INTRODUCTION TO MACROECONOMICS

1. INTRODUCTION TO MACROECONOMICS

2. Definition of Economics • According to Economist Lionel Robbins; Economics is a social science which studies human behavior as a relationship between ends and scarce means which have alternative uses.

3. Scarcity • Scarcity is a situation in which unlimited wants exceed the limited resources (means) available to fulfill those wants (ends).

4. Three Key Economic Ideas • People are rational. • People respond to economic incentives. • Optimal decisions are made at the margin.

5. People are rational: This does not mean that consumers know everything or always makes the best decision. It only means that consumers and firms use all available information as they act to achieve their goals.

6. People Respond to Economic Incentives. An Incentive is something that induces a person to act. Because rational people make decisions by comparing costs an benefits, they respond to incentives. Eg. When the price of apple rises, consumers decide to eat fewer apples, whiles apple orchards decide to produce more apples

7. Will Women Have more Babies if the Government Pays them To ? The example of Estonia.

8. Population Decline in Estonia (1970-2010) Data by Statisitcs Estonia 2010.

9. Blue - # of Births, Red - # of deaths, and Green – Population Increase

10. Optimal decisions are made at the Margin. Marginal Change is a small incremental adjustment to a plan of action. • Some decisions are all or nothing. Eg: Should you enter graduate school or take a job ? You either enter grad school or you don’t. • Most economic decisions however involve doing a little more or a little less.

11. Eg. Should you watch another hour of TV or spend that hour studying ? The marginal benefit of watching TV is the additional enjoyment you receive. The marginal cost is the lower grade you receive from having studied a little less.

12. The Economic Problem That Every Society Must Solve. • Because we live in a world of scarcity, any society faces the economic problem that is limited resources and hence able to produce a limited amount of goods and services. • Every society therefore faces tradeoffs.

13. Opportunity Cost • Opportunity cost :The highest valued alternative that must be given up to engage in an activity. Eg. The opportunity cost for a person who can work as a manager at PNC Bank for a salary of $80,000 annual, but decides to open his own consultancy is the $80,000 he forgoes.

14. Trade-offs force society to make choices when answering the following three fundamental questions: • What goods and services will be produced ? • How will the goods and services be produced ? • Who will receive the goods and services produced ?

15. Centrally Planned Economies Vs Market Economies • To answer the three questions- What, how and who- societies organize their economies in two main ways. • Centrally Planned economy • Market economy

16. Centrally Planned economy: An economy in which the government decides how economic resources will be allocated. Eg. Cuba and North Korea and Former Soviet Union. • Market economy: An economy in which the decisions of households and firms interacting in markets allocate economic resources.

17. The Mixed Economy • The Modern “Mixed” Economy: An economy in which most economic decisions result from the interaction of buyers and sellers in markets but in which the government plays a significant role in the allocation of resources.

18. Positive & Normative Economic analysis • Positive Economic analysis: Analysis concerned with what is. It attempts to describe the world as it is and hence avoids value judgments. Eg: Minimum wage laws cause unemployment. • Normative Economic analysis: Analysis concerned with what ought to be. Eg: The government should raise the minimum wage.

19. Economic Models. • Economists rely on economic models, or theories, to analyze real-world issues. Economic models are simplified versions of reality.

20. The role of Assumptions in Economic Models • Any model is based on making assumptions because models have to be simplified to be useful. • We cannot analyze an economic issue unless we reduce its complexity Eg. Economists assume that firms act to maximize profits.

21. Macroeconomics & Microeconomics Macroeconomics is the study of the performance of national economies and the policies that governments use to try to improve that performance. Microeconomics is the study of how households and firms make choices, how they interact in markets, and how government attempts to influence their choices.

22. Macroeconomic policies Macroeconomic policies are government actions designed to affect the performance of the economy as a whole.

23. Macroeconomic policies • Structural policy—government policies aimed at changing the underlying structure, or institutions, of the nation’s economy. It involves introducing changes to a nation's economy: Eg. The promotion of exports; liberalization, through a reduction in government subsidies in order to bring domestic prices more in line with world prices, etc

24. Macroeconomic policies 2) Fiscal policy—decisions that determine the government’s budget, including the amount and composition of government expenditures and government revenues (taxes).

25. Macroeconomic policies 3) Monetary policy—determination of the nation’s money supply and interest rates. Monetary policy is typically conducted with changes in the federal funds rate.

26. Federal Funds Rate • The federal funds rate in the interest rate that commercial banks charge each other for very short-term (usually overnight) loans.

27. Federal Funds Rate

28. Major Macroeconomic Issues 1)Economic growth and living standards 2) Recessions and Expansions 3) Unemployment 4) Inflation 5) Economic Interdependence among nations

29. Economic growth—An increase in the economy’s production of goods and services.

30. Ways growth can take place: 1) Unemployment resources are put to work. 2) New resources are found or there is an increase in technology.

31. Standard of Living—The degree to which people have access to goods and services that make their lives easier, healthier, safer, and more enjoyable.

32. Measures of the standard of living 1) nominal GDP (or simply GDP) 2) real GDP 3) per capita real GDP

33. Nominal GDP—the market value of all final goods and services produced in a country during a given period of time—evaluated at current prices.

34. Real GDP—the market value of all final goods and services produced in a country during a given period of time—evaluated in prices from a base year. We currently use 2000 as the base year.

35. real GDP per capita = real GDP/population

36. Real GDP

37. Recession (contraction)—a period when the economy is growing at a rate significantly below normal.

38. Expansion—A period when the economy is growing at a rate significantly above normal.

39. Business cycle—reflects the fall and rise of real GDP relative to the long-term trend of the economy. Trend real GDP—the rate at which real GDP would have grown if it had grown smoothly over time.

40. Trend real GDP and the Business Cycle

41. Unemployment The unemployment rate is the fraction of people who would like to be employed, but cannot find work. The civilian unemployment rate is the percentage of those in the civilian labor force who are not employed, but are either looking for employment for have looked in the last four weeks.

42. U.S. Civilian Unemployment Rate

43. Inflation—The inflation rate is the percentage rate per period at which the price level is rising.

44. U.S. Inflation Rate (CPI)

45. Inflation rate in 2010 = (P2010 - P2009)/P2009 x 100 where, P = price level

46. Measures of the price level 1) CPI—consumer price index—constructed to measure the changes in the cost of living, or the cost of buying the usual “basket” of goods for a “typical” household.—A measure over time of the cost of a fixed “market basket” of consumer goods and services.

47. 2) GDP deflator—a comprehensive price index of all goods and services included in GDP. The GDP deflator in the ratio of nominal GDP to real GDP. GDP deflator = nominal GDP/real GDP

48. Economic Interdependence among Nations • 1)Imports--goods produced outside the U.S. and sold within the U.S. • 2)Exports—goods produced within the U.S. and sold outside the U.S. • 3)Trade balance (net exports) = exports - imports.