EC 102.01

1. EC 102.01 Lecture 1

2. Syllabus • Instructors: Asst. Prof. Burçay ERUS and Dr. Burcu YAKUT-ÇAKAR • How to reach the instructor: • By e-mail: burcay.erus@boun.edu.tr, burcu.yakut@boun.edu.tr • By phone from the office: 359 7638 or 359 7652 • After the class or by appointment • Office Hours: Tuesday 15:00-17:00 and by appointment • Textbook: : Macroeconomics in Context, Goodwin, et al., M.E. Sharpe, 2009, • Powerpoints will be posted on the website

3. Course requirements: • Midterms (2*30%) • Final (40%) • Cheating will be severely punished! • See the syllabus at the course website for more info.

4. What is economics • Study of how society decides what, how and for whom to produce • Study of the way people organize themselves to sustain life and enhance its quality • resource maintenance, production, distribution and consumption of goods and services.

5. Macroeconomics vs. Microeconomics • Microeconomics focuses on how decisions are made by individuals and firms and the consequences of those decisions. • Ex.: How much it would cost for a university or college to offer a new course? (including the cost of the instructor’s salary, the classroom facilities, the class materials, and so on). Having determined the cost, the school can then decide whether to offer the course.

6. Macroeconomics vs. Microeconomics Macroeconomics examines the aggregate behavior of the economy ─ how the actions of all the individuals and firms in the economy interact to produce a particular level of economic performance as a whole. • Ex.: Overall level of prices in the economy (how high or how low they are relative to prices last year) rather than the price of a particular good or service.

7. Microeconomic vs Macroeconomic Questions

8. Digression: Development of Macroeconomics Classical Period: 18th century – industrial revolution Stressing the issues of growth and development based on an image of smoothly-functioning markets. Specialization/division of labour + laissez faire Great Depression, Keynes and Monetarism Aggregate demand is important, need to use fiscal policy to keep demand and employment at high levels – Keynes Governments should only aim for steadiness in the money supply via monetary policies - Monetarism

9. How Individuals Make Choices: • Basic principles behind the individual choices: • 1. Resources are scarce. • 2. The real cost of something is what you must give up to get it • Opportunity cost • It is all about what you have to forgo to obtain your choice.

10. How Individuals Make Choices: • 3. “How much?” is a decision at the margin. • Trade-offs • Marginal decisions and marginal analysis • 4. People usually take advantage of opportunities to make themselves better off. • Incentives

11. Economic Activity in Context Macroeconomic Goals positive vs. normative questions Concept of “well-being” Living standards – “keep living standards of the individuals high enough to maintain long, healthy and enjoyable lives” economic growth + political freedom + social inclusion - economic development Growth but: What is produced? How ? For whom?

12. Economic Activity in Context (ii) Stability – temporal dimension fluctuations - boom vs. recession business/trade cycles – alternating periods of B/R (iii) Sustainability financially? – “debt crises” socially? – “disparities in living standards” ecologically? – “catastrophic effects” Need for a rethinking of economic growth

13. Economic Activity in Context

14. What Economies Do? Goals (were): good stds of living, stability and sustainability – need to understand building blocks Need to combine micro and macro perpectives to understand the functionings Four essential economic activities: resource maintenance, production, distribution and consumption of goods and services.

15. Essential Economic Activities Resource maintenance: tending to preserving or improving the stocks of resources for preservation and quality of life Capital stock – valuable for economic contribution! Types: natural (physical assets provided by nature), manufactured (human productive activities added to natural), human (individual’s capacity fo labour – skills and knowledge), social (stock of trust, mutual understanding).

16. Essential Economic Activities Production: conversion of resources into useble products – tangible/intangible, manufactured Inputs -> outputs + waste products Need to consider capital stocks Distribution: sharing of products and resources among people Markets facilitate exchange relations Transfers - payments given without return expectation (monetary/non-monetary – in kind)

17. Essential Economic Activities Consumption: final use of goods and services by individuals to satisfy needs. May choose to save for consumption in the following periods. Flow of savings (either from individuals, business and government) add to the stock of available financial assets. Use of financial intermediaries help facilitate the savers to loan out to those who want to borrow Some borrowed funds could be used for creation of new investment goods – aim to maintain resources

18. Spheres of Economic Activity Core Sphere – household, family, community that organize resource management, production and consumption. work is rewarded directly by what it produces eg. Childcare, elderly care, decisions on labour supply, decision on skills and education, allocation of consumption (and savings/investment) Public-Purpose Sphere – governments, NGOs, international organizations Exist for a specific purpose related to the “public good”, i.e. beyond individual and family interest. eg. Regulation, direct provision

19. Spheres of Economic Activity Business Sphere – firms, looking for opportunities to buy and manage resources. Responds to demands for goods and services (as opposed to core: direct needs; public-purpose: its constitutents) Propriatorships, partnerships, cooperatives, corporations One clear goal : making profit! (most valuable outputs to produce, produce at the least possible cost, innovation) Less Developed Country Context – Informal Sphere Outside government oversight and regulation – could be illegal, illicit but not necessarily.

20. Models in Economics: • A model is a simplified representation of a real situation that is used to better understand real-life situations. • The production possibility frontier (PPF) illustrates the trade-offs facing an economy that produces only two goods. It shows the maximum quantity of one good that can be produced for any given production of the other.

21. Tom’s Trade-offs: The Production Possibility Frontier

22. Increasing Opportunity Cost

23. Economic Growth Economic growth results in an outward shift of the PPF because production possibilities are expanded.

