CHAPTER 1

The Science of Macroeconomics

A PowerPoint Tutorial

To Accompany

MACROECONOMICS, 6th. ed.

N. Gregory Mankiw
By
Chapter One

Mannig J. Simidian

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
Chapter One

Welcome to Macroeconomics!
Everyone has reason to think critically about macroeconomic
issues. It is imperative that we seek to understand why some
countries are growing faster or slower than others or
why some have greater fluctuations in inflation or
unemployment. The state of the macroeconomy
affects everyone in many ways. It plays a significant
role in the political sphere while also affecting public
policy and societal well-being, at the national and global levels.
Some of the most important variables macroeconomists use
to measure the performance of the economy are real GDP, the
inflation rate, and the unemployment rate. Macroeconomists are also
concerned with matters such as monetary and fiscal policyboth of
which, will be discussed at length in Macroeconomics, 6th ed.,
Mankiws Macroeconomics Modules, and in your macroeconomics
course. Good luck!
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Chapter One

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.

Price

Supply

P*
Demand
Chapter One

Q * Quantity

This is the most famous

economic model. It describes
the ubiquitous relationship
between buyers and sellers in
the market. The point of
intersection is called an
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equilibrium.

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
D
D
S
P
decisions reach an equilibrium.
B
Now, suppose that there is a sudden
P
A
increase in the demand for CDs.
P*
Demand will shift from D to D.
The increase in demand places upward
ge
a
t
pressure on the price to point B since the
r
o
h
S
original price, P* no longer clears 5the
Chapter One
Q* Q
Q market. Notice the shortage.

S 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:
D' both price and quantity are higher.
D

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.
Chapter One

S S'

D
Q
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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.
Chapter One

Microeconomics is the study of how households and firms

make decisions and how these decision makers interact in the
broader marketplace. In microeconomics, an individual chooses to
maximize his or her utility subject to his or her budget constraint.

Macroeconomic events arise from the interaction of many

individuals trying to maximize their own welfare. Because
aggregate variables are the sum of the variables describing
individuals decisions, the study of macroeconomics
is based on microeconomic foundations.
Chapter One

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
Classical Theory, The Economy in the Long Run
Growth Theory, The Economy in the Very Long Run
Business Cycle Theory: The Economy in the Short Run
Macroeconomic Policy Debates
More on the Microeconomics Behind Macroeconomics
Chapter One

Macroeconomics
Macroeconomics
Real
RealGDP
GDP
Inflation
Inflationand
andDeflation
Deflation
Unemployment
Unemployment
Recession
Recession
Depression
Depression
Models
Models
Endogenous
Endogenousvariables
variables
Exogenous
Exogenousvariables
variables
Market
Marketclearing
clearing
Flexible
Flexibleand
andsticky
stickyprices
prices
Microeconomics
Microeconomics
Chapter One

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