CHAPTER 1
INTRODUCTION
1
,Chapter Outline
Introduction to macroeconomics
The long run and short run
Economic models and the real world
A first look at the AD-AS framework
Unemployment and inflation
Actual and potential GDP
Economic cycles
Recessions and economic slumps
Changes from the Previous Edition
A few minor modifications have been made to Chapter 1. All figures involving data have been
updated, as have Table 1-1 and Section 1-3 (the preview of the text). New Figure 1-10 and two
new paragraphs explaining the distinction between a recession and a slump have been added to
Section 1-2. All of the subsequent figures have been renumbered. Finally, here and throughout
the rest of the textbook each box has been labeled either "History Speaks" or "What More Do We
Know?" to let students know what they can expect to learn from these materials.
Introduction to the Material
Chapter 1 provides an overview of the key concepts covered in the textbook. It also outlines the
different time frames that are used to describe the economy in the aggregate. The very long-run
model focuses on the growth of productive capacity and ignores fluctuations in employment and
output. This is important when trying to explain why some countries have higher average growth
rates (and thus higher living standards) than others. In the long run, fluctuations in demand
relative to the level of productive capacity determine the level of prices. But in the very short run,
the level of output is determined by aggregate demand alone, while prices are not affected by
changes in aggregate demand. The medium run describes the transition between the short run
and the long run. In this case, economic policies or disturbances affect the rates of inflation and
unemployment simultaneously, and the speed at which prices adjust is critical for analyzing the
effects of the disturbances or policy changes.
The behavior of the economy can be analyzed using the AD-AS model. Three different AS-
curves are presented here, each describing a different time frame: the vertical AS-curve describes
2
,the very long run, the horizontal AS-curve describes the very short run, and the upward-sloping
3
, AS-curve describes the medium run. The AD-AS framework is a very simplified representation of
the real world that cannot describe the behavior of all people and enterprises in an economy.
However, it serves very well to explain how economic disturbances affect output, employment,
and prices, and how policies can be used to mitigate economic disturbances.
To understand the behavior of the economy as a whole, students must learn some basic
concepts. Among the major concepts presented in Chapter 1 is GDP, that is, the market value of
all final goods and services currently produced in a country over a certain time period. A nation's
GDP changes as the amount of available resources and the efficiency with which these resources
are used changes. Since the level of nominal GDP can change simply due to inflation or a change
in population, real GDP per capita is often used as a measure for the standard of living in a country.
But even real GDP per capita is not a perfect measure for people's welfare since it does not take
into consideration such things as changes in the distribution of income, environmental quality, or
leisure activities.
The performance of an economy is generally judged by three broad measures: the growth
rate of output, the unemployment rate, and the inflation rate. The trend path of output is the
path that real GDP would take if all factors of production were fully employed (also known as
potential GDP). Actual GDP generally tends to be below this trend path, since in most years the
factors of production are not fully employed. The output gap measures the size of these cyclical
deviations and is defined as the gap between potential GDP and actual GDP. This gap grows during
recessions when unemployment increases. In periods of exceptional growth, like in the late
1990s, actual GDP can become larger than potential GDP, so the GDP gap can actually become
negative. Section 1-2 discusses how inflation, growth, and unemployment are related through
economic cycles, that is, patterns of expansion and contraction in economic activity around the
trend path of GDP. A distinction is made between a recession as it is officially defined and an
economic slump.
Knowing the speed with which prices adjust is critical in understanding the workings of the
economy, and much economic research is devoted to this subject. The Phillips curve shows an
empirical relationship between changes in inflation and the unemployment rate in the medium
run. The question of whether there is a useful trade-off between unemployment and inflation is
of considerable importance for the implementation of macroeconomic stabilization policies, and
there is much controversy among economists about the usefulness of the Phillips-curve.
Suggestions for Lecturing
4
INTRODUCTION
1
,Chapter Outline
Introduction to macroeconomics
The long run and short run
Economic models and the real world
A first look at the AD-AS framework
Unemployment and inflation
Actual and potential GDP
Economic cycles
Recessions and economic slumps
Changes from the Previous Edition
A few minor modifications have been made to Chapter 1. All figures involving data have been
updated, as have Table 1-1 and Section 1-3 (the preview of the text). New Figure 1-10 and two
new paragraphs explaining the distinction between a recession and a slump have been added to
Section 1-2. All of the subsequent figures have been renumbered. Finally, here and throughout
the rest of the textbook each box has been labeled either "History Speaks" or "What More Do We
Know?" to let students know what they can expect to learn from these materials.
Introduction to the Material
Chapter 1 provides an overview of the key concepts covered in the textbook. It also outlines the
different time frames that are used to describe the economy in the aggregate. The very long-run
model focuses on the growth of productive capacity and ignores fluctuations in employment and
output. This is important when trying to explain why some countries have higher average growth
rates (and thus higher living standards) than others. In the long run, fluctuations in demand
relative to the level of productive capacity determine the level of prices. But in the very short run,
the level of output is determined by aggregate demand alone, while prices are not affected by
changes in aggregate demand. The medium run describes the transition between the short run
and the long run. In this case, economic policies or disturbances affect the rates of inflation and
unemployment simultaneously, and the speed at which prices adjust is critical for analyzing the
effects of the disturbances or policy changes.
The behavior of the economy can be analyzed using the AD-AS model. Three different AS-
curves are presented here, each describing a different time frame: the vertical AS-curve describes
2
,the very long run, the horizontal AS-curve describes the very short run, and the upward-sloping
3
, AS-curve describes the medium run. The AD-AS framework is a very simplified representation of
the real world that cannot describe the behavior of all people and enterprises in an economy.
However, it serves very well to explain how economic disturbances affect output, employment,
and prices, and how policies can be used to mitigate economic disturbances.
To understand the behavior of the economy as a whole, students must learn some basic
concepts. Among the major concepts presented in Chapter 1 is GDP, that is, the market value of
all final goods and services currently produced in a country over a certain time period. A nation's
GDP changes as the amount of available resources and the efficiency with which these resources
are used changes. Since the level of nominal GDP can change simply due to inflation or a change
in population, real GDP per capita is often used as a measure for the standard of living in a country.
But even real GDP per capita is not a perfect measure for people's welfare since it does not take
into consideration such things as changes in the distribution of income, environmental quality, or
leisure activities.
The performance of an economy is generally judged by three broad measures: the growth
rate of output, the unemployment rate, and the inflation rate. The trend path of output is the
path that real GDP would take if all factors of production were fully employed (also known as
potential GDP). Actual GDP generally tends to be below this trend path, since in most years the
factors of production are not fully employed. The output gap measures the size of these cyclical
deviations and is defined as the gap between potential GDP and actual GDP. This gap grows during
recessions when unemployment increases. In periods of exceptional growth, like in the late
1990s, actual GDP can become larger than potential GDP, so the GDP gap can actually become
negative. Section 1-2 discusses how inflation, growth, and unemployment are related through
economic cycles, that is, patterns of expansion and contraction in economic activity around the
trend path of GDP. A distinction is made between a recession as it is officially defined and an
economic slump.
Knowing the speed with which prices adjust is critical in understanding the workings of the
economy, and much economic research is devoted to this subject. The Phillips curve shows an
empirical relationship between changes in inflation and the unemployment rate in the medium
run. The question of whether there is a useful trade-off between unemployment and inflation is
of considerable importance for the implementation of macroeconomic stabilization policies, and
there is much controversy among economists about the usefulness of the Phillips-curve.
Suggestions for Lecturing
4
