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MACROECONOMICS
and theFINANCIAL SYSTEM
N. Gregory Mankiw
& Laurence M. Ball
The Science ofMacroeconomics
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CHAPTER 1 The Science of Macroeconomics
In this chapter, you will learn:
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CHAPTER 1 The Science of Macroeconomics
In this chapter, you will learn:
about the issues macroeconomists study
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CHAPTER 1 The Science of Macroeconomics
In this chapter, you will learn:
about the issues macroeconomists study
the tools macroeconomists use
some important concepts in macroeconomic
analysis
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CHAPTER 1 The Science of Macroeconomics
Important issues in macroeconomics
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CHAPTER 1 The Science of Macroeconomics
Important issues in macroeconomics
Macroeconomics, the study of the economy asa whole, addresses many topical issues, e.g.:
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CHAPTER 1 The Science of Macroeconomics
Important issues in macroeconomics
What causes recessions? What is
government stimulus and why might it help?
Macroeconomics, the study of the economy asa whole, addresses many topical issues, e.g.:
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CHAPTER 1 The Science of Macroeconomics
Important issues in macroeconomics
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?
Macroeconomics, the study of the economy asa whole, addresses many topical issues, e.g.:
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CHAPTER 1 The Science of Macroeconomics
Important issues in macroeconomics
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?
Macroeconomics, the study of the economy asa whole, addresses many topical issues, e.g.:
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CHAPTER 1 The Science of Macroeconomics
Important issues in macroeconomics
Macroeconomics, the study of the economy asa whole, addresses many topical issues, e.g.:
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CHAPTER 1 The Science of Macroeconomics
Important issues in macroeconomics
What causes financial crises? How should the
government respond to them?
Macroeconomics, the study of the economy asa whole, addresses many topical issues, e.g.:
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CHAPTER 1 The Science of Macroeconomics
Important issues in macroeconomics
What causes financial crises? How should the
government respond to them?
Why does the cost of living keep rising?
Macroeconomics, the study of the economy as
a whole, addresses many topical issues, e.g.:
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CHAPTER 1 The Science of Macroeconomics
Important issues in macroeconomics
What causes financial crises? How should the
government respond to them?
Why does the cost of living keep rising?
Why are so many countries poor? What policies
might help them grow out of poverty?
Macroeconomics, the study of the economy as
a whole, addresses many topical issues, e.g.:
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U.S. Real GDP per capita(2000 dollars)
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U.S. Real GDP per capita(2000 dollars)
long-run upward trend
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U.S. Real GDP per capita(2000 dollars)
GreatDepression
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U.S. Real GDP per capita(2000 dollars)
GreatDepression
World War II
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U.S. Real GDP per capita(2000 dollars)
GreatDepression
World War II
First oilprice shock
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U.S. Real GDP per capita(2000 dollars)
GreatDepression
World War II
First oilprice shock
Second oil
price shock
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U.S. Real GDP per capita(2000 dollars)
GreatDepression
World War II
First oilprice shock
Second oil
price shock
9/11/2001
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U.S. Inflation Rate(% per year)
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U.S. Unemployment Rate(% of labor force)
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CHAPTER 1 The Science of Macroeconomics 8
Economic models
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CHAPTER 1 The Science of Macroeconomics 8
Economic models
are simplified versions of a more complex reality
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CHAPTER 1 The Science of Macroeconomics 8
Economic models
are simplified versions of a more complex reality
irrelevant details are stripped away
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CHAPTER 1 The Science of Macroeconomics 8
Economic models
are simplified versions of a more complex reality
irrelevant details are stripped away
are used to
show relationships between variables
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CHAPTER 1 The Science of Macroeconomics 8
Economic models
are simplified versions of a more complex reality
irrelevant details are stripped away
are used to
show relationships between variables
explain the economys behavior
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CHAPTER 1 The Science of Macroeconomics 8
Economic models
are simplified versions of a more complex reality
irrelevant details are stripped away
are used to
show relationships between variables
explain the economys behavior
devise policies to improve economicperformance
