Download Chapter 1: Human Misery

Chapter 1:
The Science of Macroeconomics
Main Macroeconomic Variables
Economic growth rate measures the percentage
change of the Real GDP
Inflation rate measures the percentage change of
the general price level (e.g., the CPI)
Unemployment rate measures the percentage of
the labor force who are out of work
Historical Record of the U.S. Economy
Real GDP per capita (or income per person) has
increased (in 1992 prices) from about $5,000 in
1900 to over $30,000 in 2000.
This rapid growth, however, has been interrupted
by periods of declining income, called recession or
depression (e.g., 1929-33, 1990-91)
Figure 1-1: Growth Trends
Historical Record of the U.S. Economy
High inflation during periods of expansion and boom (e.g.,
WW I and II)
Low inflation or deflation during periods of recession (e.g.,
1920-21 and 1929-33)
During the energy crises of the 1970s, the economy
recorded high inflation in periods of recession (stagflation)
Figure 1-2: Inflation Trends
Historical Record of the U.S. Economy
Unemployment is high during periods of recession
and depression (e.g., 1929-33)
Unemployment is low during periods of expansion
and boom (WW I and II, the 1990s)
Figure 1-3: Unemployment Trends
Economic Models
A model is a simplified theory that shows the relationships
among variables.
Exogenous variables are those that come from outside of
the model.
Endogenous variables are those that the model explains
The model shows how changes in the exogenous
variables affect the endogenous variables.
Figure 1-4: Economic Model
Exogenous Variables
Model
Endogenous Variables
Demand-Supply Model
Demand model: Q = D(P, Y); Supply model: Q = S(P, Pm)
Endogenous variables are quantity (Q) and price (P) of the
good
Exogenous variables are consumer income (Y) and price
of materials (Pm)
Market equilibrium D(P, Y) = S(P, Pm) determines P and
Q. The model explain how changes in Y and/or Pm affect
equilibrium values.
Market System
Network of buyers & sellers who transact in the
market
Buyers “demand” goods & services
Sellers “supply” goods & services
Advantage of Market Economy
Free interactions between buyers & sellers
Full information to make decisions
Freedom of choice between alternatives
Demand
Definition: quantities of a good or service
consumers are able to buy at various prices
Law of Demand: P and Q are negatively related
Movement along demand is caused by a change
in P
Demand Line
Price
D
A
2.00
B
1.50
D
1000
1500
Quantity
Increase in Demand
Price
D’
An increase in Y causes
the demand to increase
D
A
2.00
C
B
D’
D
1500
2000
Quantity
Supply
Definition: quantities of a good or service
producers are able to sell at various prices
Law of Supply: P and Q are positively related
Movement along supply is caused by a change in
P
Supply Line
Price
S
2.00
B
1.50
A
S
500
1000
Quantity
Increase in Supply
Price
S
S’
B
An decrease Pm causes
the supply to increase
A
1.50
C
S
S’
500
1000
Quantity
Equilibrium
A condition at which the independent plans of
buyers and sellers exactly coincide in the
marketplace.
At equilibrium: D(P, Y) = S(P, Pm) determine
equilibrium P & Q
Demand-Supply Interaction
Price
2.50
D
Surplus
S
Equilibrium
2.00
B
1.50
Shortage
S
500
D
1000
1500
Quantity
Stability
Shortage: at a price below equilibrium quantity
demanded > quantity supplied
Surplus: at a price above equilibrium quantity
supplied > quantity demanded
Price adjustments eliminate shortages &
surpluses
Increase in Demand:
Price
D’
D
S
Higher Price
Larger Quantity
B
P’
P
A
D’
D
S
Q Q’
Quantity
Increase in Supply:
Price
D
S
S’
A
P
P’
B
S
Lower Price
Larger Quantity
D
S’
Q
Q’
Quantity
Increase in Demand & Supply:
Price
D’
D
S
S’
P’
B
Here:
Higher Price
Larger Quantity
A
P
D’
S
S’
Q
D
Q’ Quantity