Principles of Economics, Case and Fair,8e

Macro I:Introduction to Macroeconomics

1Chapter PART I INTRODUCTION TO ECONOMICSThe Scope and Methodof Economics1

THE OVERALL THEME OF MACROEconomic Growth An increase in the total output of an economy. It occurs when a society acquires new resources or when it learns to produce more using existing resources.Growth & StabilityStability A condition in whichnational output is growing steadily, with low inflation and full employment of resources.aggregate behavior is the behavior of all households and firms together.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair2Opportunity cost does not have to be measured in dollar terms. The value of an alternative activity is usually measured in both monetary and nonmonetary costs.Opportunity cost is referred to as implicit cost. Accountants count only explicit costs. Economic cost is higher than accounting costs because it includes implicit, or opportunity, cost.

MACROECONOMIC CONCERNSThree of the major concerns of macroeconomics are:

Inflation

Output growth

UnemploymentCHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

MACROECONOMIC CONCERNSINFLATION AND DEFLATIONinflation An increase in the overall price level.hyperinflation A period of very rapid increases in the overall price level.deflation A decrease in the overall price level.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

Nominal and Real PricesNominal price: the absolute price of a good in terms of dollarsThe price you see on a good in a storeReal price: the nominal price of a good relative to the average dollar price of all other goodsReal prices are adjusted for inflationCHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair5

Nominal and Real PricesItem1897 Sears Catalog price1997 dollar equivalent1 lb. baking soda$0.06?100 lb. nails$1.70?13" hammer$0.42?Scissors$0.75?Bread pan$0.37?Telephone$13.50?Pair of socks$0.13?Dictionary$0.70?Bicycle$24.95?CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair6

Nominal and Real PricesItem1897 Sears Catalog price1997 dollar equivalent1 lb. baking soda$0.06$5.34100 lb. nails$1.70$151.3913" hammer$0.42$37.40Scissors$0.75$66.79Bread pan$0.37$32.95Telephone$13.50$1,202.23Pair of socks$0.13$11.58Dictionary$0.70$62.34Bicycle$24.95$2,221.90CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair7

INFLATIONPRICE INDEXESconsumer price index (CPI) A price index computed each month by the Bureau of Labor Statistics using a bundle that is meant to represent themarket basket purchased monthly by the typical urban consumer.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

INFLATIONInflation Changes the Distribution of IncomeIf your income is fixed and prices rise, yourability to purchase goods and services falls proportionately.Effects on Debtors and Creditorsreal interest rate The difference between the interest rate on a loan and the inflation rate.Inflation that is higher than expected benefits debtors; inflation that is lower than expected benefits creditors.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

MACROECONOMIC CONCERNSunemployment rate The percentage of the labor force that is unemployed.UNEMPLOYMENT

CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

RECESSIONS, DEPRESSIONS, AND UNEMPLOYMENTlabor force The number of people employed plus the number of unemployed.labor force = employed + unemployedpopulation = labor force + not in labor forceCHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

RECESSIONS, DEPRESSIONS, AND UNEMPLOYMENTunemployed A person 16 years old or older who is not working, is available for work, and has made specific efforts tofind work during the previous 4 weeks.not in the labor force A person who is not looking for work, because he or she either does not want a job or has givenup looking.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

RECESSIONS, DEPRESSIONS, AND UNEMPLOYMENTdiscouraged-worker effect The decline in the measured unemployment rate that results when people who want to work but cannot find jobs grow discouraged and stop looking, thus dropping out of the ranks of the unemployed and the labor force.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

RECESSIONS, DEPRESSIONS, AND UNEMPLOYMENTSome Unemployment Is InevitableTHE COSTS OF UNEMPLOYMENTWhen we consider the various costs of unemployment, it is useful to categorize unemployment into three types:Frictional unemployment

Structural unemployment

Cyclical unemploymentCHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

frictional unemployment The portion of unemployment that is due to the normal working of the labor market; used to denote short-run job/skill matching problems.structural unemployment The portionof unemployment that is due to changes in the structure of the economy that result in a significant loss of jobs in certain industries.cyclical unemployment The increase in unemployment that occurs during recessions and depressions.Together, the "natural rate" of unemploymentCHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

