CHAPTER 1 The Science of Macroeconomics

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1

Chapter One

CHAPTER 1

The Science of Macroeconomics

®

A PowerPoint

Tu瑯物慬

To Accompany


MACROECONOMICS, 7th. Edition

N. Gregory Mankiw

Tutorial written by:

Mannig J. Simidian

B.A. in Economics with Distinction, Duke University

M.P.A., Harvard University Kennedy School of Government

M.B.A., Massachusetts Institute of Technology (MIT) Sloan School of Management

2

Chapter One



Mankiw’s Macroeconomics Modules

for
Macroeconomics 7
th

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.


In Memoriam

Ara Vahan Simidian

with
Mankiw’s Macroeconomics Modules

author, Mannig J. Simidian, 2007.

3

Chapter One

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!












Mannig J. Simidian






June 2009


Acknowledgements

4

Chapter One


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
macroeconomics might be challenging you! Enjoy!!!



Welcome to Macroeconomics!

5

Chapter One

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.


6

Chapter One

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


Demand

Q

*

P


Supply

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
equilibrium.

7

Chapter One

Market clearing is an alignment process whereby decisions between
suppliers and demanders reach an equilibrium. Here’s how it works.

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.

Let’s say you begin with a
demand

and
supply

curve for CDs.

P

Q

D

S

Now, suppose that there is a sudden

increase in the demand for CDs.

Demand will shift from
D

to

D
´
.

The center point A is where market
decisions reach an
equilibrium
.

Q*

P*

A

D
´

Q
´

P
´

B

The increase in demand places upward
pressure on the price to point B since the
original price, P* no longer clears the
market. Notice the “shortage.”

8

Chapter One

SHIFTS IN DEMAND:

Suppose your income

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:

both price and quantity are higher.

P

D

S

Q

D
'

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.

P

D

S

Q

S
'

9

Chapter One

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.


10

Chapter One

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.

11

Chapter One

The modules mirror the sequencing of the text,
Macroeconomics, 7
th

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

®

12

Chapter One




Macroeconomics




Real GDP


Inflation and deflation


Unemployment


Recession


Depression


Models


Endogenous variables


Exogenous variables


Market clearing


Flexible and sticky prices


Microeconomics