1 of 44 Chapter 1 The Science of Macroeconomics. 2 of 44 Learning objectives This chapter introduces...

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Chapter 1 The Science of Macroeconomics

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Learning objectives

This chapter introduces you to

• the issues macroeconomists study

• the tools macroeconomists use

• some important concepts in macroeconomic analysis

3 of 44© 2008 Worth Publishers Macroeconomics, European Edition Mankiw • Taylor

Important issues in macroeconomics

• Why does the cost of living keep rising?

• Why is the unemployment rate in continental Europe higher than in the U.S. or Japan?

• Why are there recessions? Can the government do anything to combat recessions? Should it??


Important issues in macroeconomics

• What is the government budget deficit? How does it affect the economy?

• Why does the U.S. have such a huge trade deficit?

• Why are so many countries poor? What policies might help them grow out of poverty?

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Example 1:How bad is inflation in Zimbabwe?

• Zimbabwe has been tormented this entire decade by both deep recession and high inflation.

• The government said it would triple the salaries of soldiers and teachers. But this will only worsen inflation, for printing too many worthless dollars.

• Zimbabwe fell into hyperinflation after the government began seizing commercial farms in about 2000. Foreign investors fled, manufacturing ground to a halt, goods and foreign currency needed to buy imports fell into short supply and prices shot up.

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Example 2:Unemployment rate in Europe VS US

• Eurozone unemployment stables at 7.3%.

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Example 2:Unemployment rate in Europe VS US

• US unemployment is about 5%.

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Example 3:Subprime crisis ( 次贷危机）• 收入并不稳定甚至根本没有收入的人，他们

怎么买房呢 ? 因为信用等级达不到标准，他们就被定义为次级贷款者。

• 在房价上涨预期和贷款公司许下的优惠贷款利率的诱惑下，他们选择了贷款买房。

• 贷款公司找到投行，通过发行和销售 CDO（ Collateralized Debt Obligation ，债务抵押债券 ) ，让债券的持有人来分担房屋贷款的风险。

• 投行又怎样卖出高风险的普通 CDO 呢？于是投行找到了对冲基金。

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Example 3:Subprime crisis ( 次贷危机）• 对冲基金在世界范围内找利率最低的银行借来钱，

然后大举买入这部分普通 CDO 债券。 • 对冲基金又把手里的 CDO 债券抵押给银行，换得

10 倍的贷款，然后继续追着投行买普通 CDO 。 • 2001 年末，美国的房地产一路飙升。于是贷款公司

、投行、银行、对冲基金人人都赚钱，• 投行除了继续买对冲基金之外，他们又想出了一个

新产品，就叫 CDS (Credit Default Swap ，信用违约交换 ) 。每年从 CDO 里面拿出一部分钱作为保金，白送给保险公司，但是将来出了风险，大家一起承担。

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Example 3:Subprime crisis ( 次贷危机）• 时间走到了 2006 年年底，风光了整整 5 年

的美国房地产终于从顶峰重重摔了下来，这条食物链也终于开始断裂。因为房价下跌，优惠贷款利率的时限到了之后，先是普通民众无法偿还贷款，然后贷款公司倒闭，对冲基金大幅亏损，继而连累保险公司和贷款的银行，花旗、摩根相继发布巨额亏损报告，同时投资对冲基金的各大投行也纷纷亏损，然后股市大跌，民众普遍亏钱，无法偿还房贷的民众继续增多……最终，美国次贷危机爆发。

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Example 3:Subprime crisis ( 次贷危机）

• Borrowing under a securitization structure

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Example 4:US social security budget deficit

• President Bush and Vice President Cheney have told audiences that Social Security faces an $11 trillion shortfall if nothing is done to fix the current system.

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The graph shows number of births in the United States • Post-World War II baby boom

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• Life expectancy has increased.

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• The Social Security Trustees' 2004 projection shows a $3.7 trillion shortfall over a 75-year period , roughly the length of a human lifetime.

• For the social security system to be completely solvent over the next 75 years, without adjusting benefits, payroll taxes would have to go up by 1.8 percent immediately.


An example of macroeconomics terms:Gross Domestic Product of the USin billions of chained 1996 dollars

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

1970 1975 1980 1985 1990 1995 2000

long-run upward trend…


An example of macroeconomics terms:Gross Domestic Product of the USin billions of chained 1996 dollars

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

1970 1975 1980 1985 1990 1995 2000

Recessions

longest economic expansion on record


Why learn macroeconomics?

The macroeconomy affects society’s well-being.

• example: Unemployment and social problems


Unemployment and social problems

In the U.S., each one-point increase in the

unemployment rate is associated with:• 920 more suicides• 650 more murders• 4,000 more people admitted to state

mental institutions• 3,300 more people sent to state prisons• 37,000 more deaths• increases in domestic violence and

homelessness


Why learn macroeconomics?

The macroeconomy affects society’s well-being.• example:

Unemployment and social problems

The macroeconomy affects your well-being.

