Summary
Macroeconomics
Macroeconomics European Edition
N. Gregory Mankiw and Mark P. Taylor
Chapter 1 – 17
Content
1
,Chapter 1: The Science of Macroeconomics...............................................................3
1.1: What Macroeconomists Study.......................................................................3
1.2: How Economists Think.................................................................................. 3
Chapter 2: The Data of Macroeconomics....................................................................4
2.1: Measuring the Value of Economic Activity: Gross Domestic Product.............4
2.2: Measuring the Cost of Living: The Consumer Price Index..............................6
2.3: Measuring Joblessness: The Unemployment Rate.........................................7
Chapter 3: National Income: Where It Comes From and Where It Goes......................7
3.1: What Determines the Total Production of Goods and Services?....................7
3.2: How Is National Income Distributed to the Factors of Production?................8
3.3: What Determines the Demand for Goods and Services?.............................10
3.4: What Brings the Supply and Demand for Goods and Services into
Equilibrium?....................................................................................................... 11
3.5: Conclusion................................................................................................... 12
Chapter 4: The Monetary System: What It Is and How It Works...............................12
4.1: What Is Money?........................................................................................... 12
4.2: The Role of Banks in the Monetary System.................................................13
4.3: How Central Banks Influence the Money Supply.........................................14
Chapter 5: Inflation: Its Causes, Effects and Social Costs.........................................16
5.1: The Quantity Theory of Money....................................................................16
5.2: Seigniorage: The Revenue from Printing Money..........................................17
5.3: Inflation and Interest Rates.........................................................................17
5.4: The Nominal Interest Rate and the Demand for Money..............................18
5.5: The Social Costs of Inflation........................................................................19
5.6: Hyperinflation............................................................................................. 20
5.7: Conclusion: The Classical Dichotomy..........................................................21
Chapter 6: The Open Economy................................................................................. 21
6.1: The International Flows of Capital and Goods.............................................21
Chapter 7: Unemployment....................................................................................... 21
7.1: Job Loss, Job Finding and the Natural Rate of Unemployment.....................22
7.2: Job Search and Frictional Unemployment....................................................22
7.3: Real-Wage Rigidity and Structural Unemployment......................................22
7.4: Labour-Market Experience: The United Kingdom........................................23
2
, 7.5: Labour-Market Experience: Continental Europe..........................................24
7.6: Conclusion................................................................................................... 24
Chapter 8: The Accumulation of Capital...................................................................24
8.1: The Accumulation of Capital.......................................................................24
8.2: The Golden Rule Level of Capital.................................................................26
8.3: Population Growth....................................................................................... 27
8.4: Conclusion................................................................................................... 28
Appendix Chapter 9: Accounting for the Sources of Economic Growth.....................28
Chapter 10: Introduction to Economic Fluctuations..................................................29
10.1: The Facts about the Business Cycle..........................................................29
10.2: Time Horizons in Macroeconomics............................................................30
10.3: Aggregate Demand................................................................................... 30
10.4: Aggregate Supply...................................................................................... 31
10.5: Stabilization Policy.................................................................................... 31
Chapter 11: Aggregate Demand I: Building the IS-LM Model....................................32
11.1: The Goods Market and the IS Curve..........................................................33
11.2: The Money Market and the LM Curve........................................................35
11.3: Conclusion: The Short-Run Equilibrium.....................................................36
Chapter 12: Aggregate Demand II: Applying the IS-LM Model..................................37
12.1: Explaining Fluctuations with the IS-LM Model...........................................37
12.2: IS-LM as a Theory of Aggregate Demand..................................................38
12.3: The Great Depression................................................................................ 39
Appendix Chapter 12................................................................................................ 40
Chapter 13: The Open Economy Revisited: The Mundell-Fleming Model and the
Exchange-Rate Regime............................................................................................. 40
13.1: The Mundell-Fleming Model......................................................................40
13.2: The Small Open Economy under Floating Exchange Rates.......................40
13.3: The Small Open Economy under Fixed Exchange Rates............................41
13.4: Interest-Rate Differentials.........................................................................42
13.5: Should Exchange Rates Be Floating of Fixed?...........................................43
13.6: From the Short Run to the Long Run: The Mundell-Fleming Model with a
Changing Price Level.......................................................................................... 43
Appendix Chapter 13................................................................................................ 44
Chapter 14: Aggregate Supply and the Short-Run Trade-Off between Inflation and
Unemployment......................................................................................................... 44
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, 14.1: Three Models of Aggregate Supply............................................................44
14.2: Inflation, Unemployment and the Phillips Curve.......................................46
Appendix Chapter 14................................................................................................ 48
Chapter 17: Common Currency Areas and European Economic and Monetary Union
................................................................................................................................. 48
17.1: Common Currency Areas...........................................................................48
17.2: The Benefits of a Single Currency.............................................................48
17.3: The Costs of a Single Currency.................................................................48
17.4: The Theory of Optimum Currency Areas...................................................49
17.5: Is Europe an Optimum Currency Area?.....................................................50
17.6: Fiscal Policy and Common Currency Areas................................................50
17.7: Conclusion................................................................................................. 51
Chapter 15: Stabilization Policy................................................................................51
15.1: Should Policy Be Active or Passive?...........................................................51
15.3: Should Policy Be Conducted by Rule or by Discretion?..............................52
15.3: Inflation Targeting: Rule or Constrained Discretion?..................................54
15.4: Central Bank Independence......................................................................54
15.5: Inflation Targeting and Central Bank Independence..................................54
15.6: Conclusion: Making Policy in an Uncertain World......................................55
Appendix Chapter 15................................................................................................ 55
Chapter 16: Government Debt.................................................................................55
16.1: The Size of the Government Debt.............................................................55
16.2: Problems in Measurement.........................................................................55
16.3: The Traditional View of Government Debt.................................................56
16.4: The Ricardian View of Government Debt..................................................56
16.5: Other Perspectives on Government Debt..................................................57
16.6: Fiscal Sustainability, Budget Deficits and the Debt-to-GDP Ratio..............58
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,Chapter 1: The Science of Macroeconomics
1.1: What Macroeconomists Study
Macroeconomic circumstances change over time, sometimes radically. The basic
principles of macroeconomics do not change from decade to decade, but the
macroeconomist must apply these principles with flexibility and creativity to meet
changing circumstances.
