Lecture1_intro to Macro

8/2/2019 Lecture1_intro to Macro

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Introduction to Economics


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Definition ofeconomics the study ofhow individuals and

societies use limited resources to satisfyunlimited wants.

It is a Social Science a science asapplied to humans


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Definition ofeconomics "Economics is the study of people in the ordinary

business of life."--Alfred Marshall, Principles ofeconomics; an introductory volume

(London: Macmillan, 1890)

"Economics is the science which studies human behavioras a relationship between given ends and scarce meanswhich have alternative uses."

-- Lionel Robbins, An Essay on the Nature and Significance ofEconomicScience (London: MacMillan, 1932)

Economics is the "study ofhow societies use scarceresources to produce valuable commodities anddistribute them among different people."

-- Paul A. Samuelson, Economics (New York: McGraw-Hill, 1948)


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Why study Economics? To learn a way of thinking

To understand society To understand global affairs

To be an informed voter


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To learn a way of thinking

Threefundamental concepts:

Opportunity cost

Marginalism

Efficient markets

Opportunity CostThe best alternative that we

forgo, or give up, when we make a choice ora decision.

Marginalism The process ofanalyzing theadditional or incremental costs or benefits

arising from a choice or decision.


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To learn a way of thinking

Sunk Costs Costs that cannot be avoided,regardless ofwhat is done in thefuture,because they have already been incurred.

Efficient marketA market in which profitopportunities areeliminated almost

instantaneously.

The study ofeconomics teaches us a way ofthinking and helps us make decisions.


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To understand society Industrial Revolution The period in England during

the lateeighteenth and early nineteenth centuries

in which new manufacturing technologies andimproved transportation gave rise to the modernfactory system and a massive movement of thepopulation from the countryside to the cities.

The study ofeconomics is an essential part of thestudy ofsociety.


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To understand global affairs An understanding ofeconomics is essential to an

understanding ofglobal affairs.

E C O N O M I C S I N P R A C T I C E

iPod and the World

An iPod Has Global Value. Ask the

(Many) Countries That Make It.The New York Times

World TradeDestruction


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To be an informed voter

A knowledge ofeconomics is essential to be aninformed citizen.

When we participate in the political process, weare voting on issues that require a basicunderstanding ofeconomics.

Knowledge ofeconomics provides individuals with

an understanding ofeconomic policies that are aptfor the countrys current situation. Hence, votershave an informed choice in selecting leaders basedon their economic, social and political platform.


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Four Factors ofProduction Land is all natural resources used in production. It

includes all the resources of land, sea and air (e.g., land

used to produce wheat) Capital is man-made goods used in production (e.g.,

machine, trucks, computers, telephone)

Labor is all human effort, both physical and mental used

in production. Enterprise is a human factor and is the activity that

organizes the other factors of production.Entrepreneurship is the risk taking involved in organizing

production. Sometimes this factor is combined withlabor (e.g., farmer)


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The Basic Economic Problem

What to produce?

How much to produce? How to produce?

For whom to produce?


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An economy must identify what arethe commodities needed to beproduced for the utilization of thesociety in everyday life. A societymust also take into account theresources it possesses beforedeciding what goods or servicesto produce

What to produce?


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How much to produce? This identifies the number ofcommodities

needed to be produced in order to answer

the demand of the society. This optimumamount must be approximated byproducers.

Underproduction -> failure to meet the needsand wants of the society

Overproduction ->excess goods and servicesgoing to waste


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Example: Lexus

Toyota designs a luxury car with buyers inmind

Toyota decides how much to produce givethe price and their costs

Buyers decide how many to buy, based onprice, their income, tastes, etc.


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How to produce There is a need to identify the different methods

and techniques in order to produce commodities.

The society must determine whether to employlabor intensive production or capital intensiveproduction

Labor intensive uses more human resource or

manual labor in producing goods and services

Capital intensiveemploys more technology andcapital goods like machineries and equipment in

production


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Example: Lexus Toyota designs factory, uses machinery, &

trains workers to minimize cost BUT retain a

certain quality

Some government restricts this decision:

Pollutionlaws

safetylaws

laborlaws


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For whom to produce This identifies the people or sectors who

demand the commodities produced in a

society. Economists must determine thetarget market of the goods and serviceswhich are to be produced to understand their

consumption behaviors and patt

erns.

