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Where You Are!
Economics 305 – Macroeconomic Theory
T and Th from 11:00am to 12:15pm
Text: Gregory Mankiw: Macroeconomics, Worth, 9th, edition.
Course Webpage
http://www.terpconnect.umd.edu/~jneri/Econ305
NOTE: upper-case E
Who am I ?
Dr. John Neri
Office: Morrill Hall, Room 1106D,
T and Th 4:30pm to 5:30pm
Go over syllabus
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Introduction and Chapter 1:
What are the three major concerns of
macroeconomics?
Quick review of tools macroeconomists use –
models.
Some important concepts in macroeconomics
Federal Government Tax Rebates: May - July 2008
Federal Government Tax Rebates: Counter Factual
May - July 2008. Dramatic fall in wealth.
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Interest Rate Changes
The federal funds rate
The short-term
Treasury bill rate
The long-term bond
rate
Interest Rates
Interest Rate Changes
The federal funds rate
The short-term
Treasury bill rate
The long-term bond
rate
Interest Rates
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Potential and Actual Real GDP
About 7%
below
potential
Potential and Actual Real GDP
About 7%
below
potential
2000 to
2007 trend
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U.S. Unemployment Rate
(% of labor force)
Great
Depression
First
oil price
shock
Second
oil price
shock
Financial
crisis
World
War I
0
5
10
15
20
25
30
19
00
19
10
19
20
19
30
19
40
19
50
19
60
19
70
19
80
19
90
20
00
20
10
Great
Depression
Financial
crisis World
War II
World
War I Oil price
shocks
Employed Part Time for Economic Reasons
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U.S. Inflation Rate (% per year)
-15
-10
-5
0
5
10
15
20
25
19
00
19
10
19
20
19
30
19
40
19
50
19
60
19
70
19
80
19
90
20
00
20
10
Great
Depression
First
oil price
shock
Second
oil price
shock
Financial
crisis
World
War I
http://www.bls.gov/news.release/cpi.nr0.htm
Tools Economist Use -
Economic models
simplified versions of a more complex reality
irrelevant details are stripped away
used to
show relationships between variables
explain the economy’s behavior
devise policies to improve economic
performance
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Mankiw presents the supply & demand
for new cars as an example of a model:
assumes the market is competitive: each buyer
and seller is too small to affect the market price
Variable definitions and notation
Qd = quantity of cars that buyers demand
Qs = quantity of cars that producers supply
P = price of new cars
Y = aggregate income
Ps = price of steel (an input)
The demand for cars:
demand equation: Q d = D (P,Y )
Read as quantity demanded is a function of
(depends upon) the price of new cars (P) and
aggregate income (Y).
Shows that the quantity of cars consumers
demand is related to the price of cars and
aggregate income
Mankiw Notation
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:
Q d =D (P,Y ) = 60 – 10P + 2Y
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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 )
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 )
The market for cars: Equilibrium
Q
Quantity of cars
P Price
of cars S
D
equilibrium
price
equilibrium
quantity
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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 )
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 )
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 & behavior
as given.
In the model of supply & demand for cars,
endogenous: P, Qd, Qs
exogenous: Y, Ps
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NOW YOU TRY:
Supply and Demand
1. Market for Pizza
2.
3.
4. Solve for equilibrium P and Q
60 10 2dQ P Y
100 5 15sQ P Pc
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 decrease in aggregate income
affects price & quantity of cars.
cannot tell us why aggregate income falls.
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
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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
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
Outline of the 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)[Not covered]
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
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Outline of the 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
In the long-run, supply rules.
Capacity to produce goods and services
(productive capacity) determines the standard of
living (GDP/person)
GDP depends on factors of production: amount of
Labor (L) and capital (K) and technology used to turn K
and L into output.
In the long-run, public policy can increase GDP only by improving productive capacity of the economy
Policy to increase productivity of labor (education and
increase technological progress)
Policy to increase national saving which lowers
interest rates, increases investment and leads to
larger capital stock.
Some macro conclusions
In the short-run, aggregate demand rules.
Changes in aggregate demand influences the
amount of goods and services that a country
produces
Chapter 10,11, 12 and 14
Monetary policy, fiscal policy
Shocks to the system
Some macro conclusions
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In the long-run, the rate of money growth
determines the rate of inflation, but it does not
affect the rate of unemployment
Chapter 5
High inflation raises the nominal interest rate
(the real interest rate is not affected)
There is no trade-off between inflation and
unemployment in the long run
Some macro conclusions
There is a trade-off between inflation and
unemployment in the short-run
Chapter 14, short-run Phillips curve
Increase Aggregate Demand => U↓ and π↑
Contract Aggregate Demand => U↑ and π↓
Some macro conclusions
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