Macroeconomics 7 th

edition
N.Gregory Mankiw
Chapter One

The Science of
Macroeconomics
Learning outcome
This chapter introduces you to
the issues macroeconomists
study
the tools macroeconomists use
some important concepts in
macroeconomic analysis
Economics defined

Economics : is the social science that studies

the choices that individuals, businesses,
governments, and entire societies make as they
cope with scarcity, the incentives that
influence those choices, and the arrangements
that coordinate them.
Economics : is the study of how people
allocate their scare resources with the
unlimited wants
Micro and Macro views
Microeconomics: is the study of
economic behavior of individual decision-
making units, such as individual
consumers, resources owners and business
firms.
Macroeconomics: is the study of the total
or aggregate level of output, income,
employment, consumption, investment
and prices the prices of the economy
viewed as a whole.
The importance of
Macroeconomics
Macroeconomics address these issues
Why does the cost of living keep rising?
Why are millions of people unemployed,
even when the economy is booming?
What causes recessions?
Can the government do anything to
combat recessions? Should it?
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What is the government budget deficit?
How does it affect the economy?
Why are so many countries poor?
What policies might help them grow out
of poverty?
The Historical Performance of the
U.S. Economy
Economists use many types of data to
measure the performance of an economy.
 Three macroeconomic variables are
especially important:
1. Real gross domestic product (GDP)
Real GDP measures the total income of
everyone in the economy
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2. inflation rate measures how fast prices
are rising
3. Unemployment rate measures the
fraction of the labor force that is out of
work
U.S. Real GDP per capita
(2000 dollars)
U.S. inflation rate (% per year)
U.S. unemployment rate
(% of labor force)
Economics Models
Economists use models to learn
about and illustrate the world.
These models are most often
composed of diagrams and
equations.
 Economic models
Economic models
 Are simplified versions of a more complex
reality
 Irrelevant details are stripped away
 Show relationships between variables
 explain the economy’s behavior
 Are devise (design) policies to improve
economic performance
Example of a model:
Supply & demand for Pizza
shows how various events affect price and
quantity of pizza
assumes the market is competitive: each
buyer and seller is too small to affect the
market price
Variables:
Q d = quantity of Pizza that buyers demand
Q s = quantity that producers supply
P = price of pizza
Y = aggregate income
Pm = price of materials (an input)
The demand for Pizza
demand equation: Q d = D (P,Y )
shows that the quantity of pizza
consumers demand is related to the
price of pizza and aggregate income
 The market for pizza: Demand

demand equation: P
Price
d
Q  D (P ,Y ) of pizza

The demand curve

shows the relationship
between quantity D
demanded and price, Q
other things equal. Quantity
of pizza
 The market for pizza: Supply

supply equation: P
Price
s
Q  S (P , Pm ) of pizza S

The supply curve shows

the relationship between
quantity supplied and D
price, other things equal. Q
Quantity
of pizza

The Science of
CHAPTER 1

Macroeconomics
The market for pizza: Equilibrium

P
Price
of pizza S

equilibrium
price
D
Q
Quantity
of pizza
equilibrium
quantity
 The effects of an increase in income
demand equation: P
Q d  D (P ,Y ) Price
of pizza S

An increase in income
increases the quantity P2
of pizza consumers P1
demand at each price… D2
D1
Q
…which increases the Q1 Q2
Quantity
equilibrium price and of pizza
quantity.
 The effects of a material price increase
supply equation: P
s
S2
Q  S (P , Ps ) Price
of pizza S1

An increase in Pm reduces
the quantity of pizza P2
producers supply at each P1
price…
D

…which increases the Q

Q2 Q1
market price and Quantity
of pizza
reduces the quantity.

The Science of
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Macroeconomics
 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,
exogenous: Y , Ps
d s
endogenous: P , Q , Q CHAPTER 1 The Science of
Macroeconomics
A multitude of models
No one model can address all the issues
we care about.
e.g., our supply-demand model of the
pizza market…
◦ can tell us how a fall in aggregate income
affects price & quantity of pizza.
◦ cannot tell us why aggregate income falls.

The Science of
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Macroeconomics
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 variables are exogenous
◦ the questions it can help us understand,
and those it cannot
The Science of
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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
 Prices: flexible vs. sticky
The economy’s behavior depends partly on
whether prices are sticky or flexible:
If prices are sticky, then demand won’t 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
 Chapter Summary
Macroeconomics is the study of the economy
as a whole, including
◦ growth in incomes,
◦ changes in the overall level of prices,
◦ the unemployment rate.
Macroeconomists attempt to explain the
economy and to devise policies to improve its
performance.

CHAPTER 1 The Science of Macroeconomics slide 27

 Chapter Summary
Economists use different models to examine
different issues.
Models with flexible prices describe the
economy in the long run; models with sticky
prices describe the economy in the short run.
Macroeconomic events and performance arise
from many microeconomic transactions, so
macroeconomics uses many of the tools of
microeconomics.
CHAPTER 1 The Science of Macroeconomics slide 28