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CHAPTER ONE

The Science of Macroeconomics

macroeconomics fifth edition
N. Gregory Mankiw
PowerPoint® Slides by Ron Cronovich
© 2002 Worth Publishers, all rights reserved

Learning objectives
This chapter introduces you to the issues macroeconomists study the tools macroeconomists use some important concepts in macroeconomic analysis

CHAPTER 1

The Science of Macroeconomics

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Important 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 1

The Science of Macroeconomics

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S.Important issues in macroeconomics What is the government budget deficit? How does it affect the economy? Why does the U. have such a huge trade deficit? Why are so many countries poor? What policies might help them grow out of poverty? CHAPTER 1 The Science of Macroeconomics slide 3 .

S. Gross Domestic Product in billions of chained 1996 dollars 10.000 3.000 9.000 7.000 5.000 4.000 1970 g on l 1975 1980 up n -r u ard w t d en r … 1985 1990 1995 2000 CHAPTER 1 The Science of Macroeconomics slide 4 .000 6.U.000 8.

000 7.000 4.S.U.000 9.000 1970 1975 1980 1985 1990 1995 2000 CHAPTER 1 The Science of Macroeconomics slide 5 . Gross Domestic Product in billions of chained 1996 dollars 10.000 8.000 3.000 5.000 longest economic expansion on record Recessions 6.

example: Unemployment and social problems CHAPTER 1 The Science of Macroeconomics slide 6 . The macroeconomy affects society’s well-being.Why learn macroeconomics? 1.

Unemployment and social problems Each one-point increase in the unemployment rate is associated with: 920 more suicides 650 more homicides 4000 more people admitted to state mental institutions 3300 more people sent to state prisons 37.000 more deaths increases in domestic violence and homelessness CHAPTER 1 The Science of Macroeconomics slide 7 .

example: Unemployment and social problems 2.Why learn macroeconomics? 1. example 1: Unemployment and earnings growth example 2: Interest rates and mortgage payments CHAPTER 1 The Science of Macroeconomics slide 8 . The macroeconomy affects your well-being. The macroeconomy affects society’s well-being.

Unemployment and earnings growth 55 44 33 22 11 00 -1 -1 -2 -2 -3 -3 -4 -4 -5 -5 1965 1965 % % 1970 1970 1975 1975 1980 1980 1985 1985 1990 1990 1995 1995 2000 2000 growth rate of inflation-adjusted hourly earnings growth rate of inflation-adjusted hourly earnings change in Unemployment rate change in Unemployment rate CHAPTER 1 The Science of Macroeconomics slide 9 .

84% monthly payment $1064 $981 annual payment $12.000 30-year mortgage: date Dec 2000 Dec 2001 actual rate on 30-year mortgage 7.771 $11.65% 6.Interest rates and mortgage payments For a $150.782 CHAPTER 1 The Science of Macroeconomics slide 10 .

The macroeconomy affects politics & current events. The macroeconomy affects your well-being. example 1: Unemployment and earnings growth Interest rates and mortgage payments 3.Why learn macroeconomics? 1. example 2: example: Inflation and unemployment in election years CHAPTER 1 The Science of Macroeconomics slide 11 . The macroeconomy affects society’s well-being. example: Unemployment and social problems 2.

0% 3.3% 3.4% 4.1% 3.5% 4.4% elec.Inflation and Unemployment in Election Years year 1976 1980 1984 1988 1992 1996 2000 U rate 7.0% inflation rate 5.5% 5.5% 7.7% 7.3% 4.1% 7.5% 5. outcome Carter (D) Reagan (R) Reagan (R) Bush I (R) Clinton (D) Clinton (D) Bush II (R) slide 12 CHAPTER 1 The Science of Macroeconomics .8% 13.

Economic models …are simplied versions of a more complex reality • irrelevant details are stripped away Used to • show the relationships between economic variables • explain the economy’s behavior • devise policies to improve economic performance CHAPTER 1 The Science of Macroeconomics slide 13 .

assumes the market is competitive: each buyer and seller is too small to affect the market price Variables: Q d = quantity of cars that buyers demand Q s = quantity that producers supply P = price of new cars Y = aggregate income Ps = price of steel (an input) CHAPTER 1 The Science of Macroeconomics slide 14 .Example of a model: The supply & demand for new cars explains the factors that determine the price of cars and the quantity sold.

The demand for cars demand equation: Q = D (P .Y ) d shows that the quantity of cars consumers demand is related to the price of cars and aggregate income. CHAPTER 1 The Science of Macroeconomics slide 15 .

Digression: Functional notation General functional notation shows only that the variables are related: Q = D (P .Y ) d A list of the variables that affect Q d CHAPTER 1 The Science of Macroeconomics slide 16 .

