Study Guides (238,467)
Canada (115,151)
Economics (454)
ECON 1BB3 (162)

Macro Textbook Notes (MIDTERM).docx

37 Pages
Unlock Document

McMaster University
Rita Cossa

Chapter 2: Thinking like an economist 1/8/2013 11:17:00 AM The economist as scientist:  Economists try to address their subject with a scientist’s objectivity.  They approach the study of the economy with the scientific method. The scientific method: Observation, Theory, and more observation.  Economists use theory and observation  Obstacles: o Experiments are often difficult in economics o Usually have to make do with whatever data the world happens to give them.  To find substitute for lab experiments, economists pay close attention to the natural experiments offered by history. The Role of Assumptions  Economist make assumptions to simplify the complex world and make it easier to understand.  Uses different assumptions to answer different questions.  For studying the short-run effects of the policy, we may assume that prices do not change much.  For studying long-run effects of the policy, we assume that all prices are completely flexible. Economic Models  Economists use models to learn about the world which most often composed of diagrams and equations. o Does not include every feature of the economy  All models are built with assumptions o Simplifies reality in order to improve the understanding of it. The Circular-Flow Diagram A visual model of the economy that shows how dollars flow through markets among households and firms.  Includes two types of decision makers o Households  Owns the factors of production  Consume all the goods and services o Firms  Produce goods and services using inputs (factor of production) such as labor, land (natural resources), and capital (buildings and machines).  Both interact in two types of markets: o Markets for goods and services:  Households are buyers and firms are sellers o Markets for the factors of production:  Households are sellers and firms are buyers.  Households provide the inputs that the firms use to produce goods and services.  The inner loop represents the flow of inputs and outputs. o The households sells the use of their labour, land, and capital to the firms in the markets for the factors of production. The firms then use these factors to produce goods and services, which in turn are sold to the households in the markets for goods and services.  The outer loop represents the corresponding flow of dollars. o The households spend money to buy goods and services from the firms. The firms use some of the revenue from these sales to pay for the factors of production. What’s left is the profit of the firm owners, who themselves are members of households. The production possibilities Frontier (Second model)  A graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology.  With the resources it has, the economy can produce at any point on or inside the production, but it cannot produce at points outside.  An outcome is said to be efficient, if the economy is getting all it can from the scarce resources it has available. o Points on the production possibilities frontier represent efficient levels of production.  There is no way to produce more on one product without producing the other product less. (Tradeoff)  Inside the production possibilities frontier represents inefficient outcome. Microeconomic vs. Macroeconomic  Microeconomic: study of how households and firms make decisions and how they interact in specific markets. o Ex. study the effects of rent control on housing in Toronto  Macroeconomic: study of economy wide phenomena. o Ex. Inflation, Unemployment, Economic Growth.  It is impossible to understand macroeconomic developments without considering associated microeconomic decisions. The economist as Policy Adviser  When economists are trying to explain the world, they are scientists.  When they are trying to help improve it, they are policy advisers. Positive vs. Normative Analysis.  Positive statement: are descriptive, they make a claim about how the world is. o Ex. Min. wage laws cause unemployment o Usually by scientists o Confirm or refute positive statements by examining evidence.  Normative statement: prescriptive, they make a claim about how the world ought to be. o Ex. The government should raise the minimum wage. o Usually by policy advisers. o Evaluating it involves values as well as facts but cannot be judged using data alone. Deciding what is good or bad policy is not merely a matter of science. It also involves our views on ethnics, religion, and political philosophy.  A key difference between positive and normative statements is how we judge their validity.  Positive views about how the world works affect normative views about what policies are desirable.  Much of economics is positive but often have goals that are normative. Economists in Ottawa  Harry Truman (U.S. President) was right in realizing that economists’ advice is not always straight forward.  The influence of economists on policy goes beyond their role as advisers: Their research and writings often affect policy indirectly. Why Economists disagree  Two reaons why economists so often appear to give conflicting advice to policymakers o Economists may disagree about the validity of alternative positive theories about how the world works o Economists may have different values and, therefore, different normative views about what policy should try to accomplish.  At other times, economists are united in the advice they offer, but policymakers may choose to ignore it. The Proposition about which Most economists Agree 1) A ceiling on rents reduces the quantity and quality of housing available. (93%) 2) Tariffs and import quotas usually reduce general economic welfare. (93%) 3) Flexible and floating exchange rates offer an effective international monetary arrangement (90%) 4) Fiscal Policy (e.g., tax cut and/or government expenditure increase) has a significant stimulative impact on a less than fully employed economy. (90%) 5) If the federal budge is to be balanced, it should be done over the business cycle rather than yearly (85%) 6) Cash payments increase the welfare of recipients to a greater degree than do transfers-in-kind of equal cash value. (84%) 7) A large federal budget deficit has an adverse effect on the economy. (83%) 8) A minimum wage increases unemployment among young and unskilled workers. (79%) 9) The government should restructure the welfare system along the lines of a “negative income tax.” (79%) 10) Effluent taxes and marketable pollution permits represent a better approach to pollution control than imposition of pollution ceilings. (78%) Environmental economists  “green economists”  use economic arguments and systems to persuade companies to clean up pollution and to help conserve natural areas. Chapter 1: Introduction 1/8/2013 11:17:00 AM Economy:  Comes from Greek word for “one who manages a household”  Like the economy, household must allocate its scarce resources among its various members, taking into account each member’s abilities, efforts, and desires.  