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Lecture

Macroeconomics Chapters 1-6

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Department
Economics
Course
ECON 1BB3
Professor
Bridget O' Shaughnessy
Semester
Winter

Description
1 Chapter 1 Ten Principles of Economics How people make decisions 1) People face tradeoffs  Efficiency vs. equity  Efficiency: society is getting the most it can from its scarce resources  Equity: the benefits of the resources are distributed fairly among the members of society  Ex. efficiency= size of economic pie, equity= how the pie is divided 2) The cost of something is what you give up to get it  Opportunity cost  Making decisions requires comparing the costs and benefits of alternative courses of action  What you give up to do or get something else 3) Rational people think at the margin  “The next step” (forward thinking)  People tend to weight the cost vs. the benefit 4) People respond to incentives  Because people make decisions by weighing costs and benefits, people will respond to incentives How people interact 5) Trade can make everyone better off  Ex. International trade  The benefits for the majority outweigh the losses of the minority  To compensate for the losses, the majority must provide something back  Ex. job retraining 6) Markets tend to increase efficiency  Compared to “central planning”  Open market vs. communism  Communism is not equitable because not everyone works equally, but everyone is expected to share the profits equally 7) Sometimes the government can eliminate market inefficiencies  Externalities can cause market failure (a situation in which a market left on its own fails to allocate resources efficiently)  Positive  Ex. vaccines benefit society because if one person is vaccinated then they can’t infect someone else  Negative  Ex. smoking can give other people problems  The government eliminates this by raising taxes How the economy works as a whole 8) A country’s standard of living depends on its productivity  Standard of living: per capita GDP  Productivity: output per worker 9) Prices increase when the government prints too much money  Ex. Zimbabwe  2009 inflation rate: 5.1%  2008 inflation rate: 14.9 billion %  Hyperinflation 10) There is a short-run trade-off between inflation and unemployment  Unemployment increases when inflation decreases 2 Chapter 2 1) How to express ideas in economics a) English language: “When the price of Coke goes up, people drink less” b) Algebra/equations: Q c 100 – 0.65P c c) Diagrams/graphs 2) Economics is a social science  Social = people  Science = use scientific method  “Natural experiment”  designed for another purpose but can be used for data collection  Observe  Theorize  Test theory 3) Microeconomics vs. macroeconomics  Microeconomics: individual households/firms and how they interact  Macroeconomics: economy wide  Interest rates, unemployment, money, growth 4) Efficiency vs. equity  Efficiency: size of a pie  Equity: how the pie is divided 5) Positive analysis vs. normative analysis  Positive: an attempt to describe the world “as it is”  Can be proved or disproved  Normative: an attempt to describe the world “as it should be”  Value judgement, opinion 6) Model = simplification  Ex. map of a city: smaller, simpler, main streets only  Diagrams or equations  Assumptions  Variables 7) Classify variables  Real variables vs. nominal variables  Real variables: quantities  physical units  Nominal variables: $  Stock variables vs. flow variables  Stock: snapshot at a point in time  Flow: measured over a time period 3 Example of a model: Circular Flow Diagram Why economists disagree 1) Differences in scientific judgments  Economics is a young science  Sometimes economists disagree on the validity of alternative theories or about the size of important parameters 2) Differences in values  Are certain policies fair?  Economists often disagree on public policy  Policies cannot be written or judged on scientific grounds alone 3) Perception vs. Reality  Even though economists may disagree in scientific judgments and values, often economists offer a united view  Ex. rent control: almost all economists believe that rent control adversely affects the availability and quality of housing and is a costly way to helping the most needy members of society  So why do certain policies still exist?  