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® CHAPTER 1 The Science of Macroeconomics A PowerPointTutorial To Accompany MACROECONOMICS, 7th. Edition N. Gregory Mankiw Tutorial written by: Mannig J. Simidian B.A. in Economics with Distinction, Duke University 1 Chapter One M.P.A., Harvard University Kennedy School of Government M.B.A., Massachusetts Institute of Technology (MIT) Sloan School of Management In Memoriam Mankiw’s Macroeconomics Modules for Macroeconomics 7th ed. are dedicated to the loving memory of my cherished father, best friend and mentor. Daddy– you are still my inspiration for making sure these tutorials are the best they can be for students worldwide! Ara Vahan Simidian (June 24, 1928 - December 19, 2008) May he continue to enjoy learning and loving economics from heaven above. Chapter One Ara Vahan Simidian 2 with Mankiw’s Macroeconomics Modules author, Mannig J. Simidian, 2007. Acknowledgements Professor Greg Mankiw is not only a prolific, talented, and ingenious economist, but humble and kind-hearted. His unique and extraordinary creative ability to impart knowledge makes him both an economist and artist. I am so honored and grateful again be a part of supplementing his unprecedented craftsmanship. My mentor, and friend for over a decade Professor Mike McElroy (North Carolina State University) was the first to see the novelty in these tutorials while I was an undergraduate student at Duke University. His contributions and influence will be a part of my work indefinitely. My gratitude is endless as well to Professors David Denslow, Mark Rush, Ed Tower, and Jeff Frankel. My love and gratitude goes to my dear friend and surrogate father Dr. Lawrence Brockman, D.M.D, an endodontist but an economist in spirit who has been my teacher, inspiration and dearest friend for over a decade. I also want to thank the following special people in my life: my mother, Jane, Michael Hill, Elle & Ava, Stephanie & Jack Taylor, Lara Kleinman & Eric Wolf, Lula Peoples, GiGi and David Greene and Michele Rubino. Thank you all for always loving me, believing in me and cheering me on! Chapter One Mannig J. Simidian June 2009 3 Welcome to Macroeconomics! Everyone has reason to think critically about macroeconomic issues. It is imperative that we seek to understand why some countries are growing faster or slower than others or why some have greater fluctuations in inflation or unemployment. The state of the macroeconomy affects everyone in many ways (especially recently). It plays a significant role in the political sphere while also affecting public policy and societal well-being, at national and global levels. Macroeconomists use variables to measure the performance of the economy such as real GDP, the inflation rate, and the unemployment rate among others. They are also concerned with matters such as monetary and fiscal policy—both of which will be discussed at length in MACROECONOMICS, 7th ed., Mankiw’s Macroeconomics Modules, and in your macroeconomics course. Good luck and have fun using these tutorials to guide you when 4 Chapter One macroeconomics might be challenging you! Enjoy!!! President Barack Obama and the State of the Economy When President Obama moved into the White House in 2009, the economy was in a state of turmoil. Mortgage defaults and a drop in housing prices were the major culprits. The crisis affected other sectors of the economy, pushing the economy into another recession. Some liken the situation to that of the Great Depression which occurred in the 1930s. Chapter One 5 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 Supply P* Demand Chapter One Q * 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 6 equilibrium. Market clearing is an alignment process whereby decisions between suppliers and demanders reach an equilibrium. Here’s how it works. Let’s say you begin with a demand and supply curve for CDs. 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. The center point A is where market D D´ S P decisions reach an equilibrium. B Now, suppose that there is a sudden P´ A increase in the demand for CDs. P* Demand will shift from D to D´. The increase in demand places upward pressure on the price to point B since the original price, P* no longer clears 7the Chapter One Q´ Q* Q market. Notice the “shortage.” S SHIFTS IN DEMAND: Suppose your income P rises? Your demand for a given product, for example, pizza, will also increase. This translates into a rightward shift in the demand curve from D to D'. Result: D' both price and quantity are higher. D Q P 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 from S to S'. Result: price falls, quantity rises. Chapter One S S' D Q 8 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 unrealistic. 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. Market-clearing models may not describe every instant in an economy, but they do depict the equilibrium toward which the economy gravitates. Chapter One 9 Microeconomics is the study of how households and firms make decisions and how these decision makers interact in the broader marketplace. In microeconomics, an individual chooses to maximize his or her utility subject to his or her budget constraint. Macroeconomic events arise from the interaction of many individuals trying to maximize their own welfare. Because aggregate variables are the sum of the variables describing individuals’ decisions, the study of macroeconomics is based on microeconomic foundations. Chapter One 10 ® The modules mirror the sequencing of the text, Macroeconomics, 7th ed. There are six parts and a total of nineteen chapters with a module written for each chapter. Enjoy! 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 Chapter One 11 Macroeconomics Real GDP Inflation and deflation Unemployment Recession Depression Models Endogenous variables Exogenous variables Market clearing Flexible and sticky prices Microeconomics Chapter One 12