In this video we will analyze the main topics of study of macroeconomics. We will bring a view from the perspective of the theory of economic growth in the long term, its fixed productive capacity, the formation of aggregate supply and demand curves from the perspective of the three models of long, medium and short term and we will conclude with the analysis of the Phillips curve relating inflation and unemployment. Let's go to the video.
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Macroeconomics is concerned with the behavior of the economy as a whole – with expansions and recessions, total production of goods and services, output growth, inflation and unemployment rates, balance of payments and exchange rates. Macroeconomics deals with both long-term economic growth and the short-term fluctuations that make up the business cycle. Macroeconomics focuses on economic behavior and policies that affect consumption and investment, on the exchange rate and trade balance, on factors that determine changes in wages and prices, on monetary and fiscal policies, on the money stock, in the federal budget, interest rates and domestic debt.
In addition, macroeconomics deals with the most important economic issues and everyday problems. To understand such questions, we have to reduce the complicated details of the economy to manageable essentials. These essential points are the interactions between goods, labor and the asset market in the economy, and the interactions between national economies that exchange with each other.
In dealing with the essentials, we go beyond the details of the behavior of individual economic units, such as households and companies, or the determination of prices in specific markets, which are themes of microeconomics. In macroeconomics, we deal with the market for goods as a whole, treating all these distinct markets – such as markets for agricultural products and medical services – as a single market. In the same way, we deal with the labor market by abstracting the differences between the markets for, for example, unskilled labor and doctors.
With the same overview we treat the asset market, abstracting the differences between the IBM stock markets and the Rembrandt paintings. The benefit of abstraction is that it facilitates a greater understanding of the most important interactions between markets for goods, labor, and assets. The cost of abstraction is that sometimes the details omitted are important.
Studying how macroeconomics works is like asking how it can work better. The fundamental question is: Can and should the government intervene in the economy to improve its performance? The great macroeconomists have always had a keen interest in the application of macroeconomic theory to economic policy.
Macroeconomics has a lot to do with the relationship between fact and theory. The study of macroeconomics is organized around three models that describe the world, each of which has its greatest applicability in a different time frame. The long-term behavior of the economy is the domain of economic growth theory, which addresses the growth capacity of the economy to produce goods and services.
The study of the long-term model focuses on historical capital accumulation and technological improvements. In the model that we call the long-run model, we take a picture of the very long-run model and, from that, the capital stock and the level of technology can be considered relatively fixed, although temporary shocks are admitted. Fixed capital and technology determine the productive capacity of the economy – we call this capacity “potential output”.
In the long-run model, the supply of goods and services is equal to the potential output. Prices and inflation over this horizon are determined by fluctuations in demand. In the short-term model, fluctuations in demand determine how much of the available capacity is used and, consequently, the levels of output and unemployment.
Unlike the long-run model, in the short run prices are relatively fixed and output is variable. It is in the context of the short-term model that we find the most important role for macroeconomic policy. Almost all macroeconomics experts agree with these three models, but opinions differ as to the time span in which each model is best applied.
Everyone agrees that behavior over the decades is best described by the model of economic growth theory. There is less agreement on the applicable time horizon for the long-term model compared to the short-term model. Let's now talk about each of the macroeconomic models: 1) Long-term growth The long-term behavior of the economy is the field of economic growth theory.
In studying this theory, we ask how the accumulation of inputs – investments in machinery, for example – and technological improvements lead to an increase in the standard of living. We ignore recessions, expansions and short-term fluctuations in the employment of people and other related resources. We assume that labor, capital, raw materials, and so on, are fully employed.
How can a model that ignores fluctuations in the economy tell us anything sensible? Fluctuations in the economy – the ups and downs of unemployment, for example – tend to average over the years. Over very long periods, what matters is how fast the average economy grows.
Economic growth theory seeks to explain average growth rates over several years or decades. Why does one country's economy grow 2% a year while another's grows 4%? The study of macroeconomics examines the causes of economic growth and differences between countries' growth rates.