What jobs will be done and who will do them. The management of society’s resources (e.g. people, land, buildings machinery) is important because resources are scarce.  Scarcity: that society has limited resources and therefore cannot produce all the goods and services people wisht o have. Economics: the study of how society manages its scarce resources  In most societies, resources are allocated not by a single central planner but through the combined actions of millions of households and firms.  Economists studies how people make decisions: o How they work o What they buy o How much they save o How they invest their savings o Also studies how people interact with each other o Analyzes forces and trends that affect the economy as a whole. (Average income, unemployment…etc.) 10 principles of economics HOW PEOPLE MAKE DECISIONS  The behavior of an economy reflects the behavior of the individuals. Principle #1: People Face Tradeoffs  Making decisions requires trading off one goal against another o There’s no such thing a free o Ex. If someone chooses to spend their time studying, they give up that time to study instead of napping, biking…etc.  When people are grouped into societies, they face different kinds of tradeoffs o Classic tradeoff: Between “guns and butter”  The more we spend on national defence (guns) to protect our shores from foreign agressors, the less we can spend on consumer goods (butter) to raise the living standard. o In modern society, the tradeoff between a clean environment and a high level of income  Laws that require firms to reduce pollution raise the cost of producing goods and services.  Higher cost = lower wages, charging higher prices, earning smaller profits. o Tradeoff between efficiency and equity.  Efficiency: the society is getting the most it can from its scarce resources (size of the pie)  Equity: the benefits of those resources are distributed fairly among society’s members. (how the pie is divided)  The two goals tend to conflict.  When the government tries to cut the economic pie into more equal slices, the pie gets smaller.  Rich people help support the poorer people who needs support but in the end the people who work harder gets less reward. Principle #2: The cost of Something is what you give up to get it.  Opportunity cost: whatever must be given up to obtain another item. Principle #3: Rational People Think at the Margin  Economists normally assume that people are rational o Rational people: systematically and purposefully do the best they can to achieve their objectives, given the opportunities they have. o Marginal changes: Small incremental adjustments to a plan of action.  Marginal changes are adjustments around the edges of what you are doing.  Ex. You decision is not between blowing them off or studying 24 hours a day, but whether to spend an extra hour reviewing your notes instead of watching tv. o Rational people often make decisions by comparing marginal benefits and marginal costs.  They only take the action if and only if the marginal benefit of the action exceeds the marginal cost.  Explains why airlines are willing to sell tickets below average cost and why people are willing to pay more for diamonds than for water. Principle #4: People Respond to Incentives  Incentive: something (such as the prospect of a punishment or a reward) that induces a person to act.  Because rational people make decisions by comparing costs and benefits, they respond to incentives.  Analyzing any policy, we must consider not only the direct effects but also the indirect effects that work through incentives. It the policy changes incentives, it will cause people to alter their behavior. HOW PEOPLE INTERACT Principle #5: Trade can make everyone better off  Trade between countries can make each country better off.  Although there will be competition, trade allows each person to specialize in the activities he or she does best. By trading with others, people can buy greater variety of goods and services at lower cost. Principle #6: Markets are usually a good way to organize economic activity  Market economy: replaced the central planner system with an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services. o Central Planners: Those who decides what goods and services were produced, how much was produced, and who produced and consumed these goods and services.  Are in communist countries. o The market economy tends to contain more self-interested decision makers, however proven to be successful in a way that promotes overall economic well-being.  Adam Smith: Households and firms interacting in markets act as if they are guided by an “invisible hand” that leads them to desirable market outcomes. o Market prices reflect both the value of a good to society and the cost to society of making the good. o Prices adjust to guide these individual buyers and sellers to reach outcomes that, in many cases, maximize the welfare of society as a whole. o When the government prevents prices from adjusting naturally to supply and demand, it impedes the indivisible hand’s ability to coordinate the millions of households and firms that make up the economy.  Explains why taxes adversely affect the allocation of resources. Principle #7: Governments can sometimes improve market outcomes  One reason we need government is that the indivisible hand can work if rules are enforced and institutions are maintained  Markets work only if property rights are enforced o Property rights: The ability of an individual to own and exercise control over scarce resources.  