Chapter 1 The Science of Macroeconomics / Macroeconomics 12th Edition 2025 N. Gregory Mankiw Solution Manuals

Answers to Textbook Questions and Problems

CHAPTER 1 The Science of Macroeconomics

Questions for Review

1.     Microeconomics is the study of how individual firms and households make decisions and how they interact with one another. Microeconomic models of firms and households are based on principles of optimization: firms and households do the best they can, given the constraints they face. For example, households choose which goods to purchase to maximize their utility, whereas firms choose inputs and outputs to maximize profits. In contrast, macroeconomics is the study of the economy as a whole; it focuses on issues such as how total output, total employment, and the overall price level are determined. These economy-wide variables are based on the interaction of many households and many firms; therefore, microeconomics forms the basis for macroeconomics.

2.     Economists build models as a means of summarizing the relationships among economic variables.These models are essential for explaining important economic variables, such as GDP, inflation, and unemployment, by demonstrating the relationships between them, often through mathematical expressions. Models are useful because they abstract from the many details in the economy and allow one to focus on the most important economic connections.

3.     A market-clearing model is a model in which prices adjust to equilibrate supply and demand. Market-clearing models are useful in situations where prices are flexible. Yet, in many situations, flexible prices may not be a realistic assumption. For example, labor contracts often set wages for up to three years, and firms such as magazine publishers may change their prices only every few years. Most macroeconomists believe that price flexibility is a reasonable assumption for studying long-run issues. Over the long run, prices respond to changes in demand or supply, even though in the short run they may be slow to adjust.

Problems and Applications

1.    

Since the beginning of 2021, inflation has become a significant macroeconomic issue, notably accelerating throughout 2022 before coming down in 2023. Current inflation remains above the target of the Federal Reserve Bank. The pandemic’s economic disruptions led to a rapid price increase with inflation reaching 9 percent in June 2022. The rapid rise in prices can be attributed to several key factors, such as disruptions in the supply chain and an increased demand for certain goods and services. Additionally, the price increase was exacerbated by the military conflict in Ukraine and the government’s fiscal expansion enacted to combat the economic effects of the pandemic.

In response to rising inflation, the Federal Reserve Bank and other central banks around the world took decisive steps to restore price stability. These measures include increasing interest rates to dampen inflationary pressures and inflation expectations while keeping a delicate balance of supporting economic recovery.

2.    Between 1960 and 2020, real GDP per capita increased by about a total of  215 percent.

Between 1960 and 2022, real GDP per capita increased by about a total of 238 percent.

2b.  10; 14.8

2c.  190; 14.6 percent

3.     Many philosophers of science believe that the defining characteristic of a science is the use of the scientific method of inquiry to establish stable relationships. Scientists examine data, often provided by controlled experiments, to support or disprove a hypothesis. Economists are more limited in their use of experiments. They cannot conduct controlled experiments on the economy; they must instead rely on the natural course of developments in the economy to collect data. To the extent that economists use the scientific method of inquiry—that is, developing hypotheses and testing them—economics has the characteristics of a science.

4a.  We can use a simple variant of the supply-and-demand model to answer this question.

        The new peanut-grinding technology lowers the cost of making peanut butter, which benefits producers as it means they can produce more peanut butter at the same cost as before. The decrease in production costs leads to a rightward shift in the supply curve. This shift indicates that at every price level, a larger quantity of peanut butter is supplied to the market than before the introduction of the new machine. The rightward shift in the supply curve results in a new equilibrium where the quantity of peanut butter increases while the equilibrium price decreases. This is illustrated in Fig 1-1 where the rightward shift in the supply curve from S₁ to S₂ causes the price of peanut butter to fall and the quantity of peanut butter to increase.

b.  A drought reduces the supply of peanuts, which increases the cost of production for peanut butter. This decrease in supply would be represented by a leftward shift of the supply curve for peanut butter. As a result, the equilibrium price of peanut butter would increase, and the equilibrium quantity would decrease, assuming the demand remains constant. This is illustrated in Fig 1-2 where the leftward shift in the supply curve from S₁ to S₂ causes the price of peanut butter to fall and the quantity of peanut butter to increase.

c.  When the price of a complement, like grape jelly, increases, the demand for peanut butter is likely to decrease as the two products are often consumed together. This demand curve for peanut butter would shift to the left. Consequently, the equilibrium price of peanut butter would fall, and the equilibrium quantity would also decrease. This is illustrated in Fig 1-3 where the leftward shift in the demand curve from D₁ to D₂ causes the price of peanut butter and the quantity of peanut butter to decrease.

d.    An increase in the price of a substitute, such as cheese, would lead to an increase in the demand for peanut butter as consumers switch to the less expensive substitute. This would shift the demand curve for peanut butter to the right. The equilibrium price of peanut butter would rise, and the equilibrium quantity sold would also increase. This is illustrated in Fig 1-4 where the rightward shift in the demand curve from D₁ to D₂ causes the price of peanut butter and the quantity of peanut butter to increase.

e. In this model of the peanut butter market, the price of peanut butter is an endogenous variable, and the price of cheese is an exogenous variable.

