Principles of Macroeconomics / Unit 18 MAC 1717 worked example, 60 to 90 seconds
Choosing the Right Model
The idea
Given an unfamiliar question, decide which model answers it before doing anything else. Ask what the question's variables are. Output and the price level together means aggregate demand and supply. One good's price and quantity means a single market. An interest rate means either the money market or loanable funds, and what is traded decides which.
In practice
A question asks what a rise in consumer confidence does to output and prices: two aggregate variables, so aggregate demand and supply. A question asks what a tax on imported steel does to the price and quantity of steel: one good, so a single market. A question asks what happens to the real interest rate when households save more: saving against borrowing, so loanable funds. A question asks what happens to the interest rate when the central bank buys bonds: money against bonds, so the money market. A question asks what happens to exports when a currency weakens: foreign exchange, then the goods market it feeds.
Where people slip
Two of those could be argued into a second model, and the tie-breaker is what the question names as changing. A central bank action names the money supply, so it is the money market. Household saving names saving, so it is loanable funds. Follow the variable the question actually moves rather than the outcome it asks about.
Your place on the trail
Every lesson rests on earlier ones and opens later ones. Tap any to jump.
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