• example 1: Unemployment and earnings growth

• example 2:Interest rates and mortgage payments


French unemployment and earnings growth

-5

-4

-3

-2

-1

0

1

2

3

4

5

1997 1998 1999 2000 2001 2002 2003 2004 2005

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

growth in hourly wages - adjusted for inflation (lhs) change in unemployment rate (rhs)

%


Interest rates and mortgage payments

For a £100,000 30-year mortgage:

£7,033£5865.7%Dec 2001

£8,550£7137.6%Dec 2000

annual payment

monthly payment

actual rate on 30-year mortgage

date

In 2001 you would have received about 1.6 Euros for each Pound.


Why learn macroeconomics? The macroeconomy affects society’s well-

being.• example: Unemployment and social problems

The macroeconomy affects your well-being.

• example 1: Unemployment and earnings growth

• example 2: Interest rates and mortgage payments

The macroeconomy affects politics & current events.

• example: Inflation and unemployment in election years


Inflation and Unemployment in Election Years in the United States

year U rate inflation rate elec. outcome1976 7.7% 5.8% Carter (Dem)1980 7.1% 13.5% Reagan (Rep)1984 7.5% 4.3% Reagan (Rep)1988 5.5% 4.1% Bush I (Rep)1992 7.5% 3.0% Clinton (Dem)1996 5.4% 3.3% Clinton (Dem)2000 4.0% 3.4% Bush II (Rep)2004 5.5% 2.7% Bush II (Rep)


Economic models

…are simplified versions of a more complex reality• irrelevant details are stripped away

Used to • show the relationships between economic

variables

• explain the economy’s behavior

• devise policies to improve economic performance


Example of a model: The supply & demand for new cars

• explains the factors that determine the price of cars and the quantity sold.

• assumes the market is competitive: each buyer and seller is too small to affect the market price

• Variables:Q d = quantity of cars that buyers demand

Q s = quantity that producers supply

P = price of new cars

Y = aggregate income

Ps = price of steel (an input)


The demand for cars

shows that the quantity of cars consumers demand is related to the price of cars

and aggregate income.


Digression: Functional notation

• General functional notation shows only that the variables are related:

A list of the variables

that affect Q d


Digression: Functional notation

• General functional notation shows only that the variables are related:

• A specific functional form shows the precise quantitative relationship:


The market for cars: demand

Q Quantit

y of cars

P Price

of cars

D

The demand curve shows the relationship between quantity demanded and price, other things equal.


The market for cars: supply

Q Quantit

y of cars

P Price

of cars

D

S

The supply curve shows the relationship between quantity supplied and price, other things equal.


The market for cars: equilibrium

Q Quantit

y of cars

P Price

of cars S

D

equilibrium price

equilibriumquantity


The effects of an increase in income:

D2

Q Quantit

y of cars

P Price

of cars S

D1

Q1

P1

An increase in income increases the quantity of cars consumers demand at each price…

…which increases the equilibrium price and quantity.

P2

Q2


The effects of a steel price increase:

Q Quantit

y of cars

P Price

of cars S1

D

Q1

P1

An increase in Ps reduces the quantity of cars producers supply at each price…

…which increases the market price and reduces the quantity.

P2

Q2

S2


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,


Now you try:1. Write down demand and supply

equations for mobile phones; include two exogenous variables in each equation.

2. Draw a supply-demand graph for mobile phones.

3. Use your graph to show how a change in one of your exogenous variables affects the model’s endogenous variables.


A Multitude of Models

No one model can address all the issues we care about. For example,

• If we want to know how a fall in aggregate income affects new car prices, we can use the S/D model for new cars.

• But if we want to know why aggregate income falls, we need a different model.


A Multitude of 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 of its variables are endogenous and which are exogenous,

– the questions it can help us understand,

– and those it cannot.


Prices: Flexible Versus Sticky• Market clearing: an assumption that prices

are flexible and adjust to equate supply and demand.

• In the short run, many prices are sticky---they adjust only sluggishly in response to supply/demand imbalances.

For example:– labor contracts that fix the nominal wage for a

year or longer

– magazine prices that publishers change only once every 3-4 years


Prices: Flexible Versus Sticky• The economy’s behaviour depends partly on

whether prices are sticky or flexible:

• If prices are sticky, then demand won’t always equal supply. This helps explain– unemployment (excess supply of labor)

– the occasional inability of firms to sell what they produce

• Long run: prices flexible, markets clear, economy behaves very differently.


Outline of this book:• Introductory material (chaps. 1 & 2)

• Classical Theory (chaps. 3-6) How the economy works in the long run, when prices are flexible

• Growth Theory (chaps. 7-8)The standard of living and its growth rate over the very long run

• Business Cycle Theory (chaps 9-13)How the economy works in the short run, when prices are sticky.


Outline of this book:• Policy debates (Chaps. 14-16)

Should the government try to smooth business cycle fluctuations? Is the government’s debt a problem?

• Microeconomic foundations (Chaps. 17-20)Insights from looking at the behaviour of consumers, firms, and other issues from a microeconomic perspective.


Chapter summary

Macroeconomics is the study of the economy as a whole, including

• growth in incomes• changes in the overall level of prices• the unemployment rate

Macroeconomists attempt to explain the economy and to devise policies to improve its performance.


Chapter summary Economists use different models to

examine different issues. Models with flexible prices describe

the economy in the long run; models with sticky prices describe economy in the short run.

Macroeconomic events and performance arise from many microeconomic transactions, so macroeconomics uses many of the tools of microeconomics.

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