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MACROECONOMICS

2011 Worth Publishers, all rights reserved

SEV

ENT

H

EDI

TION

PowerPointSlides by Ron Cronovich

N. Gregory Mankiw

C H A P T E R

The Science of Macroeconomics

1

2010

UP

DA

TE

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In this chapter, you will learn:

about the issues macroeconomists study

the tools macroeconomists use

some important concepts in macroeconomic

analysis

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2CHAPTER 1 The Science of Macroeconomics

Important issues in macroeconomics

What causes recessions? What is

government stimulus and why might it help?

How can problems in the housing market spread

to the rest of the economy?

What is the government budget deficit?How does it affect workers, consumers,

businesses, and taxpayers?

Macroeconomics, the study of the economy asa whole, addresses many topical issues, e.g.:

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Important issues in macroeconomics

Why does the cost of living keep rising?

Why are so many countries poor? What policiesmight help them grow out of poverty?

What is the trade deficit? How does it affect the

countrys well-being?

Macroeconomics, the study of the economy asa whole, addresses many topical issues, e.g.:

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U.S. Real GDP per capita(2000 dollars)

long-run upward trend

Great

Depression

World War II

First oil

price shock

Second oil

price shock

9/11/2001

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U.S. Inflation Rate(% per year)

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U.S. Unemployment Rate(% of labor force)

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Social problems like homelessness,

domestic violence, crime, and

poverty are linked to the economy.

For example

Why learn macroeconomics?

1. The macroeconomy affects societys well-being.

pe

rcentoflabo

rforce

crimespe

r100,000po

pulation

U.S. Unemployment andProperty Crime Rates

Unemployment(left scale)

Property crimes

(right scale)

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2. The macroeconomy affects your well-being.

-3

-2

-1

0

1

2

3

4

5

1965 1970 1975 1980 1985 1990 1995 2000 2005

-7

-5

-3

-1

1

3

5

unemployment rate inflation-adjusted mean wage (right scale)

changefrom1

2mosearlier

percentchangefrom1

2

mosearlierIn most years, wage growth falls

when unemployment is rising.

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3. The macroeconomy affects election outcomes.

Unemployment & inflation in election yearsyear U rate inflation rate elec. outcome

1976 7.7% 5.8% Carter (D)

1980 7.1% 13.5% Reagan (R)1984 7.5% 4.3% Reagan (R)

1988 5.5% 4.1% Bush I (R)

1992 7.5% 3.0% Clinton (D)

1996 5.4% 3.3% Clinton (D)

2000 4.0% 3.4% Bush II (R)

2004 5.5% 3.3% Bush II (R)

2008 7.2% 3.8% Obama (D)

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Economic models

are simplified versions of a more complex reality irrelevant details are stripped away

are used to

show relationships between variables

explain the economys behavior

devise policies to improve economic

performance

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Example of a model:

Supply & demand for new cars

shows how various events affect price andquantity of cars

assumes the market is competitive: each buyer

and seller is too small to affect the market priceVariables

Qd= quantity of cars that buyers demand

Qs

= quantity that producers supplyP= price of new cars

Y= aggregate income

Ps= price of steel (an input)

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The demand for cars

demand equation: Q

d

= D

(P,Y) shows that the quantity of cars consumers

demand is related to the price of cars and

aggregate income

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Digression: functional notation

General functional notationshows only that the variables are related.

Qd= D(P,Y)

A specific functional formshows

the precise quantitative relationship.

Example:

D(P,Y) = 6010P+ 2Y

A list of the

variables

that affectQd

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The market for cars: Demand

Q

Quantityof cars

PPrice

of cars

D

The demand curve

shows the relationship

between quantity

demanded and price,

other things equal.

demand equation:

Qd= D(P,Y)

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The market for cars: Supply

Q

Quantityof cars

PPrice

of cars

D

S

The supply curve

shows the relationship

between quantity

supplied and price,

other things equal.

supply equation:

Qs= S(P,PS)

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The market for cars: Equilibrium

Q

Quantityof cars

PPrice

of cars S

D

equilibrium

price

equilibrium

quantity

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The effects of an increase in income

Q

Quantityof cars

PPrice

of cars S

D1

Q1

P1

An increase in income

increases the quantityof cars consumers

demand at each price

which increasesthe equilibrium price

and quantity.

P2

Q2

D2

demand equation:

Qd= D(P,Y)

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The effects of a steel price increase

QQuantityof cars

PPrice

of cars S1

D

Q1

P1

An increase in Ps

reduces the quantity ofcars producers supply

at each price

which increases themarket price and

reduces the quantity.

P2

Q2

S2

supply equation:

Qs= S(P,PS)

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Endogenous vs. exogenous variables

The values of endogenousvariablesare determined in the model.

The values of exogenousvariables

are determined outside the model:the model takes their values & behavior

as given.

In the model of supply & demand for cars,endogenous: P, Qd, Qs

exogenous: Y,Ps

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NOW YOU TRY:

Supply and Demand

1. Write down demand and supply equations

for wireless phones; include two exogenous

variables in each equation.

2. Draw a supply-demand graph for wireless

phones.

3. Use your graph to show how a change in

one of your exogenous variables affects the

models endogenous variables.

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The use of multiple models

No one model can address all the issues wecare about.

E.g., our supply-demand model of the car

market

can tell us how a fall in aggregate income

affects price & quantity of cars.

cannot tell us whyaggregate income falls.

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The use of multiple models

So we will learn different models for studyingdifferent issues (e.g., unemployment, inflation,

long-run growth).

For each new model, you should keep track of

its assumptions

which variables are endogenous,

which are exogenous

the questions it can help us understand,those it cannot

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Prices: flexible vs. sticky

Market clearing: An assumption that prices areflexible, adjust to equate supply and demand.

In the short run, many prices are sticky

adjust sluggishly in response to changes insupply or demand. For example:

many labor contracts fix the nominal wage

for a year or longer

many magazine publishers change prices

only once every 3-4 years

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Prices: flexible vs. sticky

The economys behavior depends partly onwhether prices are sticky or flexible:

If prices sticky (short run),

demand may not equal supply, which explains: unemployment (excess supply of labor)

why firms cannot always sell all the goods

they produce

If prices flexible (long run), markets clear and

economy behaves very differently

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Outline of this book:

Introductory material (Chaps. 1 & 2)

Classical Theory (Chaps. 3-6)

How the economy works in the long run, when

prices are flexible

Growth Theory (Chaps. 7-8)

The standard of living and its growth rate over the

very long run

Business Cycle Theory (Chaps. 9-14)

How the economy works in the short run, when

prices are sticky

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Outline of this book:

Policy debates (Chaps. 15-16)

Should the government try to smooth business

cycle fluctuations? Is the governments debt a

problem? Microeconomic foundations (Chaps. 17-19)

Insights from looking at the behavior of

consumers, firms, and other issues from amicroeconomic perspective

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Chapter Summary

Macroeconomics is the study of the economyas a whole, including

growth in incomes

changes in the overall level of prices

the unemployment rate

Macroeconomists attempt to explain the

economy and to devise policies to improve its

performance.

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Chapter Summary

Economists use different models to examinedifferent issues.

Models with flexible prices describe the

economy in the long run; models with stickyprices describe the economy in the short run.

Macroeconomic events and performance arise

from many microeconomic transactions, so

macroeconomics uses many of the tools of

microeconomics.

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