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CHAPTER ONE
The Science of Macroeconomics
i
Macroeconomics
macroeconomicsfifth edition
N. Gregory Mankiw
PowerPoint® Slides by Ron Cronovich
© 2002 Worth Publishers, all rights reserved
The best time for a macro angle on The best time for a macro angle on lifelifelife…life…
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 1
What happened on the global What happened on the global markets in the last year?markets in the last year?markets in the last year?markets in the last year?
Governments designing ``rescue plans'' for their economies and then designing ``e iteconomies; and then, designing exit strategies.''
Major economies going into recessionsMajor economies going into recessionssimultaneously; and also coming out recently.
Central banks desperately throw liquidity on theCentral banks desperately throw liquidity on the markets; but until when?
Stock market indices falling sharply around theStock market indices falling sharply around the world, and then going back up since March.
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 2
Important issues in macroeconomicsImportant issues in macroeconomicsWhy are these things happening?
What is their impact on incomes investmentWhat is their impact on incomes, investment, savings of the local economy, on inflation and exchange rates?
What can the central banks and the governments do in situations like this?
How are economies working? (And why are they failing?)
What are the functions of money? And how can we make more of them?
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 3
Is the crisis over?
Important issues in macroeconomicsImportant issues in macroeconomics
Why does the cost of living keep rising?
Why are millions of people unemployed, even when the economy is booming?
Why are there recessions? Can the government do anything to combat recessions? Should it??
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 4
Important issues in macroeconomicsImportant issues in macroeconomics
What is the government budget deficit? How does it affect the economy?How does it affect the economy?
Why does the U.S. have such a huge trade deficit?
Why are so many countries poor? y a e so a y cou t es pooWhat policies might help them grow out of poverty?
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 5
U.S. Gross Domestic ProductU.S. Gross Domestic Productin billions of chained 1996 dollarsin billions of chained 1996 dollars
9 000
10,000
8,000
9,000
6,000
7,000
5,000
6,000
3,000
4,000
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 6
1970 1975 1980 1985 1990 1995 2000
U.S. Gross Domestic ProductU.S. Gross Domestic Productin billions of chained 1996 dollarsin billions of chained 1996 dollars
9 000
10,000
longest economic
8,000
9,000g
expansion on record
6,000
7,000
Recessions
5,000
6,000
3,000
4,000
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 7
1970 1975 1980 1985 1990 1995 2000
Why learn macroeconomics?Why learn macroeconomics?1. The macroeconomy affects society’s well-being.
example:pUnemployment and social problems
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 8
Unemployment and social problems Unemployment and social problems
Each one-point increase in the unemployment rate is associated with:unemployment rate is associated with:
920 more suicides650 more homicides650 more homicides4000 more people admitted to state mental institutionsinstitutions3300 more people sent to state prisons37 000 more deaths37,000 more deathsincreases in domestic violence and homelessness
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 9
homelessness
Why learn macroeconomics?Why learn macroeconomics?1. The macroeconomy affects society’s well-being.
example:pUnemployment and social problems
2. The macroeconomy affects your well-being.y y gexample 1: Unemployment and earnings growth
l 2example 2:Interest rates and mortgage payments
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 10
Unemployment and earnings growthUnemployment and earnings growth
345
0123
%
3-2-10%
-5-4-3
1965 1970 1975 1980 1985 1990 1995 20001965 1970 1975 1980 1985 1990 1995 2000
growth rate of inflation-adjusted hourly earningschange in Unemployment rate
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 11
change in Unemployment rate
Interest rates and mortgage paymentsInterest rates and mortgage payments
For a $150,000 30-year mortgage:
annual t
monthly t
actual rate on 30-year date
$12 771$10647 65%Dec 2000
paymentpaymento 30 yeamortgage
date
$11,782$9816.84%Dec 2001
$12,771$10647.65%Dec 2000
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 12
Why learn macroeconomics?Why learn macroeconomics?1. The macroeconomy affects society’s well-being.
example:pUnemployment and social problems
2. The macroeconomy affects your well-being.y y gexample 1: Unemployment and earnings growth
l 2example 2:Interest rates and mortgage payments
What is economics?
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 13
Economic modelsEconomic models…are simplied versions of a more complex reality
irrelevant details are stripped away• irrelevant details are stripped away
Used to • show the relationships between economic
variables• explain the economy’s behavior• devise policies to improve economic
fperformance
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 14
Example of a model:Example of a model:The supply & demand for new carsThe supply & demand for new carsThe supply & demand for new carsThe supply & demand for new carsexplains the factors that determine the price of cars and the quantity sold.cars and the quantity sold.
assumes the market is competitive: each buyer and seller is too small to affect the market priceand seller is too small to affect the market price
Variables:Q d = quantity of cars that buyers demandQ d = quantity of cars that buyers demandQ s = quantity that producers supplyP = price of new carsP = price of new carsY = aggregate incomeP = price of steel (an input)
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 15
Ps = price of steel (an input)
The demand for carsThe demand for cars
demand equation: ( , )dQ D P Y=
shows that the quantity of cars consumers demand
is related to the price of cars d t iand aggregate income.
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 16
Digression: Functional notationDigression: Functional notation
General functional notation shows only that the variables are related:that the variables are related:
( , )dQ D P Y=
A li t f thA list of the variables
that affect Q dthat affect Q
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 17
Digression: Functional notationDigression: Functional notation
General functional notation shows only that the variables are related:that the variables are related:
( , )dQ D P Y=
A specific functional form shows the precise quantitative relationship:Examples:
1) ( , ) 60 10 2= = − +dQ D P Y P Y) ( , )Q
= =0.3
2) ( , )d YQ D P YP
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 18
P
The market for cars: The market for cars: demanddemand
P Price
demand equation: Price
of cars ( , )=dQ D P Y
The demand curveshows the relationship
QD
shows the relationship between quantity demanded and price, th thi l Quantity
of carsother things equal.
