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