5.     The price of haircuts changes rather infrequently. From casual observation, hairstylists tend to charge the same price over a one- or two-year period, regardless of the demand for haircuts or the supply of cutters. A market-clearing model for analyzing the market for haircuts has the unrealistic assumption of flexible prices. Such an assumption is unrealistic in the short run, when we observe that prices are inflexible. Over the long run, however, the price of haircuts does tend to adjust; a market-clearing model is therefore appropriate.

CHAPTER 1

The Science of Macroeconomics

Notes to the Instructor

Chapter Summary

Chapter 1 presents a brief introduction to macroeconomics. The chapter explains the type of questions macroeconomists address, introduces the concept of an economic model, and discusses the roles of price flexibility and price stickiness in macroeconomic models.

Comments

The amount of introduction required naturally depends upon the students’ previous exposure to macroeconomics in principles or in other courses. I try to stress the relevance of macroeconomics; a good way to do this is to bring in copies of that day’s newspapers and show how they contain stories related to the course. I also stress the importance of basic macroeconomic literacy and emphasize that macroeconomics teaches a way of thinking about and understanding the economy rather than a set of facts. I highlight how models help us focus on essentials and avoid unnecessary distractions that can lead us astray. One way to do this is to show how common sense can sometimes give incorrect answers; an example from the textbook is that protectionist policies don’t improve the trade balance.

The supply and demand model presented in Chapter 1 provides a vehicle to explain the role of microeconomics in macroeconomics and to show how macroeconomics uses many tools and ideas from microeconomics. The lecture notes emphasize this and also explain how macroeconomics differs from microeconomics in its level of aggregation and in that it has more of a general-equilibrium focus. The textbook works, as do economists, by using different models to answer different questions, but I reassure students that we also emphasize how different models fit together.

For enhancing your classroom lectures, I strongly recommend the use of the PowerPoint slides for instructors that are available on the Worth website or in the Achieve course. This resource includes explanations of the text’s models and case studies, along with notes to instructors. The presentations are organized by chapter and you can easily augment them by inserting your own slides.

Use of the Economy.com Website

The Economy.com website provides a rich source of data for supplementing lectures and designing class projects. A good use of this resource for Chapter 1 is to create graphs of real GDP growth, CPI inflation, and the unemployment rate over the past few years to provide an up-to-date picture of the economy’s main economic indicators. Locate the data on the website’s data page and choose the appropriate settings to create a graph.

The Federal Reserve Bank of St. Louis website (https://fred.stlouisfed.org/) is a helpful source of macroeconomics data for students to enhance lectures and do class projects. For Chapter 1, a valuable application of this resource involves generating up-to-date graphs of real GDP growth, CPI inflation, and the unemployment rate. Locate the data on FRED’s website and configure the graph accordingly.

Chapter Supplements

This chapter includes the following supplements:

1-1          The Recent Behavior of the U.S. Economy: A Guide to the Case Studies

1-2          Presidential Elections and the Economy

1-3          When Is the Economy in a Recession?

1-4          Economic Rhetoric

1-5          Additional Readings

Lecture Notes

1-1        What Macroeconomists Study

Economics is the study of how people, businesses, and governments behave and interact in the production and allocation of goods and services. Traditionally, economics is divided into microeconomics, which studies the behavior of individuals and organizations (consumers, firms, and the like) at a disaggregated level, and macroeconomics, which studies the overall or aggregate behavior of the economy. Since this book studies macroeconomics, we seek to explain phenomena such as inflation, unemployment, and economic growth, and we are not concerned with, say, the demand for or supply of peanuts.

In macroeconomics, we do two things. First, we seek to understand the economic functioning of the world we live in; and second, we look at whether we can do anything to improve the performance of the economy. That is, we are concerned with both explanation and policy prescriptions.

Explanation involves an attempt to understand the behavior of economic variables, both at a moment in time and as time passes. Modern macroeconomics recognizes that it is important to focus on more than just short periods of time, and so it has an explicitly dynamic focus. We thus try to explain the behavior of economic variables over time. This means that we wish to explain the behavior of the economy both in the long run and in the short run.

• Supplement 1-1, “The Recent Behavior of the U.S. Economy”
• Supplement 1-2, “Presidential Elections and the Economy”
• Supplement 1-3, “When Is the Economy in a Recession?”

