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The Science of Macroeconomics
1
CHAPTER

CHAPTER 1 The Science of Macroeconomics
TO THE INSTRUCTOR:

Many slides contain “notes” in this area of your screen. They are visible only to you and will not display during your classroom presentations. I use these notes to provide additional information you may find helpful.

Depending on the slide, this information may include data sources and teaching suggestions.

Many slides contain data. These notes usually provide the source—often the exact URL—in case you wish to visit the source and update the data to the latest available before teaching.

I will update these slides approximately once per year until the next edition of the textbook is published. The updated slides will be available at the companion website for the textbook under “instructor resources.” You may need instructor-level access; your Worth sales rep can provide you with a username and password.

If you find a typo or have a suggestion or comment, I would be grateful to hear from you. Please email me at:
rcronovich@carthage.edu

IN THIS CHAPTER, YOU WILL LEARN:
About the issues macroeconomists study
About the tools macroeconomists use
Some important concepts in macroeconomic analysis

CHAPTER 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 as a whole—addresses many topical issues, e.g.:

CHAPTER 1 The Science of Macroeconomics

This slide and the next contain a list of some topical issues that macroeconomics can help students understand. Feel free to substitute others as new issues emerge.

Important issues in macroeconomics
Why does the cost of living keep rising?
Why are so many countries poor? What policies might help them grow out of poverty?
What is the trade deficit? How does it affect a country’s well-being?
Macroeconomics—the study of the economy as a whole—addresses many topical issues, e.g.:

CHAPTER 1 The Science of Macroeconomics

U.S. Real GDP per capita
(2009 dollars)

Great Depression

World War II

First
oil price shock

Second oil price shock

9/11/2001

World War I
Financial crisis

CHAPTER 1 The Science of Macroeconomics
Two main features of these data:

Over the long run, clear upward trend in living standards.
In the short run, fluctuations.

Source: Same as the textbook.

GDP per capita 1900 1901 1902 1903 1904 1905 1906 1907 1908 1909 1910 1911 1912 1913 1914 1915 1916 1917 1918 1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 6003.9 6201.16 6389.64 6456.3 6111.43 6666.62 6807.03 6856.93 5998.25 6305.29 6240.96 6343.22 6537.88 6663.85 6036.54 6112.61 6863.63 6599.81 7116.87 7138.95 6979.36 6688.86 6963.35 7746.64 7833.88 7898.83 8302.58 8267.41 8259.87999999998 8661.12 7840.05 7282.38 6302.57 6186.65 6810.29 7366.4 8266.44 8635.17 8284.28 8872.91 9574.48 11161 13126.95 15152.96 16167.26 15836 13855.39 13443.79 13762.44 13452.82 14384.51 15281.26 15633.24 16099.4 15729.94 16556.65 16613.26 16660.44 16266.13 17095.35 17181.9 17334.63 18114.05 18632.33 19437.08 20442.3 21540.8 21892.61 22738.8 23221.83 23003.18 23462.63 24431.7 25564.9 25199.86 24907.28 25995.71 26921.91 28120.33 28694.04 28294.53 28740.74 27923.33 28953.24 30784.2 31805.07 32624.24 33453.3 34544.05 35478.82 35755.71 35257.76 36029.22 36540.37 37557.46 38125.12 39113.65 40383.14 41691.95 43215.86 44494.65 44471.56 44832.35 45660.06 46968.24 48094.38 48910 49310.56 48707.74 46927.16 47709.96 48239.6 49231.18 49797

U.S. Inflation Rate
(% per year)

Great Depression

First
oil price shock

Second
oil price shock
Financial crisis

World War I

CHAPTER 1 The Science of Macroeconomics
Source: Same as the textbook.