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 19
The market for cars: The market for cars: supplysupply
P Price
supply equation: Price
of cars ( , )=ssQ S P P S
The supply curve shows the relationship
QD
shows the relationship between quantity supplied and price, th thi l Quantity
of carsother things equal.
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 20
The market for cars: The market for cars: equilibriumequilibrium
P PricePrice
of cars S
equilibrium price
QD
price
Quantity of cars
equilibriumquantity
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 21
quantity
The effects of an increase in income:The effects of an increase in income:
P Price
demand equation:
( )dQ D P Y Price of cars S
An increase in income
( , )=dQ D P Y
DP1
increases the quantity of cars consumers demand at each price
P2
D2
QD1
Q
demand at each price…
which increases Q Quantity of cars
Q1…which increases the equilibrium price and quantity.
Q2
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 22
The effects of a steel price increase:The effects of a steel price increase:
P Price
S2
supply equation:
( )sQ S P P Price of cars S1
An increase in Ps
( , )= sQ S P P
P1
sreduces the quantity of cars producers supply at each price
P2
QD
Q
at each price…
…which increases the Q2 Quantity of cars
Q1…which increases the market price and reduces the quantity.
Q2
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 23
Endogenous vs. exogenous variables:Endogenous vs. exogenous variables:
The values of endogenous variables are determined in the modelare determined in the model.
The values of exogenous variables d t i d t id th d lare determined outside the model:
the model takes their values & behavior as givenas given.
In the model of supply & demand for cars,
d d sP Q Qendogenous: , , d sP Q Qexogenous: , sY P
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 24
s
A Multitude of ModelsA Multitude of ModelsNo one model can address all the issues we care about For examplecare about. For example,
If we want to know how a fall in aggregate income affects new car prices we can useincome affects new car prices, we can use the S/D model for new cars.
f k hBut if we want to know why aggregate income falls, we need a different model.
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 25
A Multitude of ModelsA Multitude of ModelsSo we will learn different models for studying different issues (e g unemployment inflationdifferent issues (e.g. unemployment, inflation, long-run growth).
F h d l h ld k t k fFor each new model, you should keep track of – its assumptions,
which of its variables are endogenous and– which of its variables are endogenous and which are exogenous,the questions it can help us understand– the questions it can help us understand,
– and those it cannot.
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 26
Prices: Flexible Versus StickyPrices: Flexible Versus StickyMarket clearing: an assumption that prices are flexible and adjust to equate supply andare flexible and adjust to equate supply and demand.
In the short run many prices are sticky---In the short run, many prices are stickythey adjust only sluggishly in response to supply/demand imbalances. pp y
For example,– labor contracts that fix the nominal wage
f lfor a year or longer– magazine prices that publishers change
only once every 3-4 years
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 27
only once every 3 4 years
Prices: Flexible Versus StickyPrices: Flexible Versus StickyThe economy’s behavior depends partly on whether prices are sticky or flexible:whether prices are sticky or flexible:
If prices are sticky, then demand won’t al a s eq al s ppl This helps e plainalways equal supply. This helps explain– unemployment (excess supply of labor)– the occasional inability of firms to sell whatthe occasional inability of firms to sell what
they produce
Long run: prices flexible markets clearLong run: prices flexible, markets clear, economy behaves very differently.
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 28
Outline of this book:Outline of this book:Introductory material (chaps. 1 & 2)
Cl i l ThClassical Theory (chaps. 3-6) How the economy works in the long run, when prices are flexiblewhen prices are flexible
Growth Theory (chaps. 7-8)The standard of living and its growth rateThe standard of living and its growth rate over the very long run
B i C l Th ( h 9 13)Business Cycle Theory (chaps 9-13)How the economy works in the short run, when prices are sticky
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 29
when prices are sticky.
Outline of this book:Outline of this book:Policy debates (Chaps. 14-15)Should the government try to smooth businessShould the government try to smooth business cycle fluctuations? Is the government’s debt a problem? p
Microeconomic foundations (Chaps. 16-19)Insights from looking at the behavior ofInsights from looking at the behavior of consumers, firms, and other issues from a microeconomic perspective.p p
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 30
Chapter summaryChapter summary1. Macroeconomics is the study of the
economy as a whole includingeconomy as a whole, including• growth in incomes• changes in the overall level of priceschanges in the overall level of prices• the unemployment rate
2 Macroeconomists attempt to explain the2. Macroeconomists attempt to explain the economy and to devise policies to improve its performance.p
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 31
Chapter summaryChapter summary3. Economists use different models to
examine different issuesexamine different issues.
4. Models with flexible prices describe the economy in the long run; models witheconomy in the long run; models with sticky prices describe economy in the short run.run.
5. Macroeconomic events and performance arise from many microeconomicarise from many microeconomic transactions, so macroeconomics uses many of the tools of microeconomics.
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 32
Administration of the macro partAdministration of the macro partGrade distribution:
1 Midterm: 20 points1. Midterm: 20 points
2. Final: 25 points
3 Attendance and pa ticipation 5 points3. Attendance and participation: 5 points
Hints:
St d kl b i1. Study on a weekly basis
2. Attend the lectures and exercises
3. Problems?: [email protected]
4. Course web-site: http://home.cerge-ei cz/pstankov/VSE IP401 F09 htm
CHAPTER 1CHAPTER 1 The Science of MacroeconomicsThe Science of Macroeconomics slide 33
ei.cz/pstankov/VSE_IP401_F09.htm