Case Study: The Historical Performance of the U.S. Economy

Perhaps the three most important indicators of the macroeconomic performance of an economy are real gross domestic product (GDP), the inflation rate, and the unemployment rate. Real GDP is a measure of the quantity of goods and services produced in the economy in a given year. The historical record shows that real GDP has risen substantially over time, although this growth is irregular, and there are periods when output actually falls. The inflation rate is a measure of how prices are changing, on average. The inflation rate has usually been positive but low in the United States, indicating that prices have tended to go up on average, but not at a particularly rapid pace. There have been periods in U.S. history when prices have tended to fall. The unemployment rate measures the percentage of those who are seeking work but do not have jobs. There is always some unemployment in the U.S. economy, although the level fluctuates substantially. The unemployment rate has generally been less than 10 percent but rose to 25 percent during the Great Depression. In February 2020, the unemployment rate was 3.5 percent, the lowest in more than half a century. With the Covid-19 pandemic, the unemployment rate increased rapidly over the next few months, rising especially due to significant parts of the economy being temporarily forced to shut down. However, as the economy gradually reopened, the unemployment rate fell rapidly and was back to its historical lows by the end of 2022.

• Figure 1-1
• Figure 1-2
• Figure 1-3

1-2  How Economists Think

Theory as Model Building

A key element of economic analysis—both microeconomic and macroeconomic—is the study of marketsand prices. In an economy, goods are traded and exchanged. We think about this as taking place in markets. The economist’s idea of a market is an abstract representation of a real market, where, for example, farmers might bring their produce for sale. Economists analyze markets by thinking about suppliers and demanders of goods. As an example, consider the market for pizza. Thinking first about the supply of pizza, an economist might posit that the number of pizzas that pizzerias will put up for sale depends on the price of pizza: the higher the price, the more pizza supplied. An economist might also think that the supply of pizza depends on the cost of the materials, such as tomatoes and cheese. The higher the cost of cheese, the fewer pizzas will be supplied at any given price of pizza. Turning to the demand for pizza, an economist might think that the number of pizzas that consumers will want to buy will depend on the price of pizza and on consumers’ aggregate income.

• Figure 1-4

If we suppose that the price of pizza adjusts so that demand equals supply, we add an equilibrium condition to our representation of the pizza market, whereby the supply of pizza (Q^s) equals the demand for pizza (Q^d):

Q^s = Q^d.

In terms of a graph, this is equivalent to looking for the point where the supply and demand curves meet. We return to this example shortly.

• Figure 1-5

The economy is a complicated system. Every day, millions of people make economic decisions. They buy their morning coffee, they buy lunch, they withdraw money from their checking accounts, they go to movies, they buy clothes, and they sell old textbooks. All of these are economic decisions with implications for the economy. In macroeconomics, we are trying to understand the way that the whole economy works. But, obviously, we cannot consider every individual transaction in every market in the economy. Instead, we have to simplify; we have to abstract from reality; we have to focus on what is important and discard what is unimportant.

To try to understand the economy and focus on what is important, we do a couple of things. First, we aggregate. Instead of worrying about individual goods—pizza, bread, automobiles, peanuts, and the like—we think about some aggregate of them all. We call this good real GDP and denote it by the symbol Y. GDP stands for gross domestic product. It is a measure of the total production in the economy; indeed, explaining the behavior of the economy is largely a matter of explaining the behavior of real GDP over time. We consider the definition of GDP more carefully later.

The second thing we do is to build models. Models are abstractions from reality that serve as frameworks of analysis. Just as aerospace engineers build model planes to put in a wind tunnel and judge that these models need not be equipped with “fasten seat belt” signs but should be equipped with wings, so economists construct representations of the economy that include important variables and exclude unimportant variables. Many different sciences, such as meteorology, physics, and biology, use models. In economics, as in many other sciences, the models with which we work are usually mathematical. We develop mathematical explanations of the economy and use algebra and graphs to help understand how the economy works. The aim of macroeconomics and this textbook is not so much to provide facts about macroeconomics as to give a framework of analysis for coherent thinking about macroeconomic issues.

The previous analysis of the pizza market is an example of a model. This model represents the determination of the equilibrium price and quantity traded in a simple setting. In constructing that model, we judged that the price of pizza, the price of cheese, and aggregate income are all important in understanding the demand for and supply of pizza; we implicitly decided that all other variables were less important and could be left out. Knowing what to include and what not to include in a model is the art of the economist; it requires judgment and skill.

• Figure 1-6

We can use the model of the pizza market to answer certain questions. For example, we might wonder what effect an increase in consumers’ incomes might have on the price of pizza. An increase in income would imply that at any given P, consumers would demand more pizza. The demand curve would shift to the right. Thus, we see that price and quantity both rise. Similarly, an increase in the price of materials would cause the supply curve to shift in, raising the equilibrium price of pizza and lowering the quantity traded.