Rate 1900 1901 1902 1903 1904 1905 1906 1907 1908 1909 1910 1911 1912 1913 1914 1915 1916 1917 1918 1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2.74841437632135 2.88065843621398 2.79999999999999 4.66926070038911 2.78810408921934 0.723327305605787 3.59066427289047 6.23916811091855 -0.163132137030992 -0.326797385620923 2.62295081967213 -0.479233226837051 4.01284109149278 0.771604938271602 0.918836140888202 3.18664643399089 12.6470588235294 23.3681462140992 16.5079365079365 2.45231607629427 13.9184397163121 -14.7859922178988 -5.47945205479452 2.80193236714977 -1.2218045112782 1.80780209324452 0.467289719626175 -2.41860465116279 0.762631077216397 0.378429517502357 -3.67577756833175 -10.3718199608611 -11.6812227074236 -2.71940667490729 5.59085133418044 2.04572803850782 1.06132075471698 4.31738623103848 -2.9082774049217 -1.036866359447 1.16414435389988 6.78941311852704 7.86637931034483 5.3946053946054 2.3696682464455 2.59259259259259 11.913357400722 10.8064516 129032 5.60407569141193 -0.137835975189522 1.0351966873706 7.24043715846994 1.71974522292995 1.18973074514715 0.928217821782169 1.7167381974249 3.43580470162749 3.32167832167832 2.19966159052454 1.21412803532008 1.41766630316249 1.1290322580645 1.3290802764487 1.10178384050368 1.50492994291645 1.84049079754603 2.81124497991967 3.125 4.21401515151515 4.95229441163108 5.28138528138528 4.97532894736842 4.30865648256952 5.55764175741644 9.07150480256137 9.45857795172865 5.75089392133492 6.36799098337559 7.01986754966887 8.31683168316832 9.11791590493601 9.38219895287958 6.08845491097071 3.95235517054684 3.76736111111111 3.0282750543751 2.20850925625203 2.89164283444551 3.44348363187151 3.77668308702 792 3.85500575373994 3.54570637119114 2.36757624398073 2.20828433294133 2.10943492712862 2.09089770877676 1.9009075300466 1.76916596461668 1.12346263008515 1.47351186995672 2.16664745879913 2.25606316976875 1.69884169884169 2.10434971255017 2.81525549771592 3.32713370531101 3.23999999999999 2.89616427741187 2.20276757977971 1.06843511098831 1.206 1.9653 1.74912 1.50952

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

Great Depression
Financial crisis

World
War II

World War I

Oil price shocks

CHAPTER 1 The Science of Macroeconomics
Interesting features:

The unemployment rate is never zero.
The most obvious feature is the 25% unemployment rate during The Great Depression.
Also quite impressive is the huge drop coinciding with World War II.
Unemployment often responds to shocks with a lag. For example, after each of the oil shocks (1973, 1979), it took a year or two before unemployment shot up.
Although the most recent recession officially ended in June 2009, the unemployment rate remained abnormally high through the end of 2011.

Source: Same as the textbook.

Rate 1900 1901 1902 1903 1904 1905 1906 1907 1908 1909 1910 1911 1912 1913 1914 1915 1916 1917 1918 1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 5 4 3.7 3.9 5.4 4.3 1.7 2.8 8 5.1 5.9 6.7 4.6 4.3 7.9 8.5 5.1 4.6 1.4 1.4 5.2 11.7 6.7 2.4 5 3.2 1.8 3.3 4.2 3.2 8.9 16.3 24.1 25.2 22 20.3 17 14.3 19.1 17.2 14.6 9.9 4.7 1.9 1.2 1.9 3.9 3.9 3.8 5.9 5.3 3.3 3 2.9 5.5 4.4 4.1 4.3 6.8 5.5 5.5 6.7 5.5 5.7 5.2 4.5 3.8 3.8 3.6 3.5 4.9 5.9 5.6 4.9 5.6 8.5 7.7 7.1 6.1 5.8 7.1 7.6 9.7 9.6 7.5 7.2 7 6.2 5.5 5.3 5.6 6.8 7.5 6.9 6.1 5.6 5.4 4.9 4.5 4.2 4 4.7 5.8 6 5.5 5.1 4.6 4.6 5.8 9.3 9.6 8.9 8.1 7.4

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

CHAPTER 1 The Science of Macroeconomics

Example of a model:
Supply & demand for new cars
Shows how various events affect price and quantity of cars
Assumes the market is competitive: each buyer and seller is too small to affect the market price
Variables
Qd = quantity of cars that buyers demand
Qs = quantity that producers supply
P = price of new cars
Y = aggregate income
Ps = price of steel (an input)

CHAPTER 1 The Science of Macroeconomics

Students know the auto market is not competitive. However, if all we want to know is how an increase in the price of steel or a fall in consumer income affects the price and quantity of autos, then it’s fine to use this model.

