ECON7074 Chap.1 Macroeconomic Questions, Models and Causality
Macroeconomic Questions, Models and Causality
This opening chapter sets out what macroeconomics studies and how it reasons. It begins with scarcity and incentives, separates the household-and-firm focus of microeconomics from the economy-wide focus of macroeconomics, and lists the kinds of questions the course asks about national wealth, inflation episodes, financial crises and deficits.
The fallacy of composition explains why aggregates need their own analysis: a plan that works for one firm or household can fail when everyone follows it. The chapter then dissects a model into exogenous inputs, endogenous outcomes and parameters, solves a small spending model and runs a one-variable experiment.
It closes with correlation versus causation, the course's three tests of a useful model, and the assumptions economists usually make about people and resources.
What this chapter covers
- 01
Scarcity, choice and incentives
- 02
Microeconomics versus macroeconomics
- 03
The fallacy of composition
- 04
Exogenous, endogenous and parameter roles
- 05
Solving a model and running an experiment
- 06
Correlation, causation and model testing
Worked example · free
Why every depositor withdrawing cash can sink a sound bank
- +1For one depositor acting alone, the bank pays from the reserves it keeps for routine withdrawals, so her savings stay safe.
- +1When every depositor withdraws together, the requests far exceed the bank's reserves, because most deposits have been lent out.
- +1To raise cash quickly the bank must sell its loans cheaply, so a bank that was sound under normal conditions takes heavy losses.
- +1If the losses exceed its capital the bank fails and later depositors lose savings; assuming the individual result scales up is the fallacy of composition.
Key terms
- Scarcity
- The condition in which wants exceed the resources available to satisfy them, which forces every choice to give up an alternative.
- Macroeconomics
- Branch of economics that analyses the performance of national and global economies through aggregates such as output, prices and unemployment.
- Exogenous variable
- An input whose path the modeller sets from outside the model; the model takes it as given rather than explaining it.
- Endogenous variable
- An outcome determined inside a model by its equations, such as output in a spending model.
- Model parameter
- A fixed number linking inputs to outcomes that changes only when the modeller alters it to run an experiment.
- Spurious correlation
- Co-movement between two series that arises by chance or from a shared driver rather than from a causal link between them.
Macroeconomic Questions, Models and Causality FAQ
What is the difference between micro and macroeconomics?
Microeconomics studies the choices of individual households and firms and how they interact in particular markets. Macroeconomics studies the performance of an economy as a whole, using aggregates such as total output, the general price level and the unemployment rate. The course treats macro as a separate field because aggregate outcomes can differ from the sum of individual plans.
Why does the fallacy of composition matter for macroeconomics?
It shows that a plan which works for one decision maker can fail when everyone adopts it, because the combined action changes incomes and prices for all. Cutting spending or withdrawing deposits can each help one household, yet reduce demand or break a bank when done economy-wide. Spotting this feedback is a core macroeconomic skill.
How do I tell exogenous variables from parameters?
Both are taken as given by the model, but they play different roles. An exogenous variable is a given input whose value may vary from period to period, such as government purchases. A parameter is a fixed coefficient that links inputs to outcomes, such as the share of extra income consumed, and changes only when you deliberately run an experiment on it.
Does a strong correlation prove that one variable causes another?
No. A correlation only shows that two series move together. The link can be coincidental, or a third factor can drive both. For a causal claim the course asks that the cause comes before the effect and is directly connected to it in the data, and a careful answer names the most likely common driver and explains why it is ruled out.
What makes an economic model useful?
The course gives three tests: the model predicts well, its mechanism can be understood and explained, and its results are not just a restatement of its assumptions. A good model also gets magnitudes roughly right. Data that agree with its predictions confirm it provisionally, while data that contradict it falsify it and call for a revised model.
Exam move
Build this chapter around habits you will reuse all semester. For every model you meet, write a three-column list of exogenous inputs, endogenous outcomes and parameters before doing any algebra, then solve and check the answer against the original equation. Practise the fallacy of composition by taking a sensible individual plan, such as saving more or cutting prices, and tracing what happens when everyone follows it.
For causal questions, rehearse a four-sentence answer: the association, the proposed mechanism, a rival common driver, and the evidence that would separate them. These short structures make later growth and money questions faster to answer cleanly.
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