7/26/2010

Economics 101: Introduction and

Overview
A.D. Kraft

Outline
• Scope of macroeconomics
• Methodology
• Main macroeconomic models
▫ Very long run
▫ Long run
▫ Short-run

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Scope of macroeconomics
▫ The scope of macroeconomics
 Macroeconomics is the study of the economy as a
whole.
 Macroeconomics studies the economic behavior
and policies that affect “macro” variables such as
the total output of goods and services, inflation,
unemployment and exchange rates
 Some of the questions it seeks to answer include:
 What determines the rate of inflation?
 How much did the economy grow this year?
 What is the rate of unemployment?
 How can government policies affect these trends?

Scope of macroeconomics
 The job of explaining how the economy as a whole
works falls on macroeconomists
 Collect data on incomes, prices, unemployment
and many other variables from different periods
and from different countries
 Attempt to formulate general theories from data
 While the basic principles of macroeconomics do
not change, the macroeconomist must apply these
principles with flexibility and creativity to meet
changing circumstances.

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Scope of macroeconomics
▫ Long and Short run in Macroeconomics - Issues
that it is concerned with at different time
frames
 Long-run - Macroeconomics studies the issues of
growth, in particular, the growth of the
productive capacity of the economy.
 E.g. the growth of output is like the side or slope of
a mountain that is seen from afar as ascending.
 In the long-run, we expect nations to grow. The
issue is how fast or how slow the nation is growing
relative to the others.

Scope of macroeconomics
 In the short-run: Macroeconomics studies the
issue of why the path to growth is not smooth.
 In our mountain analogy, we note that the side of
the mountain is not smooth
 Translating to economic terms, we expect that the
economy would experience fluctuations in growth.
Output on a year to year basis could be increasing
rapidly or slowly, it could even decline or decline
continuously as in a recession.
 Thus, the study of macroeconomics is likewise
concerned about explaining why these fluctuations
occur.

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Scope of macroeconomics
▫ Macroeconomics vs Microeconomics

 Unit of analysis:
 Microeconomics is concerned with the behavior of
individual economic units such as households and
firms.

 Micro concerned with outputs and prices in specific

markets

 Macro concerned with aggregate markets as a whole,

e.g. goods market, (rather than the market for
pineapples), labor market (rather than the market for
female economics professors), asset markets (rather
than the market for PLDT stocks).

Scope of macroeconomics
▫ Macroeconomics vs Microeconomics
 By focusing our attention on the aggregate, we go
beyond the details of the behavior of economic
agents.

 Advantage: facilitates understanding of the

variables
 Disadvantage: some details matter

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Scope of macroeconomics
▫ Macroeconomics vs. Microeconomics
 Link between macroeconomics and
microeconomics:
 Aggregate variables are just the sum of individual
decisions, macro theory therefore rests on a
microeconomic foundation
 Optimizing behavior of households and firms are
implicit in most of the macroeconomic models -
consumers are still assumed to maximize utility,
firms are still assumed to maximize profit or
minimize costs
 Micro behavior is in the background, just not shown.

Methodology
• Main methodology - the use of models

▫ Models will be utilized as the main tool in our study

of macroeconomics

▫ Models:
 Illustrate the key features of the object
 Abstraction, only the essence of the object is filled
in
 Explain key relationship between economic
variables

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Methodology
• Main methodology - the use of models

▫ Models contain:
▫ Endogenous variables – variables that the
model tries to explain. Also known as
dependent variables.
▫ Exogenous variables – variables that are taken
as given. Also known as independent variables.
▫ Purpose of model is to explain how the
exogenous variables influence the endogenous
variables.
 Embodied in the functional relationship between
the exogenous and endogenous variables.
 Expressed as functions or graphs

Methodology
▫ It matters what we include and what we assume
away in a model

 Criterion for judging: Does the model include a

feature of the economy that is crucial to the issue
at hand?
 Different questions also require different
assumptions. Endogenous variables may be
exogenous to one model and vice versa.