EXPLAINING THE EXISTENCE OF UNEMPLOYMENTMINIMUM WAGE LAWSminimum wage laws Laws that set a floor for wage ratesthat is, a minimum hourly rate for any kind of labor.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

THE U.S. ECONOMY SINCE 1900:TRENDS AND CYCLESA Typical Business CycleEXPANSION AND CONTRACTION: THE BUSINESS CYCLE

CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

MACROECONOMIC CONCERNSdepression A prolonged and deep recession.recession A period during which aggregate output declines. Conventionally, a period in which aggregate output declines for twoconsecutive quarters.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

GROSS DOMESTIC PRODUCTgross domestic product (GDP) The total market value of all final goods and services produced within a given period by factors of production located within a country.GDP is the total market value of a countrys output. It is the market value of all final goods and services produced within a given period of time by factors of production located within a country.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

GROSS DOMESTIC PRODUCTfinal goods and services Goods and services produced for final use.FINAL GOODS AND SERVICESintermediate goods Goods that are produced by one firm for use in further processing by another firm.value added The difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

GROSS DOMESTIC PRODUCT

Tires taken from that pile and mounted on the wheels of the new car before it is sold are considered intermediate goods to the auto producer. Tires from that pile to replace tires on your old car are considered final goods. If, in calculating GDP, we included the value of the tires (an intermediate good) on new cars and the value of new cars (including the tires), we would be double counting.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

NOMINAL VERSUS REAL GDPcurrent dollars The current prices that one pays for goods and services.nominal GDP Gross domestic product measured in current dollars.Gapminder?CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

LIMITATIONS OF THE GDP CONCEPTGDP AND SOCIAL WELFARESociety is better off when crime decreases; however, a decrease in crime is not reflected in GDP.An increase in leisure is an increase in social welfare, but not counted in GDP.Nonmarket and household activities are not counted in GDP even though they amount to real production.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

LIMITATIONS OF THE GDP CONCEPTunderground economy The part of the economy in which transactions take place and in which income is generated that is unreported and therefore notcounted in GDP.Whenever sellers looking for a profit come into contact with buyers willing to pay, markets will arise, often underground.

CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

LONG-RUN AND SHORT-RUN CONCERNS: GROWTH, PRODUCTIVITY, UNEMPLOYMENT, AND INFLATIONoutput growth The growth rate of the output of the entire economy.per-capita output growth The growth rate of output per person in the economy.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

Macro II:Aggregate Demand and Supply

1Chapter PART I INTRODUCTION TO ECONOMICSThe Scope and Methodof Economics26

THE ROOTS OF MACROECONOMICSClassical ModelsClassical economists applied microeconomic models, or market clearing models, to economy-wide problems.Simple classical models failed to explain the prolonged existence of high unemployment during the Great Depression. This provided the impetus for the development of macroeconomics.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

THE ROOTS OF MACROECONOMICSThe Keynesian RevolutionIn 1936, John Maynard Keynes published The General Theory of Employment, Interest, and Money.Much of macroeconomics has roots in Keyness work. According to Keynes, it is not prices and wages that determine the level of employment, as classical models had suggested, but instead the level of aggregate demand for goods and services.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

THE METHODOLOGY OF MACROECONOMICSAGGREGATE DEMAND AND AGGREGATE SUPPLYaggregate demand The total demand for goods and services in an economy.aggregate supply The total supply of goods and services in an economy.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

The Wiki AS curve

CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

Macro III:Fiscal Policy and Taxation

1Chapter PART I INTRODUCTION TO ECONOMICSThe Scope and Methodof Economics31

GOVERNMENT IN THE MACROECONOMYfiscal policy Government policies concerning taxes and expenditures (spending).monetary policy The tools used by the Federal Reserve to control the quantity of money in the economy.discretionary fiscal policy Changes in taxes or spending that are the result ofdeliberate changes in government policy.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

THE FEDERAL BUDGETDebt vs. Deficitfederal debt The total amount owed by the federal government.federal surplus (+) or deficit () Federal government receipts minus expenditures. CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

