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INTRO MACROECONOMIC THEORY Test 1 Notes - 4.0ed this test!

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ECON 0110
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Macro: Big, whole US economy - overall Econ GF’s., overall inflation rate, overall unemployment Micro: small, individual consumers /bus’s - influences on price of 1 product - reasonable small bus. Practices Employment Act of 1946: It is the policy and responsibility of the federal govn’t to promote maximum employment, prod. & purchasing power - WWII ending, soldiers return & work  defense industry contraction/ women enter workforce… unemployment rate ^^^ Purchasing power: keeping up with inflation Economic Policy: govn’t action to influence the economy - Fiscal Policy: changes in tax laws or govn’t spending o Determined by congress/ the president - Monetary Policy: influences money supply/ interest rates* o Done through “fed” (federal reserve system) o Tries to promote strong purchasing power Low interest rates on Big purchases (homes,cars,boats) stimulates economy Descriptive Statements: factual, historical reference, backed by data “Minimum wage was $7.25 in 2013 Positive Statements: If P, you may expect Q... “If we get rid of minimum wage, then work workers may lose their jobs.” Normative Statements: Opinionated, judgments about what is good/bad…NO RIGHT ANSWER “we should get rid of minimum wage” Fallacy of False Cause: just because A happened, does not mean it directly caused B A May be factor, but not definitely Fallacy of Composition: what works for 1 person may not necessarily work if the whole group does it….small scale theory ineffective on macro-level (standing at a baseball game to see better) Paradox of thrift: 1 person saves, thus that individual has more. Everyone saves, thus economy slows, and as a whole, saves less. (No one spends  businesses lose money  unemployment  foreclosure…) The other things equal fallacy: economy ≠ controlled expt.  arguments between economists about actual causes of events - Conditions are constantly changing, true indep.-dep. Variable testing is impossible Law of Demand- If price ^, sales \/ Economic Decision Makers – act in own Rational Self-Interest *people choose actions why they perceive to be in their own best interests* 1. Households Goals: maximize their Utility Utility: satisfaction level, sense of well-being, overall happiness  For Given cost, try to max. benefits  For given benefit, try to min. costs 2. Firms Goals: max. profits (not revenues; must consider costs)  Short run benefits (profits) vs. Long term consequences 3 Types of Firms: Sole Proprietors- self employment Partnerships- splitting of leftover profits (contractual agreements) Corporations (20% of businesses, 90% of revenue) 3. Governments a. Why do we need government influence? 1. 2. Protect private prop. 7. Deal w/Externalities 3. Enforce contracts 8. Promote Macroeconomic Goals 4. Promote competition 9. Provide for the disadvantaged & disabled 5. Regular natural monopolies 6. Provide public goods Consumer motivation = maximize utility Business motivation = maximize profits Govn’t motivation = maximize capacity/ efficiency in serving its citizens Private vs. Public Goods Private Goods = Exclusive; supplier can exclude non-paying individuals (a candy bar) o Rival in consumption o amount consumed by 1 person diminishes availability to others Public Goods = Non-exclusive; supplier can’t exclude non-paying individuals (nat’l defense, clean air, dams) o non-rival in consumption o one person’s benefit does not diminish availability to others Govn’ts / Externalities: promote positive externalities through tax subsidies, discourage negative through higher taxes/laws Free rider problem: people receiving benefits w/out paying Result: force people to pay taxes rd Externalities: activities performed that affect 3 parties Negative: impose cost (steel mill polluting air…govn’t imposed smoke stack scrubbers) Positive: confer benefits (good education, medical improvements) Macroeconomic Goals 1. Economic Growth 2. Increased Production 3. Low inflation 4. Smooth out the business cycle 5. Promote maximum unemployment How to promote them? Goal # 1: Economic Growth - Increase total output of goods/services - Boost output per capita: to maintain standard of living- pop. Growth must = output growth)  Measuring output = nominal GDP • $ Value of final yearly output produced in US (can be foreign based company) o Products made internationally not included • Prices existing during that year If Output ^ 10%, then Econ Growth…..If Prices ^ 10%, then inflation...