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Main Macroeconomic Models

• Main macroeconomic models
▫ Three time frames of concern are:

▫ Very long run

 domain of growth theory
 focuses on the growth of productive capacity
▫ Long run
 treat productive capacity as given
 given productive capacity determines output
 fluctuations in demand determine prices and inflation
▫ Short run
 fluctuations in demand determine how much of capacity
is used and thus the level of output and employment

Models
• Very long run : Growth
▫ Growth theory as the main tool for analysis
▫ Main issue: How the accumulation of inputs and
improvements in technology lead to an increased
standard of living
▫ Main assumption: Labor and other resources are
fully employed
▫ Growth theory seeks to explain growth rates
averaged over many years or decades and ignores
fluctuations that average out over the years
▫ Growth rate: Usually measured by the rate at which
GDP or Gross domestic product is increasing

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Models
▫ Factors that underlie growth – a preview
▫ Changes in the factors of production –
 changes in the available amount of resources such as
labor, and capital stock affect the growth of the
economy
 labor force - increases due to increases in
population and labor force participation
 capital stock - increases because of investment

▫ Productivity increases –
 how efficiently we are utilizing resources also
underlies growth of the economy
 increases in efficiency effectively increases the
resources that are available
 increase in the stock of knowledge is one of the
factors that affect efficiency

Models
• Long run: The Economy with Fixed Productive
Capacity
▫ Features:
 Level of output is determined solely by supply-
side considerations, i.e., by the productive
capacity of the economy
 Price level is determined by the level of demand
relative to the output the economy can supply

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Long-run AD and AS
P AD AS

Po

Yo Y

Models
▫ AS- depicts for each given price level the
quantity of output firms are willing to supply
▫ AD – depicts for each given price level the
quantity of output at which the goods and
money market are at equilibrium
 Note the difference between the definition of the
aggregate demand and demand curves in
microeconomics.
 The details of the AD curve will be derived later.
 The position of the AD depends on consumer
confidence, as well as monetary and fiscal policy

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Models
▫ Main feature of the Long Run: AS is vertical

 Output is where the AS curve hits the horizontal.

Since no amount of price changes will induce
firms to supply more since they are constrained
by the capacity of the economy.

 Price can take on any value

Models
▫ Main Findings:
 Output is determined by AS alone.
 Prices are determined by both AS and AD.
 Link with the very long-run - Growth in
productive capacities shift the AS curve to the
right
 Very high inflation rates are due to changes in
the aggregate demand.

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AS in the Very Long Run

Y

Y4 P

Y3

Y1

Y0

t Y4
Y0 Y1 Y3 Y

Models
• Short Run

▫ Main feature: AS is flat

▫ Short-run fluctuations in output is mostly the
domain of aggregate demand.
▫ Main Finding: In the short-run output is
determined by aggregate demand alone and
prices are unaffected by the level of output.

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AD and AS: Short-run

P AD

AS
Po

Yo Y

Organization of course
• Introduction
▫ Overview
▫ Macroeconomic Data
• The “big picture”
▫ Classical theory – The economy in the long run
▫ Growth theory – The economy in the very long run
▫ The economy in the short run
• The “details”
▫ Aggregate demand
▫ Aggregate supply
▫ Macro policy issues

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Organization of the course

• International linkages
▫ The Open economy
▫ International adjustments

• The microfoundations
▫ Consumption
▫ Investment
▫ Money demand and supply

• Synthesis

Main reference
• Mankiw, N. Gregory, (2010) Macroeconomics,
7th ed. New York: Worth Publishers

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Course requirements and grading

system

▫ Exams 80%
▫ Homework/Exercise Sets 20%
▫ Exemption Grade 2.0
▫ Exemption grade basis 75% exams
25% exercises

Consultation days and hours:

• Tuesdays and Thursdays, 9-12, 1-5 or by

appointment
• UPSE Rm. 314
• Secretary: Ms. Baby Santos, Rm. 222

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Class policies
▫ Attendance
 University rules prescribe that those with more than 6
unexcused absences would be dropped from the class.
 Attendance would matter for those on the margins
 Please strive to be on time.

▫ Exams
 Early exams for those who cannot make it because of
conflicts with other exams can be scheduled, subject to
formal letter of request and excuse slip from concerned
teacher.
 No make-up exams

Class policies

▫ Please - no pagers, cellphones and other

electronic devices in class

▫ Please - no pagers, cellphones and other

electronic devices during exams.

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Class policies

▫ANY ACT OF
DISHONESTY WILL NOT
BE TOLERATED

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