This experiment is typical of the way economists use a model. They change one variable, taken as given, and look at the effect on other variables that the model explains. Variables taken as given from outside the model are known as exogenous variables; variables explained within the model are known as endogenous variables. A typical experiment with an economic model thus involves changing an exogenous variable and looking at the effect on endogenous variables. This is known as a comparative static experiment.

Economists use mathematics—particularly graphs and algebra—to help understand the economy. For example, we have thus far said two things:

1. The supply of pizza depends on the price of pizza and the price of materials.
2. The demand for pizza depends on the price of pizza and aggregate income.

A mathematician uses symbols to express concepts such as these more compactly:

1. Q^s = S(P, P_m);
2. Q^d = D(P, Y).

Here S( ) and D( ) are functions: they indicate relationships among variables. Q^s, Q^d, P, P_m, and Y are variables,denoting the quantity of pizza supplied, the quantity of pizza demanded, the price of pizza, the price of materials, and aggregate income, respectively. An example of a supply function is

Q^s = 15P − 2P_m.

Another example is

Q^s = 13(P/P_m).

Very often in economics, we do not know very much about the exact nature of the relationships among variables, and so we prefer the general functional notation used earlier.

We can illustrate these relationships on a diagram. This diagram shows that the supply of pizza increases with the price of pizza, and the demand for pizza decreases with the price of pizza. To remind us that the quantity of pizza supplied also depends on the price of materials, P_m is sometimes put in parentheses when we label the supply curve. Similarly, we sometimes put Y in parentheses when we label the demand curve to remind us that demand also depends on income.

• Supplement 1-4, “Economic Rhetoric”

The Use of Multiple Models

Macroeconomists use a multitude of models because different models are appropriate for different questions. If we wanted to understand the effects of government deficits on interest rates, for example, we would not want to use a model that included the price of cheese. An important aim of the textbook is to demonstrate economists’ methods of analysis and use of models, and so the textbook works as economists do, by using different models to answer different questions. Part of the skill of being an economist is learning how to integrate these different models into a coherent view of the economy.

Prices: Flexible Versus Sticky

We noted earlier that macroeconomics is concerned with both explanation and policy recommendations. Not surprisingly, much of the debate among macroeconomists has to do with their different views on policy. Essentially, these debates often come down to whether or not the economy, left on its own, does a good job of allocating resources, or whether government intervention can improve upon the performance of the economy. This theme recurs throughout our analysis.

In trying to understand the role of policy in macroeconomics, our conclusions depend crucially on what we believe about the behavior of prices. In our example of the pizza market, we supposed that the price of pizza adjusted to equate supply and demand—we supposed that the market cleared. In this case, the market does a good job of matching up suppliers and demanders, and all mutually beneficial trades are carried out. In some markets, prices are indeed very flexible, but in other markets, we have much less confidence that market clearing occurs at all times. Instead, we think that some prices are sticky—slow to adjust. For example, labor contracts often set wages for a number of years in advance, and mail-order catalogs post prices that are set for a number of months.

Economists thus usually think that, for macroeconomics, it is reasonable to suppose that prices are completely flexible in the long run only. In the short run, we often make an assumption of price stickiness to help us explain the behavior of the economy.

One other difference between microeconomics and macroeconomics is worth mentioning. In microeconomics, we usually focus on a single market. In macroeconomics, we pay attention to how outcomes in one market affect what goes on in another market. For example, we often think about both the market for goods—real GDP—and the market for labor. Firms hire workers to produce goods. The more goods firms want to produce, the more workers they will want to hire. So an increase in the demand for goods may translate into an increased demand for workers. Similarly, the wages that workers are paid are used to buy goods, so outcomes in the labor market can affect the demand for goods. All of these things are going on at once, so we need to be able to think about a lot of markets at once. Macroeconomics develops a way of putting markets together. In economists’ terminology, much of macroeconomics has a general-equilibrium focus, in contrast to microeconomics, which tends to have a partial-equilibrium focus.

Microeconomic Thinking and Macroeconomic Models

Although microeconomics and macroeconomics are separate aspects of economic inquiry, they make use of many of the same tools. Indeed, the distinction between macroeconomics and microeconomics, though sometimes useful, is also somewhat artificial. Modern macroeconomics recognizes that good macroeconomic analysis is usually based on sound microeconomics and thus emphasizes the microfoundations of macroeconomic behavior. At times in the textbook, the use of microeconomic tools is explicit; at other times, it is implicit. For example, we often suppose that individuals’ consumption depends on their income (as in the pizza example) without going into details about the microeconomics behind the choices they make.