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Example of a model:
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CHAPTER 1 The Science of Macroeconomics
Example of a model:
Supply & demand for new cars
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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
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CHAPTER 1 The Science of Macroeconomics
p
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
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CHAPTER 1 The Science of Macroeconomics
p
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
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Example of a model:
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CHAPTER 1 The Science of Macroeconomics
p
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
Qd = quantity of cars that buyers demand
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Example of a model:
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CHAPTER 1 The Science of Macroeconomics
p
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
Qd = quantity of cars that buyers demand
Qs = quantity that producers supply
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Example of a model:
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CHAPTER 1 The Science of Macroeconomics
p
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
Qd = quantity of cars that buyers demand
Qs = quantity that producers supply
P= price of new cars
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Example of a model:
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CHAPTER 1 The Science of Macroeconomics
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
Qd = quantity of cars that buyers demand
Qs = quantity that producers supply
P= price of new carsY= aggregate income
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Example of a model:
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CHAPTER 1 The Science of Macroeconomics
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
Qd = quantity of cars that buyers demand
Qs = quantity that producers supply
P= price of new carsY= aggregate income
Ps = price of steel (an input)
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The demand for cars
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CHAPTER 1 The Science of Macroeconomics 10
The demand for cars
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The demand for cars
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CHAPTER 1 The Science of Macroeconomics 10
The demand for cars
demand equation: Qd = D(P,Y)
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CHAPTER 1 The Science of Macroeconomics 10
The demand for cars
demand equation: Qd = D(P,Y)
shows that the quantity of cars consumers
demand is related to the price of cars andaggregate income
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Digression: functional notation
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CHAPTER 1 The Science of Macroeconomics 11
Digression: functional notation
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CHAPTER 1 The Science of Macroeconomics 11
Digression: functional notation
General functional notationshows only that the variables are related.
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CHAPTER 1 The Science of Macroeconomics 11
Digression: functional notation
General functional notationshows only that the variables are related.
Qd = D(P,Y)A list of the variables
that affectQd
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CHAPTER 1 The Science of Macroeconomics 11
Digression: functional notation
General functional notationshows only that the variables are related.
Qd = D(P,Y)A list of the variables
that affectQd
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CHAPTER 1 The Science of Macroeconomics 11
Digression: functional notation
General functional notationshows only that the variables are related.
Qd = D(P,Y)
A specific functional form shows
the precise quantitative relationship.
Example:
D(P,Y) = 60 10P + 2Y
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The market for cars: Demand
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CHAPTER 1 The Science of Macroeconomics 12
The market for cars: Demand
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CHAPTER 1 The Science of Macroeconomics 12
demand equation:Qd = D(P,Y)
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CHAPTER 1 The Science of Macroeconomics 12
The demand curveshows the relationshipbetween quantitydemanded and price,
other things equal.
demand equation:Qd = D(P,Y)
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CHAPTER 1 The Science of Macroeconomics 12
The demand curveshows the relationshipbetween quantitydemanded and price,
other things equal.
demand equation:Qd = D(P,Y)
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CHAPTER 1 The Science of Macroeconomics 12
PPrice
of cars
The demand curveshows the relationshipbetween quantitydemanded and price,
other things equal.
demand equation:Qd = D(P,Y)
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CHAPTER 1 The Science of Macroeconomics 12
Q
Quantityof cars
PPrice
of cars
The demand curveshows the relationshipbetween quantitydemanded and price,
other things equal.
demand equation:Qd = D(P,Y)
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CHAPTER 1 The Science of Macroeconomics 12
Q
Quantityof cars
PPrice
of cars
D
The demand curveshows the relationshipbetween quantitydemanded and price,
other things equal.
