Macroeconomics

Gregory Mankiw 8/eLecturer: M. Avais

Course Outline – Macroeconomics

• Different Concepts of GNP, GDP, NNP, NI at Factor Cost, PI and PI,

• Monetary Policy• Tools of Monetary Policy• Fiscal Policy• Tools of Fiscal Policy• Inflation• Type of Inflation• Control of Inflation• Foreign Trade• Balance of Trade

Contents to be Covered from this book

• Chapter 1• Chapter 2• Chapter 3• Chapter 4• Chapter 5• IS-LM Curve and• Excerpts from the book which would be notified

during class, so attendance is very important.

Chapter 1 – The Science of Macroeconomics

1. What Macroeconomists Study2. How Economists Think

1 – What Macroeconomists Study

• Why some countries experience higher growth rate?• Why some have high inflation and some have stable

prices?• What are recessions and why countries experience

these?• These are the questions that might bother a person

who is affected by these issues.• Is this a part of international politics and policies

e.g., China, USA ($$$ ), Europe, BRICS😀

1 – What Macroeconomists Study• Almost all of us are affected by such issues and that is the reason

it is a mandatory part of political debate and a government can be judged by its macroeconomics handling and policies.

• It has a major role in the lives of the country and what quality of life they have.

• It is the job of the leaders to draw the economic policies while the explanation of the workings of the economy belongs to macroeconomists.

• They collect data and then they try to form different theories and explain the data.

• They also do not have the liberty of conducting controlled or laboratory experiments.

1 – What Macroeconomists Study

1 – What Macroeconomists Study

• The Historical Performance of US Economy – Case Study (Fig. 1.1)

• Real GDP grows over time and in the latest year it is about eight time higher than that of 1900 and also the growth is not steady.

• Recession is lack of growth and if it severe it is called depression.

1 – What Macroeconomists Study

1 – What Macroeconomists Study

• Figure 1.2 shows the inflation rate. In the first half of the 20th century it was slightly above zero (averaged) and periods of falling prices (deflation) was almost same as periods of rising prices.

• In figure 1.3, there is U.S unemployment rate, notice that there is always some unemployment rate in the economy. Highest was during 1930s.

• In the following chapters we may refer to these variables and discuss those.

1 – What Macroeconomists Study

2 – How Economists Think

• Economists often study politically charged issue yet economics has its own set of tool, terminology, data, and way of thinking.

I. Theory as Model BuildingII. The Use of Multiple ModelsIII. Prices: Flexible vs. StickyIV. Microeconomics Thinking and

Macroeconomics Models

2 – How Economists Think

• Theory as Model Building • Model is a copy of real world situation to

understand the what and how things in the real world can be happening.

• It is like a child playing with a toy (car, airplane etc.) and with that the child gets to know a lot of information about the actual car and airplane.

2 – How Economists Think

• As the real economics can be very difficult to understand, so economists use models that try to copy the real world situation.

• In social sciences, the behaviors are converted into numbers for empirical analysis (analyzing a phenomenon through numbers NOT just theoretical explanation).

• Economics also tries to make models of different happenings and then tries to understand and attempts to know what can be the outcomes of a model.

2 – How Economists Think

• Models help us to simplify the complex situation of real life and economics models are shown in the form of symbols and equations.

• Economists make their own ‘model economies’ that would help explain different variables like GDP, Inflation, Unemployment etc.

• In models one can skip irrelevant details and focus on the ones we need.

2 – How Economists Think

• There are two kinds of variables in a model.– Exogenous variables are those that model takes as given and,– Endogenous variables that a model tries to explain.

• The purpose of the model is to know that how the exogenous variables affect the endogenous variables.

• In other words, as Figure 1-4 illustrates, exogenous variables come from outside the model and serve as the model’s input, whereas endogenous variables are determined within the model and are the model’s output.

2 – How Economists Think

2 – How Economists Think

• Let’s review the most celebrated of all economic models—the model of supply and demand.

• Imagine that an economist wants to figure out what factors influence the price of pizza and the quantity of pizza sold.

• He or she would develop a model that described the behavior of pizza buyers, the behavior of pizza sellers, and their interaction in the market for pizza.

• For example, the economist supposes that the quantity of pizza demanded by consumers Qd depends on the price of pizza P and on aggregate income Y. This relationship is expressed in the equation:

2 – How Economists ThinkQd = D(P, Y ),

• where D( ) represents the demand function. • Similarly, the economist supposes that the quantity of pizza supplied

by pizzerias Qs depends on the price of pizza P and on the price of materials Pm, such as cheese, tomatoes, flour etc.

• This relationship is expressed asQs = S(P, Pm),

• where S( ) represents the supply function. Finally, the economist assumes that the price of pizza adjusts to bring the quantity supplied and quantity demanded into balance:

Qs = Qd. • These three equations compose a model of the market for pizza.

2 – How Economists Think

2 – How Economists Think• Figure 1-5.The demand curve shows the relationship between the quantity of

pizza demanded and the price of pizza, holding aggregate income constant. • The demand curve slopes downward because a higher price of pizza

encourages consumers to switch to other foods and buy less pizza.• The supply curve shows the relationship between the quantity of pizza

supplied and the price of pizza, holding the price of materials constant.• The supply curve slopes upward because a higher price of pizza makes selling

pizza more profitable, which encourages pizzerias to produce more of it.• The equilibrium for the market is the price and quantity at which the supply

and demand curves intersect.• At the equilibrium price, consumers choose to buy the amount of pizza that

pizzerias choose to produce.

2 – How Economists Think

2 – How Economists Think

• The model shows that both the equilibrium price and the equilibrium quantity of pizza rise.

• Similarly, if the price of materials increases, then the supply of pizza decreases, as in panel (b) of Figure 1-6. The model shows that in this case the equilibrium price of pizza rises and the equilibrium quantity of pizza falls.

2 – How Economists Think

• This model of the pizza market has two exogenous variables and two endogenous variables.

• The exogenous variables are aggregate income and the price of materials.

• The endogenous variables are the price of pizza and the quantity of pizza exchanged

2 – How Economists Think

• The Use of Multiple Models• Economists use different models to answer

different questions but no single model can answer all the questions.

• The model is only as good as its assumptions

2 – How Economists Think

• Prices: Flexible vs. Sticky• It is assumed that the prices change quickly

for the equilibrium as shown in pizza example. • This assumption, called market clearing.• Although market-clearing models assume that

all wages and prices are flexible, in the real world some wages and prices are sticky.

2 – How Economists Think

• Microeconomic Thinking and Macroeconomic Models

• Microeconomics is the study of how households and firms make decisions and how these decision makers interact in the marketplace.

2 – How Economists Think

• Firms and individuals optimize, they try to maximize their benefits or satisfaction in a given set of options or constraints.

• And satisfaction or profit or benefits in economics can be called utility. And microeconomics assume that every micro unit of the economy tries to maximize their utility in a given set of constraints.

2 – How Economists Think

• We should try to understand that it is the unit that make the whole and microeconomics is the basis of macroeconomics.

• One cannot neglect the units to decide about macro units or variables.