Everyone is concerned about macroeconomics lately. We wonder why some countries are growing faster than others and why inflation fluctuates. Why? Because 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.
Recently, there is much discussion of recessions— periods in which real GDP falls mildly– and depressions, when GDP falls more severely. Macroeconomists are also concerned with issues such as inflation, unemployment, monetary and fiscal policies—all of which, will be discussed at length in Macroeconomics, 5th ed., Mankiw’s Macroeconomics Modules, and in your macroeconomics course.
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.
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 equilibrium.
Market clearing is an alignment process whereby decisions between suppliers and demanders reach an equilibrium. Here’s how it works. 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.
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 not realistic. 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.