Macroeconomics Notes

Macroeconomics Notes Chapter 1          Economics- The social science that studies how individuals, institutions, and society make optimal choices under conditions of scarcity. Economics is a social science concerned with making optimal choices under conditions of scarcity. Human wants are unlimited, but the means to satisfy the wants are limited. Economic wants exceed society’s productive capacity. Economics deals primarily with the concept of scarcity. Economic Perspective- Economic way of thinking. A viewpoint that envisions individuals and institutions making rational decisions by comparing the marginal benefits and marginal costs associated with their actions. o “You can’t have it all” We have to choose or select what we really want or forgo or postpone. Suppose you get $550 as allowance to spend every month. As a student, you have to use that to meet daily college expenses—photocopying, buying lunch/snacks, or books (option A). You can either spend the $550 on these things or simply get an iPad (option B). You cannot have both at the same time. You cannot have it all. Either option A or option B. Maybe you can postpone getting an iPad for next month or maybe later. What is the resource here? “Money”. This makes us understand the concept of forgoing one thing to have the other. That sacrifice is the concept of opportunity cost- forgoing one thing to have another. As resources are always limited or fall short of the needs of human beings. Opportunity Cost- To obtain more of one thing, society forgoes the opportunity of getting the next best thing. Choices and tradeoffs. The price that you pay for giving something up. o Opportunity cost is not only monetary cost. o Opportunity cost is the value of the next best thing forgone. o Opportunity costs are always present whenever a decision is made. Tradeoffs- The idea that because of scarcity, producing more of one good means producing less of the other. Classic example is of “Guns and Butter”. The more a society spends on national defense to protect its shores from foreign aggressors, the less it can spend on consumer goods to raise the standard of living. The overriding reason why households and societies face many decisions is that resources are scarce. When a society cannot produce all the goods and services people wish to have, it is said that the economy is experiencing scarcity. The adage, “There is no such thing as a free lunch,” means people face tradeoffs. Sofia is planning her activities for a hot summer day. She would like to go to the local swimming pool and see the latest blockbuster movie, but because she can only get        tickets to the movie for that same time that the pool is open, she can only choose one activity. This illustrates the basic principle that people face tradeoffs. Guns and butter are used to represent the classic societal tradeoff between spending on national defense and consumer goods. Resources/Factors of Production/ Factor Inputs- anything that can be used to produce something else. Resources are scare. The quantity available is not large enough to satisfy all productive uses. Examples of resources are land, labor, capital and human capital. Since resources are limited, society must make choices. o Land- gifts of nature. For example, rivers, oil, waterways, fuel, trees, forests, land for mining or agriculture purposes. o Labor- labor and ingenuity, skilled labor, human capital. Labor in economics does not only mean workers with blue collared jobs, but all working labor. o Capital- tools and equipment, machinery. Capital does not mean only money in economics. Investment in machines, buildings, commercial vehicles used in a business. o Time- Time is also a resource. In most societies, resources are allocated by the combined actions of millions of households and firms. Efficiency refers to how much a society can produce with its resources. Equality refers to how evenly the benefits from using resources are distributed among members of society. Purposeful Behavior/ Rational Behavior- is when people make decisions with some desired outcome in mind. Being rational, making the best choice. o Rational self-interest entails making decisions to achieve maximum utility. A Utility is the pleasure or satisfaction obtained from consuming a good or service. o Different preferences and circumstances (including errors) lead to different choices. o Rational self-interest is not the same thing as selfishness. Marginal Analysis- comparing benefits and costs. Marginal Analysis is comparisons of marginal benefits and marginal costs, for decision making. o Most decisions concern a change in current conditions; therefore the economic perspective is largely focused on marginal analysis. o Each option considered weighs the marginal benefit against the marginal cost. o Whether the decision is personal or one make by business or government, the principle is the same. o The marginal cost of an action should not exceed its marginal benefits. Theories, Principles, and Models- Economists use the scientific method to establish theories, laws, and principles. Economics is based on theories, principles, and models.       o The scientific method is a procedure for the systematic pursuit of knowledge involving the observation of facts and the formulation and testing of the hypothesis to obtain theories, principles, and laws. o The scientific method consists of:  The formation of facts (real data).  The formulations of explanations of cause and effect relationships (hypothesis) based upon the facts.  The testing of the hypothesis.  The acceptance, rejection, or modification of the hypothesis.  