The Science of Macroeconomics

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MANKIW'S MACROECONOMICS MODULES

CHAPTER 1 The Science of Macroeconomics
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Acknowledgements
I would like to thank Greg Mankiw for creating
another macroeconomics masterpiece! It is none
other than an honor to be a part of his prolific
work. To Mike McElroy (North Carolina State
University), I express eternal gratitude for his
continued interest in my endeavors. For almost 10
years, he has been reading and contributing to my
macroeconomics modules. I also want to thank Mark
Rush (University of Florida), David Denslow
(University of Florida) and the director for
making my earliest experiences in economics so
entertaining. Jeffrey Frankel (Harvard
University), Ed Tower (Duke University), and
Roberto Rigobon (M.I.T) also encouraged my love
for economics. I thank Peter Max, Americas
painter-laureate, for all he has taught me
through his wisdom and art. Lawrence Brockman,
D.M.D, an economist in spirit, has been my
teacher and great friend throughout the years.
Thanks go to my former colleagues at the
Massachusetts Institute of Technology (MIT),
Michele Rubino, Guido Meardi and Stewart Brazil.
I also thank Franco Modigliani (MIT) and Rudi
Dornbusch (MIT) posthumously, for their
courageous tutelage until the very end. I also
want to thank my sweet two year old daughter Elle
(perhaps a future economist) for being my
beautiful inspiration in teaching macroeconomics.
Of course, I thank my Dad for his best friendship
and unending love and support. Through the
thousand hours of discussing economics and
business, he showed me how love and learning are
inextricably linked. Mannig J.
Simidian January 2006
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Welcome to Macroeconomics!
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Economists use models to understand what goes on
in the economy. Here are two important points
about models endogenous variables and exogenous
variables. Endogenous variables are those which
the model tries to explain. Exogenous variables
are those variables that a model takes as given.
In short, endogenous are variables within a
model, and exogenous are the variables outside
the model.
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The Basics of Market Clearing

• Market clearing is an alignment process whereby
  decisions between suppliers and demanders reach
  an equilibrium. Heres how it works.

Lets say you begin with a demand and supply
curve for CDs.
Remember that the demand curve slopes downward
meaning that as you increase the price (by moving
along the demand curve), the quantity demanded
decreases. Conversely, the supply curve slopes
upward implying that as the price increases (by
moving along the supply curve), the amount
supplied will increase.
The center point A is where market decisions
reach an equilibrium.
Now, suppose that there is a sudden increase in
the demand for CDs.
Demand will shift from D to D.
The increase in demand places upward pressure on
the price to point B since the original price, P
no longer clears the market. Notice the
shortage.
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The Basics of Supply and Demand
SHIFTS IN DEMAND Suppose your income rises? Your
demand for a given product, for example, pizza,
will also increase.
This translates into a rightward shift in
the demand curve from D to D'. Result both price
and quantity are higher.
SHIFTS IN SUPPLY A fall in the price of
materials increases the supply of pizza at any
given price, pizzerias find that the sale of
pizza is more profitable, and thus the supply of
pizza rises.
This translates into a rightward shift in
supply from S to S' .Result price falls,
quantity rises.
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Prices Flexible vs. Sticky
Economists typically assume that the market will
go into an equilibrium of supply and demand,
which is called the market clearing process.
This assumption is central to the pizza example
on the previous slide. But, assuming that
markets clear continuously, is unrealistic. For
markets to clear continuously, prices would have
to adjust instantly to changes in supply and
demand. But, evidence suggests that prices and
wages often adjust slowly. So, remember that
although market clearing models assume that wages
and prices are flexible, in actuality, some wages
and prices are sticky. Market clearing models may
not describe every instant in an economy, but
they do depict the equilibrium toward which the
economy gravitates.
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Using Microeconomics in Macroeconomics
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How Mankiw's Macroeconomics Modules Proceed

The modules mirror the sequencing of the text,
Macroeconomics, 6th ed. There are six parts and a
total of nineteen chapters with a module written
for each chapter. Enjoy!
Introduction
Part One
Classical Theory, The Economy in the Long Run
Part Two
Growth Theory, The Economy in the Very Long Run
Part Three
Business Cycle Theory The Economy in the Short
Run
Part Four
Macroeconomic Policy Debates
Part Five
More on the Microeconomics Behind Macroeconomics
Part Six
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Key Concepts of Ch. 1

• Macroeconomics
• Real GDP
• Inflation and Deflation
• Unemployment
• Recession
• Depression
• Models
• Endogenous variables
• Exogenous variables
• Market clearing
• Flexible and sticky prices
• Microeconomics