(not econ growth) Growth rate = (New-Old)/ Old * 100% Nominal GDP vs. ΔCP i Creation of CP i 1. Create base year Y (P usually 100) 0 n 2. Chose rep. set of quantities of items (Q ) purchase0 by consumers 3. Determine price of Q using pr0ces during those years. P n 0 Can use ΔCP from i year * Q to find P n.Price indexnfor year n = P Q * 100 (no%) 0 0 Inflation = “avg” rate of growth of all items shown by CP i Inflation rate = New CP -Old CPi Old CP * i00%...= priies went up X%...X% inflation What was value of output in 2005 w/ 2005 prices? Nominal GDP  Value of output in 2004 Prices? Real GDP Real GDP = noiinal GDP / CP * 100 (io %) …iex (15,000/150) * 100 = 10,000… ^^^for Year i = P 0 ,1P Q 0et2. Holds prices constant, measures growth of shopping cart w/standard prices Nominal GPD = P Q , 0 Q0P 1 1, 2 2… nothing constant, growth of card not adjusted by price change, potentially no change in real value… Rule of 72: years required to double 72/g g = growth rate as actual % # (5.3% = g = 5.3) g can be prices, output, or anything… Contraction of Real GDP = recession How to promote full output potential? 1. Increase physical capital & Improve Human Capital (better edu/job training) a. Physical Capital: physical human creations b. Human Capital = knowledge and skills required to increase productivity 2. Full utilization of capital; no excess…reduce unemployment of capital Goal #2: Low inflation (i.e. Maintain Stable Prices) - Maintain purchasing power of economy/consumer - Inflation hurts when high/ or unanticipated Unanticipated inflation  hurts some while helps others…interest rates with banking and lenders - Can ruin lenders and decrease economic growth, also hurts people w/fixed incomes Goal #3: Promote full employment....who are the unemployed? - New entrants - Re-entrants Not entirely “evil” unemployment - Job-leavers - Job losers***  need to reduce o Job losers ^ when lack of aggregate demand, usually caused by recession (people save money & downward spiral ensues) Goal #4: Smooth out Business Cycle….expansions  peak  contractions  trough Recession: 2+ consecutive quarters of declining REAL GDP Depression:Asevere recession. *Expansions usually 5-6x longer than contractions Classical Economic Theory: doesn’t work in reality - Natural tendency of the economy to move toward full employment - Thus no need for economic (fiscal/monetary) policy. Classical reasoning: unemployed workers compete against each other. Wages decrease. Lower wages  ^^^ profits. Higher profits = ^^^ employment Keynesian Economic Theory: John Maynard Keynes (1936 during Great depression) - Unemployment caused by lack of sufficient aggregate demand - Producers adjust output to satisfy customers/ equal demand - If demand dec., then output dec. What to do? Keynesian policy recommends: - When aggregate demand dec., govn’t should try to ^ aggregate demand. o Increase in govn’t spending should stimulate economy o Tax cut should stimulate economy (tax increase would reduce disposable income)  …..with other things being equal…(Fallacy??) 3 Questions need to be answered by any economic system: 1. What type of good produced? Consumption, investment, govn’t? 2. How much of each will be produced? 3. How will output be allocated? Types of Economies 1. Barter economy- exchange requires double coincidence of wants…extremely inefficient 2. Laissez Faire- minimal govn’t interference 3. Command; Planned economy- group of central planners decide “what,” “how much,” and “who gets” output - Socialism = high amount of govn’t int. in economic affairs o  higher taxes, low inventive to work o Tendency of extensive health/unemployment benefits 4. Capitalism = Private ownership, profit motive, free price mobility (signals to increase/decrease production)  Emphasis on free market system  Producers & consumers = free to make own choices USA= mixed system: govn’t role is 1/3 of all economic activity Why Profit is good…Gives increased value of the production factors Production employs: 1. Land (all natural resources) 2. Labor 3. Capital (human creations/ skills & knowledge) 4. Entrepreneurship (risk taking by, & leadership of the business owners) Thus profit increases their value • Losses decreases their value Adam Smith, in Wealth of Nations (1776), believed: - “invisible hand will promote general