In industrialized countries, changes in living standards depend mainly on the development of new technologies and capital accumulation – broadly defined. In developing countries , well-functioning infrastructure is more important than the development of new technologies, which, in turn, can be imported. In all countries, the savings rate is a very important determinant of future well-being.
Countries that are willing to make sacrifices today will have a higher standard of living in the future. Do you really care if the economy grows at 2% instead of 4%? Over a lifetime, the importance will be great: at the end of a 20-year generation, the standard of living will be 50% higher under 4% growth than under 2% growth.
In a hundred years, a 4% growth rate produces a standard of living seven times higher than a 2% growth rate. Another important aspect in Macroeconomics is fixed productive capacity. What determines the rate of inflation – the change in the general level of prices?
Why do prices in some countries remain stable for several years, while in other countries they double every month? In the long run, the level of product is determined solely by supply considerations. Basically, output is determined by the productive capacity of the economy.
The price level is determined by the demand for the product that the economy can supply. The aggregate supply curve shows, for each given price level, the amount of output that firms are willing to supply. The position of the aggregate supply curve depends on the productive capacity of the economy.
The aggregate demand curve presents, for each given price level, the level of output at which goods markets and money markets are simultaneously in equilibrium. The position of the aggregate demand curve depends on monetary and fiscal policies and the level of consumer confidence. The intersection of aggregate supply and aggregate demand determines price and quantity.
In the long run, the aggregate supply curve is vertical. Output is linked to the position where this supply curve hits the axis. It so happens that in the long run the product is determined only by aggregate supply, and prices are determined by both aggregate supply and aggregate demand.
Growth theory and long-run aggregate supply models are closely related: the position of the vertical aggregate supply curve in a given year is equal to the output level for that very long-run model year. Since economic growth over the very long run averages a few percentages per year, we know that the aggregate supply curve generally moves to the right by a few percentages per year. Thus, very high inflation rates – that is, episodes with rapid increases in the general price level – always occur due to changes in aggregate demand.
The reason is simple. Aggregate supply movements are on the order of a few percentages; aggregate demand movements can be both small and large. Therefore, the only possible source of high inflation is in large movements of aggregate demand, which moves across the vertical aggregate supply curve.
Much of macroeconomics can be summarized as the study of the position and slope of aggregate supply and aggregate demand curves. The other model is the short-term one. When an extended examination of the product trajectory is taken, we see that it is not always smooth.
Short-term output fluctuations are large enough to be of much importance. Explaining short-run fluctuations in output is the field of aggregate demand. The mechanical distinction between aggregate supply and aggregate demand between the long and the short run is immediate.
In the short run, the aggregate supply curve is horizontal. It sets the price level at the point where the supply curve hits the vertical axis. The product, on the other hand, can assume any value.
The fundamental premise is that the level of output does not affect prices in the short run. It so happens that, in the short-run model, output is determined only by aggregate demand and prices are not affected by the level of output. The last model refers to the medium term.
So we need one more part to complete our sketch of how the economy works: how do we describe the transition between the short run and the long run? In other words, what is the process that changes the slope of the aggregate supply curve from horizontal to vertical? The simple answer is that when high aggregate demand raises output above the sustainable level, according to the very long-run model, firms start to raise prices and the aggregate supply curve starts to move up.
The aggregate supply curve has an intermediate slope, between horizontal and vertical. The question “what is the slope of the aggregate supply curve? ” is, in fact, the main controversy in macroeconomics.
The speed with which prices adjust is a crucial parameter for our understanding of the economy. Over a 15-year horizon, nothing matters as much as the very long-term growth rate. On a 15 second horizon, nothing matters as much as aggregate demand.
What can be said about what happens between these two cases? It turns out that prices normally adjust very slowly, thus, over a one- year horizon, changes in aggregate demand offer a good, albeit imperfect, explanation of the economy's behavior. The speed of price adjustment is summarized in the “phillips curve”, which relates inflation and unemployment.
So, as we talk throughout the video, practically everything in macroeconomics can be framed within the framework of the theory of economic growth, aggregate supply and aggregate demand. Thanks for watching, share your perception on this topic, I hope you enjoyed it, don't forget to subscribe to the channel, leave your "like" and see you in the next video. Goodbye.