demand equation:Qd = D(P,Y)
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The market for cars: Supply
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CHAPTER 1 The Science of Macroeconomics 13
Q
Quantityof cars
PPrice
of cars
D
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CHAPTER 1 The Science of Macroeconomics 13
Q
Quantityof cars
PPrice
of cars
D
supply equation:Qs = S(P,PS )
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CHAPTER 1 The Science of Macroeconomics 13
Q
Quantityof cars
PPrice
of cars
D
S
The supply curveshows the relationshipbetween quantitysupplied and price,
other things equal.
supply equation:Qs = S(P,PS )
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The market for cars: Equilibrium
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CHAPTER 1 The Science of Macroeconomics 14
Q
Quantityof cars
PPrice
of cars S
D
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The market for cars: Equilibrium
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CHAPTER 1 The Science of Macroeconomics 14
Q
Quantityof cars
PPrice
of cars S
D
equilibriumprice
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CHAPTER 1 The Science of Macroeconomics 14
Q
Quantityof cars
PPrice
of cars S
D
equilibriumprice
equilibriumquantity
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The effects of an increase in income
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CHAPTER 1 The Science of Macroeconomics 15
Q
Quantityof cars
PPrice
of cars S
D1
Q1
P1
demand equation:
Qd = D(P,Y)
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CHAPTER 1The Science of Macroeconomics 15
Q
Quantityof cars
PPrice
of cars S
D1
Q1
P1
An increase in incomeincreases the quantity
of cars consumersdemand at each price
demand equation:
Qd = D(P,Y)
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CHAPTER 1The Science of Macroeconomics 15
Q
Quantityof cars
PPrice
of cars S
D1
Q1
P1
An increase in incomeincreases the quantity
of cars consumersdemand at each price
D2
demand equation:
Qd = D(P,Y)
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CHAPTER 1The Science of Macroeconomics 15
Q
Quantityof cars
PPrice
of cars S
D1
Q1
P1
An increase in incomeincreases the quantity
of cars consumersdemand at each price
which increases theequilibrium price and
quantity.
D2
demand equation:
Qd = D(P,Y)
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CHAPTER 1The Science of Macroeconomics 15
Q
Quantityof cars
PPrice
of cars S
D1
Q1
P1
An increase in incomeincreases the quantity
of cars consumersdemand at each price
which increases theequilibrium price and
quantity.
P2
Q2
D2
demand equation:
Qd = D(P,Y)
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CHAPTER 1 The Science of Macroeconomics16
Q
Quantityof cars
PPrice
of carsS1
D
Q1
P1
supply equation:
Qs = S(P,PS )
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CHAPTER 1 The Science of Macroeconomics16
Q
Quantityof cars
PPrice
of carsS1
D
Q1
P1
An increase in Ps
reduces the quantity of
cars producers supply ateach price
supply equation:
Qs = S(P,PS )
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CHAPTER 1 The Science of Macroeconomics16
Q
Quantityof cars
PPrice
of carsS1
D
Q1
P1
An increase in Ps
reduces the quantity of
cars producers supply ateach price
S2
supply equation:
Qs = S(P,PS )
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CHAPTER 1 The Science of Macroeconomics16
Q
Quantityof cars
P
Priceof cars
S1
D
Q1
P1
An increase in Ps
reduces the quantity of
cars producers supply ateach price
which increases the
market price andreduces the quantity.
S2
supply equation:
Qs = S(P,PS )
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CHAPTER 1 The Science of Macroeconomics16
Q
Quantityof cars
P
Priceof cars
S1
D
Q1
P1
An increase in Ps
reduces the quantity of
cars producers supply ateach price
which increases the
market price andreduces the quantity.
P2
Q2
S2
supply equation:
Qs = S(P,PS )
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Endogenous vs. exogenous variables
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CHAPTER 1 The Science of Macroeconomics17
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Endogenous vs. exogenous variables
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CHAPTER 1 The Science of Macroeconomics17
The values ofendogenous variables
are determined in the model.
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Endogenous vs. exogenous variables
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CHAPTER 1 The Science of Macroeconomics17
The values ofendogenous variables
are determined in the model.