THE ECONOMYS INFLUENCEON THE GOVERNMENT BUDGETautomatic stabilizers Revenue and expenditure items in the federal budget that automatically change with the state of the economy in such a way as to stabilize GDP.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

Macro IV:Money and the Banking System

1Chapter PART I INTRODUCTION TO ECONOMICSThe Scope and Methodof Economics35

AN OVERVIEW OF MONEYWHAT IS MONEY?medium of exchange What sellers generally accept and buyers generally use to pay for goods and services.unit of account A standard unit that provides a consistent way of quoting prices.store of value An asset that can be used to transport purchasing power from one time period to another.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

AN OVERVIEW OF MONEYThe cash in your wallet is fiat moneyfiat money Items designated as money that are intrinsically worthless.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

HOW BANKS CREATE MONEYA HISTORICAL PERSPECTIVE: GOLDSMITHSrun on a bank Occurs when many of those who have claims on a bank (deposits) present them at the same time.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

HOW BANKS CREATE MONEYreserves The deposits that a bank has at the Federal Reserve bank plus its cash on hand.required reserve ratio The percentage of its total deposits that a bank must keep as reserves at the Federal Reserve.Banks usually make loans up to the point where they can no longer do so because of the reserve requirement restriction.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

HOW BANKS CREATE MONEYmoney multiplier The multiple by which deposits can increase for every dollar increase in reserves; equal to 1 divided by the required reserve ratio.An increase in bank reserves leads to a greater than one-for-one increase in the moneysupply. Economists call the relationship between the final change in deposits and thechange in reserves that caused this change the money multiplier. Stated somewhat differently, the money multiplier is the multiple by which deposits can increase for everydollar increase in reserves.THE MONEY MULTIPLIER

CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

HOW THE FEDERAL RESERVE CONTROLSTHE MONEY SUPPLYIf the Fed wants to increase the supply of money, it creates more reserves, thereby freeingbanks to create additional deposits by making more loans. If it wants to decrease the money supply, it reduces reserves.Three tools are available to the Fed for changing the money supply:

(1) changing the required reserve ratio;

(2) changing the discount rate; and

(3) engaging in open market operations.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

THE EQUILIBRIUM INTEREST RATESUPPLY AND DEMAND IN THE MONEY MARKET

If the interest rate is initially high enough to create an excess supply of money, the interest rate will immediately fall, discouraging people from moving out of money and into bonds.If the interest rate is initially low enough to create an excess demand for money, the interest rate will immediately rise, discouraging people from moving out of bondsand into money.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

CHANGING THE MONEY SUPPLY TO AFFECT THE INTEREST RATEThe Effect of an Increase in the Supply of Money on the Interest Rate

CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

EXPANSIONARY POLICY EFFECTSexpansionary fiscal policy An increase in government spending or areduction in net taxes aimed at increasing aggregate output (income) (Y).expansionary monetary policy An increase in the money supply aimed atincreasing aggregate output (income) (Y).CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

CONTRACTIONARY POLICY EFFECTScontractionary fiscal policy A decrease in government spending or an increase in net taxes aimed at decreasing aggregate output (income) (Y).contractionary monetary policy Adecrease in the money supply aimed at decreasing aggregate output (income) (Y).CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

Macro V:Stabilization Policies

1Chapter PART I INTRODUCTION TO ECONOMICSThe Scope and Methodof Economics46

TIME LAGS REGARDING MONETARYAND FISCAL POLICYTwo Possible Time Paths for GDP

CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

TIME LAGS REGARDING MONETARYAND FISCAL POLICYstabilization policy Describes both monetary and fiscal policy, the goals of which are to smooth out fluctuationsin output and employment and to keep prices as stable as possible.time lags Delays in the economys response to stabilization policies.

