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Chapter 1

Important issues in macroeconomics


Why does the cost of living keep rising? Why are millions of people unemployed, even when the economy is booming? Why are there recessions? Can the government do anything to combat recessions? Should it?

The Science of Macroeconomics

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The Science of Macroeconomics

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CHAPTER 1

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Important issues in macroeconomics


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?

Why learn macroeconomics?


1. The macroeconomy affects societys well-being.

example:

Unemployment and social problems

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Why learn macroeconomics?


1. The macroeconomy affects societys well-being.

Why learn macroeconomics?


1. The macroeconomy affects societys well-being.

example:

Unemployment and social problems


2. The macroeconomy affects your well-being.

example:

Unemployment and social problems


2. The macroeconomy affects your well-being.

example 1:

Unemployment and earnings growth

example 1:

example 2:

Unemployment and earnings growth

Interest rates and mortgage payments

example 2:

Interest rates and mortgage payments


3. The macroeconomy affects politics & current events.

example:

Inflation and unemployment in election years


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Inflation and Unemployment in Election Years


year
1976 1980 1984 1988 1992 1996 2000

Fairs Presidential Election Model

U rate
7.7% 7.1% 7.5% 5.5% 7.5% 5.4% 4.0%

inflation rate
5.8% 13.5% 4.3% 4.1% 3.0% 3.3% 3.4%

elec. outcome
Carter (D) Reagan (R) Reagan (R) Bush I (R) Clinton (D) Clinton (D) Bush II (R)
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http://fairmodel.econ.yale.edu

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Economic models
are simplied versions of a more complex reality irrelevant details are stripped away Used to show the relationships between economic variables explain the economys behavior devise policies to improve economic performance

Example of a model: The supply & demand for new cars


explains the factors that determine the price of cars and the quantity sold. assumes the market is competitive: buyers and sellers are too small to affect market price Variables: Q d = quantity of cars that buyers demand Q s = 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


demand equation:

Digression: Functional notation


General functional notation shows only that the variables are related:

Q d = D (P ,Y )

shows that the quantity of cars consumers demand is related to the price of cars and aggregate income.

Q d = D (P ,Y )

A list of the variables that affect Q d

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Digression: Functional notation


General functional notation shows only that the variables are related:

The market for cars: demand


demand equation:
Price of cars

Q d = D (P ,Y )
A specific functional form shows the precise quantitative relationship: Examples:
1)

= D (P ,Y )

Q d = D (P ,Y ) = 60 10P + 2 Y

2)

Q d = D (P ,Y ) =

0.3 Y

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

D
Quantity of cars

P
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The market for cars: supply


supply equation:
Price of cars

The market for cars: equilibrium


Price of cars

Q = S (P , Ps )
The supply curve shows the relationship between quantity supplied and price, other things equal.

D
Quantity of cars

equilibrium price

D
Quantity of cars

equilibrium quantity
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The effects of an increase in income:


demand equation:

The effects of a steel price increase:


supply equation:

Q d = D (P ,Y )
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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Price of cars

Q s = S (P , Ps )
An increase in Ps reduces the quantity of cars producers supply at each price

Price of cars

S2 S1

P2 P1 D1 Q1 Q2 D2

P2 P1 D Q2 Q1
Quantity of cars

Quantity of cars

which increases the market price and reduces the quantity.

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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,

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

endogenous:

P , Qd , Qs

Business Cycle Theory (chaps 9-13)

exogenous:
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Y , Ps
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How the economy works in the short run, when prices are sticky.
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Outline of this book:


Policy debates (Chaps. 14-15)
Should the government try to smooth business cycle fluctuations? Is the governments debt a problem?

Microeconomic foundations (Chaps. 16-19)


Insights from looking at the behavior of consumers, firms, and other issues from a microeconomic perspective.

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