Source: EC 290 Lecture Notes, Classes 1 & 2
Difficulty: Introductory | Prerequisites: None. This is a first-lecture overview.
This is the opening module of EC 290, a macroeconomics course taught with a Canadian lens. It sets up the major questions the course will spend the term answering: what drives long-run growth, what causes business cycles, and how governments try to manage both through policy. You do not need prior economics coursework, but a basic comfort with percentages and graphs will help. If you missed the first two classes, these notes cover the full conceptual ground, from defining macroeconomics through to how economists build and test theories.
Macroeconomics studies national economies as a whole, using aggregated data such as GDP, unemployment, and inflation to understand performance and guide policy. Economists split into Classical and Keynesian camps on how quickly markets self-correct, but modern practice is increasingly data-driven rather than school-of-thought-driven. Canada's economy offers a useful case study: consumption dominates GDP, investment has been volatile (especially in natural resources), and inflation targeting at 2% has been a policy priority since the early 1990s.
Macroeconomics
The study of the structure and performance of national economies and the policies governments use to influence economic performance.
In simple terms, it is the big-picture view of how an entire country's economy works, as opposed to microeconomics, which looks at individual markets.
Aggregation
The process of summing individual economic variables (e.g. individual household spending) into economy-wide totals (e.g. aggregate consumption).
Think of it as zooming out: instead of tracking what each person buys, you add it all up to get one national number.
Business cycle
Periods of faster-than-normal and slower-than-normal economic growth, consisting of expansions and contractions in economic activity.
In simple terms, the economy's natural rhythm of boom and bust.
Natural unemployment rate
The unemployment rate at which the supply of labour and demand for labour are roughly in balance. In Canada, estimated at 5.5% to 6.5%.
Think of it as the "background" level of unemployment that exists even when the economy is healthy, because people are always between jobs or retraining.
Inflation
An ongoing increase in the general price level of goods and services.
In simple terms, prices rising over time, so a dollar buys less than it used to.
Deflation
An ongoing decrease in the general price level of goods and services.
The opposite of inflation. Sounds good on the surface, but it can signal serious economic trouble and discourage spending.
CPI (Consumer Price Index)
A measure that tracks the average change in prices paid by consumers for a basket of goods and services over time.
Think of it as the government's main tool for measuring how much more (or less) expensive life is getting.
CPI Median
A trimmed measure of core inflation that strips out the top 20% and bottom 20% of price changes and looks only at the middle (median) price movements.
In simple terms, it removes the wildest price swings so you can see the underlying trend.
CPI Factor (CPI-common)
An econometric model that examines price changes across categories (groceries, transport, education, health) and extracts the common trend.
Think of it as a statistical filter that finds the inflation signal shared across many different goods.
Quantitative easing (QE)
A monetary policy tool where the central bank purchases government bonds (or other financial assets) to inject money into the economy.
In simple terms, the central bank lends the government money to stimulate spending. It is not "printing money" in the literal sense; the government is expected to repay.
Positive analysis
Examining the economic consequences of a policy without making a judgement about whether the policy is desirable.
Think of it as the "what will happen" question.
Normative analysis
Evaluating whether a policy should be implemented, based on values and beliefs.
Think of it as the "should we do it" question. This is where economists' personal values come in.
Classical approach
A school of macroeconomic thought that assumes individuals act in their own best interest and that wages and prices adjust quickly to reach equilibrium, limiting the need for government intervention.
In simple terms, the "invisible hand" idea: markets sort themselves out.
Keynesian approach
A school of macroeconomic thought that assumes wages and prices adjust slowly, which can lead to prolonged unemployment and justifies government intervention.
In simple terms, markets sometimes get stuck, and governments need to step in to unstick them.
Economic model
A simplified description of some aspect of the economy, usually expressed in mathematical form.
Think of it as a deliberately incomplete map: it leaves out detail to make the big patterns visible.
Economic theory
A set of ideas about the economy organised in a logical framework.
In simple terms, the story that explains why an economic model works the way it does.
Average labour productivity
The amount of output produced per unit of labour input (per worker or per hour of work).
In simple terms, how much stuff each worker makes. Higher productivity means a higher standard of living over time.