The continued testing with an eye toward determination of a theory, law, principle, or model. o Economic Principle- a widely accepted generalization about the economic behavior of individuals or institutions. o Other-things-equal-assumption- The assumption that factors other than those being considered are held constant. (Ceteris paribus assumption). Macroeconomics- The part of economics concerned with the economy as a whole. The study of the entire economy or a major aggregate of the economy. o It includes measures of total output, total employment, total income, aggregate expenditures, and the general price level. o It is a general overview examining the beach, not the sand, rocks and shells. Aggregate- A collection of specific economic units treated as if they were one. For example, all prices of individual goods and services are combined into a price level, or all units of output are aggregated into gross domestic product. Microeconomics- The part of economics concerned with decision making by individual units such as a household, a firm, or an industry and with individual markets, specific goods and services, and product and resource prices. Looks at specific economic units. o It is concerned with the individual industry, firm, or household and the price of specific products and resources. o It is an examination of sand, rocks, and shells, not the whole beach. Positive Economics- Economic statements that focus on facts and cause-and-effect relationships. Description. How things are. Ex. Society faces a tradeoff between inflation and unemployment. Normative Economics- The part of economics involving value judgments about what the economy should be like; focused on which economic goals and policies should be implemented; policy economics. Prescription. How things should be. Ex. Society ought to require welfare recipients to look for jobs. Economizing Problem- The choices necessitated because society's economic wants for goods and services are unlimited but the resources available to satisfy these wants are limited (scarce). The need to make choices because economic wants exceed economic means.            Budget Line- A line that shows the different combinations of two products a consumer can purchase with a specific money income, given the product's prices. Production Possibilities Curve (PPC) - A curve showing the different combinations of two goods or services that can be produced in a full-employment, full-production economy where the available supplies of resources and technology are fixed. Production Possibilities Model- Economic model that shows different combinations of two goods that an economy can produce. The production possibilities frontier provides an illustration of the principle that people face tradeoffs. The bowed shape of the production possibilities frontier can be explained by the fact that the opportunity cost of one good in terms of the other depends on how much of each good the economy is producing. Law of increasing opportunities cost- The principle that as the production of a goods increases, the opportunity cost of producing an additional unit rises. Economic growth- (1) An outward shift in the production possibilities curve that results from an increase in resource supplies or quality or an improvement in technology; (2) an increase of real output (gross domestic product) or real output per capital. Any point on a country’s production possibilities frontier represents a combination of two goods that an economy can produce using all available resources and technology. Suppose a nation is currently producing at a point inside its production possibilities frontier. We know that the nation is not using all available resources or is using inferior technology. A production possibilities frontier can shift outward if there is a technological improvement. The production possibilities frontier is used to illustrate some basic economic ideas, including scarcity, opportunity cost, and economic growth. Chapter 2       Economic Systems: -set of institutionalized arrangements. –who owns the factors of production. Command Economy- an economic system in which property resources are publicly owned and government uses central economic planning to direct and coordinate economic activities. Known as socialism or communism. Government ownership of resources. Decisions are made by a central planning board. Ex. North Korea, Cuba. Market System/ Economy- is a mix of decentralized decision making with some government control. This system is most found in much of the world. Private marketers are a dominant force. Private ownership of resources. Self-Interested behavior. o Characteristics of a Market System: -Private property –Freedom of enterprise – freedom of choice –self-interest –competition –market and prices Technology and Capital Goods: Advanced technology and capital goods are encouraged – Specialization leads to division to labor –Geographic Specialization. Five Fundamental Questionso What goods and services will be produced? –goods and services that create a profit –consumer sovereignty o How will the goods and services be produced? o Who will get the goods and services? o How will the system accommodate change? o How will the system promote progress? The invisible hand- The unobservable market force that helps the demand and supply of goods in a free market to reach equilibrium automatically. The phrase the invisible hand was introduced by Adam Smith in his book “The Wealth of Nations”. He assumed that an economy can work well in a free market scenario where everyone will work for his/ her own interest. –Something that guides free market and capitalism through competition. The Circular Flow Model:    Households- A household consists of all persons occupying a home. Households are suppliers of factors