Economists use many types of data to measure the performance of an economy.
Two important macroeconomic variables are the inflation rate and the
unemployment rate. The inflation rate measures how fast prices are rising. The
unemployment rate measures the fraction of the labour force that is out of work.
The examination of European unemployment and inflation throws up a number of
macroeconomic issues. While European inflation rate are relatively homogeneous, a
major issue of concern is why Continental European unemployment rates tend, on
average, to be so high compared with those of the UK and the US.
Another important macroeconomic variable, the real domestic product, real GDP,
measures the total income of everyone in the economy. As a summary of total
economic activity, real GPD is a good barometer of the state of the economy.
Although real GDP rises in most years, this growth is not steady. There are repeated
periods during which real GPD falls. Such periods are called recessions if they are
mid and depressions if they are more severe.
The inflation rate varies substantially over time. Sometimes deflation occurs. That
is when the prices fall. Unemployment varies from year to year, with no real long
term trend.
1.2: How Economists Think
Economists use models to understand the world. Models have two kinds of
variables: endogenous variables and exogenous variables. Endogenous variables
are those variables that a model tries to explain. Exogenous variables are those
variables that a model takes as given. The purpose of a model is to show how the
exogenous variables affect the endogenous variables.
Example: Q d =D( P ,Y ) , the amount of pizza’s demanded depends on its price
s
and one’s income. This is the demand function. Q =S (P , Pm ) , the amount of
pizza’s supplied by pizzerias depends on the price of the pizza and the price of the
materials. This is the supply function. Economists assume that the price of pizza
adjusts to bring the quantity supplied and the quantity demanded into balance:
s d
Q =Q . The exogenous variables are aggregate income and the price of
materials. The endogenous variables are the price of pizza and the quantity of pizza
exchanged. When the exogenous variables change, the endogenous variables
change with them.
Understand figure 1.5 and 1.6, p. 14, 15.
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, Like all models, this model of the pizza market makes simplifying assumptions.
Models leas to incorrect conclusions if they assume away features of the economy
that are crucial to the issue at hand. Economic modelling therefore requires care
and common sense. No single model can answer all questions.
Market clearing is the assumption that markets are normally in equilibrium, so the
price of any good or service is found where the supply and demand curves
intersect. Yet the assumption of continuous market clearing is not entirely realistic.
For markets to clear continuously, prices must adjust instantly to changes in supply
and demand. In fact, many wages and price adjust slowly. So, although market-
clearing models assume that all wages and prices are flexible, in the real world
some wages and prices are sticky. Stickiness does not make market-clearing
models useless, because prices eventually do adjust to changes in supply and
demand. Market-clearing models describe the equilibrium towards which the
economy gravitates.
Microeconomics is the study of how households and firms make decisions and
how these decision makers interact in the marketplace. Because aggregate
variables are the sum of the variables describing many individual decisions,
macroeconomic theory rests on a microeconomic foundation.
Chapter 2: The Data of Macroeconomics
This chapter focuses on the three statistics that economists and policy makers use
most often. Gross domestic product (GDP) tells us the nation’s total income and
the total expenditure on its output of goods and services. The consumer price
index (CPI) measures the level of prices. The unemployment rate tells us the
fraction of workers who are unemployed.
2.1: Measuring the Value of Economic Activity: Gross Domestic Product
GDP is the total income of everyone in the economy and GDP is the total
expenditure on the economy’s output of goods and services (because income must
equal expenditure). The national income accounting is the accounting system used
to measure GDP and many related statistics.
A stock is a quantity measured at a given point in time, whereas a flow is a
quantity measured per unit of time. A person’s wealth is a stock; his income and
expenditure are flows. GDP is probably the most important flow variable in
economics: it tells us how much money is flowing around the economy’s circular
flow per unit of time.
GDP is the market value of all final goods and services produced within an economy
in a given period of time. To compute the total value of different goods and services,
the national income accounts use market prices because these prices reflect how
much people are willing to pay for a good of service. Used goods are not part of the
GDP. When a firm increases its inventory of goods, this investment in inventory is
counted as an expenditure by the firm’s owners. A sale out of inventory is a
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