Unemployment in Canada (August 2024): 6.6% for those aged 15 and over
The natural rate sits around 5.5% to 6.5%
At end of 2021, unemployment dipped below 5%, which is unusually low
COVID and monetary policy: The Bank of Canada held interest rates too low for too long during the pandemic, which contributed to inflation persisting longer than it otherwise would have
Consumption (C): Approximately 60% of GDP. Economists emphasise that smooth, stable consumption matters because it provides consistency for households' standard of living
Investment (I): Much more volatile than consumption. Investment took significant hits during COVID and the 2008 financial crisis
Declining investment in Canada's natural resource sector from 2006 onward
Cause: the U.S. expanded its own oil supply (shale revolution), and the global shift away from fossil fuels reduced demand for Canadian resource investment
Before 2006, Canadian investment was booming, partly driven by China's rapid growth and Canada's role as a commodity supplier
AI is flagged as a potentially major investment category in coming years
Productivity growth in Canada has slowed, attributed to underinvestment and a lack of competitive pressure
Government expenditure (G): About 20% of GDP
Exports: Canada's export graph tends to mirror its trading partners' business cycles more than its own domestic cycle, because demand for Canadian exports is driven largely by foreign buyers
Why target 2% inflation? The 2% target exists partly because measured inflation slightly overestimates true price increases. A 0% target is risky: if the measured rate hits 0%, the true rate may already be negative (deflation)
Canada was one of the first countries to adopt an explicit inflation-targeting framework
Core inflation measures:
Traditional core: strip out food and gasoline (the most volatile categories) and look at the middle 60% of price changes. The outliers on both ends account for about 40% of GDP otherwise
CPI Median: removes the top and bottom 20% of price-change distribution, looks only at the median. Was 2.4% as of the lecture date
CPI Factor (CPI-common): uses an econometric model to find the common trend across different spending categories
Overall CPI: 2.5% since July 2024, still above the 2% target
Alternative data sources for prices:
Economists are moving toward online prices, scanner data, and business administrative files
In-store prices on any given day do not perfectly reflect what consumers pay
Scanner data shows quantity, actual transaction price, and type of good, giving a truer picture
Limitations: different retailers use different product identification codes, and the same retailer may change a product's code from year to year
Census of population: mandatory. Non-compliance can result in fines or jail time. Covers demographics, education, and labour market participation
Labour Force Survey: also mandatory. Provides monthly employment and unemployment data
Other surveys: optional and used for supplementary data
Macroeconomists engage in three core activities:
Macroeconomic forecasting: Predicting future economic trends (e.g. where GDP, inflation, or unemployment are heading)
Macroeconomic analysis: Monitoring and interpreting economic events as they unfold in real time
Macroeconomic research: Trying to understand the underlying structure of the economy. This forms the foundation for both forecasting and analysis
Research requires both theoretical and empirical work:
An economic theory organises ideas about the economy into a logical framework
An economic model simplifies some aspect of the economy, usually in mathematical form, so it can be tested
Quantitative and empirical analysis tests whether the model's predictions match real-world data
The goals of macroeconomics, broadly:
Build models that produce useful forecasts
Use those models to inform policy decisions
Make reasonable, testable assumptions about how the economy behaves
Four criteria for evaluating an economic model:
Are its assumptions reasonable and realistic?
Is it understandable and manageable enough to study real problems?
Does it produce implications that can be tested empirically?
When tested, are its implications consistent with the data?
Positive vs normative analysis:
Positive analysis asks "what will happen if we do X?" It examines consequences without passing judgement
Normative analysis asks "should we do X?" It involves values and beliefs about what is desirable
Two economists can agree on the positive analysis (the likely outcomes) but disagree on the normative question (whether those outcomes are worth pursuing)
Classical approach:
Individuals act in their own best interest
Wages and prices adjust quickly to reach equilibrium
Markets clear on their own, so government intervention is largely unnecessary
Often summarised as the "invisible hand" view: leave things alone and they will sort themselves out
Keynesian approach:
Wages and prices adjust slowly (there is "stickiness" or friction in the economy)
Slow adjustment can lead to prolonged unemployment and recessions
Government intervention (fiscal or monetary policy) can help the economy recover faster
Why macroeconomists disagree:
Differences in normative values (what goals matter most)
Differences in positive analysis stemming from which school of thought an economist follows
Keynesians see friction everywhere; classicals trust self-correction
Modern consensus: data should drive conclusions regardless of school of thought
The course uses a unified framework in which individuals, firms, and the government interact across three markets:
Goods market (what is produced and consumed)
Asset market (savings, investment, financial instruments)
Labour market (employment, wages, hours worked)
Components and extensions of this basic model are used to study economic growth, business cycles, inflation, and policy. The framework has limitations, but it provides a consistent starting point for analysis.
