# Macroeconomic Essentials: Understanding Economics in the News

Peter E. Kennedy
Pages: 488
https://www.jstor.org/stable/j.ctt5hhjrb

1. Front Matter
(pp. i-vi)
(pp. vii-xii)
3. Preface
(pp. xiii-xvi)
4. 1 Introduction
(pp. 1-10)

Textbooks written for economics majors present economics using the language and perspective of professional economists. Students learn to analyze economic phenomena through economic models, formalized with graphs and, at advanced levels, algebra and calculus. Much time is devoted to learning how to manipulate various graphical or algebraic models that have come to serve as an intellectual framework for economists.

In one respect it is entirely appropriate that these textbooks have this flavor because it reflects accurately what academic economists do: they build, manipulate, and estimate economic models to aid in explanation, prediction, and policy formulation. Possession of a degree in...

5. 2 The Basics of Supply and Demand, and a Big Picture
(pp. 11-22)

Supply/demand diagrams list a quantity of some good or service on the horizontal axis and its price on the vertical axis. As price varies, the demand curve traces out the quantity of the good or service people want to buy in a particular market, other things remaining the same (ceteris paribus). The supply curve traces out the quantity of the good or service that people/firms want to supply to this market as the price changes, ceteris paribus.

To introduce the concept of supply and demand, let us look at the market for beef. Figure 2.1 is a supply and demand...

6. 3 Measuring GDP and Inflation
(pp. 23-50)

Gross domestic product (or GDP) is the total dollar value of all final goods and services produced in a country during a year. Several things about this definition should be noted:

1. Both goods, such as automobiles and top hats, and services, such as the help of lawyers and plumbers, are included.

2. Current market prices, reflecting the value society places on items, are used to aggregate different outputs to a dollar total. Government purchases, many of which do not occur on markets, are valued at their cost of production.

3. Only final goods and services are included. Intermediate goods, such as steel...

7. 4 Unemployment
(pp. 51-70)

The unemployment rate, graphed in figure 4.1 from 1960 to early 2009, is defined as the number ofunemployed,people who want to have a job but do not have one, expressed as a percentage of thelabor force,the total number of people aged 16 and over who want to have a job:$\text{Unemployment rate}=\frac{\text{Unemployed}}{\text{Labor force}}$

Several qualifications, such as that the rate refers to the noninstitutionalized civilian population (i.e., excluding about 2.5 million prisoners, inmates of mental institutions, and about 1.5 million in the armed forces) aged sixteen and over, are incorporated in the official definition but do not affect...

8. 5 The Role of Aggregate Demand
(pp. 71-116)

The general idea behind the Keynesian approach is that natural forces cause our output of goods and services (i.e., aggregate supply, our national income) to match the level of aggregate demand for our goods and services. This match is called anequilibriumbecause at such a position there are no pressures for change. The automatic movement of income to match aggregate demand has two implications. First, to predict the level of national income, we should look at what is happening to the level of aggregate demand for our goods and services. Second, to influence the level of national income, we...

9. 6 The Supply Side
(pp. 117-142)

The supply side in the Keynesian analysis introduced in the preceding chapter can be represented by an aggregate supply curve with three distinct zones, as illustrated byASin figure 6.1. This curve shows how the quantity of output from firms increases as the overall price level increases.

1. At low levels of output, with excess capacity, firms are able to increase output without requiring price increases. Hoarded labor and idle machinery can be used to increase output without any increase in per unit costs. In this zone the aggregate supply curve is flat, corresponding to the flowchart explanation given in...

10. 7 Growth and Productivity
(pp. 143-166)

The rate of growth of output varies dramatically over the business cycle. As we emerge from a recession, the economy can grow very quickly, at rates exceeding 5 or 6 percent a year, as unemployed labor and idle plant and equipment are put to work. “Economic growth” refers not to such short-run spurts in an economy’s growth rate but to growth in an economy’spotentialor full-employment output, measured over quite long periods of time. Economic growth depends on increases in the quantity and quality of the two basic inputs of the macroeconomic production process—capital and labor—and on...

11. 8 The Money Supply
(pp. 167-188)

Money is defined as anything that is widely accepted in payment for goods and services and to pay off debt. Many things can serve this purpose, as evidenced historically by the use of cigarettes in prisoner-of-war camps and ownership titles to large stone wheels on the South Pacific island of Yap. This definition creates a serious problem in measuring a country’s money supply. What should be counted as money? Should we count cigarettes and stone wheels? Different choices of what should be counted as money give rise to different measures of the money supply. These measures are calledmonetary aggregates....

