1. 1 The Science of Macroeconomics Modified for EC 204 by Bob Murphy
TO THE INSTRUCTOR:
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Modified for EC 204
by Bob Murphy

2. In this chapter, you will learn:
about the issues macroeconomists study
the tools macroeconomists use
some important concepts in macroeconomic analysis 1

3. Important issues in macroeconomics
Macroeconomics, the study of the economy as a whole, addresses many topical issues, e.g.:
What causes recessions? What is “government stimulus” and why might it help?
How can problems in the housing market spread to the rest of the economy?
What is the government budget deficit? How does it affect workers, consumers, businesses, and taxpayers?
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. 2

4. Important issues in macroeconomics
Macroeconomics, the study of the economy as a whole, addresses many topical issues, e.g.:
Why does the cost of living keep rising?
Why are so many countries poor? What policies might help them grow out of poverty?
What is the trade deficit? How does it affect the country’s well-being? 3

5. 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
source: same as textbook
World War II

8. U.S. Inflation Rate (% per year)
source: same as textbook

11. U.S. Unemployment Rate (% of labor force)
source: same as textbook through More recent values from Bureau of Labor Statistics,

14. Why learn macroeconomics?
1. The macroeconomy affects society’s well-being.
percent of labor force
crimes per 100,000 population
U.S. Unemployment and Property Crime Rates
Unemployment (left scale)
Property crimes (right scale)
Social problems like homelessness, domestic violence, crime, and poverty are linked to the economy.
For example…
The chart shows that the rates of unemployment and property crimes are highly correlated.
The correlation is not perfect. The series move in opposite directions in a few years, e.g , , and 2002.
But in most years, they move in the same direction.
Sources:
unemployment rates - BLS
crime rates - Bureau of Justice Statistics, Data Online at

15. 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.

16. Why learn macroeconomics?
3. The macroeconomy affects election outcomes.
Unemployment & inflation in election years
year U rate inflation rate elec. outcome
% 5.8% Carter (D)
% 13.5% Reagan (R)
% 4.3% Reagan (R)
% 4.1% Bush I (R)
% 3.0% Clinton (D)
% 3.3% Clinton (D)
% 3.4% Bush II (R)
% 3.3% Bush II (R)
% 3.8% Obama (D)
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
2008: With unemployment rising and a deep recession taking hold, the Republicans lose the White House.

17. 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 16

18. The use of multiple models
No one model can address all the issues we care about.
E.g., a supply-demand model of the U.S. car market…
can tell us how a fall in aggregate U.S. income affects price & quantity of cars.
cannot tell us why aggregate income falls. 27

19. 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

20. 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

21. 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

22. 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. 9-14) 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…. 31

23. Outline of this book:
Policy debates (Chaps ) Should the government try to smooth business cycle fluctuations? Is the government’s debt a problem?
Microeconomic foundations (Chaps ) 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. 32

24. 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. 33

25. 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. 34