8/23/2018. Where You Are! Course Webpage. Who am I? Dr. John Neri Office: Morrill Hall, Room 1106D, M and W 10:30am to 11:30am

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1 Where You Are! Economics 305 Macroeconomic Theory M, W, F from 12:00pm to 12:50pm The Friday class is primarily graded quizzes and 3 midterm exams see the syllabus. Text: Gregory Mankiw: Macroeconomics, Worth, 9 th, 8 th edition. Course Webpage NOTE: upper-case E Who am I? Dr. John Neri Office: Morrill Hall, Room 1106D, M and W 10:30am to 11:30am Go over syllabus 1

2 Introduction and Chapter 1: Three major concerns of macroeconomics: - growth, unemployment and inflation Tools macroeconomists use models. Some important concepts in macroeconomics Federal Government Tax Rebates: May - July 2008 Federal Government Tax Rebates: Counter Factual May - July

3 Interest Rate Changes The federal funds rate The short-term Treasury bill rate The long-term bond rate Interest Rates Potential and Actual Real GDP About 7% below potential 3

4 Potential and Actual Real GDP About 7% below potential Long-term Real GDP Per Capita (2000 dollars) 9/11/2001 long-run upward trend First oil price shock Great Depression Second oil price shock World War II 4

5 /23/2018 U.S. Unemployment Rate (% of labor force) World War I Great First Depression oil price shock Second oil price shock World War I World War II Great Depression Oil price shocks Financial crisis Financial crisis 5

6 /23/2018 U.S. Inflation Rate (% per year) World War I First oil price shock Second oil price shock Great Depression Financial crisis Tools Economist Use - Economic models simplified versions of a more complex reality irrelevant details are stripped away used to show relationships between variables explain the economy s behavior devise policies to improve economic performance 6

7 Mankiw presents the supply & demand for new cars as an example of a model: assumes the market is competitive: each buyer and seller is too small to affect the market price Variable definitions and notation Q d = quantity that buyers demand Q s = quantity that producers supply P = price of new cars Y = aggregate income P s = price of steel (an input) The demand for cars: demand equation: Q d = D (P,Y ) Read as quantity demanded is a function of (depends upon) the price of new cars (P) and aggregate income (Y). Shows that the quantity consumers demand is related to the price 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: Q d =D (P,Y ) = 60 10P + 2Y 7

8 The market for cars: Demand demand equation: Q d = D (P,Y ) P Price The demand curve shows the relationship between quantity demanded and price, other things equal. D Q Quantity The market for cars: Supply supply equation: Q s = S (P,P S ) P Price S The supply curve shows the relationship between quantity supplied and price, other things equal. D Q Quantity The market for cars: Equilibrium P Price S equilibrium price equilibrium quantity D Q Quantity 8

9 The effects of an increase in income demand equation: Q d = D (P,Y ) An increase in income increases the quantity consumers demand at each price which increases the equilibrium price and quantity. P Price P 2 P 1 Q 1 Q 2 S D 1 D 2 Q Quantity The effects of a steel price increase supply equation: Q s = S (P,P S ) P S 2 Price S 1 An increase in P s reduces the quantity of cars producers supply at each price which increases the market price and reduces the quantity. P 2 P 1 Q 2 Q 1 D Q Quantity 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, Q d, Q s exogenous: Y, P s 9

10 NOW YOU TRY: Supply and Demand 1. Market for Pizza d 2. Q 60 10P 2Y s 3. Q 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. 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 10

11 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 the 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 ) How the economy works in the short run, when prices are sticky 11

12 Outline of the book: Macroeconomic theory (Chaps ) Macroeconomic dynamics, models of consumer behavior, theories of firms investment decisions Macroeconomic policy (Chaps ) Stabilization policy, government debt and deficits, financial crises Some macro conclusions In the long-run, supply rules. 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 Policy to increase national saving lowers interest rates, increases investment and leads to larger capital stock. Policy to increase efficiency of labor (education and increase technological progress) Some macro conclusions In the short-run, aggregate demand rules. Changes in aggregate demand influences the amount of goods and services that a country produces Chapter 10,11, 12 and 14 Monetary policy, fiscal policy Shocks to the system 12

13 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 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 Increase Aggregate Demand => U and π Contract Aggregate Demand => U and π 13