the general public is not convinced 4 Chapter 3 The Production Possibilities Frontier Example 1: 2 interior decorators who paint and wallpaper rooms work 40 hours per week. Martha can paint 20 rooms or wallpaper 5 rooms and Stewart can paint 10 rooms or wallpaper 8 rooms. Number of rooms done in 40 hours Number of hours needed to do 1 room Paint Wallpaper Paint Wallpaper Martha 20 5 Martha 2 8 Stewart 10 8 Stewart 4 5  Opportunity cost: whatever must be given up to obtain some item Opportunity cost of 1 room Paint Wallpaper Martha 1/4 4 Stewart 4/5 5/4  Martha’s opportunity cost of 20 painted rooms is 5 wallpapered rooms  Martha’s opportunity cost of 1 painted room is ¼ wallpapered room  Martha’s opportunity cost of 5 wallpapered rooms is 20 painted rooms  Martha’s opportunity cost of 1 wallpapered room is 4 painted rooms  Absolute advantage: the ability to produce a good with a smaller quantity of inputs  Look at total numbers Number of rooms done in 40 hours Paint Wallpaper Martha 20 5 Stewart 10 8  Overall, Martha produces 20 painted rooms to Stewart’s 10 painted rooms  Martha has the absolute advantage in painted rooms  Overall, Martha produces 5 wallpapered rooms to Stewart’s 8 wallpapered rooms  Stewarts has the absolute advantage in wallpapered rooms 5  Comparative advantage: the ability to produce a good with a smaller opportunity cost  Can never have comparative advantage in both goods  Comparative advantage reflects the relative opportunity cost Opportunity cost of 1 room Paint Wallpaper Martha 1/4 4 Stewart 4/5 5/4  The person with the smaller opportunity cost has the comparative advantage  Martha has the comparative advantage in paint  Stewart has the comparative advantage in wallpaper Example 2: Say Stewart can only produce 4 wallpapered rooms instead of 8 Number of rooms done in 40 hours Paint Wallpaper Martha 20 5 Stewart 10 4  Absolute advantage: Martha now has the absolute advantage in both goods Number of rooms done in 40 hours Paint Wallpaper Martha 20 5 Stewart 10 4  Comparative advantage: Martha has the comparative advantage in painted rooms, Stewart has the comparative advantage in wallpapered rooms Opportunity cost of 1 room Paint Wallpaper Martha 1/4 4 Stewart 2/5 5/2  Who should produce what?  Martha should produce painted rooms and Stewart should produce more wallpapered rooms  Always produce what you have the comparative advantage in because you “suck less” at producing it than the other good 6 Chapter 4 The Market Forces of Supply and Demand Markets  Market: group of buyers and sellers  4 types of market structure  1) Perfect competition: any one individual cannot influence the market  2) Monopoly: one seller controls the price (somewhat because price is based on demand)  3) Oligopoly: a few sellers  4) Monopolistic competition  We assume a perfectly competitive market (for this chapter)  The goods offered for sale are all exactly the same  No single buyer can influence the market Demand  Quantity demanded (Q ) is the amount of a good that buyers are willing and able to purchase  The variables that influence how much buyers want to buy are  1) Price  2) Income  Normal goods (if my income goes up, I buy more)  Inferior goods (I buy this because I can’t afford something better)  3) Price of other goods  Substitutes (when the price of one goes up, more of the substitute is bought)  Ex. if the price of Coke goes up, I buy more Pepsi  Complements (two things that are generally bought together)  Ex. car and gas or burgers and buns  4) Tastes  5) Expectations (expecting something to happen to the price of something in the future which affects your decision to buy today)  New information  NOT seasonal events Law of Demand  All other things equal (ceteris paribus), the quantity demanded of a good falls as the price of the good rises  Demand schedule: a table that shows the relationship between the price of a good and the quantity demanded Price Quantity 0.05 1000 0.10 800 0.15 600 0.20 400 0.25 200  Market demand: the sum of individual demands 7  Shifts in demand (change in demand) are caused by a change in anything other than price  Movement along the demand curve (change in quantity demanded) is caused by a change in price  If demand INCREASES, the curve shifts OUT (to the right)  If demand DECREASES, the curve shifts IN (to the left) Supply  Quantity supplied (Q ) is the amount of a good that sellers are willing and able to sell  The variables that influence how much sellers want to sell are  1) Price  Firms exist to make profit  When price goes up, Q goes up as well  2) Input prices (production costs)  If the price stays constant, the profit goes down when the production cost increases  Less is sold  3) Technology  4) Expectations (how a firm responds to an expected price of the good) Law of Supply  All other things equal (ceteris paribus), the quantity supplied of a good rises as the price of the good rises Price Quantity
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