12. 9 The Monetarist Rule
(pp. 189-216)

In the classical school of thought, supplanted eventually by Keynesianism, a prominent role was played by thequantity theory of money, represented by the mechanical formula

Mv=PQ

HerePis the overall price level, andQis the physical quantity of output produced. The right-hand side of this formula then is the money value of output, or, equivalently, nominal GDP. The variableMis the money supply, andvis thevelocity of money, interpreted as the number of times in a year each dollar of money supply is used to buy a final good or service. This...

13. 10 Monetary Policy and Interest Rates
(pp. 217-246)

Macroeconomists talk of “the” interest rate, but in fact a myriad of interest rates exist, depending on such variables as time to maturity of the financial asset, how the interest is taxed, how liquid the financial asset is, and what is known about the borrower (in particular, the risk of default). There are the interest rate you pay on a mortgage, the interest rate you pay on a consumer loan (e.g., to buy a car), the interest rate the bank pays you on a savings account, the interest rate the bank pays you on a term deposit, the interest rate...

14. 11 Real-versus-Nominal Interest Rates
(pp. 247-272)

Suppose that the interest rate is 5 percent and that suddenly everyone expects prices to rise by 3 percent (instead of 0 percent) during the next year. Those banks loaning money for a year at 5 percent will expect to receive, at the end of the year, dollars worth 3 percent less in terms of their purchasing power, so their expected net return in real terms is only 2 percent. To obtain a return of 5 percent, they will want to charge 8 percent. Those consumers willing to borrow earlier at 5 percent should now be willing to pay 8...

15. 12 Stagflation
(pp. 273-306)

The modern interpretation of the Phillips curve rests heavily on the concept of the natural rate of unemployment (the NRU), described in chapter 4. Before the great recession began in 2008 the U.S. natural rate was thought to be about 5 percent, determined by the amount of frictional and structural unemployment, as well as by institutional phenomena such as minimum-wage legislation and unemployment insurance programs. With unemployment above 10 percent in 2009, however, this figure probably should be revised upward slightly—a high level of unemployment means that those not working fail to gain working experience and so become less...

16. 13 The Balance of Payments
(pp. 307-326)

An economy has two basic kinds of economic interactions with the rest of the world: buying and selling goods and services, and buying and selling assets, mainly financial assets. In the former category are imports and exports of physical goods, such as lumber and automobiles; imports and exports of services, such as transportation and tourism; and payments for capital services, such as interest and dividend payments. The main components of the latter category are purchases or sales of bonds and common stock, and direct investment through purchase of businesses or real estate.

Each of these activities gives rise to a...

17. 14 Policy in an Open Economy
(pp. 327-348)

Exactly what are the forces for change that an imbalance in the balance of payments engenders? This is a crucial question, the answer to which depends on whether the economy is operating on a flexible or a fixed exchange rate system. Let us first examine a flexible exchange rate system.

Under a flexible exchange rate system, the government allows the forces of supply and demand to determine the exchange rate. If there is a balance of payments surplus, demand for our dollar on the foreign exchange market exceeds its supply. So market forces cause a rise in the value of...

18. 15 Purchasing Power Parity
(pp. 349-366)

In chapter 13 we saw that a rise in our price level, with no corresponding rise in foreign prices, leads to a balance of payments deficit, which under a fixed exchange-rate system in turn leads to an automatic contraction of our money supply. The same will happen if the rate of inflation in our economy is greater than the rate of inflation in the rest of the world.

Suppose that U.S. inflation is 8 percent, but it is only 5 percent in the rest of the world, due to differing money-supply growth rates. With a fixed exchange rate, during the...

19. 16 Interest-Rate Parity
(pp. 367-382)

In chapter 13 we saw that a rise in a country’s real interest rate, with no change in other countries’ real interest rates, causes a net capital inflow. We discussed how this would affect the balance of payments and consequently influence other economic variables of interest. One impact of the net capital inflow that we did not discuss was its effect on the real interest rate itself.

Suppose, for example, that the real interest rate in a small country such as Canada rises, creating a net capital inflow into Canada. This puts downward pressure on the Canadian real interest rate....

20. Appendix A Answers to Sample Exam Questions
(pp. 383-392)
21. Appendix B Answers to Even-Numbered Exercises
(pp. 393-428)
22. Glossary
(pp. 429-446)
23. Index
(pp. 447-466)