Learning objectives

Slide 1:

Slide 2:Learning objectives

This chapter introduces you to the issues macroeconomists study the tools macroeconomists use some important concepts in macroeconomic analysis

Slide 3:Three main variables we will study:

Gross domestic product, output (GDP) Inflation in the cost of living (CPI) Unemployment rate We will begin by looking at trends in the data for these, and make initial observations. Will see these three variables repeatedly in this section of the course: make observations, and develop theory to understand them. Will see these three variables repeatedly in this section of the course: make observations, and develop theory to understand them.

Slide 4:Ask for observations. Ask for observations.

Slide 5:GDP: Observations

Long-term upward trend. Income more than doubled over last 30 years. Short-run disruptions in the trend: recessions. Note: made up ground during great depression; not affect long run trajectory. Economists view long-run trend as separate from short-run fluctuations. Will have separate theories for them. current GDP growth rates in various countries. -US: 3.6% in second quarter of 2005 -Europe 1.1%, Germany 0.6%, Japan 1.4% Questions to address: (Nobel prizes) - Why does GDP Grow - Why we have recessions in short run?Note: made up ground during great depression; not affect long run trajectory. Economists view long-run trend as separate from short-run fluctuations. Will have separate theories for them. current GDP growth rates in various countries. -US: 3.6% in second quarter of 2005 -Europe 1.1%, Germany 0.6%, Japan 1.4% Questions to address: (Nobel prizes) - Why does GDP Grow - Why we have recessions in short run?

Slide 7:Unemployment: Observations

Unemployment always positive. Fluctuations related to GDP: unemployment higher during recessions. Current data: - US current: 4.9% (August 2005) - Europe: 8.6%; Germany 11.6% - Japan: 4.4%Current data: - US current: 4.9% (August 2005) - Europe: 8.6%; Germany 11.6% - Japan: 4.4%

Slide 9:Inflation: Observations

Inflation can be negative. Often high when GDP high, but not always (see 1970s). Current Inflation: - US 3.2% (july 2005) - Europe: 2.1% - Japan: -0.3% (july)Current Inflation: - US 3.2% (july 2005) - Europe: 2.1% - Japan: -0.3% (july)

Slide 10:How we learn Economics: Models

…are simplied versions of a more complex reality irrelevant details are stripped away Used to show the relationships between economic variables explain the economy’s behavior devise policies to improve economic performance Use algebra: mathematical relationships between variables, based on intuitive theory. If combine several of these relationships together, can get new insights on how relationships among new variables, not obvious from intuition.Use algebra: mathematical relationships between variables, based on intuitive theory. If combine several of these relationships together, can get new insights on how relationships among new variables, not obvious from intuition.

Slide 11:Example of a model: The supply & demand for new cars

explains the factors that determine the price of cars and the quantity sold. 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 Competitive?: 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. Making assumptions: In general, making unrealistic assumptions is okay, even desirable, if they simplify the analysis without affecting its validity. Competitive?: 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. Making assumptions: In general, making unrealistic assumptions is okay, even desirable, if they simplify the analysis without affecting its validity.

Slide 12:The demand for cars

shows that the quantity of cars consumers demand is related to the price of cars and aggregate income.

Slide 13:Digression: Functional notation

General functional notation shows only that the variables are related:

Slide 14:Digression: Functional notation

General functional notation shows only that the variables are related: A specific functional form shows the precise quantitative relationship: We often aren’t concerned with the exact quantitative relationship between variables, so we will often just use the general functional notation. We often aren’t concerned with the exact quantitative relationship between variables, so we will often just use the general functional notation.

Slide 15:The market for cars: demand

Q Quantity of cars P Price of cars The demand curve shows the relationship between quantity demanded and price, other things equal.

Slide 16:The market for cars: supply

Slide 17:The market for cars: equilibrium

Slide 18:The effects of an increase in income:

An increase in income increases the quantity of cars consumers demand at each price… …which increases the equilibrium price and quantity.

Slide 19: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,

Slide 20:A Multitude of Models

No one model can address all the issues we care about. For example, If we want to know how a fall in aggregate income affects new car prices, we can use the S/D model for new cars. But if we want to know why aggregate income falls, we need a different model.

Slide 21:A Multitude of Models

So we will learn different models for studying different issues (unemployment, inflation, growth). For each new model, you should keep track of its assumptions, which variables are endogenous and exogenous, which questions it can help us understand,

Slide 22:Prices: Flexible Versus Sticky

Market clearing: an assumption that prices are flexible and adjust to equate supply and demand. In the short run, many prices are sticky---they adjust only sluggishly in response to supply/demand imbalances.  For example, labor contracts that fix the nominal wage for a year or longer magazine prices that publishers change only once every 3-4 years Note will see term market clearing again in future.Note will see term market clearing again in future.

Slide 23:Prices: Flexible Versus 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) the occasional inability of firms to sell what they produce Long run: prices flexible, markets clear, economy behaves very differently.

Slide 24:Outline of the class:

Classical and Growth Theory (ch. 2-8) How the economy works in the long run, when prices are flexible and markets work well. Business Cycle Theory (ch. 9-15)How the economy works in the short run, when prices are sticky. What can policy makers do when things go wrong. Microeconomic Foundations (Chaps. 16-17)Incorporate features from microeconomics on the behavior of consumers. (if time permits) 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). 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).