FYI: The Early Lives of Macroeconomists

The Nobel Prize in economics is awarded annually. A number of winners have been macroeconomists whose work we discuss in this book. These include Milton Friedman (1976), James Tobin (1981), Franco Modigliani (1985), Robert Solow (1987), Robert Lucas (1995), George Akerlof (2001), Edward Prescott (2004), Edmund Phelps (2006), and Christopher Sims (2011).

1-3  How This Book Proceeds

Macroeconomists face difficulties as scientists because they cannot conduct experiments. (They have this in common with some other scientists, such as paleontologists or astronomers.) But macroeconomists do seek to understand the behavior of the economy, which means understanding the behavior of economic data. We make progress in macroeconomics by looking at the data, observing certain patterns, building models that may help explain those patterns, and then seeing if those models are consistent with other aspects of the data or new data when they come in. A first task, therefore, is to examine the data of macroeconomics. We then proceed to develop models that explain the behavior of the economy in the long run, when prices are flexible so that markets clear. Here, we initially study the classical model in which the capital stock, labor force, and technology are taken as given. We next extend the classical model to include growth in the capital stock, labor force, and technological knowledge to explain economic growth in the very long run. Following this, we consider models of the economy in the short run, when prices may be sticky. Next, we discuss some advanced theoretical topics, including macroeconomic dynamics, models of consumer behavior, and models of investment by firms. Finally, the last section of the book considers policy debates over the stabilization of the economy, government debt, and financial crises.

CASE STUDY EXTENSION

1-1        The Recent Behavior of the U.S. Economy: A Guide to the
Case Studies

Many of the case studies in the textbook address the recent history of the U.S. economy. Taken together, the case studies provide a picture of the U.S. economic experience during this century, particularly over the past several decades. The following is an overview:

For a basic picture of U.S. economic performance, the Chapter 1 case study “The Historical Performance of the U.S. Economy” shows the behavior of real GDP, inflation, and unemployment since 1900. The long-run picture shows that GDP grows through time, although this growth is often interrupted by recessions, most recently in 2007–2009. Chapter 11 case study “The Slowdown in Productivity Growth” notes the slowdown in the long-run growth rate experienced by the United States and other countries that began in the early 1970s. Another Chapter 11 case study, “Good Management as a Source of Productivity,” highlights the importance of differences in management practices as a reason why countries have experienced differences in productivity performance. Chapter 16 case studies “The Sacrifice Ration in Practice” and “The Covid-19 Recession and Its Inflationary Aftermath” show unemployment and inflation in the 1980s, and the effects of the Covid-19 pandemic on employment and the economy respectively.

Chapter 12 case study “How OPEC Helped Cause Stagflation in the 1970s and Euphoria in the 1980s” explains how the experience of the 1970s was in large measure the result of supply shocks associated with increases in the price of oil. The United States thus entered the 1980s with very high inflation rates by historical standards. Eliminating this inflation was a top priority for Federal Reserve Chair Paul Volcker, who pursued a tight monetary policy. Nominal interest rates rose in the short run but fell in the longer run as the inflation rate fell, as discussed in the Chapter 13 case study “Does a Monetary Tightening Raise or Lower Interest Rates?” As a result of these policies, the U.S. economy also entered what was at the time the most severe contraction since the 1930s.

Although monetary policy was contractionary, fiscal policy in the 1980s was expansionary. Taxes were cut, and spending rose. The fall in government saving (rise in the government deficit) caused the debt to reach a level unprecedented in peacetime (see the Chapter 19 case study “The Troubling Long-Term Outlook for Fiscal Policy” for a long-run perspective on the debt).

Ultimately, the tight monetary policies did succeed in decreasing inflation and inflation expectations, and the economy gradually returned to full employment. This recovery was aided by a fall in oil prices in the mid-1980s (Chapter 12 case study cited above). By the end of the decade, output was close to the natural rate, and inflation was low.

While the 1990s witnessed the longest period of expansion during the postwar era, the business cycle had not been vanquished as two recessions occurred during the first decade of the 2000s. The onset of recession in 2001 is analyzed in the Chapter 14 case study “The U.S. Recession of 2001.” Following several years of expansion, the economy then experienced a deep and prolonged recession beginning at the end of 2007, as discussed in the Chapter 14 case study “The Financial Crisis and Great Recession of 2008–2009.” The sluggish recovery from that recession may have been exacerbated by uncertainty concerning the course of economic policy, a topic discussed in the Chapter 18 case study “How Does Policy Uncertainty Affect the Economy?”

ADDITIONAL CASE STUDY

1-2        Presidential Elections and the Economy

The influence of economic events on politics is apparent during presidential elections. Economic policy provides a primary topic of debate for the candidates, and the state of the economy has a powerful influence on the outcome of the election. In fact, according to economist Ray Fair, one can forecast the outcome of a presidential election with remarkable accuracy by looking at how well the economy is doing. History shows that the incumbent party is helped by growing incomes and is hurt by rising prices.

