The Science of Macroeconomics 1 The Science of Macroeconomics Dear Colleague, Thank you for trying these PowerPoints. I have worked hard to make them useful, accurate, and interesting in hopes of saving you prep time and contributing to an effective classroom experience for your students. To help you get the most from these slides, I have prepared a README file with User Instructions, and I have annotated many individual slides with notes – visible only to you – that appear in this area of your screen. I will be preparing minor updates about once a year between major revisions of the text, to update the data and correct typos, etc. If you find a typo or have a suggestion, please email it to me and I will consider it for the next update. My email address is roncron@unlv.nevada.edu. Sincerely, Ron Cronovich

Learning Objectives This chapter introduces you to the issues macroeconomists study the tools macroeconomists use some important concepts in macroeconomic analysis CHAPTER 1 The Science of Macroeconomics

Important issues in macroeconomics Macroeconomics, the study of the economy as a whole, addresses many topical issues: Why does the cost of living keep rising? Why are millions of people unemployed, even when the economy is booming? What causes recessions? Can the government do anything to combat recessions? Should it? This slide and the next contain a list of some topical issues that macro can help students understand. Feel free to substitute others as new issues emerge. CHAPTER 1 The Science of Macroeconomics

Important issues in macroeconomics Macroeconomics, the study of the economy as a whole, addresses many topical issues: 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? CHAPTER 1 The Science of Macroeconomics

U.S. Real GDP per capita (2000 dollars) 9/11/2001 First oil price shock long-run upward trend… Second oil price shock Great Depression World War II CHAPTER 1 The Science of Macroeconomics

U.S. inflation rate (% per year) CHAPTER 1 The Science of Macroeconomics

U.S. unemployment rate (% of labor force) CHAPTER 1 The Science of Macroeconomics

Why learn macroeconomics? 1. The macroeconomy affects society’s well-being. Each one-point increase in the unemployment rate is associated with: 920 more suicides 650 more homicides 4000 more people admitted to state mental institutions 3300 more people sent to state prisons 37,000 more deaths increases in domestic violence and homelessness It might be useful to briefly define the unemployment rate so that students will be able to understand this and the next few slides. Source: Barry Bluestone and Bennett Harrison, The Deindustrialization of America (New York: Basic Books, 1982), Chapter 3, cited in Robert J. Gordon, Macroeconomics, 4th edition (Boston: Little, Brown and Company), p.334. If you know of more recent estimates, please email me so I can update this slide!!! Thanks! (My email address is roncron@unlv.nevada.edu) CHAPTER 1 The Science of Macroeconomics

Why learn macroeconomics? 2. The macroeconomy affects your well-being. change from 12 mos earlier percent change from 12 mos earlier In most years, wage growth falls when unemployment is rising. Macroeconomics helps students understand forces that will affect their financial well-being. Here’s an example. When the unemployment rate is rising, tens or hundreds of thousands of people are losing their jobs. This affects even those who don’t lose their jobs: As the graph shows, during most years there is a clear negative relationship between the (12-month) change in unemployment and the annual growth rate of real wages. In plain English, rising unemployment is associated with falling (and often negative) wage growth. So when the economy goes into recession, even if our students get to keep their jobs, they will find it much harder to get a raise, and may have to accept a real wage cut. Students find this relationship intuitive. When unemployment is rising, the supply of workers is rising faster than demand, so wages grow more slowly or even fall. Conversely, falling unemployment gives workers more bargaining power over wages, as it becomes increasingly hard for employers to replace their workers, and increasingly easy for workers to find good opportunities with other companies. CHAPTER 1 The Science of Macroeconomics

Why learn macroeconomics? 3. The macroeconomy affects politics. 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) I’d also suggest you briefly define the inflation rate (as the percentage increase in the cost of living) to help students understand this slide. Main point of this data: The state of the economy has a huge impact on election outcomes. When the economy is doing poorly, there tends to be a change in the party that controls the White House. 1976: The rates of inflation () and unemployment (u) both high. Incumbent (Ford, R) loses. 1980: u still high,  even higher. Incumbent (Carter, D) loses. 1984: u still high, but  much lower. Incumbent (Reagan) wins. 1988:  the same, u much lower. Incumbent party wins. 1992:  low, but u much higher (and was higher yet in 1991). Incumbent loses. 1996: u much lower, incumbent wins. 2000: Economy doing great, and incumbent party candidate (Gore, D) wins majority of popular vote, but loses electoral college to challenger. 2004: u somewhat higher, but lower than in 2001 recession;  low; incumbent wins CHAPTER 1 The Science of Macroeconomics

