Chapter 1 - MBA

7/29/2019 Chapter 1 - MBA

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MACROECONOMICS

and theFINANCIAL SYSTEM

N. Gregory Mankiw

& Laurence M. Ball

The Science ofMacroeconomics

Friday, August 5, 2011


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CHAPTER 1 The Science of Macroeconomics

In this chapter, you will learn:



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about the issues macroeconomists study



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about the issues macroeconomists study

the tools macroeconomists use

some important concepts in macroeconomic

analysis



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Important issues in macroeconomics



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



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What causes recessions? What is

government stimulus and why might it help?




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How can problems in the housing market spread

to the rest of the economy?




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How can problems in the housing market spread

to the rest of the economy?

What is the government budget deficit?

How does it affect workers, consumers,

businesses, and taxpayers?




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What causes financial crises? How should the

government respond to them?




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Why does the cost of living keep rising?

Macroeconomics, the study of the economy as

a whole, addresses many topical issues, e.g.:



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Why does the cost of living keep rising?

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, e.g.:



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



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long-run upward trend



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GreatDepression



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GreatDepression

World War II



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GreatDepression

World War II

First oilprice shock



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GreatDepression

World War II


Second oil

price shock



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GreatDepression

World War II


Second oil

price shock

9/11/2001



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U.S. Inflation Rate(% per year)



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



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CHAPTER 1 The Science of Macroeconomics 8

Economic models



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Economic models

are simplified versions of a more complex reality



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Economic models


irrelevant details are stripped away



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Economic models



are used to

show relationships between variables



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Economic models



are used to


explain the economys behavior



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Economic models



are used to


explain the economys behavior

devise policies to improve economicperformance


Example of a model:


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Example of a model:

Supply & demand for new cars


Example of a model:


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Example of a model:

Supply & demand for new cars shows how various events affect price and

quantity of cars


Example of a model:


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p


quantity of cars

assumes the market is competitive: each buyer

and seller is too small to affect the market price


Example of a model:


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p


quantity of cars



Variables


Example of a model:


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p


quantity of cars



Variables

Qd = quantity of cars that buyers demand


Example of a model:


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p


quantity of cars



Variables


Qs = quantity that producers supply


Example of a model:


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p


quantity of cars



Variables



P= price of new cars


Example of a model:


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quantity of cars



Variables



P= price of new carsY= aggregate income


Example of a model:


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quantity of cars



Variables



P= price of new carsY= aggregate income

Ps = price of steel (an input)


The demand for cars


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The demand for cars


The demand for cars


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The demand for cars

demand equation: Qd = D(P,Y)


The demand for cars


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The demand for cars

demand equation: Qd = D(P,Y)

shows that the quantity of cars consumers

demand is related to the price of cars andaggregate income


Digression: functional notation


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General functional notationshows only that the variables are related.




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Qd = D(P,Y)A list of the variables

that affectQd




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Qd = D(P,Y)A list of the variables

that affectQd




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Qd = D(P,Y)

A specific functional form shows

the precise quantitative relationship.

Example:

D(P,Y) = 60 10P + 2Y


The market for cars: Demand


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demand equation:Qd = D(P,Y)




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The demand curveshows the relationshipbetween quantitydemanded and price,

other things equal.





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other things equal.





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PPrice

of cars


other things equal.





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Q

Quantityof cars

PPrice

of cars


other things equal.





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Q

Quantityof cars

PPrice

of cars

D


other things equal.



The market for cars: Supply


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Q

Quantityof cars

PPrice

of cars

D




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Q

Quantityof cars

PPrice

of cars

D

supply equation:Qs = S(P,PS )




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Q

Quantityof cars

PPrice

of cars

D

S

The supply curveshows the relationshipbetween quantitysupplied and price,

other things equal.

supply equation:Qs = S(P,PS )


The market for cars: Equilibrium


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Q

Quantityof cars

PPrice

of cars S

D




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Q

Quantityof cars

PPrice

of cars S

D

equilibriumprice




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Q

Quantityof cars

PPrice

of cars S

D

equilibriumprice

equilibriumquantity


The effects of an increase in income


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Q

Quantityof cars

PPrice

of cars S

D1

Q1

P1

demand equation:

Qd = D(P,Y)




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CHAPTER 1The Science of Macroeconomics 15

Q

Quantityof cars

PPrice

of cars S

D1

Q1

P1

An increase in incomeincreases the quantity

of cars consumersdemand at each price

demand equation:

Qd = D(P,Y)




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Q

Quantityof cars

PPrice

of cars S

D1

Q1

P1



D2

demand equation:

Qd = D(P,Y)




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Q

Quantityof cars

PPrice

of cars S

D1

Q1

P1



which increases theequilibrium price and

quantity.

D2

demand equation:

Qd = D(P,Y)




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Q

Quantityof cars

PPrice

of cars S

D1

Q1

P1



which increases theequilibrium price and

quantity.