Fair has used the historical evidence to produce an equation that forecasts the winner of the popular vote (but not that of the electoral college!) using the following information:

• which party is currently in power,
• whether an incumbent is running for reelection,
• the number of terms the incumbent party has been in power,
• the growth in income per person in the first three quarters of the election year,
• the rate at which prices have been rising in the two years prior to the election, and
• the number of quarters during the current administration (prior to the election) in which the growth rate of real income per person was greater than 3.2 percent.

Fair’s equation would have correctly predicted the winner of the popular vote in 21 of the 26 presidential elections from 1916 to 2016.[1] The elections it would have missed were Kennedy–Nixon in 1960, Humphrey–Nixon in 1968, Bush–Clinton in 1992, Bush–Gore in 2000, and Clinton–Trump in 2016. Predicting the Bush–Clinton election was complicated by the strong showing of a third-party candidate, Ross Perot. Fair’s model assumes that Perot drew votes away equally from Bush and Clinton. Interestingly, the equation predicted that Al Gore would lose the popular vote in the 2000 election, when in fact he won a majority but lost in the electoral-college tally. Similarly, the model predicted Clinton would fall short in the popular vote in 2016, but she actually bested her opponent by 3 million votes, while losing the presidency in the electoral college.

Fair’s analysis indicates that voters apparently have a short time horizon with regard to economic events. This provides support for the view that administrations can manipulate the economy in an attempt to improve their reelection chances.[2]

Even though the state of the economy is apparently very important in determining presidential election outcomes, this need not mean that voters look only to their own economic well-being. Research by social psychologists and political scientists on the motivations of individual voters suggests that they in fact take a broader view. Donald Kinder and David Sears summarize this research as follows:

With respect to economic performance, voters may simply examine their own circumstances, supporting candidates and parties that best advance their own economic interests. Yet such “pocketbook” voters are hard to find. Although the economic predicaments of personal life do occasionally influence political choice, the effects are never very strong and usually they are utterly trivial. Declining financial condition, job loss, preoccupation with personal problems—none of these seems generally to motivate presidential voting.

Whereas pocketbook voters might ask the political system and its officials, “What have you done for me lately?” sociotropic voters would ask, “What have you done for the country lately?” The political preferences of sociotropic voters are shaped by the country’s economic predicament, not their own; they support candidates and parties that appear to best advance the nation’s well-being. And indeed, presidential voting seems to reflect more the assessment of national economic conditions than the economic circumstances of private life.[3]

ADDITIONAL CASE STUDY

1-3        When Is the Economy in a Recession?

On November 26, 2001, the Business Cycle Dating Committee of the National Bureau of Economic Research reported that the U.S. economy had entered a recession during March 2001. The committee, which is composed of leading macroeconomists, made its decision even though data on real GDP showed a small increase in April through June quarter of the year and began to decline only during the July to September quarter. A popular rule of thumb used by the media (and economists) is that a recession occurs when a decline in real GDP lasts for at least two consecutive quarters. At the time that the Business Cycle Dating Committee issued its report, real GDP had declined for only one quarter. Why then did the committee make the call that a recession had begun?

The committee defines a recession as “a significant decline in activity spread across the economy, lasting more than a few months, [and] visible in industrial production, employment, real income, and wholesale-retail trade.”[4] Unlike the popular rule of thumb, “the committee gives relatively little weight to real GDP because it is only measured quarterly and it is subject to continuing, large revisions.”[5] The data the committee emphasizes are available monthly, with at most only a couple of weeks’ lag between the end of the month and the time when the data are released. This feature of the data allows the committee to date recessions monthly. Although the monthly data are subject to revisions, these revisions tend to occur sooner and are often smaller than those for GDP.

In their report, the committee noted that real manufacturing and trade sales had peaked in August 2000, industrial production (the output of factories, mines, and utilities) had peaked in September 2000, and employment had peaked in March 2001. In addition, all three of these indicators had shown persistent declines into the fall of 2001. Real personal income (net of transfer payments), however, had not reached a peak and was still growing. The committee concluded that the decline in industrial output and employment was substantial enough and sufficiently spread across sectors of the economy to warrant the dating of a recession. In choosing the peak-employment month of March as the turning point, the committee emphasized total employment as the broadest measure of economic activity on a monthly basis.

