Chapter 1
Introduction to
Macroeconomics
1.1 Introduction
In this chapter, we learn
• the definition of macroeconomics and important
questions to consider.
• foundations of macroeconomic models and
modeling.
• the three-part structure of the text:
• the long run
• the short run
• issues for the future.
Subfields in Economics
• Macroeconomics
• The study of how the interactions of people
and firms through markets affect overall
economic activity
• Microeconomics
• The study of individual people, firms, or
market behavior
Important Macroeconomic Questions to Consider
Why is today’s average American
• more than 10 times richer than 100 years ago?
• 50 times richer than the average Ethiopian?
Do we understand and know the causes of the recent
global financial crisis?
What role do stock markets play in the economy?
How did the 2008 Affordable Care Act impact the price
of healthcare, economic growth, and government
expenditures?
Per Capita GDP in Seven Countries
Inflation Rate in Certain Rich Countries
Inflation
It is obvious that (most) unemployment is bad.
But, what are the costs of inflation to society?
• Unexpected and symmetric inflation
• Unexpected and asymmetric inflation
• Deflation
• Sticky prices
The Unemployment Rate in the United States, Europe, and Japan
1.2 How Macroeconomics Studies Key Questions
Macroeconomists have a general approach to study
questions of interest:
• Document the facts.
• Develop a model.
• Compare predictions of the model with original facts.
• Use the model to make other predictions that will
eventually be tested.
Models
• Models simplify the complicated real world into its most
relevant elements.
• A model is useful if it has good predictive power.
• Economic models often involve systems of multiple
equations.
Parts of an Economic Model—1
Parameter
• An input that is fixed over time, except when the
model builder changes it for an experiment
Exogenous variable
• An input that can change over time, but determined
ahead of time by the model builder
• Exogenous = “outside of the model”
Endogenous variable
• An outcome of the model—something that is
explained by the model
• Endogenous = “within the model”
Parts of an Economic Model—2
Suppose We Have a Working Model…
How can we use it?
• Change parameters and exogenous variables to see
how they affect endogenous variables.
• Predict costs and benefits of new government
policies.
Model Example—1
Labor supply and demand
Variables:
• 𝐿𝐿𝑠𝑠 = number of hours laborers want to work
• 𝐿𝐿𝑑𝑑 = number of labor hours firms want to hire
• 𝑤𝑤 = wage
Parameters:
Model Example—2
Supply function
•
•
•
Demand function
•
•
•
Model Example—3
Supply function
•
Demand function
•
Equilibrium
•
Model Example—4
• Increase in income taxes
• Increase in an input price
1.3 An Overview of the Book
Economics
Macroeconomics
Microeconomics
Long run
Short run
International
Economic growth
Business cycles
Open economy
Standards of
living
Inflation
Unemployment
Monetary/Fiscal
policy
Currency crises
Exchange rates
An Overview
More divisions
• Theoretical
• Mathematical models
• Empirical
• Data
• Theoretical and empirical methods are not
independent.
The Long Run
Income per person in the United States:
• $2,800 in 1870
• $44,000 in 2008
• Many countries have not experienced similar
increases in living standards.
The analysis of economic growth helps explain the long
run.
Per Capita GDP in the United States, 1870–2015
The Short Run
Potential output
• Measure of how per capita GDP would evolve with
completely flexible prices and fully employed
resources
• In 1982, actual output was 5 percent less than
potential output.
• Deviations in actual and potential output usually
last only a short time.
Long-term growth dominates short-run fluctuations.
Welfare
Welfare: Variable used to determine preferable policies and
rank outcomes
Measuring welfare is highly subjective.
• More GDP (consumption) increases welfare.
Are there variables other than GDP that we should
consider?
Examples:
• Leisure
• Equality
• Life expectancy
• Environmental quality
• Individual freedom
Pareto Efficiency and Free Markets—1
Complete and competitive markets
Deviations:
• Market power
• Externalities
• Public goods
• Asymmetric (imperfect) information
Pareto Efficiency and Free Markets—2
Why do economists disagree?
• Nature of market failures (magnitude)
• Theory of complete and competitive markets breaks
down.
• Which Pareto efficient outcome is best?
Clicker Question 1
The average annual growth rate of per capita GDP in
the United States from 1870 to 2015 is
a. 0 percent.
b. 2 percent.
c. 5 percent.
d. 10 percent.
Clicker Question 1 – Answer
The average annual growth rate of per capita GDP in
the United States from 1870 to 2015 is
a. 0 percent.
b. 2 percent.
c. 5 percent.
d. 10 percent.