Sales ofgoods increase profits

For those who can pay the highest price thegoods are produced


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Example: Lexus

Those who are willing and able to pay

$50,000 for one.With markets, price rations a scarce

resource


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3 Es in Economics Efficiency refers to productivity and proper

allocation of resources. It is a relationship

between scarcefactor inputs and outputs ofgoods and services. This can be measured inphysical terms (technological efficiency) or costterms (economic efficiency)

Production->modern technology->increase inrevenue and profit


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3 Es in Economics Equity means justice and fairness.

Thus, while technological advancementmay increase production, it can alsobear disadvantages to employment ofworkers


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3 Es in Economics Effectiveness means attainment ofgoals and

objective. Economics is an important and

functional tool that can be utilized by otherfields.

For instance, with the use ofboth productions

(through manual labor or technology),whatever the output is, it will be useful for theconsumption of the society and the rest of theworld.


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Scope ofEconomics Microeconomics -> The branch ofeconomics that

examines thefunctioning of individual industries andthe behavior of individual decision-making unitsthat

is, business firms and households.

Macroeconomics -> The branch ofeconomics thatexamines theeconomic behavior of aggregatesincome, employment, output, and so onon a national

scale. Microeconomics looks at the individual unitthe

household, thefirm, the industry. It sees and examinesthetrees. Macroeconomics looks at the whole, the

aggregate. It sees and analyzes theforest.


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Microeconomics and MacroeconomicsTABLE 1.1 Examples of Microeconomic and Macroeconomic Concerns

Divisions

of Economics Production Prices Income Employment

Microeconomics Production/output inindividual industries andbusinesses

Howmuchsteel

Howmuchofficespace

Howmanycars

Price of individualgoods and services

Priceofmedicalcare

PriceofgasolineFoodprices

Apartmentrents

Distribution ofincome andwealth

Wagesintheautoindustry

Minimumwage

Executivesalaries

Poverty

Employment byindividual businessesand industries

Jobsinthesteelindustry

Numberofemployeesinafirm

Numberofaccountants

Macroeconomics Nationalproduction/output

Totalindustrialoutput

Grossdomesticproduct

Growthofoutput

Aggregate price level

Consumerprices

Producerprices

Rateofinflation

National income

Totalwagesandsalaries

Totalcorporateprofits

Employment andunemployment in

the economy

Totalnumberofjobs

Unemploymentrate


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The Scope ofEconomics

TABLE 1.2 The Fields of EconomicsComparative economic

systems

examinesthewaysalternativeeconomicsystemsfunction.Whataretheadvantagesanddisadvantagesofdifferentsystems?

Econometrics appliesstatisticaltechniquesanddatatoeconomicproblemsinanefforttotesthypothesesandtheories. Mostschoolsrequireeconomicsmajorstotakeatleastonecourseinstatisticsoreconometrics.

Economic development focusesontheproblemsoflow-incomecountries.Whatcanbedonetopromotedevelopmentinthesenations? Importantconcernsofdevelopmenteconomists

includepopulationgrowthandcontrol,provisionforbasicneeds,andstrategiesforinternationaltrade.

Economic history tracesthedevelopmentofthe moderneconomy.Whateconomicandpoliticaleventsandscientificadvancescausedthe Industrial Revolution?WhatexplainsthetremendousgrowthandprogressofpostWorldWarII Japan?WhatcausedtheGreat Depressionofthe 1930s?

Economics of race and

gender

examinestheroleofraceandgenderineconomictheory,ineconomiclife,andinpolicymaking. Howhasdiscriminationbyraceorgenderaffectedthewell-beingof

householdsandthedistributionofincomeandwealth?Environmental economics studiesthepotentialfailureofthe marketsystem toaccountfullyfortheimpactsof

productionandconsumptionontheenvironmentandonnaturalresourcedepletion.Havealternativepublicpoliciesandneweconomicinstitutionsbeeneffectiveincorrectingthesepotentialfailures?

Finance examinesthewaysinwhichhouseholdsandfirmsactuallypayfor,orfinance,theirpurchases. Itinvolvesthestudyofcapital markets (includingthestockandbondmarkets),futuresandoptions,capitalbudgeting,andassetvaluation.

TheDiverseFields ofEconomics


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The Scope ofEconomics

TABLE 1.2 The Fields of Economics (continued)The history of economic

thought,

whichisgroundedinphilosophy,studiesthedevelopmentofeconomicideasandtheoriesovertime,from Adam Smithintheeighteenthcenturytotheworksofeconomistssuchas ThomasMalthus, Karl Marx,andJohn Maynard Keynes.Becauseeconomictheoryisconstantlydevelopingandchanging,studyingthehistoryofideashelpsgive meaningto moderntheoryandputsitinperspective.

