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Chapter 1:The Science of MacroeconomicsChapter 1:The Science of Macroeconomics
Main Macroeconomic Variables
Economic growth rate measures the percentage change of the Real GDP
Inflation rate measures the percentage change of the general price level (e.g., the CPI)
Unemployment rate measures the percentage of the labor force who are out of work
Historical Record of the U.S. Economy
Real GDP per capita (or income per person) has increased (in 1992 prices) from about $5,000 in 1900 to over $30,000 in 2000.
This rapid growth, however, has been interrupted by periods of declining income, called recession or depression (e.g., 1929-33, 1990-91)
Figure 1-1: Growth Trends
Historical Record of the U.S. Economy
High inflation during periods of expansion and boom (e.g., WW I and II)
Low inflation or deflation during periods of recession (e.g., 1920-21 and 1929-33)
During the energy crises of the 1970s, the economy recorded high inflation in periods of recession (stagflation)
Figure 1-2: Inflation Trends
Historical Record of the U.S. Economy
Unemployment is high during periods of recession and depression (e.g., 1929-33)
Unemployment is low during periods of expansion and boom (WW I and II, the 1990s)
Figure 1-3: Unemployment Trends
Economic Models
A model is a simplified theory that shows the relationships among variables.
Exogenous variables are those that come from outside of the model.
Endogenous variables are those that the model explains
The model shows how changes in the exogenous variables affect the endogenous variables.
Figure 1-4: Economic Model
Model Endogenous VariablesExogenous Variables
Demand-Supply ModelDemand model: Q = D(P, Y); Supply model: Q = S(P, Pm)
Endogenous variables are quantity (Q) and price (P) of the good
Exogenous variables are consumer income (Y) and price of materials (Pm)
Market equilibrium D(P, Y) = S(P, Pm) determines P and Q. The model explain how changes in Y and/or Pm affect equilibrium values.
Market System
Network of buyers & sellers who transact in the market
Buyers “demand” goods & services
Sellers “supply” goods & services
Advantage of Market Economy
Free interactions between buyers & sellers
Full information to make decisions
Freedom of choice between alternatives
DemandDemand
Definition: quantities of a good or service consumers are able to buy at various prices
Law of Demand: P and Q are negatively related
Movement along demand is caused by a change in P
Demand LineDemand Line
Price
Quantity
D
D
1.50
2.00
1000 1500
A
B
Increase in Demand
Price
Quantity
D
D
2.00
1500 2000
A
B
D’
D’
C
An increase in Y causesthe demand to increase
Supply
Definition: quantities of a good or service producers are able to sell at various prices
Law of Supply: P and Q are positively related
Movement along supply is caused by a change in P
Supply Line
Price
Quantity
S
S
1.50
2.00
500 1000
A
B
Increase in Supply
Price
Quantity
S
S
1.50
500 1000
S’
S’
A
B
C
An decrease Pm causesthe supply to increase
EquilibriumEquilibrium
A condition at which the independent plans of buyers and sellers exactly coincide in the marketplace.
At equilibrium: D(P, Y) = S(P, Pm) determine equilibrium P & Q
Demand-Supply Interaction
Price
Quantity
D
D
1.50
2.00
1000 1500
Equilibrium
B
500
2.50S
SShortage
Surplus
Stability
Shortage: at a price below equilibrium quantity demanded > quantity supplied
Surplus: at a price above equilibrium quantity supplied > quantity demanded
Price adjustments eliminate shortages & surpluses
Increase in Demand:
Price
Quantity
D
D
P
P’
Q Q’
A
D’
D’
B
S
S
Higher PriceLarger Quantity
Increase in Supply:
Price
Quantity
S
S
P’
P
Q Q’
S’
S’
A
B
D
D
Lower PriceLarger Quantity
Increase in Demand & Supply:
Price
Quantity
D
D
D’
D’
S
S
A
S’
S’
B
P
P’
Q Q’
Here:Higher PriceLarger Quantity