Clicker Question 2
In the labor market model, an endogenous variable is
a. the wage rate.
b. the number of labor unions.
c. the population.
d. the income tax rate.
Clicker Question 2 – Answer
In the labor market model, an endogenous variable is
a. the wage rate.
b. the number of labor unions.
c. the population.
d. the income tax rate.
Clicker Question 3
The difference between a parameter and an exogenous
variable is that
a. a parameter is allowed to change over time, while
an exogenous variable is fixed over time.
b. a parameter is an outcome of the model, while an
exogenous variable is an input to the model.
c. a parameter is an input to the model, while an
exogenous variable is an output of the model.
d. a parameter is fixed over time, while an
exogenous variable is allowed to change over
time.
Clicker Question 3 – Answer
The difference between a parameter and an exogenous
variable is that
a. a parameter is allowed to change over time, while
an exogenous variable is fixed over time.
b. a parameter is an outcome of the model, while an
exogenous variable is an input to the model.
c. a parameter is an input to the model, while an
exogenous variable is an output of the model.
d. a parameter is fixed over time, while an
exogenous variable is allowed to change over
time.
Clicker Question 4
Over the last 100 years, potential output has
a. always been above actual output.
b. always been below actual output.
c. always been equal to actual output.
d. been relatively equal to actual output except for
the Great Depression era.
Clicker Question 4 – Answer
Over the last 100 years, potential output has
a. always been above actual output.
b. always been below actual output.
c. always been equal to actual output.
d. been relatively equal to actual output except
for the Great Depression era.
Clicker Question 5
The difference between an exogenous and an endogenous
variable is that
a. an exogenous variable is an input to the model, while
an endogenous variable is an outcome of the model.
b. an exogenous variable is an outcome of the model,
while an endogenous variable is an input to the model.
c. an exogenous variable is fixed over time, while an
endogenous varies over time.
d. an exogenous variable is an input to the model, while
an endogenous variable changes over time as
determined by the model builder.
Clicker Question 5 – Answer
The difference between an exogenous and an endogenous
variable is that
a. an exogenous variable is an input to the model,
while an endogenous variable is an outcome of the
model.
b. an exogenous variable is an outcome of the model,
while an endogenous variable is an input to the model.
c. an exogenous variable is fixed over time, while an
endogenous varies over time.
d. an exogenous variable is an input to the model, while
an endogenous variable changes over time as
determined by the model builder.
Clicker Question 6
Which of the following questions would a
macroeconomist be most interested in answering?
a. Why do monopolies set higher prices?
b. Why do individuals substitute across goods when
prices rise?
c. Why did prices rise in many countries in the
1970s?
d. Why is a single firm’s stock price rising?
Clicker Question 6 – Answer
Which of the following questions would a
macroeconomist be most interested in answering?
a. Why do monopolies set higher prices?
b. Why do individuals substitute across goods when
prices rise?
c. Why did prices rise in many countries in the
1970s?
d. Why is a single firm’s stock price rising?
Clicker Question 7
The unemployment rate in the United States has
historically been
a. higher than in Europe.
b. lower than in Europe.
c. higher than in Europe until 1980 and since then,
lower than in Europe.
d. lower than in Europe until 1980 and since then,
higher than in Europe.
Clicker Question 7 – Answer
The unemployment rate in the United States has
historically been
a. higher than in Europe.
b. lower than in Europe.
c. higher than in Europe until 1980 and since
then, lower than in Europe.
d. lower than in Europe until 1980 and since then,
higher than in Europe.
Clicker Question 8
Which of the following is NOT a step that
macroeconomists take to study aggregate economic
questions?
a. Document the facts.
b. Include all possible variables from the real world
to construct a comprehensive model.
c. Make assumptions about the real world to
simplify the construction of the model.
d. Shock the model to make other predictions.
Clicker Question 8 – Answer
Which of the following is NOT a step that
macroeconomists take to study aggregate economic
questions?
a. Document the facts.
b. Include all possible variables from the real
world to construct a comprehensive model.
c. Make assumptions about the real world to
simplify the construction of the model.
d. Shock the model to make other predictions.