Nearly 20 months after reporting on the start of the recession, the committee met again on July 17, 2003, and determined that the recession had ended in November 2001. The relatively long delay in dating the trough of the recession was the result of mixed signals from the data. Even though real GDP, sales, and income all grew strongly during 2002, employment had not yet begun to recover and industrial production remained well below its previous peak. As a result, “the committee waited to make the determination of the trough date until it was confident that any future downturn in the economy would be considered a new recession and not a continuation of the recession that began in March 2001.”[6]

Again in late 2008, as signs intensified that economic performance had deteriorated, the committee met on November 28 and determined that the economic expansion had ended nearly a year earlier, in December 2007. In arriving at its decision, the committee emphasized payroll employment, which it described as the “most reliable comprehensive estimate of employment.”[7] The committee noted that employment peaked in December 2007 and had declined every month since then.

Almost two years later, on September 20, 2010, the committee determined that economic conditions had bottomed out in June 2009, making the recession, at 18 months, the longest since the Great Depression. Once again, the committee had waited to make its decision to ensure that “any future downturn would be a new recession and not a continuation of the recession that began in December 2007.”[8] In arriving at its decision, the committee emphasized accelerating growth in GDP during the last half of 2009, even as employment continued to decline, noting that in “previous business cycles, aggregate hours and employment have frequently reached their troughs later than the NBER’s trough date.”[9]

LECTURE SUPPLEMENT

1-4        Economic Rhetoric

The textbook proceeds, as do economists, by applying different models to different questions. Judging whether or not a given model is appropriate is difficult; any model, by definition, leaves things out, and there is no simple way to know whether we have included or excluded the “right” features of the world. Progress is made in macroeconomics by building models that help to explain existing data and then by comparing those models to other data. Economists agree about much of this progress. But it would be dishonest not to recognize that disputes do exist about the appropriate model for a given problem, or, for that matter, to argue that such disputes are resolved in a neat and orderly way by careful statistical tests of theory.

The data inform our inquiry but are simply not good enough or abundant enough to settle many of the important questions beyond dispute.[10] The important questions, meanwhile, often turn in part on issues of policy and politics. Throughout the history of macroeconomics, there has been disagreement between economists who believe that the economy functions well without government intervention and those who believe that the government can improve economic performance. This basic disagreement has survived numerous refinements of our macroeconomic models and numerous confrontations of those models with the data.

The economist and economic historian D. McCloskey argues that economists claim to adopt a particular “scientific” methodology to settle such disputes, whereas in practice they—like other scientists—proceed by persuasion, rhetoric, and metaphor.[11] The modernist methodology to which economists nominally subscribe is, according to McCloskey and many others, rigid and outdated; McCloskey believes that economics would benefit if economists acknowledged how their research is really carried out[12]:

Economists . . . would resent the suggestion that their talk is “rhetoric.” That they cling to a somber modernist faith does not mean, of course, that in their actual scholarly practices they follow it. One sign of the tension between rhetorical practice and methodological faith is their joking. A memorandum circulated in May 1983 among the staff at the Council of Economic Advisors, for instance, included these pieces of encapsulated unease: “Mankiw’s Maxim: No issue in economics has ever been decided on the basis of the facts.” “Nihilistic Corollary I: No issue has ever been decided on the basis of theory, either.[13]

McCloskey’s argument is not at all that economics is unscientific or useless but simply that the conventions of economic discourse impede fruitful communication:

In the flight of rockets the layman can see the marvel of physics, and in the applause of audiences the marvel of music. No one understands the marvel of economics well who has not studied it with care. This leaves its reputation in the hands of politicians and journalists, who have other things on their minds. The result is much mistaken criticism of economics as being too mathematical or as not being “realistic” enough or as not saving the world from its folly. The misinformation is a pity, really, and worth trying to offset. Yet these outside observers of economics cannot be blamed for misunderstanding it. Economics does not very well understand itself. If it understood its own way of conversing—its rhetoric—maybe some of its neurotic behavior would stop.[14]

The extent of real disagreement among economists, as we have argued several times, is in fact exaggerated. The extent of their agreement, however, makes the more puzzling the venom they bring to minor disputes. The assaults on Milton Friedman or on J.K. Galbraith have a bitterness beyond reason. The unreason, though, has its reason. If one cannot reason about values, and if what matters most is placed in the value half of the fact-value split, then it follows that one will embrace unreason when talking about things that matter. The claims of an overblown methodology of science serve merely to spoil the conversation. Economists, without thinking much, have metaphors about the economy; and they have also, without thinking much, metaphors for their scholarly conversation. It would be good for them to become aware of their metaphors and improve them in shared discourse.[15]

Mastery of the models and ideas explained in the textbook will not provide answers to all of the questions or disputes that concern macroeconomists. But it will help the reader to be an informed participant in the macroeconomic conversation.

LECTURE SUPPLEMENT

1-5        Additional Readings

Supplements to various chapters suggest additional readings that may be useful for students who are writing papers, doing projects, or simply wishing to know more about the topics covered in the textbook. The sources listed are relatively accessible to students. Some of the readings cited in the supplements are from these sources.