(back seat driver?)CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

TIME LAGS REGARDING MONETARYAND FISCAL POLICYrecognition lag The time it takes for policy makers to recognize the existence of a boom or a slump.implementation lag The time it takes to put the desired policy into effect once economists and policy makers recognize that the economy is in a boom or a slump.response lag The time that it takes for the economy to adjust to the new conditions after a new policy is implemented; the lag that occurs because of the operation of the economy itself.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

TIME LAGS REGARDING MONETARYAND FISCAL POLICYSummaryStabilization is not easily achieved. It takes time for policy makers to recognize the existence of a problem, more time for them to implement a solution, and yet more time for firms and households to respond to the stabilization policies taken.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

Macro VI:Stocks, bonds, international trade, and currency exchange

1Chapter PART I INTRODUCTION TO ECONOMICSThe Scope and Methodof Economics51

STOCKS AND BONDSstock A certificate that certifies ownership of a certain portion of a firm.(may pay dividends)capital gain An increase in the value of an asset.bond A document that formally promises to pay back a loan under specified terms, usually over a specific time period. (may pay interest)CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

THE STOCK MARKET SINCE 1948Dow Jones Industrial Average An index based on the stock prices of 30 actively traded large companies. The oldest and most widely followed index of stock market performance.

But who cares?

The Dow is a price-weighted index. Its simple, and was computationally feasible for 1910.It's irrelevant today. CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

THE STOCK MARKET SINCE 1948NASDAQ Composite An index based on the stock prices of over 5,000 companies traded on the NASDAQ Stock Market.

The NASDAQ market takes its name from the National Association of Securities Dealers Automated Quotation System.

(Tech companies...)CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

THE STOCK MARKET SINCE 1948Standard and Poors 500 (S&P 500) An index based on the stock prices of the largest 500 firms traded on the New York Stock Exchange, the NASDAQ Stock Market, and the American Stock Exchange.

This is the standard, typically. Its not based on the prices as much as the firm size (value weighted). CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

THE ECONOMIC BASIS FOR TRADE:COMPARATIVE ADVANTAGEtheory of comparative advantage Ricardos theory that specialization and free trade will benefit all trading partners (real wages will rise), even those that may be absolutely less efficient producers.Specialization and free trade will benefit all trading partners (real wages will rise), even those that may be absolutely less efficient producers.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

THE ECONOMIC BASIS FOR TRADE:COMPARATIVE ADVANTAGEabsolute advantage The advantage in the production of a product enjoyed by one country over another when it uses fewerresources to produce that product than the other country does.comparative advantage The advantage in the production of a product enjoyed by onecountry over another when that product can be produced at lower cost in terms of other goods than it could be in the other country.ABSOLUTE ADVANTAGE VERSUS COMPARATIVE ADVANTAGECHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

THE ECONOMIC BASIS FOR TRADE:COMPARATIVE ADVANTAGEWhy Does Ricardos Plan Work?When countries specialize in producing goods in which they have a comparative advantage,they maximize their combined output and allocate their resources more efficiently.Comparative Advantage Means Lower Opportunity Cost

CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

TRADE BARRIERS: TARIFFS, EXPORT SUBSIDIES, AND QUOTASprotection The practice of shielding a sector of the economy from foreign competition.tariff A tax on imports.export subsidies Government payments made to domestic firms to encourage exports.dumping A firm or industrys sale of products on the world market at prices below the cost of production.quota A limit on the quantity of imports.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

Open-Economy Macroeconomics:Exchange RatesWhen people in different countries buy from and sell to each other, an exchange ofcurrencies must also take place.exchange rate The price of one countrys currency in terms of another countrys currency; the ratio at which two currencies are traded for each other.CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

THE OPEN ECONOMY WITH FLEXIBLEEXCHANGE RATESThe Equilibrium Exchange Rateappreciation of a currency The rise in value of one currency relative to another.depreciation of a currency The fall in value of one currency relative to another.The Equilibrium Exchange RateThe equilibrium exchange rate occurs at the point at which the quantity demanded ofa foreign currency equals the quantity of that currency supplied.

CHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair

THE OPEN ECONOMY WITH FLEXIBLEEXCHANGE RATESFACTORS THAT AFFECT EXCHANGE RATESlaw of one price If the costs of transportation are small, the price of the same good in different countries should be roughly the same.purchasing-power-parity theory A theory of international exchange holding that exchange rates are set so that the price of similar goods in different countries is the same.Purchasing Power Parity: The Law of One PriceCHAPTER 1: The Scope and Methodof Economics 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair