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
D

A
2.00
B
1.50

Quantity
1000 1500
 Increase in Demand

Price D An increase in Y causes

D the demand to increase

A C
2.00
B
D
D
Quantity
1500 2000
 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

500 1000 Quantity

 Increase in Supply
Price S An decrease Pm causes
the supply to increase
B S

A
1.50 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 D
Surplus S
2.50

Equilibrium
2.00
B
1.50
Shortage
S D

Quantity
500 1000 1500
 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
P B Larger Quantity

P A

D
S D

Quantity
Q Q
 Increase in Supply:
Price D S
S
A
P Lower Price
P B Larger Quantity

S D
S

Q Q Quantity
 Increase in Demand & Supply:

Price
D D
S
S
P B Here:
P A Higher Price
Larger Quantity
D
S S D

Q Q Quantity