Chapter 1 - MBA

MACROECONOMICS
FINANCIAL SYSTEM
N. Gregory Mankiw & Laurence M. Ball
CHAPTER
and the
The Science of 1 Macroeconomics
Friday, August 5, 2011
Inthischapter,youwilllearn:
CHAPTER 1
The Science of Macroeconomics
about the issues macroeconomists study
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about the issues macroeconomists study the tools macroeconomists use
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about the issues macroeconomists study the tools macroeconomists use some important concepts in macroeconomic
analysis
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Important issues in macroeconomics
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Macroeconomics, the study of the economy as a whole, addresses many topical issues, e.g.:
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What causes recessions? What is
government stimulus and why might it help?
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to the rest of the economy?
How can problems in the housing market spread
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to the rest of the economy?
How can problems in the housing market spread What is the government budget deficit?
How does it affect workers, consumers, businesses, and taxpayers?
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What causes financial crises? How should the

government respond to them?
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Why does the cost of living keep rising?
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Why does the cost of living keep rising? Why are so many countries poor? What policies
might help them grow out of poverty?
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U.S. Real GDP per capita

(2000 dollars)

(2000 dollars)
long-run upward trend

(2000 dollars)
Great Depression

(2000 dollars)
Great Depression World War II

(2000 dollars)
First oil price shock

(2000 dollars)
First oil price shock
Second oil price shock

(2000 dollars)
9/11/2001 First oil price shock
Second oil price shock
U.S. Inflation Rate

(% per year)
U.S. Unemployment Rate

(% of labor force)
Economic models
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Economic models
are simplified versions of a more complex reality
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Economic models
are simplified versions of a more complex reality irrelevant details are stripped away
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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
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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
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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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Example of a model:
Supply & demand for new cars
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Example of a model:

shows how various events affect price and
quantity of cars
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Example of a model:

quantity of cars assumes the market is competitive: each buyer and seller is too small to affect the market price
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Example of a model:

Variables
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Example of a model:

Variables Qd = quantity of cars that buyers demand
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Example of a model:

Variables Qd = quantity of cars that buyers demand Qs = quantity that producers supply
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Example of a model:

Variables Qd = quantity of cars that buyers demand Qs = quantity that producers supply P = price of new cars
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Example of a model:

Variables Qd = quantity of cars that buyers demand Qs = quantity that producers supply P = price of new cars Y = aggregate income
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Example of a model:

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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The demand for cars
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The demand for cars

demand equation: Q d = D (P,Y )
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10
The demand for cars

shows that the quantity of cars consumers

demand is related to the price of cars and aggregate income
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Digression: functional notation
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General functional notation
shows only that the variables are related.
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Q d = D (P,Y ) shows only that the variables are related.
A list of the variables that affect Q d
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A list of the variables that affect Q d
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A specific functional form shows
the precise quantitative relationship. Example: D (P,Y ) = 60 10P + 2Y

11
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The market for cars: Demand
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The demand curve shows the relationship between quantity demanded and price, other things equal.
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demand equation: Qd = D (P,Y )
P
Price of cars
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12

P
Price of cars
Q
Quantity of cars
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P
Price of cars
Q
Quantity of cars
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12
The market for cars: Supply

P
Price of cars
Q
Quantity of cars
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supply equation: Qs = S (P,PS )
P
Price of cars
Q
Quantity of cars
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P
Price of cars S
The supply curve shows the relationship between quantity supplied and price, other things equal.
Q
Quantity of cars
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The market for cars: Equilibrium

P
Price of cars S
Q
Quantity of cars
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P
Price of cars S
equilibrium price
Q
Quantity of cars
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P
Price of cars S
equilibrium price
Q
equilibrium quantity
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Quantity of cars
14
The effects of an increase in income

P
Price of cars S
P1 D1 Q1
Q
Quantity of cars
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An increase in income increases the quantity of cars consumers demand at each price
P
Price of cars S
P1 D1 Q1
Q
Quantity of cars
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An increase in income increases the quantity of cars consumers demand at each price
P
Price of cars S
P1 D1 Q1
D2
Q
Quantity of cars
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An increase in income increases the quantity of cars consumers demand at each price which increases the equilibrium price and quantity.
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P
Price of cars S
P1 D1 Q1
D2
Q
Quantity of cars
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An increase in income increases the quantity of cars consumers demand at each price which increases the equilibrium price and quantity.
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P
Price of cars P2 P1 D1 Q1 Q2 D2 S
Q
Quantity of cars
15
The effects of a steel price increase

supply equation: Q s = S (P,PS )
P
Price of cars S1
P1 D Q1
Q
Quantity of cars
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supply equation: Q s = S (P,PS )
An increase in Ps reduces the quantity of cars producers supply at each price
P
Price of cars S1
P1 D Q1
Q
Quantity of cars
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P
Price of cars S2 S1
An increase in Ps reduces the quantity of cars producers supply at each price
P1 D Q1
Q
Quantity of cars
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P
Price of cars S2 S1
An increase in Ps reduces the quantity of cars producers supply at each price which increases the market price and reduces the quantity.
P1 D Q1
Q
Quantity of cars
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P
Price of cars P2 P1 D Q2 Q1 S2 S1
An increase in Ps reduces the quantity of cars producers supply at each price which increases the market price and reduces the quantity.
Q
Quantity of cars
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16
Endogenous vs. exogenous variables
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17

The values of endogenous variables
are determined in the model.
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The values of exogenous variables
are determined outside the model: the model takes their values & behavior as given.
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In the model of supply & demand for cars,
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17

endogenous: P, Q d, Q s
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endogenous: P, Q d, Q s exogenous: Y, Ps
17
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NOW YOU TRY:
Supply and Demand
NOW YOU TRY:
Supply and Demand

