So far we have looked mostly at individual markets, the field called microeconomics. This level turns to the economy as a whole, called macroeconomics: total output, growth, unemployment and the ups and downs of boom and recession.

GDP

Gross domestic product (GDP) is the total market value of all final goods and services produced within a country in a given period. It can be measured by adding up spending: household consumption, business investment, government purchases, and net exports (exports minus imports). Economists distinguish nominal GDP, at current prices, from real GDP, which is adjusted for inflation and shows whether the economy is actually producing more. GDP per person divides output by population and is a rough guide to average living standards.

GDP has known limits. It leaves out unpaid work, such as caring for children at home, does not subtract environmental damage, and says nothing about how income is shared. It measures output, not well-being, though the two are often related.

Growth

Economic growth is a rise in real GDP over time. Small differences compound: an economy growing 2 percent a year doubles in about 35 years; one growing 7 percent doubles in about 10. In the long run, living standards depend mainly on productivity, the amount produced per hour of work. Productivity rises with more and better capital (machines and infrastructure), education and skills, new technology, and institutions such as the rule of law.

Unemployment

A person is counted as unemployed if they do not have a job but are available and actively looking for one. People not looking, such as retirees and full-time students, are outside the labor force. Economists distinguish three types:

• Frictional: short spells between jobs while people search.
• Structural: a mismatch between workers' skills or locations and the available jobs, as when an industry declines.
• Cyclical: caused by a downturn in the economy as a whole.

The business cycle

Economies do not grow smoothly. They move through expansion, a peak, recession (falling output and rising unemployment) and a trough, before growing again. This is the business cycle. Why it happens, and what to do about it, is one of the oldest debates in economics.

Three views in brief

Classical economists of the nineteenth and early twentieth centuries held that markets tend to correct themselves: if workers are unemployed, wages fall until employers hire them again, so downturns are temporary. Many also warned that heavy government borrowing draws savings away from private investment, which is called crowding out.

John Maynard Keynes, in his General Theory (1936), written during the Great Depression, argued that economies can stay stuck with high unemployment for years because total spending (aggregate demand) is too low, and wages and prices do not adjust smoothly. His remedy: governments should increase spending or cut taxes in a slump, even by borrowing, to restore demand. Years earlier, rejecting the comfort that things settle down eventually, he had written, “In the long run we are all dead.”

Monetarists, led by Milton Friedman, argued that changes in the money supply drive most booms and busts. Friedman and Anna Schwartz blamed the Great Depression largely on the Federal Reserve allowing the money supply to shrink, and favored steady, predictable money growth over active government spending. The 1970s, when high inflation and high unemployment came together (“stagflation”), challenged simple Keynesian models and strengthened monetarist and later views.

Modern mainstream economics blends these ideas, though debates over how much and when governments should act remain lively. Keynesians stress the human cost of waiting; their critics stress slow and political decision-making, rising public debt, and spending that is easier to start than to stop.

Worked example: three advisers in a recession

Imagine a country where a housing slump has turned into a recession. Real GDP has fallen 3 percent in a year and unemployment has risen from 5 to 9 percent. The finance minister asks three advisers for help.

The classical adviser says: “Markets will adjust. Wages and prices will fall, interest rates will drop, and firms will start hiring and investing again. Heavy government borrowing would only add to debt and crowd out private investment. Remove rules that stop wages and prices from adjusting, and be patient.”

The Keynesian adviser says: “People and firms have stopped spending because they are worried, and when everyone cuts back at once, incomes fall further. That can last for years. The government should spend on roads, schools and unemployment benefits now, even if it must borrow, to put demand back into the economy.”

The monetarist adviser says: “The key is money. Make sure the central bank keeps the money supply from shrinking, as it disastrously did in the early 1930s. Steady, predictable monetary policy will do more good than big spending programs, which are slow to start and hard to stop.”

How should the minister judge? Ask what evidence each view rests on. Are wages actually falling? Are interest rates already near zero, leaving monetary policy little room? How quickly could spending projects begin? Ask also about values: how much weight to give the unemployed now versus taxpayers later.

In practice, most governments in recent recessions have used a mix: central banks cut rates and supported banks, and spending on unemployment benefits rose automatically as more people lost jobs.