Industrial organization lookscarefullyatthestructureandperformanceofindustriesandfirmswithinaneconomy.Howdobusinessescompete?Whogainsandwholoses?

International economics studiestradeflowsamongcountriesandinternationalfinancialinstitutions.Whataretheadvantagesanddisadvantagesforacountrythatallowsitscitizenstobuyandsellfreelyinworldmarkets?Whyisthedollarstrongorweak?

Labor economics dealswiththefactorsthatdeterminewagerates,employment,andunemployment.Howdopeopledecidewhethertowork,howmuchtowork,andatwhatkindof job?Howhavetherolesofunionsandmanagementchangedinrecentyears?

Law and economics analyzestheeconomicfunctionoflegalrulesandinstitutions.Howdoesthelawchangethebehaviorofindividualsandbusinesses? Dodifferentliabilityrules make

accidentsandinjuries moreorlesslikely?Whataretheeconomiccostsofcrime?Public economics examinestheroleofgovernmentintheeconomy.Whataretheeconomicfunctions

ofgovernment,andwhatshouldtheybe?Howshouldthegovernmentfinancetheservicesthatitprovides?Whatkindsofgovernmentprogramsshouldconfronttheproblemsofpoverty,unemployment,andpollution?Whatproblemsdoesgovernmentinvolvementcreate?

Urban and regional

economics

studiesthespatialarrangementofeconomicactivity.Whydowehavecities?Whyaremanufacturingfirmslocatingfartherandfartherfrom thecenterofurbanareas?

TheDiverseFields ofEconomics


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Method ofEconomics

Positiveeconomics An approach to economics thatseeks to understand behavior and the operation of

systems without making judgments. It describeswhatexists and how it works.

What determines the wage ratefor unskilled workers?

Divided into: (a) descriptiveeconomics; and (b)economic theory


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Method ofEconomics Descriptiveeconomics The compilation ofdata that

describe phenomena and facts.

Philippine Statistical Yearbook

Economic theory A statement or set of relatedstatements about cause and effect, action and

reaction. law ofdemand by Alfred Marshall in 1890, when a

price ofa product rises, people tend to buy less ofit; when the price ofa productfalls, they tend to

buy more.


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Method ofEconomics Normativeeconomics An approach to economics that

analyzes outcomes ofeconomic behavior, evaluatesthem as good or bad, and may prescribe courses of

action. Deals with areas of the subject that are open topersonal opinion and belief . Also called policyeconomics.

Should the government subsidize or regulateeducationexpense ofhigher level education?


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Economic Theories vs. Models Economic Theory a statement or set of related

statements about cause and effect, action and reaction

Attempts to generalize about data and interpret them.E.g., law of demand

Economic Model a formal statement of a theory.Usually a mathematical statement ofa presumedrelationship between two or more variables.

Variable a measure that can changefrom time totime or from observation to observation

Ockhams razor The principle that irrelevant detailshould be cut away.


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Ceteris Paribus Ceteris paribus - a latin phrasefor "all

else being equal." Used to analyze therelationship between two variableswhile the values ofother variables heldconstant

E.g., ifcost of text messaging increaseby 10%, how much text messages willbe sent?


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Economic models 3 ways to represent a model or convey an economic

idea - words, graphs, and equations

Words convey simple ideas effectively, but notadequatefor multi-variable models or two-variablemodel. Graphs do this job intuitively, and in a morespecific as well as accurate way. It does not only give

you the big picture, but also shows you what it is likeat a specific point. Equations are not used asfrequently as theformer two, but presents us theunderlying process, so more suitablefor in-depthresearch and modeling.


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Economic modelsGRAPH EQUATIONS

Filipino householdspend 90% of theirincome and save theremaining 10%

C= 0.90Y and S =0.10Y

Where C=consumptionS= savingsY= income


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HOW TO READ AND UNDERSTAND GRAPHS


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Logical Fallacies

fallacy ofcompositionoccurs when it is incorrectly assumed that

what is truefor each and every individualin isolation is truefor an entire group.

post hoc, ergo propter hoc fallacy(association as causation)occurs when one incorrectly assumes that

oneevent is the cause ofanother becauseit precedes the other.