Write down demand and supply equations for
wireless phones; include two exogenous variables in each equation.
NOW YOU TRY:
Supply and Demand

wireless phones; include two exogenous variables in each equation. phones.
Draw a supply-demand graph for wireless
NOW YOU TRY:
Supply and Demand

wireless phones; include two exogenous variables in each equation. phones.
Draw a supply-demand graph for wireless Use your graph to show how a change in one of
your exogenous variables affects the models endogenous variables.
The use of multiple models
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No one model can address all the issues we care
about.
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19

about.
E.g., our supply-demand model of the car

market
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19

about.
market can tell us how a fall in aggregate income affects price & quantity of cars.
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about.
market can tell us how a fall in aggregate income affects price & quantity of cars. cannot tell us why aggregate income falls.
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19
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20

So we will learn different models for studying
different issues (e.g., unemployment, inflation, long-run growth, asset prices).
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For each new model, you should keep track of
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For each new model, you should keep track of its assumptions
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For each new model, you should keep track of its assumptions which variables are endogenous,
which are exogenous
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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
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Market clearing: An assumption that prices are
flexible, adjust to equate supply and demand.
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flexible, adjust to equate supply and demand. adjust sluggishly in response to changes in supply or demand. For example:
In the short run, many prices are sticky
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flexible, adjust to equate supply and demand. adjust sluggishly in response to changes in supply or demand. For example: many labor contracts fix the nominal wage for a year or longer
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flexible, adjust to equate supply and demand. 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
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The economys behavior depends partly on
whether prices are sticky or flexible:
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22

whether prices are sticky or flexible: If prices sticky (short run), demand may not equal supply, which explains:
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22

unemployment (excess supply of labor)
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unemployment (excess supply of labor) why firms cannot always sell all the goods they produce
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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:
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23

Introductory material (Chaps. 1 & 2)
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Introductory material (Chaps. 1 & 2) Classical Theory (Chaps. 3-6)
How the economy works in the long run, when prices are flexible
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Introductory material (Chaps. 1 & 2) Classical Theory (Chaps. 3-6) Growth Theory (Chaps. 7-8)
How the economy works in the long run, when prices are flexible The standard of living and its growth rate over the very long run
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Introductory material (Chaps. 1 & 2) Classical Theory (Chaps. 3-6) Growth Theory (Chaps. 7-8)
How the economy works in the long run, when prices are flexible The standard of living and its growth rate over the very long run How the economy works in the short run, when prices are sticky
23
Business Cycle Theory (Chaps. 9-12)
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Policy debates (Chaps. 13-14)
Should the government try to smooth business cycle fluctuations? Is the governments debt a problem?
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Policy debates (Chaps. 13-14)
Should the government try to smooth business cycle fluctuations? Is the governments debt a problem? The role of banks and other financial institutions, stock and bond markets, causes of and policy responses to financial crises.
The Financial System (Chaps. 15-19)
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CHAPTERSUMMARY
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CHAPTERSUMMARY
Macroeconomics is the study of
the economy as a whole, including
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CHAPTERSUMMARY
the economy as a whole, including growth in incomes
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CHAPTERSUMMARY
the economy as a whole, including growth in incomes changes in the overall level of prices
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CHAPTERSUMMARY
the economy as a whole, including growth in incomes changes in the overall level of prices the unemployment rate
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CHAPTERSUMMARY
the economy as a whole, including growth in incomes changes in the overall level of prices the unemployment rate the financial system
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CHAPTERSUMMARY
the economy as a whole, including growth in incomes changes in the overall level of prices the unemployment rate the financial system and to devise policies to improve its performance.
Macroeconomists attempt to explain the economy
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CHAPTERSUMMARY
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CHAPTERSUMMARY
Economists use different models to
examine different issues.
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CHAPTERSUMMARY
Models with flexible prices describe the economy
in the long run; models with sticky prices describe the economy in the short run.
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CHAPTERSUMMARY
Models with flexible prices describe the economy Macroeconomic events and performance arise
from many microeconomic transactions, so macroeconomics uses many of the tools of microeconomics.
in the long run; models with sticky prices describe the economy in the short run.
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26

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MACROECONOMICS

The Science of 1 Macroeconomics

Friday, August 5, 2011

The Science of Macroeconomics

The Science of Macroeconomics

The Science of Macroeconomics

The Science of Macroeconomics

Important issues in macroeconomics

The Science of Macroeconomics

Important issues in macroeconomics

The Science of Macroeconomics

Important issues in macroeconomics

What causes recessions? What is

government stimulus and why might it help?

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

The Science of Macroeconomics

Important issues in macroeconomics

What causes recessions? What is

government stimulus and why might it help?

Important issues in macroeconomics

The Science of Macroeconomics

Important issues in macroeconomics

What causes financial crises? How should the

The Science of Macroeconomics

Important issues in macroeconomics

What causes financial crises? How should the

Why does the cost of living keep rising?

The Science of Macroeconomics

Important issues in macroeconomics

What causes financial crises? How should the

The Science of Macroeconomics

U.S. Real GDP per capita

Friday, August 5, 2011

U.S. Real GDP per capita

long-run upward trend

Friday, August 5, 2011

U.S. Real GDP per capita

Friday, August 5, 2011

U.S. Real GDP per capita

Great Depression World War II

Friday, August 5, 2011

U.S. Real GDP per capita

First oil price shock

Great Depression World War II

Friday, August 5, 2011

U.S. Real GDP per capita

First oil price shock

Great Depression World War II

Second oil price shock

Friday, August 5, 2011

U.S. Real GDP per capita

Great Depression World War II

Second oil price shock

Friday, August 5, 2011

U.S. Inflation Rate