Another reason we need government: the invisible hand is powerful, but it is not omnipotent (unlimited power, able to do anything).  Two broad reasons for government to intervene: o Promote efficiency o Promote equity  Most policies aim either to enlarge the economic pie or to change how the pie is divided  Market failure: refer to a situation in which the market on its own fails to produce an efficient allocation of resources. o Possible causes of market failure:  Externality: impact of one person’s actions on the well- being of a bystander.  Ex. Pollution  Market power: refers to the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices.  A market economy rewards people according to their ability to produce things that other people are willing to pay for. HOW THE ECONOMY AS A WHOLE WORKS Principle #8: A country’s standard of living depends on its ability to produce goods and services.  Almost all variation in living standards in attributable to differences in countries’ productivity o Productivity: the amount of goods and services produced from each hour of a worker’s time.  The growth rate of a nation’s productivity determines the growth rate of its average income.  To boost living standards, policymakers need to raise productivity by ensuring that workers are well educated, have the tools needed to produce goods and services, and have access to the best available technology Principle #9: Prices Rise when the government prints too much money  Inflation: Increase in the overall level of prices in the economy  Growth in the quantity of money causes inflation. o When a government creates large quantities of the nation’s money, the value of the money falls. Principle #10: Society faces a short-run tradeoff between inflation and unemployment.  Simply means that, over a period of time many economic policies push inflation and unemployment in opposite directions.  Although higher level of prices increases the quantity of money in the long run. It is more complex and controversial in the short run.  Short-run effects of monetary injections: o Stimulates the overall level of spending and thus the demand for goods and services. o Higher demand may, over time, cause firms to raise their prices. But also encourages them to increase the quantity of goods and services they produce and to hire more workers to produce those goods and services. o More hiring = lower unemployment.  Business cycle: the irregular and largely unpredictable fluctuations in the economic activity, as measured by production of goods and services or employment.  Short-run tradeoff between inflation and unemployment can be exploited/influenced by changing the amount that government spends, taxes, amount of money printed. Part 2 1/8/2013 11:17:00 AM Graphing: A Brief Review  Many of the concepts that economists study can be expressed with numbers. o Often these economic variables are related to one another  Ex. when the price of bananas rises, people buy fewer bananas. Graphs serve two purposes:  When developing economic theories, graphs offer a way to visually express ideas that might be more clear then describing it with words  When analyzing economic data, graphs provide a way to finding how variables are in fact related in the world. Graphs of a Single Variable  Three common types of graphs are: Pie chart, Bar Graph, and Time-series Graph. Graphs of Two Variables: The Coordinate System  Displays the relationship between two variables on a single graph  Positive correlation: the relationship between the two variables are close  Negative correlation: the relationship between the two variables are far. Curves in the Coordinate System  Economists prefer looking at how one variable affects another, holding everything else constant. Demand Curve: traces the effect of a good’s price on the quantity of the good consumers want to buy  When the demand curve is downward sloping, and the two variables are moving opposite direction, it is to say that the two variables are negatively related.  When two variables move in the same direction, the curve relating them is upward sloping, we say the variables are positively related.  Movement along a curve: When the demand curve stays the same and only the point moves along it o Happens when a variable on an axis on the graph changes.  Shifts of a curve: When the demand curve actually shifts out. o It is necessary to shift a curve when a variable that is not named on either axis changes, the curve shifts. Slope  Helps answer questions about how much one variable responds to changes in another variable  The triangles are: Greek letter (delta) stands for the change in variable.  Slope will be a small positive number for a fairly flat upward o Large number for a steep upward-sloping line o Negative number for a downward sloping line. o Horizontal line = slope of 0  Slope = y1 – y2 / x1 – x2 Cause and Effect  Economists often use graphs to argue about how one set of events causes another set of events.  Issues with cause and effect: o We might decide that one variable on our graph is causing changes in the other variable, when actually those changes are caused by a third omitted variable.  It is difficult to hold everything else constant. o Reverse Causality: We might decide that A causes B when in fact B causes A.  Ex. Rather then police causing crime, crime may cause an increase in police hiring.  An easy way to determine the direction of causality is to examine which variable moves first.  Flaw: often people change their behavior not in response to a change in their present conditions but in response to a change in their expectations of future conditions.  Ex. Couples often buy a minivan in anticipation of the birth of a child. The minivan comes before the baby, but we wouldn’t want to conclude that the sale of minivans causes the population to grow. Chapter 3: Interdependence And Gains from Trade 1/8/2013 11:17:00 AM Production Possibilities  Consumption possibilities frontier: What the production possibilities frontier also becomes when it is self-sufficient and without trade. o Ex. the Farmer decides to grow his own potatoes and meat without trade. Specialization and Trade  The result of specialization and trade allows consumers to have more products in the end without working any more hours.  