welfare” Downsides: no central authority to: discourage neg. externalities, protect disadvantaged, potential monopolies.. Consumer sovereignty: “consumers’decide” (…what gets produced) Only problem: little emphasis on public or investment goods, only consumer goods…  can hinder economic growth Production Possibilities Frontier- shows trade-offs facing economy w/only 2 goods produced. Illustrates Level of employment, efficiency, choice, economic growth (PPF expands), OC * Assumptions 1. Fixed quant./qual. Of resources 2. Fixed tech. 3. Full employment of all resources (human capital/ physical capital) 4. Most efficient use of resources 5. Unchanged rules of the game Rules of the game = formal institutions that support the economy- the laws, customs (manners/connventions) etc… which encourage people to pursue productive activity. Reasons inside PPF: Unemployment of labor (want to work/ can’t find job…recessionary times?) Underemployment of Labor: (have PhD in field X but work in field Y, or want 40 hrs/week and only work 30.) Non-maximized efficiency of physical capital/ Inefficient allocation of resources * societies choose between consumer/ capital (investment goods) Capital goods help maximize efficiency (factories, tractors, tools etc.) How Haiti would rebuild: expand PPF 1. increase physical capital (have enough personal output to live) 2. use capital to produce items 3. trade and or specialize items between consumers/countries 4. educate work force (respect the rules of the game too)…everything takes off from there. Opportunity Cost: best alternative given up when we make a choice (most utility given up) = slope on XY-axis on slope of PPF Division of labor = minimized OC…yields sophistication on large scale (^ prod.) Downside: possible work injuries/ dissatisfaction Comparative adv. Vs.Absolute adv - Comparative adv.: whichever producer has lower OC cost for making given item has comp. adv. (OC comparison yielding “what else can be made?”) - Absolute adv.: whichever producer can make more of a given product with the given resource (most product with least resources) * To increase total world output of specific good, have country with LOWER OC specialize in it. (country with comparative advantage)  then trade with country.... (gains from specialization & trade) If country’s demands for secondary product (P ) ar2 less than what they produced, than they should trade their excess primary product (P ) f1r P (p2oduced by other country (X) in excess because of lower OC for that product) at a rate higher than their own OC of production but less than Country X’s OC…thus mutually beneficial (*check practice test for examples*) If total production in each Country ^^, don’t total job opps increase accordingly to offset loss of jobs in specific reduced industry? - COMPLETE SPECIALIZATION NOT NECESSARY Effects of Trade Restrictions In general, restrictions to free trade: decreases total output, ^^ in selling price of good - Hurt consumers - Are attempts to protect/benefit producers & workers in the specific industry 3 Types of restrictions 1. Embargo: prohibit foreign firms/ nations from exporting product to US 2. Tariff : requires foreign firms/ countries to pay taxes on their sales in the US 3. Quota: puts limits on amount of product a foreign firm/ country can sell in US Reasons: Infant industry, nat’l defense. * Insert Market quota graph here* Effects of a Quota? Ex: Sugar Quota: 2003 w/ quota (quantity restricting license) w/ out quota…. P = $ 0.08 / lb caused price to increase $0.21/ lb Foreign Exchange: 1 Euro = $1.33 USD $1.00 = 0.75 Euros Increased Demand for foreign currency (US wants European Products (euro)) - Causes depreciation of domestic currency ($ weakens) - And appreciation of foreign currency. (Euro strengthens) Appreciation of foreign currency Compared w/ domestic currency… Good for: domestic producers/ foreign consumers Bad for: foreign producers/ domestic consumers Business: 3 most important forms of business enterprise 1. Sole proprietorship- is business for self (no corporation papers)….75% of businesses-  multiple employees, 1 owner can keep all profits after cost (cost = employees wages) 2. Corporations- 90% total sales, 20 % total businesses  Can buy stock, represents a portion of ownership in business  Can be sued as legal entities  51% = TOTAL CONTROL!!!!!!! Liability = who is responsible for outstanding payments? (debts) Unlimited Liabili
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