Lecture 1 – Macroeconomics as a science. History of Macroeconomic Thought

1. Macroeconomics & its Major Problems. Macroeconomic models

2. Macroeconomics Schools of Thought

2.1. Macroeconomics with microeconomics backgrounds

2.2. Macroeconomics as background of microeconomics

2.3. Orthodox macroeconomics

2.4. New tendencies of macroeconomics

Key terms:

Failures in the Market – провали ринку

Politically Induced Incentives – політичні стимули

Economic Bubbles – економічні бульбашки

Human Capital – людський капітал

1. Macroeconomics & its Major Problems

Macroeconomics (from Greek prefix " μακρός " meaning "large" + "economics") is a branch of economics that deals with the performance, structure, behaviour and decision-making of the entire economy, be that a national, regional, or the global economy.

Macroeconomics is the study of the economy as a whole — including growth in incomes, changes in prices, and the rate of unemployment. Macroeconomists attempt both to explain economic events and to devise policies to improve economic performance.

The term "macroeconomics" stems from a similar usage of the term "macrosystem" by the Norwegian economist Ragnar Frisch in 1933.

Modern macroeconomics can be said to have began with John Maynard Keynes and the publication of his book The General Theory of Employment, Interest and Money in 1936.

Before Keynes, economists used microeconomic methods to explain aspects of economics like employment, price level, and interest rates. Keynes's seminal work sparked the Keynesian Revolution. It shifted the focus of many economists to the study of aggregates, such as the unemployment rate, total income and the aggregate price level and inflation.

The major macroeconomic problems are:

• Economic growth, economic cycles: What is growth? What factors can affect economic growth?

• Unemployment: Who are the unemployed? Is the unemployment rate positive or negative factor for the economy? How to deal with unemployment?

• Inflation: What is inflation? What type of inflation is useful and what type is harmful?

• Money, interest rate: What is the role of money in macroeconomics?

• Balance of trade: How do export and import change exchange rate?

• Budget: How does the state regulate their income and expenses?

To understand the economy, economists use models — theories that simplify reality in order to reveal how exogenous variables influence endogenous variables.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.

Economic models illustrate, often in mathematical terms, the relationships among the variables. They are useful because they help us to dispense with irrelevant details and to focus on important connections.

Models have two kinds of variables: endogenous variables and exogenous variables. Endogenous variables are those variables that a model tries to explain. Exogenous variables are those variables that a model takes as given. The purpose of a model is to show how the exogenous variables affect the endogenous variables.

A key feature of a macroeconomic model is whether it assumes that prices are flexible or sticky. According to most macroeconomists, models with flexible prices describe the economy in the long run, whereas models with sticky prices offer a better description of the economy in the short run.

Economists normally presume that the price of a good or a service moves quickly to bring quantity supplied and quantity demanded into balance. This assumption is called market clearing. For answering most questions, economists use marketclearing models.

Yet the assumption of continuous market clearing is not entirely realistic. For markets to clear continuously, prices must adjust instantly to changes in supply and demand. In fact, however, many wages and prices adjust slowly. Labor contractsoften set wages for up to three years. Many firms leave their product prices the same for long periods of time — for example, magazine publishers typically change their newsstand prices only every three or four years. Although marketclearing models assume that all wages and prices are flexible, in the real world some wages and prices are sticky.