An Introduction to Macroeconomics

Microeconomics studies the behavior of individual households and firms in particular markets. Macroeconomics zooms out to study the economy as a whole — total output, total employment, and the overall price level. This chapter introduces the questions macroeconomists ask and the framework we will use to answer them throughout the course.

The Big Questions

Macroeconomics is organized around a few central questions. Why does total output grow over the long run, raising living standards generation after generation? Why does the economy fluctuate in the short run, with booms and recessions? Why are some periods marked by rising prices and others by high unemployment? And what, if anything, can government policy do to improve outcomes? Keeping these questions in view helps make sense of the many concepts that follow.

The Long Run and the Short Run

A central distinction in macroeconomics is between the long run and the short run.

In the long run, an economy's output is determined by its productive capacity — the size and skill of its workforce, its stock of capital, and the state of technology. Long-run analysis is the study of economic growth: why capacity expands over decades.

In the short run, actual output can rise above or fall below that capacity because total spending fluctuates. Short-run analysis is the study of the business cycle: why the economy expands and contracts over months and years. Much of macroeconomic policy is about keeping actual output close to potential.

Real Versus Nominal

Because macroeconomics measures things in dollars, we must separate changes in quantities from changes in prices.

A nominal value is measured in current dollars, unadjusted for price changes. A real value is adjusted for inflation, so it reflects actual quantities. If your salary rises 3% but prices also rise 3%, your nominal income is up but your real income is unchanged. Distinguishing real from nominal is essential whenever we compare economic figures across time.

The Three Headline Indicators

Three statistics dominate macroeconomic discussion.

Output, measured by gross domestic product, captures the total value of goods and services the economy produces. When real output grows, the economic pie gets bigger.

Unemployment measures the share of people who want to work but cannot find a job. High unemployment means idle resources and real hardship.

Inflation measures the rate at which the overall price level is rising. Both very high inflation and outright deflation create problems for an economy.

These three indicators recur throughout the course, and the rest of the macro chapters are largely about explaining how they are measured and what determines them.

Aggregate Demand and Aggregate Supply

The workhorse model of short-run macroeconomics is aggregate demand and aggregate supply. Aggregate demand is the total spending on goods and services in the economy at each price level; aggregate supply is the total output firms are willing to produce. Where they balance determines the economy's output and price level in the short run. We develop this model in detail later, but it is worth previewing now because it ties together output, employment, and inflation in a single framework.

The Role of Expectations and Shocks

Economies are buffeted by shocks — unexpected events such as oil price spikes, financial crises, or pandemics — that move output and prices away from where they would otherwise be. Expectations also matter: what households and firms believe about the future shapes how they spend, invest, and set prices today. Modern macroeconomics takes both seriously, because they help explain why downturns happen and why policy responses sometimes work and sometimes disappoint.

Why It Matters

The macroeconomy is not an abstraction. Whether you can find a job, how far your paycheck stretches, the interest rate on a car loan, and the trajectory of your retirement savings all depend on macroeconomic conditions. Learning to read these forces gives you a framework for understanding the economic news and the policy debates that shape your life.

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Next chapter: before we can analyze the macroeconomy, we have to measure it — starting with GDP and national income.

Further Listening & Reading

• 🎧 Planet Money #522: The Invention of "The Economy" (NPR) — how the very idea of the macroeconomy, and GDP, was born during the Great Depression.