The values ofexogenous variables
are determined outside the model:
the model takes their values & behavioras given.
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Endogenous vs. exogenous variables
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CHAPTER 1 The Science of Macroeconomics 17
The values ofendogenous variables
are determined in the model.
The values ofexogenous variables
are determined outside the model:
the model takes their values & behavioras given.
In the model of supply & demand for cars,
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CHAPTER 1 The Science of Macroeconomics 17
The values ofendogenous variables
are determined in the model.
The values ofexogenous variables
are determined outside the model:
the model takes their values & behavioras given.
In the model of supply & demand for cars,
endogenous: P, Qd, Qs
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Endogenous vs. exogenous variables
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CHAPTER 1 The Science of Macroeconomics 17
The values ofendogenous variables
are determined in the model.
The values ofexogenous variables
are determined outside the model:
the model takes their values & behavioras given.
In the model of supply & demand for cars,
endogenous: P, Qd, Qs
exogenous: Y,Ps
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NOW YOU TRY:
Supply and Demand
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NOW YOU TRY:
Supply and Demand
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Write down demand and supply equations for
wireless phones; include two exogenous
variables in each equation.
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Supply and Demand
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Write down demand and supply equations for
wireless phones; include two exogenous
variables in each equation.
Draw a supply-demand graph for wireless
phones.
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NOW YOU TRY:
Supply and Demand
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Write down demand and supply equations for
wireless phones; include two exogenousvariables 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 models
endogenous variables.
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The use of multiple models
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CHAPTER 1 The Science of Macroeconomics 19
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The use of multiple models
No one model can address all the issues we care
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CHAPTER 1 The Science of Macroeconomics 19
No one model can address all the issues we care
about.
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The use of multiple models
No one model can address all the issues we care
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CHAPTER 1 The Science of Macroeconomics 19
No one model can address all the issues we care
about.
E.g., our supply-demand model of the car
market
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The use of multiple models
No one model can address all the issues we care
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CHAPTER 1 The Science of Macroeconomics 19
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 incomeaffects price & quantity of cars.
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The use of multiple models
No one model can address all the issues we care
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CHAPTER 1 The Science of Macroeconomics 19
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 incomeaffects price & quantity of cars.
cannot tell us whyaggregate income falls.
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The use of multiple models
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CHAPTER 1 The Science of Macroeconomics 20
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The use of multiple models
So we will learn different models for studying
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CHAPTER 1 The Science of Macroeconomics 20
So we will learn different models for studying
different issues (e.g., unemployment, inflation,long-run growth, asset prices).
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So we will learn different models for studying
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CHAPTER 1 The Science of Macroeconomics 20
So we will learn different models for studying
different issues (e.g., unemployment, inflation,long-run growth, asset prices).
For each new model, you should keep track of
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So we will learn different models for studying
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CHAPTER 1 The Science of Macroeconomics 20
So we will learn different models for studying
different issues (e.g., unemployment, inflation,long-run growth, asset prices).
For each new model, you should keep track of
its assumptions
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So we will learn different models for studying
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CHAPTER 1 The Science of Macroeconomics 20
So we will learn different models for studying
different issues (e.g., unemployment, inflation,long-run growth, asset prices).
For each new model, you should keep track of
its assumptions
which variables are endogenous,which are exogenous
Friday, August 5, 2011
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So we will learn different models for studying
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CHAPTER 1 The Science of Macroeconomics 20
So we will learn different models for studying
different issues (e.g., unemployment, inflation,long-run growth, asset prices).
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
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Prices: flexible vs. sticky
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CHAPTER 1 The Science of Macroeconomics 21
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Prices: flexible vs. sticky
Market clearing: An assumption that prices are
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CHAPTER 1 The Science of Macroeconomics 21
Market clearing: An assumption that prices are
flexible, adjust to equate supply and demand.
