Economic Essentials: From Scarcity to Equilibrium

2. Theme 1:Fundamentals of Economic Analysis • Economic resources (aka factors of production) • Land, labor, capital, entrepreneurs • Scarcity= we have limited resources for our unlimited wants • Trade offs/Opportunity cost= what could you do with resources instead? (OC= next best alternative)

3. Theme 1:Fundamentals of Economic Analysis • Marginal analysis= the additional costs and benefits from the consumption of the next unit of a g/s

4. Theme 1:Fundamentals of Economic Analysis • Production possibilities Table Curve (frontier)

5. Theme 1:Fundamentals of Economic Analysis • Absolute Advantage= who can produce more of a good • Comparative Advantage= who can produce at the lower opportunity cost

6. Theme 1:Fundamentals of Economic Analysis • Functions of economic systems: the Market System • Aka capitalism • Private property: individuals own most economic resources • Self interest & incentives • Competition

7. P 60 in “5 Steps…”

8. Theme 2: Demand, Supply, & Market Equilibrium • Law of Demand: when price increases, quantity demanded decreases • Income effect= the change in QD resulting from a change in the consumer’s purchasing power • Substitution effect= the change in QD resulting from a change in the price of one good relative to the price of other goods • Substitutes: cars vs. trucks • Complements: peanut butter & jelly

9. DEMAND • The Demand Schedule and Demand Curve • Demand slopes Down • Change in price= movement along curve • PIPER= shifts

10. SUPPLY • Law of Supply: there is a direct (positive) relationship between the price & QS of a good • The Supply Schedule and Supply Curve • Supply goes up • Change in price= movement • CERTT/SS= shifts

11. EQUILIBRIUM • When QS=QD • Shortage: QD > QS • Surplus: QD < QS

12. P78 in “5 Steps…”

13. Theme 3: Public Goods and Externalities • Private goods- both rival & excludable • Ex: bag of chips, cup of tea • Public goods- nonrival & nonexcludable • Ex: national defense, environmental protection • Free-rider problem • Positive externality= spillover benefit • Negative externality= spillover cost

14. P 166 in “5 Steps…” • Skip #1

15. Theme 4: Macroeconomic Measures of Performance • The Circular Flow Model (draw it!)

16. The Circular Flow Model + Govt Intervention

17. GDP • Gross Domestic Product= the market value of the final g/s produced within a nation in a year • GDP= C + Ig + G + Xn (output) • Nominal GDP= GDP not adjusted for inflation • Real GDP= GDP adjusted for inflation

18. Business Cycle

19. Consumer Price Index (CPI) • measures changes in the price level of a market basket of consumer g/s purchased by households

20. Price Index Current Year= 100 * (Spending Current Year)/ (Spending Base Year) • 2001 Price Index= 100 * (531)/(486)= 109.26 • Has inflation occurred from 2000 to 2001?

21. Unemployment • The labor force= all those 16 and up who are currently employed or unemployed • Unemployment rate= unemployed/labor force • Types: • Frictional: short-term unemployment when someone new enters the labor market • Seasonal: due to periodic and predictable job loss that follows the calendar • Structural:unemployment due to technological advances • Cyclical: unemployment rates that fluctuate with the business cycle

22. P 183 in “5 Steps…”

23. Theme 5: Consumption, Saving, Investment, and the Multiplier

24. Consumption and Saving • Disposable income= money left after taxes

25. Marginal Propensity to Consume & Save • MPC= ΔC/ΔDI • MPS= ΔS/ΔDI • MPC + MPS = 1 • Determinants of Consumption and Saving: • Wealth • Expectations • Household Debt • Taxes and Transfers

26. Investment • Decision to invest– is it going to make me money? • If R% is greater than or equal to i%, make the investment.