3 Y P slide 17 CHAPTER 1 The Science of Macroeconomics .Y ) = 60 − 10P + 2 Y 2) Q = D (P .Y ) = d 0.Y ) A specific functional form shows the precise quantitative relationship: Examples: 1) d Q d = D (P .Digression: Functional notation General functional notation shows only that the variables are related: Q = D (P .

The market for cars: demand demand equation: Price of cars P Q d = D (P . other things equal. D Quantity of cars Q CHAPTER 1 The Science of Macroeconomics slide 18 .Y ) The demand curve shows the relationship between quantity demanded and price.

D Quantity of cars Q CHAPTER 1 The Science of Macroeconomics slide 19 .The market for cars: supply supply equation: Price of cars P Q = S (P . other things equal. Ps ) s S The supply curve shows the relationship between quantity supplied and price.

The market for cars: equilibrium Price of cars P S equilibrium price D Quantity of cars Q equilibrium quantity CHAPTER 1 The Science of Macroeconomics slide 20 .

Y ) An increase in income increases the quantity of cars consumers demand at each price… …which increases the equilibrium price and quantity.The effects of an increase in income: demand equation: Q d = D (P . Price of cars P S P2 P1 D1 Q1 Q2 D2 Quantity of cars Q CHAPTER 1 The Science of Macroeconomics slide 21 .

Q CHAPTER 1 The Science of Macroeconomics slide 22 . Ps ) An increase in Ps reduces the quantity of cars producers supply at each price… s Price of cars P S2 S1 P2 P1 D Q2 Q1 Quantity of cars …which increases the market price and reduces the quantity.The effects of a steel price increase: supply equation: Q = S (P .

Endogenous vs. 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 . Ps slide 23 The Science of Macroeconomics . exogenous variables: The values of endogenous variables are determined in the model. Qs exogenous: CHAPTER 1 Y .

Use your graph to show how a change in one of your exogenous variables affects the model’s endogenous variables. Draw a supply-demand graph for wireless phones. 2. Write down demand and supply equations for wireless phones. 3. CHAPTER 1 The Science of Macroeconomics slide 24 . include two exogenous variables in each equation.Now you try: 1.

But if we want to know why aggregate income falls. For example.A Multitude of Models No one model can address all the issues we care about. If we want to know how a fall in aggregate income affects new car prices. we can use the S/D model for new cars. CHAPTER 1 The Science of Macroeconomics slide 25 . we need a different model.

inflation. – which of its variables are endogenous and which are exogenous. unemployment.A Multitude of Models So we will learn different models for studying different issues (e.g. For each new model. – the questions it can help us understand. The Science of Macroeconomics CHAPTER 1 slide 26 . you should keep track of – its assumptions. – and those it cannot. long-run growth).

many prices are sticky--they adjust only sluggishly in response to supply/demand imbalances. In the short run. – labor contracts that fix the nominal wage for a year or longer – magazine prices that publishers change only once every 3-4 years CHAPTER 1 The Science of Macroeconomics slide 27 . For example.Prices: Flexible Versus Sticky Market clearing: an assumption that prices are flexible and adjust to equate supply and demand.

markets clear.Prices: Flexible Versus Sticky The economy’s behavior depends partly on whether prices are sticky or flexible: If prices are sticky. economy behaves very differently. CHAPTER 1 The Science of Macroeconomics slide 28 . then demand won’t always equal supply. This helps explain – unemployment (excess supply of labor) – the occasional inability of firms to sell what they produce Long run: prices flexible.

7-8) The standard of living and its growth rate over the very long run Business Cycle Theory (chaps 9-13) How the economy works in the short run. 3-6) How the economy works in the long run. 1 & 2) Classical Theory (chaps. when prices are sticky. when prices are flexible Growth Theory (chaps.Outline of this book: Introductory material (chaps. CHAPTER 1 The Science of Macroeconomics slide 29 .

firms. CHAPTER 1 The Science of Macroeconomics slide 30 . 16-19) Insights from looking at the behavior of consumers. and other issues from a microeconomic perspective. 14-15) Should the government try to smooth business cycle fluctuations? Is the government’s debt a problem? Microeconomic foundations (Chaps.Outline of this book: Policy debates (Chaps.

Macroeconomics is the study of the economy as a whole. 2. including • growth in incomes • changes in the overall level of prices • the unemployment rate economy and to devise policies to improve its performance.Chapter summary 1. Macroeconomists attempt to explain the CHAPTER 1 The Science of Macroeconomics slide 31 .

4. The Science of Macroeconomics 5.Chapter summary 3. Economists use different models to examine different issues. Models with flexible prices describe the economy in the long run. arise from many microeconomic transactions. Macroeconomic events and performance CHAPTER 1 slide 32 . so macroeconomics uses many of the tools of microeconomics. models with sticky prices describe economy in the short run.

CHAPTER 1 The Science of Macroeconomics slide 33 .