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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)
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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)
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)
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)
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 Quantity 1000 1500
Increase in Demand D’ Price An increase in Y causes the demand to increase D A C 2.00 B D’ D Quantity 1500 2000
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 An decrease Pm causes the supply to increase S B S’ 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 D Price Surplus S 2.50 Equilibrium 2.00 B 1.50 Shortage S D Quantity 500 1000 1500
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’ A P D’ D S Quantity Q Q’
Increase in Supply: Price D S S’ A P Lower Price Larger Quantity B P’ S D S’ Q’ Quantity Q
Increase in Demand & Supply: Price D’ D S S’ P’ B Here: Higher Price Larger Quantity A P D’ S D S’ Quantity Q Q’