27. Market for Loanable Funds • = money that is available to be borrowed for investment projects • The supply of loanable funds comes from the $ saved by households and government • The demand comes from investment

28. The Multiplier Effect • Round 1: Firms increaseinvestment spending by $10 • Round 2: The $10 acts as income to resource suppliers. With an MPC= .80, households spend $8 and save $2. • Round 3: The $8 of new consumption spending (C) is income for other households, and they also spend 80%, or $6.40 and save $1.60. • Round 4: The $6.40 of new C is income for other households and they spend 80%, or $5.12, and save $1.28.

29. The Multiplier Effect • The spending multiplier formula: Multiplier = 1/(1-MPC) 1/(1-.80)= 5 OR Multiplier= 1/MPS OR Multiplier= (ΔGDP)/(Δspending)

30. The Multiplier Effect • Decrease in taxes  increase in disposable income (follow MPC) • Example: Johnny Taxpayer receives $200 from the government. If the MPC is .90, JT spends $180 but saves $20. • *taxes always have a smaller multiplier than government spending! Tm = (ΔGDP)/(Δtaxes)

31. The Multiplier Effect • The Balanced-Budget Multiplier= 1 • Example: The gov. wants to spend $100 on a federal program and pay for it by collecting $100 in additional taxes. The MPC = .90. • The spending multiplier = 10 implies that the $100 of new spending (G) creates a $100 increasein real GDP.(spending effect) • The tax multiplier Tm = 9 implies that a $100 increase in taxes decreases real GDP by $900. (taxation effect) • Change in real GDP = $1000 - $900 = $100(balanced budget effect)

32. Theme 6: Aggregate Demand and Aggregate Supply • Aggregate = TOTAL

33. Aggregate Demand • The sum of spending by households, firms, the government, and net exports • Substitutes for national output: • g/s produced in other nations (foreign sector sub. Effect) • g/s in the future (interest rate effect) • Money & financial assets (wealth effect) • The AD curve, like the demand curve, is downward sloping

34. Aggregate Demand • Changes in AD: • Consumer Spending (C): more money = more spending • Investment Spending (I): firms increase investment if foresee profit • Government Spending (G): gov adds money through spending, reducing taxes, increasing transfer payments • Net Exports (X-M): selling more exports than imports purchased increases AD

35. Aggregate Supply • TOTAL supply • SRAS vs. LRAS

36. Shifts in AS • Short-Run Shifts: • Input prices • Tax policy • Deregulation • Political or environmental phenomena • Long-Run Shifts: • Availability of resources • Technology and productivity • Policy incentives

37. EXAMPLE

38. Macroeconomic Equilibrium

39. AS PRICE LEVEL VERTICAL RANGE AD 3 INTERMEDIATE RANGE HORIZONTAL AD 2 AD 1 OUTPUT OF REAL GDP

40. An increase in AD causes real GDP to increase, unemployment to decrease and price level to increase • A decrease in AD causes real GDP to decrease, unemployment to increase and price level to decrease • An increase in AS causes real GDP to increase, unemployment to decrease and price level to decrease • A decrease in AS causes a decrease in real GDP, unemployment and price level increase

41. The Trade-Off Between Inflation and Unemployment

42. Phillips Curve • Short run  • Supply shocks 

43. Phillips Curve (Long Run)

44. Theme 7: Money, Banking, and Monetary Policy

45. Money • =anything used in the exchange of g/s • Functions of money: • Medium of exchange • Unit of account • Store of value • Money today is more valuable than the same amount of money in the future. Why?

46. The Supply of Money • M1= cash + coins + checking deposits + traveler’s checks • Most liquid • M2= M1 + savings deposits + small time deposits + money market deposits + money market mutual funds • M3= M2 + large time deposits • Least liquid

47. Demand for Money • Transaction demand= amount of money held in order to make transactions • Asset demand: the amount of money demanded as an asset.

48. The Money Market • Different than the Market for Loanable Funds: • Breadth of scope • Different philosophies

49. Changes in Money Supply

50. A Decrease in the Money Supply