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Where You Are! Economics 305 – Macroeconomic Theory T, Th and from 11:00am to 12:15pm Text: Gregory Mankiw: Macroeconomics, Worth, 9th, 8th edition, 7th editions. A used copy of 8th or 7th edition is good. Course Webpage http://www.terpconnect.umd.edu/~jneri/Econ305 NOTE: upper-case E Who am I ? Dr. John Neri Office: Morrill Hall, Room 1102B, T and Th 3:30pm to 4:30pm Chapter 1 presents: Three major concerns of macroeconomics - growth, unemployment and inflation Tools macroeconomists use Some important concepts in macroeconomic analysis GDP Growth: 2000- 2015 Potential and Actual GDP Potential and Actual GDP Long-term Real GDP per capita (2000 dollars) 9/11/2001 First oil price shock long-run upward trend… Great Depression Second oil price shock World War II U.S. Unemployment Rate (% of labor force) 30 World War I 25 20 World War I 15 Second oil price shock Great First Depression oil price shock Oil price shocks Financial crisis World War II 10 5 Financial crisis Great Depression 2010 2000 1990 1980 1970 1960 1950 1940 1930 1920 1910 1900 0 U.S. Inflation Rate (% per year) 25 World War I 20 Second oil price shock First oil price shock 15 10 5 0 -5 Financial crisis Great Depression -10 2010 2000 1990 1980 1970 1960 1950 1940 1930 1920 1910 1900 -15 Headline and Core Inflation Headline Core Headline Core Economic models …are simplified versions of a more complex reality irrelevant details are stripped away …are used to show relationships between variables explain the economy’s behavior devise policies to improve economic performance Mankiw presents the supply & demand for new cars a an example of a model: 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 of cars that producers supply P = price of new cars Y = aggregate income Ps = price of steel (an input) The demand for cars demand equation: Q d = D (P,Y ) shows that the quantity of cars consumers demand is related to the price of cars and aggregate income Read as Quantity demanded depends upon price of new cars and aggregate income. 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: D (P,Y ) = 60 – 10P + 2Y The market for cars: Demand demand equation: Qd = D (P,Y ) The demand curve shows the relationship between quantity demanded and price, other things equal. P Price of cars D Q Quantity of cars The market for cars: Supply supply equation: Qs = S (P,PS ) The supply curve shows the relationship between quantity supplied and price, other things equal. P Price of cars S D Q Quantity of cars The market for cars: Equilibrium P Price of cars S equilibrium price D Q equilibrium quantity Quantity of cars The effects of an increase in income demand equation: Q d = D (P,Y ) An increase in income increases the quantity of cars consumers demand at each price… …which increases the equilibrium price and quantity. P Price of cars S P2 P1 D1 Q1 Q2 D2 Q Quantity of cars The effects of a steel price increase supply equation: Q s = S (P,PS ) P S2 Price of cars An increase in Ps reduces the quantity of cars producers supply at each price… …which increases the market price and reduces the quantity. S1 P2 P1 D Q2 Q1 Q Quantity of cars 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 NOW YOU TRY: Supply and Demand 1. Market for Pizza 2. Qd 60 10 P 2Y 3. Q s 100 5P 15Pc 4. Solve for equilibrium P and Q 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. 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 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 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 Outline of this 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 Outline of this 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 Some macro conclusions In the long-run, 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 leads to larger capital stock. Increase efficiency of labor (education and increase technological progress) Some macro conclusions In the short-run, aggregate demand influences the amount of goods and services that a country produces Chapter 10,11 and 14 (9,10 and 13 older ed.) Monetary policy, fiscal policy Shocks to the system 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 (4 older ed.) 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 Some macro conclusions There is a trade-off between inflation and unemployment in the short-run Chapter 14, short-run Phillips curve (13 older) Expand Aggregate Demand => U↓ and π↑ Contract Aggregate Demand => U↑ and π↓