Macroeconomics: The Science of Macroeconomics, Slides of Macroeconomics

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The Science of Macroeconomics

Learning Objectives

This chapter introduces you to

§ the issues macroeconomists study

§ the tools macroeconomists use

§ some important concepts in macroeconomic analysis

Important issues in

macroeconomics

§ What is the government budget deficit?

How does it affect the economy?

§ Why does the U.S. have such a huge trade deficit?

§ Why are so many countries poor?

What policies might help them grow out of poverty?

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

0

10,

20,

30,

40,

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

U.S. Real GDP per capita

(2000 dollars)

Great Depression

World War II

First oil price shock

Second oil price shock

long-run upward trend…

9/11/

U.S. unemployment rate

(% of labor force)

0

5

10

15

20

25

30

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Why learn macroeconomics?

1. The macroeconomy affects society’s well-being.

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

Why learn macroeconomics?

Unemployment & inflation in election years

year U rate inflation rate elec. outcome

1976 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)

3. The macroeconomy affects politics.

Economic models

…are 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

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

Digression: functional notation

§ General functional notation shows only that the variables are related.

Q d^ = D ( P,Y )

§ A specific functional form shows the precise quantitative relationship.

§ Example:

D ( P,Y ) = 60 – 10 P + 2 Y

A list of the variables

that affect Q d

The market for cars: Supply

Q Quantity of cars

P Price of cars

D

supply equation:

Q s  S P ( , Ps )^ S

The supply curve shows the relationship between quantity supplied and price, other things equal.

The market for cars: Equilibrium

Q Quantity of cars

P Price of cars^ S

D

equilibrium price

equilibrium quantity

The effects of a steel price increase

Q Quantity of cars

P Price of cars^ S^1

D Q 1

P 1

An increase in P s reduces the quantity of cars producers supply at each price…

…which increases the market price and reduces the quantity.

P 2

Q 2

S 2

supply equation: Q s  S P ( , Ps )

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 , Q d^ , Qs

exogenous: Y , P s