MACROECONOMICSMACROECONOMICS

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The Science of The Science of MacroeconomicsMacroeconomics

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In this chapter, you will learn:In this chapter, you will learn:

about the issues macroeconomists study

the tools macroeconomists use

some important concepts in macroeconomic analysis

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

4CHAPTER 1 The Science of Macroeconomics

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 the country’s well-being?

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

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

long-run upward trend…

Great Depression

World War II

First oil price shock

Second oil price shock

9/11/2001

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7CHAPTER 1 The Science of Macroeconomics

U.S. Inflation Rate(% per year)

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

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14CHAPTER 1 The Science of Macroeconomics

Social problems like homelessness, domestic violence, crime, and poverty are linked to the economy.

For example…

Social problems like homelessness, domestic violence, crime, and poverty are linked to the economy.

For example…

Why learn macroeconomics?1. The macroeconomy affects society’s well-being.

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crimes per 100,000 population

U.S. Unemployment and Property Crime Rates

U.S. Unemployment and Property Crime Rates

Unemployment (left scale)

Property crimes (right scale)

Why learn macroeconomics?2. The macroeconomy affects your well-being.

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

Why learn macroeconomics?3. The macroeconomy affects election outcomes.

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)

2008 7.2% 3.8% Obama (D)

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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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The use of multiple models

No one model can address all the issues we care 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 why aggregate income falls.

30CHAPTER 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

31CHAPTER 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 3-4 years

32CHAPTER 1 The Science of Macroeconomics

Prices: flexible vs. sticky

The economy’s 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

33CHAPTER 1 The Science of Macroeconomics

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

34CHAPTER 1 The Science of Macroeconomics

Outline of this book:

Policy debates (Chaps. 15-16)Should the government try to smooth business cycle fluctuations? Is the government’s debt a problem?

Microeconomic foundations (Chaps. 17-19)Insights from looking at the behavior of consumers, firms, and other issues from a microeconomic perspective

Chapter SummaryChapter 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 SummaryChapter 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.