In general, making unrealistic assumptions is okay, even desirable, if they simplify the analysis without affecting the validity of the results.

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

CHAPTER 1 The Science of Macroeconomics

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 – 10P + 2Y

A list of the variables
that affect Q d

CHAPTER 1 The Science of Macroeconomics

We often aren’t concerned with the exact quantitative relationship between variables, so we will often use the general functional notation.

The market for cars: Demand

Q Quantity of cars
P
Price
of cars

D
The demand curve shows the relationship between quantity demanded and price, other things equal.
Demand equation:
Q d = D (P,Y )

CHAPTER 1 The Science of Macroeconomics

The market for cars: Supply

Q Quantity of cars
P
Price
of cars

D

S
The supply curve shows the relationship between quantity supplied and price, other things equal.
Supply equation:
Q s = S (P,PS )

CHAPTER 1 The Science of Macroeconomics

The market for cars: Equilibrium

Q Quantity of cars
P
Price
of cars

S

D
equilibrium price

equilibrium
quantity

CHAPTER 1 The Science of Macroeconomics

The effects of an increase in income

Q Quantity of cars
P
Price
of cars

S

D1

Q1
P1
An increase in income increases the quantity
of cars consumers demand at each price…
…which increases the equilibrium price and quantity.
P2

Q2

D2
Demand equation:
Q d = D (P,Y )

CHAPTER 1 The Science of Macroeconomics

The effects of a steel price increase

Q Quantity of cars
P
Price
of cars

S1

D

Q1
P1
An increase in Ps reduces the quantity of cars producers supply at each price…
…which increases the market price and reduces the quantity.
P2

Q2

S2

Supply equation:
Q s = S (P,PS )

CHAPTER 1 The Science of 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 and behavior
as given.
In the model of supply & demand for cars,
endogenous: P, Q d, Q s
exogenous: Y, Ps

CHAPTER 1 The Science of Macroeconomics

NOW YOU TRY
Supply and Demand
1. Write down demand and supply equations for smartphones, include two exogenous variables in each equation.
2. Draw a supply–demand graph for smartphones.
3. Use your graph to show how a change in one of your exogenous variables affects the model’s endogenous variables.

CHAPTER 1 The Science of Macroeconomics
The PowerPoint slides for most chapters in this book contain one or more “Now You Try” slides. These slides contain questions or problems that serve to break up a lecture, give students an opportunity to apply what you’re teaching them, and give you a sense of whether they are “getting it.”

In the supply–demand model for smartphones:

Endogenous variables: price of smartphones, quantity of smartphones
Exogenous variables:
consumer income
price of data and voice service (a complement)
price of landline phones & landline phone service (a substitute)
technology

The use of multiple models
No one model can address all the issues we care about.
E.g., our supply–demand model of the car market…
can tell us how a fall in aggregate income affects price & quantity of cars.
cannot tell us why aggregate income falls.

CHAPTER 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

CHAPTER 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 to 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 (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 are flexible (long run), markets clear and economy behaves very differently.

CHAPTER 1 The Science of Macroeconomics

Outline of this book:
Introductory material (Chaps. 1, 2)
Classical Theory (Chaps. 3–7)
How the economy works in the long run, when prices are flexible
Growth Theory (Chaps. 8, 9)
The standard of living and its growth rate over the very long run
Business Cycle Theory (Chaps. 10–14)
How the economy works in the short run, when prices are sticky

CHAPTER 1 The Science of Macroeconomics

The portion of the book described on this slide comprises the core material. It is organized around time horizons: the long run (flexible prices), the very long run (growth in capital, the population, and technology itself), and the short run (sticky prices and economic fluctuations).

The next slide continues the outline.

Outline of this book:
Macroeconomic theory (Chaps. 15–17)
Macroeconomic dynamics, models of consumer behavior, theories of firms’ investment decisions
Macroeconomic policy (Chaps. 18–20)
Stabilization policy, government debt and deficits, financial crises

CHAPTER 1 The Science of Macroeconomics

Are you covering Chapter 2 next? The PowerPoint presentation for Chapter 2 includes some in-class exercises to reinforce concepts as they are presented. These exercises also help break up the lecture into smaller pieces. If you’d like to try them, please ask your students to bring calculators to the next class meeting.

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

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

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