1 Chapter One A PowerPoint  Tutorial To Accompany macroeconomics, 5th. ed. N. Gregory Mankiw Mannig J. Simidian ®

2 Chapter One I would like to express my deepest gratitude to Greg Mankiw, and reviewers Nancy Jianakoplos (Colorado State University), and David Spencer (Brigham Young University) for their invaluable comments. I also thank Mike McElroy (Duke University/North Carolina State University) for his support and mentorship over the years. Finally, I thank my Dad for his continued willingness to discuss the pedagogy of macroeconomics at all times! Mannig J. Simidian Harvard University June 2002 Acknowledgements

3 Chapter One A PowerPoint  Tutorial to Accompany macroeconomics, 5th ed. N. Gregory Mankiw Mannig J. Simidian ® CHAPTER ONE The Science of Macroeconomics

4 Chapter One Everyone is concerned about macroeconomics lately. We wonder why some countries are growing faster than others and why inflation fluctuates. Why? Because the state of the macroeconomy affects everyone in many ways. It plays a significant role in the political sphere while also affecting public policy and societal well-being. Recently, there is much discussion of recessions-- periods in which real GDP falls mildly-- and depressions, when GDP falls more severely. Macroeconomists are also concerned with issues such as inflation, unemployment, monetary and fiscal policies—all of which, will be discussed at length in Macroeconomics, 5th ed., Mankiw’s Macroeconomics Modules, and in your macroeconomics course. Good luck! W WW Welcome to Macroeconomics!

5 Chapter One Economists use models to understand what goes on in the economy. Here are two important points about models: endogenous variables and exogenous variables. Endogenous variables are those which the model tries to explain. Exogenous variables are those variables that a model takes as given. In short, endogenous are variables within a model, and exogenous are the variables outside the model.Price Demand Demand Q * P Supply Supply Quantity * This is the most famous economic model. It describes the ubiquitous relationship between buyers and sellers in the market. The point of intersection is called an equilibrium.

6 Chapter One Market clearing is an alignment process whereby decisions between suppliers and demanders reach an equilibrium. Here’s how it works. Remember that the demand curve slopes downward meaning that as you increase the price (by moving along the demand curve), the quantity demanded decreases. Conversely, the supply curve slopes upward implying that as the price increases (by moving along the supply curve), the amount supplied will increase. Let’s say you begin with a demand and supply curve for CDs. PQ DS Now, suppose that there is a sudden increase in the demand for CDs. Demand will shift from D to D´. The center point A is where market decisions reach an equilibrium. Q* P*A D´ Q´ P´B The increase in demand places upward pressure on the price to point B since the original price, P* no longer clears the market. Shortage

7 Chapter One SHIFTS IN DEMAND: Suppose your income rises? Your demand for a given product, say pizza for example, will also increase. This translates into a rightward shift in the ' demand curve from D to D '. Result: both price and quantity are higher. P DSQ D'D'D'D' SHIFTS IN SUPPLY: A fall in the price of materials increases the supply of pizza; at any given price, pizzerias find that the sale of pizza is more profitable, and thus the supply of pizza rises. This translates into a rightward shift in supply '. Result: price falls, quantity rises. from S to S '. Result: price falls, quantity rises. P DSQ S'S'S'S'

8 Chapter One Economists typically assume that the market will go into an equilibrium of supply and demand, which is called the market clearing process. This assumption is central to the pizza example on the previous slide. But, assuming that markets clear continuously is not realistic. For markets to clear continuously, prices would have to adjust instantly to changes in supply and demand. But, evidence suggests that prices and wages often adjust slowly. So, remember that although market clearing models assume that wages and prices are flexible, in actuality, some wages and prices are sticky.

9 Chapter One Microeconomics is the study of how households and firms make decisions and how these decision makers interact in the marketplace. In microeconomics, a person chooses to maximize his or her utility subject to his or her budget constraint. Macroeconomic events arise from the interaction of many people trying to maximize their own welfare. Therefore, when we study macroeconomics, we must consider its microeconomic foundations.

10 Chapter One The modules mirror the sequencing of the text, macroeconomics, 5 th ed. There are six parts and a total of nineteen chapters with a module written for each chapter. Introduction Classical Theory, The Economy in the Long Run Growth Theory, The Economy in the Very Long Run Business Cycle Theory: The Economy in the Short Run Macroeconomic Policy Debates More on the Microeconomics Behind Macroeconomics ®

11 Chapter One Macroeconomics Real GDP Inflation Rate Unemployment Rate Recession Depression Deflation Models Endogenous variables Exogenous variables Market clearing Flexible and sticky prices Microeconomics Macroeconomics Real GDP Inflation Rate Unemployment Rate Recession Depression Deflation Models Endogenous variables Exogenous variables Market clearing Flexible and sticky prices Microeconomics