In this chapter, you will learn:

 about the issues macroeconomists study

Chapter 1: The Science of  the tools macroeconomists use
 some important concepts in macroeconomic
Macroeconomics y
analysis

CHAPTER 1 The Science of Macroeconomics 0

Important issues in macroeconomics Important issues in macroeconomics

Macroeconomics, the study of the economy as
a whole, addresses many topical issues, e.g.:
 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 as
a whole, addresses many topical issues, e.g.:
 Why does the cost of living keep rising?
 Why are so many countries poor? What policies
might help them grow out of poverty?
 What is the trade deficit? How does it affect the
country’s well-being?

CHAPTER 1 The Science of Macroeconomics 2 CHAPTER 1 The Science of Macroeconomics 3

U.S. Real GDP per capita U.S. Inflation Rate

(2000 dollars) (% per year)

9/11/2001

First oil
long-run upwardprice shock
trend…

Great
Depression Second oil
price shock

World War II

1
 U.S. Unemployment Rate Why learn macroeconomics?
(% of labor force) 1. The macroeconomy affects society’s well-being.
U.S. Unemployment and

crimes per 10
Property Crime Rates
Social problems like homelessness,

bor force
domestic violence, crime,
Propertyand
crimes
(right
poverty are linked to the scale)
economy.

percent of lab

00,000 population
For example…

Unemployment
(left scale)

Why learn macroeconomics?

Economic models
2. The macroeconomy affects your well-being.
5 In most years, wage growth falls 5 …are simplified versions of a more complex reality
12 mos earlier

4
when unemployment is rising.  irrelevant details are stripped away
mos earlier

3
3 …are used to
2
1
 show relationships between variables
change from 12 m

percent change from 1

1 -1  explain the economy’s behavior

0
-3
 devise policies to improve economic
-1 performance
-5
-2

-3 -7
1965 1970 1975 1980 1985 1990 1995 2000 2005
unemployment rate inflation-adjusted mean wage (right scale) CHAPTER 1 The Science of Macroeconomics 9

Example of a model:
The demand for cars
Supply & demand for new cars
 shows how various events affect price and demand equation: Q d = D (P,Y )
quantity of cars  shows that the quantity of cars consumers
 assumes the market is competitive: each buyer demand is related to the price of cars and
and seller is too small to affect the market price aggregate income
Variables
Qd = quantity of cars that buyers demand
Qs = quantity that producers supply
P = price of new cars
Y = aggregate income
Ps = price of steel (an input)
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2
 Digression: functional notation The market for cars: Demand

 General functional notation demand equation: P

Price
shows only that the variables are related. Qd = D (P,Y ) of cars
Q d = D (P,Y )

 A specific functional form shows The demand

Th d d curve
the precise quantitative relationship. shows the relationship
A list of the D
between quantity
 Example:
variables demanded and price, Q
) = 60 Q
d
D (P,Y
that affect – 10P + 2Y other things equal. Quantity
of cars

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The market for cars: Supply The market for cars: Equilibrium

supply equation: P P
Price Price
Qs = S (P,PS ) of cars S of cars S

Th supply
The l curve equilibrium
shows the relationship price
between quantity D D
supplied and price, Q Q
other things equal. Quantity Quantity
of cars of cars
equilibrium
quantity

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The effects of an increase in income The effects of a steel price increase

demand equation: supply equation:
P P S2
Q d = D (P,Y ) Price Q s = S (P,PS ) Price
of cars S of cars S1

An increase in income An increase in Ps

increases the quantity P2 reduces the quantity of P2
off cars consumers P1 cars producers
d supply
l P1
demand at each price… D2 at each price…
D1 D
Q Q
…which increases Q1 Q2 …which increases the Q2 Q1
Quantity market price and Quantity
the equilibrium price of cars of cars
and quantity. reduces the quantity.

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3

Endogenous vs. exogenous variables
 The values of endogenous variables
are determined in the model.
 The values of exogenous variables
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
CHAPTER 1 The Science of Macroeconomics
The use of multiple models
 No one model can address all the issues we
care 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 why aggregate income falls.
CHAPTER 1 The Science of Macroeconomics
Prices: flexible vs. sticky
 Market clearing: An assumption that prices are
flexible, adjust to equate supply and demand.
 In the short run, many prices are sticky –
adjust sluggishly in response to changes in
supply 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
CHAPTER 1 The Science of Macroeconomics
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
2. supply demand graph for wireless
phones.
3. Use your graph to show how a change in
one of your exogenous variables affects the
model’s endogenous variables.
18
The use of multiple models
 So we will learn different models for studying
different 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
20 CHAPTER 1 The Science of Macroeconomics 21
Prices: flexible vs. sticky
 The economy’s behavior depends partly on
whether 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
22 CHAPTER 1 The Science of Macroeconomics 23
4
 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
CHAPTER 1 The Science of Macroeconomics
Outline of this book:
 Policy debates (Chaps. 15-16)
Should the government try to smooth business
cycle fluctuations? Is the government’s debt a
problem?
 Microeconomic foundations (Chaps. 17-19)
Insights from looking at the behavior of
consumers, firms, and other issues from a
microeconomic perspective
24 CHAPTER 1 The Science of Macroeconomics 25