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MACROECONOMICS

SEV

ENT

H

EDI

TION

N. Gregory Mankiw

C H A P T E R

The Science of Macroeconomics

1

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In this chapter, you will learn:

about the issues macroeconomists study

the tools macroeconomists use

some important concepts in macroeconomic

analysis

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3CHAPTER 1 The Science of Macroeconomics

Important issues in macroeconomics

What causes recessions? What is

government stimulus and why might it help?

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?

Macroeconomics, the study of the economy asa 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 policiesmight help them grow out of poverty?

What is the trade deficit? How does it affect the

countrys well-being?

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

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Macroeconomics answers questions like thefollowing:

Why is average income high in some countries

and low in others?

Why do prices rise rapidly in some time periods

while they are more stable in others?

Why do production and employment expand in

some years and contract in others?

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Measuring a Nations Income

MicroeconomicsMicroeconomics is the study of how individual

households and firms make decisions and how

they interact with one another in markets.

MacroeconomicsMacroeconomics is the study of the economy as a

whole.

Its goal is to explain the economic changes thataffect many households, firms, and markets at

once.

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Economic models

are simplified versions of a more complex reality irrelevant details are stripped away

are used to

show relationships between variables

explain the economys behavior

devise policies to improve economic

performance

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The use of multiple models

No one model can address all the issues wecare 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 whyaggregate income falls.

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The use of multiple models

So we will learn different models for studyingdifferent 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

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Prices: flexible vs. sticky

Market clearing: An assumption that prices areflexible, adjust to equate supply and demand.

In the short run, many prices are sticky

adjust sluggishly in response to changes insupply 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 economys 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

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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 governments debt a

problem?

Microeconomic foundations (Chaps. 17-19)

Insights from looking at the behavior of

consumers, firms, and other issues from amicroeconomic perspective

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Chapter Summary

Macroeconomics is the study of the economyas 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.

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Chapter Summary

Economists use different models to examinedifferent issues.

Models with flexible prices describe the

economy in the long run; models with stickyprices 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.

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