Where You Are! Economics 305 – Macroeconomic Theory M and W from 12:00pm to 12:50pm Text: Gregory Mankiw: Macroeconomics, Worth, 9th, 8th edition. A used copy of 8th edition is good.

Course Webpage http://www.terpconnect.umd.edu/~jneri/Econ305 NOTE: upper-case E

Who am I ? Dr. John Neri Office: Morrill Hall, Room 1106D, M and W 10:30am to 11:30am Syllabus

https://www. c-span. org/video/ https://www.c-span.org/video/?430765-1/federal-reserve-chair-predicts-moderate-pace-economic-growth

Introduction and Chapter 1: Three major concerns of macroeconomics: growth, unemployment and inflation Tools macroeconomists use Some important concepts in macroeconomic analysis 4

Potential and Actual GDP Release: Gross Domestic Product

Potential and Actual GDP 17.0 16.8 About 1.2% below potential January 17, 2017. About 7% below potential

Potential and Actual GDP 17.0 16.8 About 1.2% below potential January 17, 2017. About 7% below potential

Long-term Real GDP Per Capita (2000 dollars) 9/11/2001 First oil price shock long-run upward trend… Second oil price shock Great Depression source: same as textbook World War II

U.S. Unemployment Rate (% of labor force) World War I Second oil price shock Great Depression First oil price shock World War I Oil price shocks Financial crisis World War II Interesting features: The unemployment rate is never zero. The most obvious feature is the 25% unemployment rate during the Great Depression. Also quite impressive is the huge drop coinciding with World War II. Unemployment often responds to shocks with a lag. For example, after each of the oil shocks (1973, 1979), it took a year or two before unemployment shot up. Although the most recent recession officially ended in June 2009, the unemployment rate remained abnormally high through the end of 2011. Source: same as textbook Financial crisis Great Depression

Growth Rate Calculations | US recession dates

Growth Rate Calculations | US recession dates

U.S. Inflation Rate (% per year) World War I Second oil price shock First oil price shock Source: same as textbook Financial crisis Great Depression

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 16

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) 17

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 18

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 19

The market for cars: Demand P Price of cars demand equation: Q d = D (P,Y ) D The demand curve shows the relationship between quantity demanded and price, other things equal. Q Quantity of cars 20

The market for cars: Supply Q Quantity of cars P Price of cars supply equation: Q s = S (P,PS ) S The supply curve shows the relationship between quantity supplied and price, other things equal. D 21

The market for cars: Equilibrium Q Quantity of cars P Price of cars S D equilibrium price equilibrium quantity 22

The effects of an increase in income demand equation: Q d = D (P,Y ) Q Quantity of cars P Price of cars S D1 Q1 P1 D2 An increase in income increases the quantity of cars consumers demand at each price… P2 Q2 …which increases the equilibrium price and quantity. 23

The effects of a steel price increase supply equation: Q s = S (P,PS ) Q Quantity of cars P Price of cars S1 D Q1 P1 S2 An increase in Ps reduces the quantity of cars producers supply at each price… P2 Q2 …which increases the market price and reduces the quantity. 24

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 25

NOW YOU TRY: Supply and Demand Market for Pizza Solve for equilibrium P and Q

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. 27

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 28

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 29

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 30

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 31

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 32

Some macro conclusions 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 Increase national saving lowers interest rates, increases investment and leads to larger capital stock. Increase efficiency of labor (education and increase technological progress)

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 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↓