1. 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.

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

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

4. https://www. c-span. org/video/

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

7. Potential and Actual GDP
Release: Gross Domestic Product

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

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

11. 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

12. 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

13. Growth Rate Calculations | US recession dates

14. Growth Rate Calculations | US recession dates

15. 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

17. 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

18. 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

19. 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

20. 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

21. 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

22. 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

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

24. 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

25. 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

26. 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

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

28. 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

29. 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

30. 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

31. 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

32. 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

33. 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

34. 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)

35. 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

36. 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

37. 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↓