MACROECONOMICS

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PowerPoint® Slides by Ron CronovichN. Gregory Mankiw

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The Science of Macroeconomics

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Obtained from Robert G. Murphy’s websiteModified for ECON 410.502 by Guangyi Ma

In this chapter, you will learn: about the issues macroeconomists study the tools macroeconomists use some important concepts in macroeconomic

analysis

3CHAPTER 1 The Science of Macroeconomics

Important issues in macroeconomics

What are the factors which influence the speed of economic growth?

Why are so many countries poor? How to explain the “gap” between developing countries and developed countries?

What causes boom and bust? What is the role of government in recessions?

Macroeconomics, the study of the economy as a whole, addresses many topical issues, e.g.:

4CHAPTER 1 The Science of Macroeconomics

Important issues in macroeconomics

What is the government budget deficit? How does it affect workers, consumers, businesses, and taxpayers?

What is the trade deficit? How does it affect the country’s well-being?

Macroeconomics, the study of the economy as a whole, addresses many topical issues, e.g.:

U.S. Real GDP per capita (2000 dollars)

long-run upward trend…

Great Depression

World War II

First oil price shock

Second oil price shock

9/11/2001

6CHAPTER 1 The Science of Macroeconomics

U.S. Inflation Rate(% per year)

U.S. Unemployment Rate(% of labor force)

9CHAPTER 1 The Science of Macroeconomics

Social problems like homelessness, domestic violence, crime, and poverty are linked to the economy.

For example…

Why learn macroeconomics?1. The macroeconomy affects society’s well-being.

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crimes per 100,000 population

U.S. Unemployment and Property Crime Rates

Unemployment (left scale)

Property crimes (right scale)

Why learn macroeconomics?2. The macroeconomy affects your well-being.

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1965 1970 1975 1980 1985 1990 1995 2000 2005-7

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unemployment rate inflation-adjusted mean wage (right scale)

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rIn most years, wage growth falls when unemployment is rising.

Why learn macroeconomics?3. The macroeconomy affects election outcomes.

Unemployment & inflation in election yearsyear U rate inflation rate elec. outcome1976 7.7% 5.8% Carter (D)1980 7.1% 13.5% Reagan (R)1984 7.5% 4.3% Reagan (R)1988 5.5% 4.1% Bush I (R)1992 7.5% 3.0% Clinton (D)1996 5.4% 3.3% Clinton (D)2000 4.0% 3.4% Bush II (R)2004 5.5% 3.3% Bush II (R)2008 7.2% 3.8% Obama (D)

13CHAPTER 1 The Science of Macroeconomics

Economic models…are extremely simplified versions of a more

complex reality irrelevant details are stripped away

…are used to show relationships between variables explain the economy’s behavior devise policies to improve economic

performance

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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

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The use of multiple models No one model can address all the issues we

care about. E.g., a supply-demand model of the U.S. car

market… can tell us how a fall in aggregate U.S. income

affects price & quantity of cars. cannot tell us why aggregate income falls.

25CHAPTER 1 The Science of Macroeconomics

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

26CHAPTER 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

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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

28CHAPTER 1 The Science of Macroeconomics

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

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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

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 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.