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Testing Theories and Models

Empirical economics the collectionand use ofdata to testeconomic

theories


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Economic Policy Criteria for judging economic outcomes

Efficiency (allocative efficiency) an efficient

economy is one that produces what people wantand does so at the least possible cost

Equity fairness

Growth (output growth) increase in total output

of theeconomy

Stability a condition in which national output issteady, or growing, with low inflation and full

employment of resources


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Economic Systems Traditional Economy

Subsistence Economy

A family produces goods only for its ownconsumption

The decision on what, how, and for whom toproduce are made by thefamily head, inaccordance with traditional means ofproduction


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Economic Systems Command Economy

Also known as central planning command economy,

centrally planned economy, or command and controleconomy

An economy in which a central authority or agencydraws up a plan thatestablishes what will be producedand when, sets production goals and makes rules fordistribution

E.g., Soviet Union, China, Eastern Europe


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Economic Systems Free Market Economy (Laissez Faire)

Laissez Faire allows (them) to do, implies

a complete lack ofgovernment involvementin theeconomy

An economy in which individual people and

firms pursue their own self interests withoutany central direction or regulation

Market the institution through whichbuyers and sellers interact and engage in

exchange


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Economic Systems Mixed Economy

A mixture ofmarket system and the

command system.

It applies the two forms in making decision


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Economic Systems Mixed Economy

Since markets are not perfect, governments interveneand often play a major role in theeconomy. Some ofthe goals ofgovernment are to:

Minimize market inefficiencies

Provide public goods

Redistribute incomeStabilize the macroeconomy:

Promote low levels ofunemployment Promote low levels of inflation


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Economic Systems Transition Economies

Transition from planned to mixed/market

Causes of transition : disadvantages ofplanned

Processes and Problems

E.g., Hungary, Poland, Russia


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Circular flow diagram A visual model of theeconomy that shows

how money/payments flow through markets

among household and firms Firms produce goods and services using inputs

or factors ofproduction. Household own the

factor ofproduction and consume all goodsand services that thefirms produce

2 markets: markets for goods and servicesand markets for thefactors ofproduction


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Figure 1 The Circular Flow

Copyright 2004 South-Western

Spending

Goods and

services

bought

Revenue

Goods

and services

sold

Labor, land,and capital

Income

= Flow of inputs

and outputs

= Flow ofdollars

Factors ofproduction

Wages, rent,

and profit

FIRMS

Produce and sell

goods and services

Hire and usefactors

ofproduction

Buy and consume

goods and services

Own and sell factors

ofproduction

HOUSEHOLDS

Households sell

Firms buy

MARKETSFOR

FACTORS OF PRODUCTION

Firms sell

Households buy

MARKETS

FOR

GOODS AND SERVICES

Resource Market

Product Market


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FirmsProduce and sell goods and servicesHire and usefactors ofproduction

HouseholdsBuy and consume goods and servicesOwn and sell factors ofproduction

Markets for Goods and ServicesFirms sellHouseholds buy

Markets for Factors ofProductionHouseholds sell

Firms buy


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Scarcity, Choice andOpportunity costs


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Fundamental economic problem Cost of going to college

-- what you can buy with tuition & fees

-- what you could earn by working-- what you could do with thefree time

you are willing to give up ...

-- tuition

-- wages

-- leisure time

to go to college bec. you expect higher income or more

rewarding career


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Scarcity Economics is the study ofhow

individuals and economies dealwith thefundamental problem ofscarcity.

As a result ofscarcity, individualsand societies must make choicesamong competing alternatives.


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Choice Since people do not have infinite

incomes they need to make choices

whenever they purchase goods andservices, individuals and societies mustchoose among available alternatives.


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Opportunity Cost

The opportunity cost ofany alternative is definedas the cost ofnot selecting the "next-best"alternative. Next best alternativeforgone when aneconomic decision is made

The opportunity cost ofcollege attendanceincludes:

the cost of tuition, books, and supplies,

foregone income(this is usually the largest costassociated with college attendance), and

psychic costs


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Opportunity cost ofattending a movie:

opportunity cost of tickets

opportunity cost of time


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Production possibilities frontier A graph that shows all combination ofgoods

and services that can be produced ifall

scoietys resources are used efficiently Assumptions:

A fixed quantity and quality ofavailableresources

A fixed level of technology

Efficient production (i.e., nounemployment and no underemployment)


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Production possibilities frontier Choice between 2 goods

PPF shows maximum possible

output combos of2 goods, givencurrent resources


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Example: Two goods 2 goods:

-- CDs

-- bottled water

use land, labor, capital to make

these goods


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CDs and Bottled WaterFood

(millionsper

yr.)

Clothes(millionsper

yr.)