Clicker Question 9
We can solve a model for all the endogenous variables
if it has five equations and six unknowns.
a. true
b. false
Clicker Question 9 – Answer
We can solve a model for all the endogenous variables
if it has five equations and six unknowns.
a. true
b. false
Clicker Question 10
Over the long term, economic growth swamps
economic fluctuations.
a. true
b. false
Clicker Question 10 – Answer
Over the long term, economic growth swamps
economic fluctuations.
a. true
b. false
Clicker Question 11
Potential output is a measure of per capita GDP in the
future.
a. true
b. false
Clicker Question 11 – Answer
Potential output is a measure of per capita GDP in the
future.
a. true
b. false
Clicker Question 12
One reason economic activity fluctuates is that the
central bank leads the economy into a recession in
order to bring down inflation.
a. true
b. false
Clicker Question 12 – Answer
One reason economic activity fluctuates is that the
central bank leads the economy into a recession in
order to bring down inflation.
a. true
b. false
Clicker Question 13
A model comparing income in the United States and
Ethiopia is successful if it predicts the United States is
richer than Ethiopia but not how much richer.
a. true
b. false
Clicker Question 13 – Answer
A model comparing income in the United States and
Ethiopia is successful if it predicts the United States is
richer than Ethiopia but not how much richer.
a. true
b. false
Clicker Question 14
In most rich countries, inflation has been relatively
high since the 1980s.
a. true
b. false
Clicker Question 14 – Answer
In most rich countries, inflation has been relatively
high since the 1980s.
a. true
b. false
Clicker Question 15
In part, macroeconomists study individual behavior
and microeconomic theories to create theories of
aggregate economic activity.
a. true
b. false
Clicker Question 15 – Answer
In part, macroeconomists study individual behavior
and microeconomic theories to create theories of
aggregate economic activity.
a. true
b. false
Clicker Question 16
At the height of the 2008 economic recession, U.S.
employment
a. decreased by approximately 0.5 percent per month.
b. increased by approximately 0.5 percent per month.
c. remained about the same every month.
d. fluctuated without a particular pattern.
Clicker Question 16 – Answer
At the height of the 2008 economic recession, U.S.
employment
a. decreased by approximately 0.5 percent per month.
b. increased by approximately 0.5 percent per month.
c. remained about the same every month.
d. fluctuated without a particular pattern.
Clicker Question 17
In a simple model of supply and demand, the equation
for the demand curve is given by Q = 20 – 10P and the
equation for the supply curve is given by Q = 5 + 5P. P
and Q are
a. microfoundations.
b. parameters.
c. exogenous variables.
d. endogenous variables.
Clicker Question 17 – Answer
In a simple model of supply and demand, the equation
for the demand curve is given by Q = 20 – 10P and the
equation for the supply curve is given by Q = 5 + 5P. P
and Q are
a. microfoundations.
b. parameters.
c. exogenous variables.
d. endogenous variables.
Clicker Question 18
In a simple model of supply and demand, the equation
for the demand curve is given by Q = 20 – 10P and the
equation for the supply curve is given by Q = 5 + 5P.
The solution of the model is
a. Q = 10 and P = 10.
b. Q = 1 and P = 1.
c. Q = 10 and P = 1.
d. Q = 1 and P = 10.
Clicker Question 18 – Answer
In a simple model of supply and demand, the equation
for the demand curve is given by Q = 20 – 10P and the
equation for the supply curve is given by Q = 5 + 5P.
The solution of the model is
a. Q = 10 and P = 10.
b. Q = 1 and P = 1.
c. Q = 10 and P = 1.
d. Q = 1 and P = 10.
Clicker Question 19
The positive budget deficit since the early 2000s in the
United States implies that
a. federal government spending exceeds federal
government revenue.
b. federal government revenue exceeds federal
government spending.
c. the United States exports more than it imports.
d. the United States imports more than it exports.
Clicker Question 19 – Answer
The positive budget deficit since the early 2000s in the
United States implies that
a. federal government spending exceeds federal
government revenue.
b. federal government revenue exceeds federal
government spending.
c. the United States exports more than it imports.
d. the United States imports more than it exports.
Clicker Question 20
Deviations between actual and potential output usually
last
a. a long time.
b. to infinity and beyond.
c. a medium time.
d. a short time.
Clicker Question 20 – Answer
Deviations between actual and potential output usually
last
a. a long time.
b. to infinity and beyond.
c. a medium time.
d. a short time.
Clicker Question 21
What is the basic structure of an economic model?
a. Inputs → Model → Outcomes
b. Model → Inputs → Outcomes
c. Inputs → Outputs → Model
d. Model → Outputs → Inputs
Clicker Question 21 – Answer
What is the basic structure of an economic model?
a. Inputs → Model → Outcomes
b. Model → Inputs → Outcomes
c. Inputs → Outputs → Model
d. Model → Outputs → Inputs