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 CHAPTER 1 The Science of Macroeconomics

Example of a model: Supply & demand for new cars shows how various events affect price and quantity of cars assumes the market is competitive: each buyer and seller is too small to affect the 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) Students will realize that the auto market is not competitive. However, if all we want to know is how an increase in the price of steel or a fall in consumer income affects the price and quantity of autos, then it’s fine to use this model. In general, making unrealistic assumptions is okay, even desirable, if they simplify the analysis without affecting its validity. CHAPTER 1 The Science of Macroeconomics

The demand for cars demand equation: Q d = D (P,Y ) shows that the quantity of cars consumers demand is related to the price of cars and aggregate income CHAPTER 1 The Science of Macroeconomics

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: D (P,Y ) = 60 – 10P + 2Y A list of the variables that affect Q d We often aren’t concerned with the exact quantitative relationship between variables, so we will often just use the general functional notation. CHAPTER 1 The Science of Macroeconomics

The market for cars: Demand P Price of cars D The demand curve shows the relationship between quantity demanded and price, other things equal. Q Quantity of cars CHAPTER 1 The Science of Macroeconomics

The market for cars: Supply Q Quantity of cars P Price of cars S The supply curve shows the relationship between quantity supplied and price, other things equal. D CHAPTER 1 The Science of Macroeconomics

The market for cars: Equilibrium Q Quantity of cars P Price of cars S D equilibrium price equilibrium quantity CHAPTER 1 The Science of Macroeconomics

The effects of an increase in income 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. CHAPTER 1 The Science of Macroeconomics

The effects of a steel price increase 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. CHAPTER 1 The Science of Macroeconomics

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, CHAPTER 1 The Science of Macroeconomics

Now you try: Write down demand and supply equations for wireless phones; include two exogenous variables in each equation. Draw a supply-demand graph for wireless phones. Use your graph to show how a change in one of your exogenous variables affects the model’s endogenous variables. Endogenous variables: price of wireless phones, quantity of wireless phones Exogenous variables: consumer income price of wireless phone service (a complement) price of landline phones & phone service (a substitute) technology CHAPTER 1 The Science of Macroeconomics

A multitude of 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 fall in aggregate income affects price & quantity of cars. cannot tell us why aggregate income falls. CHAPTER 1 The Science of Macroeconomics

A multitude of 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, and those it cannot CHAPTER 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 CHAPTER 1 The Science of Macroeconomics

Prices: flexible vs. sticky The economy’s behavior depends partly on whether prices are sticky or flexible: If prices are sticky, then demand won’t always equal supply. This helps explain unemployment (excess supply of labor) why firms cannot always sell all the goods they produce Long run: prices flexible, markets clear, economy behaves very differently CHAPTER 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. 9-13) How the economy works in the short run, when prices are sticky The portion of the book described on this slide comprises the core material. It is organized around time horizons: the long run (flexible prices), the very long run (growth in capital, the population, and technology itself), and the short run (sticky prices and economic fluctuations). But wait! There’s more! See the next slide…. CHAPTER 1 The Science of Macroeconomics

Outline of this book: Policy debates (Chaps. 14-15) Should the government try to smooth business cycle fluctuations? Is the government’s debt a problem? Microeconomic foundations (Chaps. 16-19) Insights from looking at the behavior of consumers, firms, and other issues from a microeconomic perspective All of the chapters listed on this slide are very good, but some instructors find that the semester isn’t always long enough to cover all of this material. Feel free to select chapters from these parts that best match the needs and interests of you and your students. *** Are you covering Chapter 2 next? The PowerPoint presentation for Chapter 2 includes some in-class exercises to immediately reinforce concepts as they are presented. These exercises also help break up the lecture into smaller pieces. If you’d like to try them, please ask your students to bring calculators to the next class meeting. CHAPTER 1 The Science of Macroeconomics

Chapter 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 1 The Science of Macroeconomics slide 27

Chapter 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. CHAPTER 1 The Science of Macroeconomics slide 28