P2

Q2

D2

demand equation:

Qd = D(P,Y)


The effects of a steel price increase


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CHAPTER 1 The Science of Macroeconomics16

Q

Quantityof cars

PPrice

of carsS1

D

Q1

P1

supply equation:

Qs = S(P,PS )




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Q

Quantityof cars

PPrice

of carsS1

D

Q1

P1

An increase in Ps

reduces the quantity of

cars producers supply ateach price

supply equation:

Qs = S(P,PS )




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Q

Quantityof cars

PPrice

of carsS1

D

Q1

P1

An increase in Ps



S2

supply equation:

Qs = S(P,PS )




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Q

Quantityof cars

P

Priceof cars

S1

D

Q1

P1

An increase in Ps



which increases the

market price andreduces the quantity.

S2

supply equation:

Qs = S(P,PS )




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Q

Quantityof cars

P

Priceof cars

S1

D

Q1

P1

An increase in Ps



which increases the

market price andreduces the quantity.

P2

Q2

S2

supply equation:

Qs = S(P,PS )


Endogenous vs. exogenous variables


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The values ofendogenous variables

are determined in the model.




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The values ofexogenous variables

are determined outside the model:

the model takes their values & behavioras given.




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In the model of supply & demand for cars,




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endogenous: P, Qd, Qs




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endogenous: P, Qd, Qs

exogenous: Y,Ps


NOW YOU TRY:

Supply and Demand


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NOW YOU TRY:

Supply and Demand


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Write down demand and supply equations for

wireless phones; include two exogenous

variables in each equation.


NOW YOU TRY:

Supply and Demand


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wireless phones; include two exogenous

variables in each equation.

Draw a supply-demand graph for wireless

phones.


NOW YOU TRY:

Supply and Demand


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wireless phones; include two exogenousvariables in each equation.

Draw a supply-demand graph for wireless

phones.

Use your graph to show how a change in one of

your exogenous variables affects the models

endogenous variables.


The use of multiple models


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No one model can address all the issues we care


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about.





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about.

E.g., our supply-demand model of the car

market





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about.


market

can tell us how a fall in aggregate incomeaffects price & quantity of cars.





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about.


market

can tell us how a fall in aggregate incomeaffects price & quantity of cars.

cannot tell us whyaggregate income falls.




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So we will learn different models for studying


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different issues (e.g., unemployment, inflation,long-run growth, asset prices).





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For each new model, you should keep track of





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its assumptions





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its assumptions

which variables are endogenous,which are exogenous





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its assumptions

which variables are endogenous,which are exogenous

the questions it can help us understand,

those it cannot


Prices: flexible vs. sticky


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Market clearing: An assumption that prices are


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flexible, adjust to equate supply and demand.





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In the short run, many prices are sticky

adjust sluggishly in response to changes in

supply or demand. For example:





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supply or demand. For example: many labor contracts fix the nominal wage

for a year or longer





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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


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The economy s behavior depends partly on

whether prices are sticky or flexible:





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If prices sticky (short run),demand may not equal supply, which explains:





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unemployment (excess supply of labor)





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why firms cannot always sell all the goods

they produce





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why firms cannot always sell all the goods

they produce

If prices flexible (long run), markets clear andeconomy behaves very differently


Outline of this book:


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Introductory material (Chaps. 1 & 2)


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Classical Theory (Chaps. 3-6)How the economy works in the long run,

when prices are flexible





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Growth Theory (Chaps. 7-8)The standard of living and its growth rate over the

very long run





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Growth Theory (Chaps. 7-8)The standard of living and its growth rate over the

very long run

Business Cycle Theory (Chaps. 9-12)

How the economy works in the short run, when

prices are sticky




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Policy debates (Chaps. 13-14)


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y ( p )

Should the government try to smooth business

cycle fluctuations? Is the governments debt a

problem?



Policy debates (Chaps. 13-14)


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y ( p )

Should the government try to smooth business

cycle fluctuations? Is the governments debt a

problem?

The Financial System (Chaps. 15-19)The role of banks and other financial institutions,

stock and bond markets, causes of and policy

responses to financial crises.


CHAPTER SUMMARY


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CHAPTER SUMMARY

Macroeconomics is the study of


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the economy as a whole, including


CHAPTER SUMMARY



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the economy as a whole, including growth in incomes


CHAPTER SUMMARY



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changes in the overall level of prices


CHAPTER SUMMARY



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the unemployment rate


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the financial system


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the financial system

Macroeconomists attempt to explain the economy

and to devise policies to improve its performance.


CHAPTER SUMMARY


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CHAPTER SUMMARY

Economists use different models to

examine different issues.


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CHAPTER SUMMARY

Economists use different models to

examine different issues.


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Models with flexible prices describe the economy

in the long run; models with sticky prices describe

the economy in the short run.



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Chapter 1 - MBA

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