Lecture 1 The Science of Macroeconomics

CHAPTER

1




This chapter introduces you to
• the issues macroeconomists study
• the tools macroeconomists use
• some important concepts in macroeconomic analysis

CHAPTER 1 The Science of Macroeconomics

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Macroeconomics, the study of the economy as
a whole, addresses many topical issues:
• Why does the cost of living keep rising?
• Why are millions of people unemployed,

even when the economy is booming?
• What causes recessions?
• Can the government do anything to combat
recessions? Should it?

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

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40,000

9/11/2001
First oil
price shock

30,000

long-run upward trend…

Great
Depression

20,000

Second oil
price shock

10,000

World War II

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-5
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1. The macroeconomy affects society’s well-being.
6000

Social
Social problems
problems like
like homelessness,
homelessness,
property crime
domestic violence, crime,(right
and
poverty
5000
and
poverty
scale)
8 domestic violence, crime,
are
are linked
linked to
to the
the economy.
economy.

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6

4000

For
example…
For
example…
4

unemployment
(left scale)

3000

crimes per
100,000 population

percent of labor force



2
0
1970

2000
1980

1990

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

5
4

5
3

3
1

2
1

-1

0

-3

-1
-5

-2
-3
1965

-7
1970

1975

unemployment rate

1980

1985

1990

1995

2000

2005

percent change from 12 mos earlier

2. The macroeconomy affects your well-being.
change from 12 mos earlier



inflation-adjusted mean wage (right scale)

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

3. The macroeconomy affects politics.
Unemployment & inflation in election years
year

U rate

inflation rate

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)

CHAPTER 1 The Science of Macroeconomics

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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 economy’s behavior
 devise policies to improve economic performance

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





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)
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


demand equation: Qd = D (P, Y)
shows that the quantity of cars consumers
demand is related
• to the price of cars (P) and
• aggregate income (Y)

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




General functional notation
shows only that the variables are related.
Q d = D (P, Y)
A specific functional form shows
the precise
quantitative
relationship.
A list of
the
• Example:
variables

D (P,that
Y) =affect
60 – 10P
Q d+ 2Y

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demand equation:

Q d D (P ,Y )

P

Price
of cars

The demand curve
shows the relationship
between quantity
demanded and price,
other things equal.

CHAPTER 1 The Science of Macroeconomics

D

Q

Quantity
of cars

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supply equation:
s

Q S (P , Ps )

P

Price
of cars

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

CHAPTER 1 The Science of Macroeconomics

S

D

Q

Quantity

of cars

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P

Price
of cars

S

D

Q

Quantity
of cars

CHAPTER 1 The Science of Macroeconomics

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demand equation:

Q

d

D (P ,Y )

An increase in income
increases the quantity
of cars consumers
demand at each price…

P

Price
of cars

S

P2
P1

…which increases
the equilibrium price
and quantity.

CHAPTER 1 The Science of Macroeconomics

D1
Q1 Q2

D2

Q

Quantity
of cars

ECON 100A : Intermediate Macro Theory

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supply equation:
s

Q S (P , Ps )

P

S2

Price
of cars

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

S1

P2
P1

…which increases the
market price and
reduces the quantity.

CHAPTER 1 The Science of Macroeconomics

D
Q2 Q1

Q

Quantity
of cars

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





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:
exogenous:
CHAPTER 1 The Science of Macroeconomics

P , Qd , Qs
Y , Ps
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