A 15 0

B 14 1

C 12 2

D 9 3E 5 4

F 0 5

Supposethese are 6possiblepairs:


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We can graph the table & get the

PPF:

food

clothes

15

5

9

3


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Using the PPF

points on or inside the PPF are possible

Food

clothes

points INSIDE the PPF

are inefficient

points ON the PPF

are efficient

9

3

6

2

-- do not use all resources

-- use all resources


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Using the PPF

points outside the PPF are NOT possible at

this time

food

clothes

9

3

15

6

cannot produce 15 food AND

6 clothes


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Scarcity & tradeoffs

the PPF shows limits to production

so must choose between clothes & foodcombinations

-- give up clothes to get morefood

-- give up food to get more clothes-- TRADEOFF


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Opportunity Cost

on PPF there are tradeoffs

-- how much is given up?

= opportunity cost


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Opportunity cost of1 cloth:

A to B

= 1food

B to C

= 2 food

C to D= 3 food

food(millionsper

yr.)

clothes(millionsper

yr.)

A 15 0

B 14 1

C 12 2

D 9 3

E 5 4

F 0 5


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food(millionsper

yr.)

clothes(millionsper

yr.)

Opp.cost

of1 cloth(intermsof

food)

A 15 0B 14 1 1

C 12 2 2

D 9 3 3E 5 4 4

F 0 5 5


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opportunity costs are increasing cost(in food) increases

as clothes production increases PPF is concave(bowed out)

why?

-- harder to switch resourcesbetween food and clothes


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Atfirst when making more clothes

- switch the best resources from

food production

But as we make more clothes

- resources switched are less and less

suitablefor clothes production


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Shifts in the PPF

ifwe get more resources OR

if technology improves Improvement in quantity and/or quality of

resources

then the PPF

will shift out produce more CDs and more water

economic growth!


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food

clothes

9

3

15

6

With economic growth,

the unattainable becomesattainable

6

2

A

B

C

Point A-represents a combination ofactual outputMovementfrom point A to A1- actual growthPoint B- potential output

Movementfrom point B to C potential growth

A1


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Unitsofguns

16

14

12

10

8

6

4

2

A

B

C

D

E

F

1

0

2 3 4 5 6

Point Units of Butter Units of Guns

A 15 0

B 14 1

C 12 2

D 9 3

E 5 4

F 0 5

Hypothetical Production Schedule

Exercise on PPF

To gain __ unit of Guns

Had to give up __units of butter

When you are on the line (PPF), to get more of one thing you have to give

up some of the other thing

In this particular instance, the opportunity cost

of gaining ___ unit of guns was ___units ofbutter

Production Possibilities


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Unitsofguns

16

14

12

10

8

6

4

2

A

B

C

D

E

F

1

0

2 3 4 5 6


A 15 0

B 14 1

C 12 2

D 9 3

E 5 4

F 0 5


Curve


Had to give up __ units of

butter




of gaining ___unit of guns was ____units ofbutter



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Unitsofguns

16

14

12

10

8

6

4

2

A

B

C

D

E

F

1

0

2 3 4 5 6


A 15 0

B 14 1

C 12 2

D 9 3

E 5 4

F 0 5


Curve


Had to give up ___ units of

butter




of gaining one unit of guns was four units ofbutter



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2-25

Unitsofguns

16

14

12

10

8

6

4

2

A

B

C

D

E

F

1

0

2 3 4 5 6


A 15 0

B 14 1

C 12 2

D 9 3

E 5 4

F 0 5


Curve

To gain __unit of Guns

Had to give up __ units of

butter




of gaining ___ unit of guns was ____units ofbutter


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Other Concepts Capital goods are goods used to produce

other goods and services.

Consumer goods are goods produced forpresent consumption.

Investment is the process ofusing resources

to produce new capital. Capital is theaccumulation ofprevious investment.

The opportunity cost ofevery investment in

capital is forgone present consumption.


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Economic Growth and Development Economic growth is the ability ofan economy to

produce more goods and services over time

Comes from

An increase in factor resources (land, labor, capital,entrepreneurship)

Especially made possible by increases in capital (CapitalFormation); Capital formation is the engine thatdrives economic growth

Improvements in technology

Improvements in education, training and organization oflabor

Any combination of the above

Economic Development is a measure of welfare; ofwell-being. This may be made possible by increases inconsumption goods


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Economic growthCapitalgoods

Consumer goods


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Homework (due:26 November 2011)

Explain what is meant by PPF. Use adiagram to explain the concepts ofscarcity, choice and opportunity cost.

- definitions (e.g., PPF, opportunitycost)

- diagram with example

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Lecture1_intro to Macro