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Intermediate macroeconomics chapt01

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

2.00

D
A
B

1.50

D
1000

1500

Quantity


Increase in Demand
Price

2.00

D

D’
A

An increase in Y causes
the demand to increase

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
B
A

1.50

S’

An decrease Pm causes
the supply to increase

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

A

P

Here:
Higher Price
Larger Quantity

D’
S

S’
Q

D
Q’ Quantity


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