Wage change distribution:
Wage changes are positively skewed: most people see little or no change month to month, and when a change does occur, it is almost always an increase
Wage cuts are rare. Workers typically receive either a raise or no change at all
This stickiness of wages is one of the real-world frictions that Keynesian economists point to as evidence that markets do not always clear quickly
Labour productivity:
By 2016, the average Canadian worker produced nearly six times as much output as the average worker in 1921, while working fewer hours
This growth in productivity is the primary reason Canadians enjoy a much higher standard of living today
A key assumption in macroeconomics: countries with higher savings and investment rates tend to experience stronger long-run growth and higher GDP
Macroeconomic research directly informs real decisions. Private-sector analysts at banks and large corporations use forecasts to assess risks on financial investments, identify the right timing for business expansion, and predict shifts in consumer demand based on income, employment, and economic stability. When the Bank of Canada decides whether to raise or lower interest rates, it relies on the same models and data frameworks discussed in this module.
Students often think the unemployment rate can reach zero. It cannot. Frictional unemployment (people between jobs) and structural unemployment (skills mismatches) always exist, even in a booming economy
Students often confuse quantitative easing with "printing money." QE involves the central bank purchasing government bonds to inject liquidity. The government is expected to repay these obligations
Students sometimes assume that 0% measured inflation means prices are stable. In reality, measured 0% may mask slight deflation, which is why central banks target 2% as a buffer
Students sometimes treat the Classical and Keynesian views as equally applicable in all situations. Modern economics is data-driven; the relevant approach depends on the evidence, not loyalty to a school of thought
⚠️ Know the three activities of macroeconomists (forecasting, analysis, research) and how research underpins the other two
⚠️ Be able to distinguish positive from normative analysis and give an example of economists agreeing on the positive but disagreeing on the normative
⚠️ Classical vs Keynesian: know the core difference (speed of wage/price adjustment) and the policy implication (government intervention or not)
⚠️ Four criteria for evaluating an economic model are a likely exam question; know all four
⚠️ Understand why the inflation target is 2% and not 0%
⚠️ Know what aggregation means and why it matters for macroeconomic analysis
⚠️ Understand why the unemployment rate never reaches zero (frictional and structural unemployment)
True or false: The natural unemployment rate in Canada is approximately 0%.
False. It is estimated at 5.5% to 6.5%.
Fill in the blank: The process of summing individual economic variables into economy-wide totals is called ________.
Aggregation.
True or false: Quantitative easing means the central bank prints new currency.
False. QE involves the central bank purchasing government bonds; the government repays.
Fill in the blank: The two main schools of macroeconomic thought are the ________ approach and the ________ approach.
Classical; Keynesian.
True or false: Positive analysis involves value judgements about whether a policy is desirable.
False. That is normative analysis. Positive analysis examines consequences without judgement.
Q: What is a business cycle, and does the unemployment rate ever reach zero?
A: A business cycle consists of alternating periods of expansion (faster-than-normal growth) and contraction (slower-than-normal growth). The unemployment rate falls during expansions and rises during recessions. It never reaches zero because frictional and structural unemployment always exist.
Q: Compare the Classical and Keynesian views on wage and price adjustment. What are the consequences of their differences?
A: The Classical view holds that wages and prices adjust quickly, so markets clear and government intervention is unnecessary. The Keynesian view holds that wages and prices are sticky, leading to prolonged unemployment during downturns, which justifies government intervention through fiscal or monetary policy.
Q: Might two economists agree on the effects of a policy but disagree on whether to implement it? Explain.
A: Yes. They may share the same positive analysis (agreeing on what the policy will do) but hold different normative views (disagreeing on whether those outcomes are desirable). For example, both might agree a tax cut will increase the deficit, but one may see the growth benefits as worth it while the other prioritises fiscal balance.
Q: What is aggregation, and why is it important for macroeconomic analysis?
A: Aggregation is the process of summing individual economic variables (household spending, firm investment) into economy-wide totals (aggregate consumption, total investment). It allows economists to analyse overall economic activity, spot trends, and make policy decisions based on national-level data rather than tracking millions of individual transactions.
Q: List the four criteria economists use to evaluate an economic model.
A: (1) Are its assumptions reasonable and realistic? (2) Is it understandable and manageable enough to study real problems? (3) Does it have testable empirical implications? (4) Are its implications consistent with real-world data?
This introductory material connects directly to the next module on measuring GDP (the product, income, and expenditure approaches). The GDP components discussed here (C, I, G, NX) reappear as the expenditure identity Y = C + I + G + NX. The Classical vs Keynesian distinction will resurface throughout the course when discussing monetary policy, fiscal policy, and the IS-LM model. Understanding aggregation is essential for every subsequent topic, since macroeconomics operates entirely at the aggregate level.
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