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Prices: flexible vs. sticky
Market clearing: An assumption that prices are
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CHAPTER 1 The Science of Macroeconomics 21
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:
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Prices: flexible vs. sticky
Market clearing: An assumption that prices are
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CHAPTER 1 The Science of Macroeconomics 21
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
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Prices: flexible vs. sticky
Market clearing: An assumption that prices are
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CHAPTER 1 The Science of Macroeconomics 21
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
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CHAPTER 1 The Science of Macroeconomics 22
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The economys behavior depends partly on
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CHAPTER 1 The Science of Macroeconomics 22
The economy s behavior depends partly on
whether prices are sticky or flexible:
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The economys behavior depends partly on
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CHAPTER 1 The Science of Macroeconomics 22
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:
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CHAPTER 1 The Science of Macroeconomics 22
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)
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The economys behavior depends partly on
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CHAPTER 1 The Science of Macroeconomics 22
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
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The economys behavior depends partly on
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CHAPTER 1 The Science of Macroeconomics 22
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 andeconomy behaves very differently
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CHAPTER 1 The Science of Macroeconomics 23
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Introductory material (Chaps. 1 & 2)
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CHAPTER 1 The Science of Macroeconomics 23
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Introductory material (Chaps. 1 & 2)
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CHAPTER 1 The Science of Macroeconomics 23
Classical Theory (Chaps. 3-6)How the economy works in the long run,
when prices are flexible
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Introductory material (Chaps. 1 & 2)
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CHAPTER 1 The Science of Macroeconomics 23
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
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Introductory material (Chaps. 1 & 2)
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CHAPTER 1 The Science of Macroeconomics 23
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. 9-12)
How the economy works in the short run, when
prices are sticky
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CHAPTER 1 The Science of Macroeconomics 24
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Outline of this book:
Policy debates (Chaps. 13-14)
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CHAPTER 1 The Science of Macroeconomics 24
y ( p )
Should the government try to smooth business
cycle fluctuations? Is the governments debt a
problem?
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Policy debates (Chaps. 13-14)
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CHAPTER 1 The Science of Macroeconomics 24
y ( p )
Should the government try to smooth business
cycle fluctuations? Is the governments debt a
problem?
The Financial System (Chaps. 15-19)The role of banks and other financial institutions,
stock and bond markets, causes of and policy
responses to financial crises.
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CHAPTER SUMMARY
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CHAPTER 1 The Science of Macroeconomics
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CHAPTER SUMMARY
Macroeconomics is the study of
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CHAPTER 1 The Science of Macroeconomics
the economy as a whole, including
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Macroeconomics is the study of
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CHAPTER 1 The Science of Macroeconomics
the economy as a whole, including growth in incomes
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CHAPTER SUMMARY
Macroeconomics is the study of
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CHAPTER 1 The Science of Macroeconomics
the economy as a whole, including growth in incomes
changes in the overall level of prices
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CHAPTER SUMMARY
Macroeconomics is the study of
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CHAPTER 1 The Science of Macroeconomics
the economy as a whole, including growth in incomes
changes in the overall level of prices
the unemployment rate
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CHAPTER SUMMARY
Macroeconomics is the study of
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CHAPTER 1 The Science of Macroeconomics
the economy as a whole, including growth in incomes
changes in the overall level of prices
the unemployment rate
the financial system
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CHAPTER SUMMARY
Macroeconomics is the study of
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CHAPTER 1 The Science of Macroeconomics
the economy as a whole, including growth in incomes
changes in the overall level of prices
the unemployment rate
the financial system
Macroeconomists attempt to explain the economy
and to devise policies to improve its performance.
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CHAPTER SUMMARY
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CHAPTER 1 The Science of Macroeconomics 26
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CHAPTER SUMMARY
Economists use different models to
examine different issues.
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CHAPTER 1 The Science of Macroeconomics 26
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CHAPTER SUMMARY
Economists use different models to
examine different issues.
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CHAPTER 1 The Science of Macroeconomics 26
Models with flexible prices describe the economy
in the long run; models with sticky prices describe
the economy in the short run.
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