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Chapter 1

Macro Chapter 1.docx

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Paul Cohen

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Macro Chapter 1: Are your smart choices smart for all? (Macroeconomics and Microeconomics) 1.1 Smart microeconomic choice by individuals may or may not add up to smart macroeconomic outcomes for the economy as a whole. The key question about the relationship between microeconomic and macroeconomics is, “if left alone, do markets quickly self-adjust?” -The great recession of 2008-09 and the great depression of 1929-33 involved financial bubbles that burst, high unemployment, failing living standards, bankruptcies, as well as government policy mistakes. Macroeconomics: analyzes the performance of the whole Canadian economy and global economy—the combined outcomes of all individual microeconomic choices. Microeconomics: analyzes choice that individuals in households, individual businesses, and governments make and how those choices interact in markets. Fallacy of composition: what is true for one is not true of all; whole is greater than the sum of the parts Paradox of thrift: attempts to increase savings cause aggregate savings decrease because of galling employment and incomes. -The circular flow diagram reduces the complexity of the Canadian economy to three sets of players—households, businesses, and government’s. -Input markets determine incomes; households are the sellers businesses are the buyers -Output markets determine the value of all products/services sold; households are buyers and businesses are sellers Business cycles: ups and downs of overall economic activity. -The fundamental macroeconomic question “if left aone by government, does the price mechanisms of market economies adjust quickly to maintain steady growth in living standards, full employment and stable prices?” -“Yes” answer based on Say’s Law—supply creates its own demand. -“No” answer from John Maynard Keynes, founder of macroeconomics in 1930’s. 1.2 “If left alone, do markets quickly self-adjust?” The “yes” and “no” camps differ on the fallacy of composition, cuases of business cycles, risk of government failure versus market failure, role of government, and the political spectrum. Market failure—market outcomes fial to serve in public interest Government failure: government policy fails to serve the public interest. -“government policy fails to serve the public interest. -“Yes”—left alone markets will quickly self-adjust” camp believes Macroeconomic and microeconomic outcomes are the same External events or government policy causes business cycles Government failure is worse than market failure Government should be hands-off -“No”—Left alone, markets fail to quickly self-adjust” camp belives Fallacy of composition—macroeconomic and microeconomic outcomes different Markets cause business cycles through coordination failures, roles of money banking, and expectations. Market failure is worse than government failure. Government should be hands off. -P
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