Even if one producer is better at producing both products then producer B, it will still benefit them both if they choose to specialize only in one of the product and then trade. Absolute Advantage  Absolute Advantage is used when comparing the productivity of one person, firm, or nation to that of another.  The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good. Opportunity cost and comparative advantage  Opportunity cost: whatever must be given up to obtain some item o It measures the tradeoff between the two goods that each producer faces. o Ex. a farmer produces 1kg of potatoes in 15 mins but because he needs 60 mins to produce 1 kg of meat, 15 minutes of work would yield 0.25 kg of meat. Therefore the farmer’s opportunity cost of 1 kg of potatoes is 0.25 kg of meat.  Comparative advantage: is used when describing the opportunity costs of two producers. o The producer who gives up less of other goods to produce good X has the smaller opportunity cost of producing good X and is said to have a comparative advantage in producing it.  It is possible for one person to have an absolute advantage in both goods, it is impossible for one person to have a comparative advantage in both goods. o Because the opportunity cost of one good is the inverse of the opportunity cost of the other, if a person’s opportunity cost of one good is relatively high, his opportunity cost of the other good must be relatively low. o Unless two people have exactly the same opportunity cost, one person will have a comparative advantage in one good, and the other person will have a comparative advantage in the other good. Comparative Advantage and Trade  The gains from specialization and trade are not based on absolute advantage but rather on comparative advantage. o Gain:  Total production in economy rises  Each producer benefits from trade by obtaining a good at a price that is lower than his or her opportunity costs of that good. The Price of Trade  For both parties to gain from trade, the price at which they trade must lie between the two opportunity costs. o If the price was below both of their opportunity costs, then both would want to be the consumers o If the price was above their opportunity costs, then both would want to be the producers o However in this case, both cant be the seller or consumer. Should Canada Trade with Other Countries?  Imports: goods and services produced abroad and sold domestically  Exports: Goods and Services produced domestically and sold abroad.  The principle of comparative advantage states that each good should be produced by the country that has the smaller opportunity cost of producing that good. The Market Forces Of Supply and Demand 1/8/2013 11:17:00 AM Market and Competition  Supply and demand refer to the behavior of people as they interact with one another in markets What is a Market?  Market: a group of buyers and sellers of a particular good or service. o The buyers determine the demand for the product o The seller determines the supply of the product  There are different forms of market o Markets for agricultural commodities are sometimes highly organized.  Buyers and sellers meet at a specific time and place, where an auctioneer helps set prices and arrange sales o Most markets are less organized.  Ex. Market for ice cream What is Competition?  Most markets in the economy are highly competitive o Ex. Ice cream, buyers know there are several sellers which offer similar products and as a result the price and quantity of the ice cream is not determined by any single buyer or seller. Instead, price and quantity are determined by ALL buyers and sellers as they interact in the market place.  Competitive market: a description to a market in which there are so many buyers and sellers that each has a negligible impact on the market price.  Perfectly competitive: o Highest form of competition o The goods offered for sale are all exactly the same o The buyers and sellers are so numerous that no single buyer or seller has any influence over the market price. o Price takers: buyers and sellers must accept the price the market determines. o Ex. wheat market: because no single buyer or seller can influence the price of wheat, each takes the price as given.  Monopoly: A market with only one seller, and this seller sets the price. The seller is a monopoly.  Some markets fall between the extremes of perfect competition and monopoly. Demand The Demand Curve: The relationship between price and quantity demanded  Quantity demanded: the amount of the good that buyers are willing and able to purchase o One determinant that plays the central role of quantity demanded is the PRICE of the good. o Quantity demanded is negatively related to the price  As price rises demand falls and vice versa  Law of Demand: Other things equal, when the price of a good rises, the quantity demanded of the good falls, and when the price falls, the quantity demanded rises.  Demand Schedule: A table that shows the relationship between the price of a good and the quantity demanded. o Holding constant everything else that influences how much consumers of the good want to buy.  Demand curve: a graph of the relationship between the price of a good and the quantity demanded. Market Demand vs. Individual Demand  Market demand: which is the sum of all the individual demands for a particular good or service. o The individual demand curves are summed horizontally to obtain the market demand curve. o We add the individual quantities found on the horizontal axis of each individual demand curve. Shifts in the Demand Curve  If something happens to alter the quantity demanded at any given price, the demand curve shifts. o Ex. nutritionist discovered ice cream leads people with longer and healthier lives which would raise the demand for ice cream causing a shift in the demand curve.  Demand curve shift to the right = Increase in demand  Demand curve shift to the left = Decrease in demand  Most important variables that can shift the demand curve: o Income:  Normal good: The demand for the good falls when income falls.  Inferior good: The demand for the good rise
More Less

Related notes for ECON 1BB3

Log In


Don't have an account?

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.