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(This may be a good question to discuss in class.)
6. The two accompanying diagrams show supply and de-
mand curves for two substitute commodities: tapes and 8. (More difficult) The demand and supply curves for
compact discs (CDs). T-shirts in Touristtown, U.S.A., are given by the follow-
ing equations:
Q 5 24,000 2 500P Q 5 6,000 1 1,000P
D0 D0
where P is measured in dollars and Q is the number of

T-shirts sold per year.


a. Find the equilibrium price and quantity algebraically.
b. If tourists decide they do not really like T-shirts that
much, which of the following might be the new de-
D0 D0

mand curve?
Quantity Quantity
Compact Discs Tapes
Q 5 21,000 2 500P Q 5 27,000 2 500P
(a) (b)

Find the equilibrium price and quantity after the shift of
the demand curve.
a. On the right-hand diagram, show what happens
c. If, instead, two new stores that sell T-shirts open up
when rising raw material prices make it costlier to
in town, which of the following might be the new
produce tapes.
supply curve?
b. On the left-hand diagram, show what happens to the
Q 5 4,000 1 1,000P Q 5 9,000 1 1,000P
market for CDs.
7. Consider the market for beef discussed in this chapter
Find the equilibrium price and quantity after the shift of
(Tables 1 through 4 and Figures 1 and 8). Suppose that
the supply curve.
the government decides to fight cholesterol by levying a

1. How often do you rent videos? Would you do so more farmers to slaughter cows. Use two diagrams, one for
often if a rental cost half as much? Distinguish between the milk market and one for the meat market, to illus-
your demand curve for home videos and your “quantity trate how this policy should have affected the price of
demanded” at the current price. meat. (Assume that meat is sold in an unregulated
2. Discuss the likely effects of the following:
4. It is claimed in this chapter that either price floors or
a. Rent ceilings on the market for apartments
price ceilings reduce the actual quantity exchanged in a
b. Floors under wheat prices on the market for wheat market. Use a diagram or diagrams to test this conclu-
sion, and explain the common sense behind it.
Use supply-demand diagrams to show what may hap-
pen in each case. 5. The same rightward shift of the demand curve may pro-
duce a very small or a very large increase in quantity,
3. U.S. government price supports for milk led to an un-
depending on the slope of the supply curve. Explain this
ceasing surplus of milk. In an effort to reduce the sur-
conclusion with diagrams.
plus about a decade ago, Congress offered to pay dairy

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Chapter 4 79
Supply and Demand: An Initial Look

6. In 1981, when regulations were holding the price of nat- ing women grew by 11 percent. During this time, aver-
ural gas below its free-market level, then-Congressman age wages for men grew by 20 percent, while average
Jack Kemp of New York said the following in an inter- wages for women grew by 25 percent. Which of the fol-
view with the New York Times: “We need to decontrol lowing two explanations seems more consistent with
natural gas, and get production of natural gas up to a the data?
higher level so we can bring down the price.”11 Evaluate a. Women decided to work more, raising their relative
the congressman™s statement. supply (relative to men).
7. From 1990 to 1997 in the United States, the number of b. Discrimination against women declined, raising the
working men grew by 6.7 percent; the number of work- relative (to men) demand for female workers.

The New York Times, December 24, 1981.

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Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.
Licensed to:


The Macroeconomy:
Aggregate Supply and Demand

M acroeconomics is the headline-grabbing part of economics. When economic news
appears on the front page of your daily newspaper or is reported on the nightly tel-
evision news, you are most likely reading or hearing about some macroeconomic devel-
opment in the national or world economy. The Federal Reserve has just cut interest rates.
Inflation remains low. Jobs are scarce”or plentiful. The federal government™s budget is in
deficit. The euro is rising in value. These developments are all macroeconomic news. But
what do they mean?
Part 2 begins your study of macroeconomics. It will first acquaint you with some of the
major concepts of macroeconomics”things that you hear about every day, such as gross
domestic product (GDP), inflation, unemployment, and economic growth (Chapters 5
and 6). Then it will introduce the basic theory that we use to interpret and understand
macroeconomic events (Chapters 7 through 10). By the time you finish Chapter 10”which
is only six chapters away”those newspaper articles will make a lot more sense.


5 | An Introduction 8 | Aggregate Demand and
to Macroeconomics the Powerful Consumer
6 | The Goals of 9 | Demand-Side Equilibrium:
Macroeconomic Policy Unemployment or Inflation?
7 | Economic Growth: Theory 10 | Bringing in the Supply Side:
and Policy Unemployment and Inflation?

Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.
Licensed to:

Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.
Licensed to:

An Introduction to Macroeconomics
Where the telescope ends, the microscope begins. Which of the two has the grander view?

B y time-honored tradition, economics is divided into two fields: microeconomics and
macroeconomics. These inelegant words are derived from the Greek, where micro
means something small and macro means something large. Chapters 3 and 4 introduced
you to microeconomics. This chapter does the same for macroeconomics.
How do the two branches of the discipline differ? It is not a matter of using different
tools. As we shall see in this chapter, supply and demand provide the basic organizing
framework for constructing macroeconomic models, just as they do for microeconomic
models. Rather, the distinction is based on the issues addressed. For an example of a
macroeconomic question, turn the page.

Recession and Unemployment Reaganomics and Its Aftermath
2006“2007? Economic Growth Clintonomics: Deficit Reduction and the “New
Tax Cuts and the Bush Economy
MACROECONOMICS AND Money as the Measuring Rod: Real versus
Aggregation and Macroeconomics What Gets Counted in GDP?
The Foundations of Aggregation Limitations of the GDP: What GDP Is Not THE PROBLEM OF MACROECONOMIC
The Line of Demarcation Revisited STABILIZATION: A SNEAK PREVIEW
Combating Unemployment
SUPPLY AND DEMAND IN Growth, but with Fluctuations
Combating Inflation
MACROECONOMICS Inflation and Deflation
Does It Really Work?
A Quick Review The Great Depression
Moving to Macroeconomic Aggregates From World War II to 1973
Inflation The Great Stagflation, 1973“1980

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Licensed to:
Part 2
84 The Macroeconomy: Aggregate Supply and Demand

The U.S. economy grew strongly from early 2003 to early 2006, at a compound
annual growth rate of 3.5 percent. Then, starting in the second quarter of 2006,
growth slowed down and averaged only 2.2 percent per annum over the
ensuing seven quarters. Why was that?
There is, of course, no simple answer to this question. But beginning in this
chapter and continuing throughout Parts 2 and 3, we will learn a great deal
about the factors that make economic growth fluctuate from one year to the next.
Among those factors, as we will see, are a number of government policies.

In microeconomics, the spotlight is on how individual decision-making units behave. For
example, the dairy farmers of Chapter 4 are individual decision makers; so are the
consumers who purchase the milk. How do they decide which actions are in their own
best interests? How are these millions of decisions coordinated by the market
mechanism, and with what consequences? Questions such as these lie at the heart of
Although Plato and Aristotle might wince at the abuse of their language, microeconom-
ics applies to the decisions of some astonishingly large units. The annual sales of General
Electric and General Motors, for example, exceed the total production of many nations.
Yet someone who studies GE™s pricing policies is a microeconomist, whereas someone
who studies inflation in a small country like Monaco is a macroeconomist. The micro-
macro distinction in economics is certainly not based solely on size.
What, then, is the basis for this long-standing distinction? The answer is that, whereas
microeconomics focuses on the decisions of individual units, no matter how large, macro-
economics concentrates on the behavior of entire economies, no matter how small.
Microeconomists might look at a single company™s pricing and output decisions. Macro-
economists study the overall price level, unemployment rate, and other things that we call
economic aggregates.

Aggregation and Macroeconomics
An “economic aggregate” is simply an abstraction that people use to describe some salient
feature of economic life. For example, although we observe the prices of gasoline, tele-
phone calls, and movie tickets every day, we never actually see “the price level.” Yet many
people”not just economists”find it meaningful to speak of “the cost of living.” In fact,
the government™s attempts to measure it are widely publicized by the news media each
Among the most important of these abstract notions is the concept of domestic prod-
uct, which represents the total production of a nation™s economy. The process by which
real objects such as software, baseballs, and theater tickets are combined into an ab-
straction called total domestic product is aggregation, and it is one of the foundations
Aggregation means
combining many individual of macroeconomics. We can illustrate it by a simple example.
markets into one overall An imaginary nation called Agraria produces nothing but foodstuffs to sell to con-
sumers. Rather than deal separately with the many markets for pizzas, candy bars,
hamburgers, and so on, macroeconomists group them all into a single abstract “market
for output.” Thus, when macroeconomists announce that output in Agraria grew
10 percent last year, are they referring to more potatoes or hot dogs, more soybeans or


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