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# Economic news this morning

## Total unemployed: 14 million

Unemployment rate: 9.1%

## Gaining sector: healthcare

Losing sector: government

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## The Conference Boards index slumped to 44.5,

the weakest since April 2009, from a revised 59.2 reading in July.

A leading indicator.

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## How do economists study economics?

Primary tool: models simplified versions of a more complex reality irrelevant details are stripped away

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Models

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Models

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## The Science of Macroeconomics

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Economic models
are used to show relationships between variables explain the economys behavior devise policies to improve economic performance

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Economic Models

## Key: identify variables to be determined by the

model (endogenous variables), and variables that are determined outside of the model (exogenous).

model

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## The Science of Macroeconomics

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A math analogy

X = 2+aY,

Y = 3 bX.
a = 10, b = 4.

X and Y: endogenous
a and b: exogenous

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## The Science of Macroeconomics

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Example of a model:

quantity of cars

## 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)
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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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## General functional notation

shows only that the variables are related.

Q d = D (P,Y )

## A specific functional form shows

the precise quantitative relationship.
A list of the Example: variables that affect D (P,Y ) = 60 Q d 10P + 2Y

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## The market for cars: Demand

demand equation:
Price of cars

D (P ,Y )

The demand curve shows the relationship between quantity demanded and price, other things equal.

D
Quantity of cars

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## The market for cars: Supply

supply equation:
Price of cars

P
S

Q S (P , Ps )
The supply curve shows the relationship between quantity supplied and price, other things equal.

D
Quantity of cars

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## The market for cars: Equilibrium

Price of cars

P
S

equilibrium price

D
Quantity of cars

equilibrium quantity
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## The effects of an increase in income

demand equation:

Q d D (P ,Y )
An increase in income increases the quantity of cars consumers demand at each price which increases the equilibrium price and quantity.
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Price of cars

P
S

P2

P1
D1 Q1 Q2

D2

Quantity of cars

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## The effects of a steel price increase

supply equation:

Q S (P , Ps )
An increase in Ps reduces the quantity of cars producers supply at each price

Price of cars

S2

S1

P2 P1 D Q2 Q1
Quantity of cars

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## 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.

endogenous:
exogenous:
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P, Q , Q
Y , Ps

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## Now you try:

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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## Now you try:

Demand for cell phones Exogenous variables Supply for cell phones Exogenous variables Change of equilibrium

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## The Science of Macroeconomics

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A multitude of models

care about.

market

## can tell us how a fall in aggregate income

affects price & quantity of cars.

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## The Science of Macroeconomics

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A multitude of 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, and those it cannot
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## 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
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## The economys behavior depends partly on

whether prices are sticky or flexible:

## If prices are sticky, then demand wont always

equal supply. This helps explain unemployment (excess supply of labor) why firms cannot always sell all the goods they produce

## Long run: prices flexible, markets clear,

economy behaves very differently
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## Sticky labor price and labor market disequilibrium

With decreasing labor demand, sticky wage leads to a surplus of labor (unemployment) in the labor market.

real wage

W D2
Unemployment

D1

Q Labor
hired
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## Economists as a group are sometimes criticized

for giving conflicting advice to policymakers.

Differences in scientific judgment Differences in values When economists do agree, policymakers may

not 93% of economists believe tariffs hurt general welfare 90% of economists believe fiscal stimulus works
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## Why Macroeconomists Disagree

Classicals vs. Keynesians The classical approach
The economy works well on its own The invisible hand: the idea that if there are free markets and individuals conduct their economic affairs in their own best interests, the overall economy will work well Wages and prices adjust rapidly to get to equilibrium Changes in wages and prices are signals that coordinate peoples actions Result: Government should have only a limited role in the economy
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## Classicals vs. Keynesians The Keynesian approach

The Great Depression: Classical theory failed because high unemployment was persistent Keynes: Persistent unemployment occurs because wages and prices adjust slowly, so markets remain out of equilibrium for long periods Conclusion: Government should intervene to restore full employment
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## Classicals vs. Keynesians The evolution of the classical-Keynesian debate

Keynesians dominated from WWII to 1970 Stagflation led to a classical comeback in the 1970s Last 30 years: excellent research with both approaches

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Newshour:
Video Link

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