of production (land ,labor, capital, entrepreneur)----particularly labor –used by firms to make goods and services. Households also demand goods and services produced by firms and governments. Roughly 116 million households in the US. Firm, Company, or Business- A firm is an organization that produces a good or service. Most firms produce goods and services to earn profits, there are also non- profit firms, such as universities and some hospitals. Economists use the terms firm, company and business interchangeably. There are almost 30 million businesses in the US. e.g Walmart Factors of production or factor inputs or economic resources- Firms use factors of production to produce goods and services. Main factors of production are land, labor, capital and entrepreneurial ability. Households earn income by supplying factors of production to firms.           Technology- A firm’s technology is the process it uses to produce goods and services. In Economics a firm’s technology depends on many factors, such as skill of its managers, the training of its workers, the speed and efficiency of its machinery and equipment. It is a two sector model because it talks about two sectors: 1) Households 2) Firms (More complex models discuss other sectors like Government and International trade.) 2 TYPES of markets: 1) Resource market- In this market Households sell (factor services) and businesses buy (factor services). 2) Product market 2 Types of decision makers: Households (households buy goods and services) and Firms (firms sell goods and services) Example of Starbucks: How a dollar bill makes it way from person to person through the economy. For instance if a person takes $1 to an economy’s market for goods and services i.e Starbucks coffee shop in this case, the dollar spent on coffee or cookie moves into the Starbucks cash register and it becomes the company’s revenue (Starbucks).It does not stay there for long but the firm or the company uses it to buy factor services. That is how it comes back to the incomes of households from where it is started Rent to landlord (for the space Starbucks occupies) Wages to labor (the employees of Starbucks) A simple circular flow model shows a pure market economy with: no government intervention (no taxes and government spending and no international trade. (Refer to the diagram) Circular flow in the real world -Real world circular flow models are far more complex than a simple circular flow model as they may have 3 sectors or more. They may have households, firms and government sector or international sector. Real world application of a circular flow model: Circulation of income between producers and consumers. How the expenditure of one sector becomes the income of the other and supply of goods and services by one sector of community becomes demand of the other thus it helps you understand the demand and supply models. (Firms are demanders and households are sellers in the factor market. Households are demanders and firms are sellers in the product market.) The circular-flow diagram can help us understand how the economy and provides jobs to the growing population. The number of jobs isn’t fixed, because it depends on how much households spend. However in the real world proper distinction cannot be made between households and firms e.g In a family run business it is hard to tell whether it is an example of a household or a firm (business).The figure does not show government intervention which is a vital part of an economy. Chapter 3         Markets- interaction between buyers and sellers. Markets may be: local, national, and international Price is discovered in the interactions of buyers and sellers Demand- a schedule or curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specifies period of time. Amount customers are willing and able to purchase at a given price. Law of Demand- other things equal, as price falls, the quantity of demand rises, and as price rises, the quantity of demand falls. Explanation- price acts as an obstacle to buyers. Determinants of Demand- change in consumer tastes and preferences, change in the number of buyers, change in consumers income, change in price of related goods (complementary goods, substitute goods), change in consumer expectations The Demand Curve- when there is an increase in demand, the curve shifts to the right. When there is a decrease, the curve shifts to the left. The shape of the curve does not move, just the position. Supply- A schedule or curve that shows the various amounts of a product that producers are willing and able to make available for sale at each of a series of possible prices during a specified period of time. Amount producers are willing and able to sell at a given price. Law of Supply- other things equal, as the price rises, the quantity supplied rises, as the price falls, the quantity supplied falls. Explanation- price acts as an incentive to producers.  Determinants of Supply- a change in resource prices, a change in technology, a change in the number of sellers, a change in prices of other goods, a change in producer expectations.  Market Equilibrium- Equilibrium occurs where the demand curve and supply curve intersect (equilibrium price and quantity). Equilibrium price- is the price where the intentions of buyers and sellers match.      Efficient Allocation- producing goods and services most highly valued by society. Government Set Prices- government intervention Price Ceiling- the maximum legal price a seller may charge for a product or service. Set below the equilibrium price. Ex. Rent control. Max price that sellers may charge. Price Floor- the minimum price fixed by the government. Prices are set above the market price. Ex. Minimum wage.