristic about employment that we will explore in this
course. Namely how unemployment increases rapidly during recessions. With unemployment
we see human cost of the business cycle. Avoiding recessions, as long as it is done
in a responsible way. Would be, one of the key contributions governments could make to
securing the welfare of a great many people. The costs of large scale unemployment, as
we will see can be huge.