24. Transactions: The Circular-Flow Diagram The circular-flow diagram is a model that represents the transactions in an economy by flows around a circle.

25. Circular-Flow of Economic Activities • Economic Agents: • Households: do consumption decision and are the owners of factors of production • Aim: maximize utility • Firms: rent or employ the factors of production and do the production decision • Aim maximize profits • Where they interact: • Markets for goods and services • Markets for factors of production • Market not a place but a mechanism bringing seller and buyer together • Price mechanism allocates the resources

26. Graphs: Pay attention to scale and size of increments

27. Graphs: Pay attention to the variable of interest Be wary of causality

28. The Great Depression The Great Depression precipitated a thorough rethinking of macroeconomics, which gave rise to modern macroeconomics.

29. The Business Cycle • The business cycle is the short-run alternation between economic downturns and economic upturns. • A depression is a very deep and prolonged downturn. • Recessions are periods of economic downturns when output and employment are falling. • Expansions, sometimes called recoveries, are periods of economic upturns when output and employment are rising.

31. The Business Cycle • What happens during a business cycle, and what can be done about it? • the effects of recessions and expansions on unemployment; • the effects on aggregate output; and • the possible role of government policy.

32. Employment and Unemployment • Employment is the number of people working in the economy. • Unemployment is the number of people who are actively looking for work but aren’t currently employed. • The labor force is equal to the sum of employment and unemployment.

33. Employment and Unemployment • Discouraged workers are non-working people who are capable of working but are not actively looking for a job. • Underemployment is the number of people who work during a recession but receive lower wages than they would during an expansion due to smaller number of hours worked, lower-paying jobs, or both. • The unemployment rate is the ratio of the number of people unemployed to the total number of people in the labor force, either currently working or looking for jobs.

34. History of the unemployment rate since 1948

35. Taming the Business Cycle Policy efforts undertaken to reduce the severity of recessions are called stabilization policy. • One type of stabilization policy is monetary policy, changes in the quantity of money or the interest rate. • The second type of stabilization policy is fiscal policy, changes in tax policy or government spending, or both.

36. Long-Run Economic Growth Secular long-run growth, or long-run growth, is the sustained upward trend in aggregate output per person over several decades. A country can achieve a permanent increase in the standard of living of its citizens only through long-run growth. So a central concern of macroeconomics is what determines long-run growth.

37. U.S. real gross domestic product per person from 1900 to 2004

38. Aggregate Price Level A nominal measure is a measure that has not been adjusted for changes in prices over time. A real measure is a measure that has been adjusted for changes in prices over time. The change in real wages is a better measure of changes in workers’ purchasing power than the change in nominal wages. The aggregate price level is the overall level of prices in the economy.

39. Consumer price index from 1913 to 2004

40. Inflation and Deflation • A rising aggregate price level is inflation. • A falling aggregate price level is deflation. • The inflation rate is the annual percent change in the aggregate price level. • The economy has price stability when the aggregate price level is changing only slowly.

41. Inflation and deflation since 1929

42. The Open Economy • A closed economy is an economy that does not trade goods, services, and assets. • The United States has become increasingly open, so that open-economy macroeconomics has become increasingly important. • Open-economy macroeconomics is the study of those aspects of macroeconomics that are affected by movements of goods, services, and assets across national boundaries.

43. The Open Economy • One of the main concerns introduced by open-economy macroeconomics is the exchange rate, the price of one currency in terms of another. • Exchange rates can affect the aggregate price level. • They can also affect aggregate output through their effect on the trade balance, the difference between the value of the goods and services a country sells to other countries and the value of the goods and services it buys in return. • Economists are also concerned about capital flows, movements of financial assets across borders.

44. Movements of the exchange rate between the U.S. dollar and the euro

45. Distribution: Who gets what and how??? Distribution in form of exchange and in form of transfer – Main Q: who receive the incomes generated by production and the role of government, if any. Exchange relations: two agree to trade on the basis of mutuall agreed terms. Goods and labour markets – monetary flow (L/K income) Wages, rents, profits – controversial debate over which is the productive one!

46. Distribution: Who gets what and how??? Taxes and transfers: funds flowing to and from gov. From – dependency needs not met elsewhere (care, shelter, education, health services) Two main types of transfer programs – social insurance and means-tested. Insurance- pool insurance (contributions) to hedge for risks Means-tested - non-contributory but income/assets/wealth being tested TR: Social Insurance Institution, Unemployment Insurance Fund, Social Assistance and Solidarity Fund

47. Distribution: Who gets what and how??? Taxes and transfers: funds flowing to and from gov. To – collection of income and consumption/sales taxes (e.g.VAT) – direct vs. indirect taxes Proportional?? Progressive vs. regressive Tax system in TR relies heavily on indirect taxes: in 2008, 32.7 % of tax revenues come from income taxes while indirect taxes comprise of 63 % (OECD average 42 %). Structure of taxation: share of tax revenues in TR constitutes only 24.5 % of GDP (OECD average: 35.8 %, EU-15: 38.8%) Share of income taxes in GDP (2007) in TR 5.6% (OECD: 13.2%; EU 15: 14%)

48. Distribution: Who gets what and how??? Distribution of Income - share of income received by the population/households Quintiles – equal sized groups Distribution of income in TR

49. Distribution: Who gets what and how??? Measuring Inequality - need to describe the pattern of inequality - Lorenz Curve The more bended the curve, the greater the inequality of income Gini Coefficient: ratio of area between the Lorenz Curve and diagonal 0 (perfect equality) < Gini < 1 (complete inequality)