The Journal of Economic Perspectives includes symposia and review articles designed to explain economic ideas to nonspecialists. Although the mathematical sophistication of these articles varies, students should usually be able at least to grasp the basic ideas discussed.

The American Economic Review Papers and Proceedings,published in May of each year, includes papers from the American Economic Association’s annual conference. Each issue includes about three or four short papers on each of about two dozen topics of current interest to researchers. These papers are usually nontechnical discussions of recent research by the author(s).

The Journal of Economic Literature is an important source of references. It includes listings of academic journal publications, indexed by author, and thus is the place to look for references to work by a particular individual as well as to check the contents of recent academic journals. It also includes many book reviews, grouped by subject area, and occasional detailed survey articles.

The New Palgrave is a four-volume encyclopedia of economics.[16] The articles published in it vary greatly in terms of length, technical sophistication, and breadth and idiosyncrasy of coverage. Nevertheless, with a bit of persistence, students researching a topic are more likely than not to find helpful information in these volumes.

The Brookings Papers on Economic Activity contain articles on current macroeconomic topics and a summary of discussions of those articles by leading macroeconomists. The National Bureau of Economic Research Macroeconomics Annuals (Cambridge, MA: MIT Press) adopts a similar format.

The publications of the various Federal Reserve Banks often include articles that are both useful and accessible. These are available on the Internet.

The Economist newsmagazine generally has good coverage of world economic and political events informed by sensible economic reasoning.

The Economic Report of the President is an excellent source for basic macroeconomic data.

Whereas economics journals generally contain articles that are technically sophisticated in terms of the mathematics and the statistics they employ, it is often possible for the discerning student to grasp the main point of many articles without getting too embroiled in the mathematics and econometrics. Good general journals to consult are American Economic Review, Economic Journal, Journal of Political Economy, and Quarterly Journal of Economics. Some of these journals occasionally include survey articles or review articles.

Finally, daily newspapers such as the New York Times or the Wall Street Journal are always worth reading to keep up to date on current economic news.

[1] R. Fair, “Presidential and Congressional Vote-Share Equations,” American Journal of Political Science 53, no. 1 (January 2009): 55–72. The 2014 update to Fair’s equations, available at fairmodel.econ.yale.edu/, now correctly predicts vote shares for the Wilson–Hughes election of 1916.

[2] See the discussion of the political business cycle in Chapter 16 and also Supplements 18-8, “Distrust of Policymakers,” and 18-9, “The Political Business Cycle.”

[3] D.R. Kinder and D.O. Sears, “Public Opinion and Political Action,” in The Handbook of Social Psychology, vol. 2, 3rd ed., edited by G. Lindzey and E. Aronson (New York: Random House, 1985), 689–690. This quotation omits the references in the text.

[4] Business Cycle Dating Committee, “The Business-Cycle Peak of March 2001,” National Bureau of Economic Research, November 26, 2001, p. 1. For further details on business cycle dating, see the committee’s web page, at www.nber.org/cycles.

[5] Ibid., p. 1. The recent move to a chain-weight measure of real GDP, however, eliminated one reason for revisions that occurred in the past when base-year weights were updated. Even so, GDP continues to be subject to major revisions as new source data become available, sometimes with a lag of several years.

[6] Business Cycle Dating Committee, “July 17, 2003 Announcement,” National Bureau of Economic Research, July 17, 2003, p. 1.

[7] Business Cycle Dating Committee, “Determination of the December 2007 Peak in Economic Activity,” National Bureau of Economic Research, December 11, 2008, p. 1.

[8] Business Cycle Dating Committee, “Announcement of June 2009 Business Cycle Trough/End of Last Recession,” National Bureau of Economic Research, September 20, 2010, p. 1.

[9] Ibid., p. 2.

[10] See Supplement 18-7, “Spare a Thought for the Empirical Macroeconomist.”

[11] See D. McCloskey, The Rhetoric of Economics (Madison: University of Wisconsin Press, 1985).

[12] While McCloskey accuses economists of adopting an outdated methodology, he has been accused in turn of utilizing outdated modes of literary criticism. See W. Milberg, “The Language of Economics: Deconstructing the Neoclassical Text,” Social Concept (1988) and A. Klamer, D. McCloskey, and R. Solow, The Consequences of Economic Rhetoric (Cambridge: Cambridge University Press, 1988).

[13] McCloskey, The Rhetoric of Economics, 30–31.

[14] Ibid., xix.

[15] Ibid., 184.

[16] P. Newman, J. Eatwell, and M. Milgate, eds., The New Palgrave: A Dictionary of Economics,2nd ed. (London: Palgrave Macmillan, 2008).

Full Solution Manuals here