CH 1:The Scope &
Methods of Economics
and
CH 2: The Economic Problem:
Scarcity and Choice
The Economy: is the institutional structure whereby individuals in society coordinate their wants & desires
Economics: is
the study of the economy
How scarce resources are allocated
Why Study Economics?
1. Learn a way of Thinking
2. Understand Society
3. To Understand Global Affairs
4. Be an informed Voter
Learn a way of Thinking
Opportunity
Cost: They foregone value of the next best
alternative
every
decision has cost or trade-off because of scarcity
Marginalism and Sunk Costs: Weighing
costs and benefits
of a decision beyond sunk
costs (costs that
can't be
avoided)
Efficient
Markets: Profit opportunites are eliminated
almost
instantaneously
Every Society faces 3
central
coordination issues:
1. What
to produce & how much
2. How
to produce it
3. For
whom to produce it
*
Every Individual and Society Faces Constraints, therefore we make
choices or trade offs, which is the heart of the basic economic problem
Scarcity
and Choice
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SOCIETY GENERALLY PREFERS MORE TO LESS
The Amish at Nordstrom’s?
Other General Assumptions:
1. Economic Agents are rational
in their Financial Affairs
2. When Economic Agents Trade
both parties Benefit
3. Economic Agents operate in
their own Self Interest
4. Ceteris Paribus, everything else
held constant
Adam Smith’s Invisible Hand
according to Smith the exercise of individual self- interest benefits society
run by the price mechanism or
invisible hand
Resources defined: inputs necessary for production
Ä
the amount of resources depends on human
ingenuity — technological innovation
Four Main Resources
(inputs):
Factors of Production
1. Land
2. Labor
3. Kapital
4.
Entreprenuership
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ECONOMIC REASONING
(no value judgements)
Cost/Benefit Analysis or Marginal Analysis
Benefits > Costs => Just do it!
Benefits < Costs => Forget it!
Different ways of calculating costs &
benefits
total vs. marginal benefits
Marginal Defined: additional or incremental amount beyond a certain point
Marginal
Cost => Additional costs above what you’ve already incurred
Marginal
Benefits => additional benefits beyond what you have already
received
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Number
of
marginal
total
marginal Total
ice creams
cost
cost
benefit
benefit
1
.25
.25
.35
.35
2
.25
.50
.30
.65
3
.25
.75
.25
.90
4
.25
1.00
.20
1.10
ECONOMIC DECISION RULE: If benefits exceed costs then do it, if they don’t -- then don’t do it
all things have a cost &
benefit
not always measured by price e.g.
1.
Driving
2.
Super
Market
3.
Transplants
vs. Prenatal Care (cost)
4.
Pollution
(cost)
5.
Safety
devices on autos (cost)
CDS vs. Big Macs
school vs. work
Theories -- Models –
over
simplifications /abstractions => putting theory in a contextual
setting
OPPORTUNITY COST:
OPPORTUNITY COST: the foregone value of the next
best
alternative
what you give up to get something else
SCARCITY IMPLIES TRADE-OFFS
unlimited wants with a budget
constraint
what did you give up to attend
college?
CDS vs. Jumbo
Jacks
school vs. work
Bart Simpson vs. Venus Williams
Opportunity Costs can be seen numerically by way of a PRODUCTION POSSIBILITY TABLE
like an input/output table
Opportunity Costs can be seen graphically by way of a PRODUCTION POSSIBILITY FRONTIER (PPF) or Production Possiblity Curve (PPC)
The table & the curve will show
different
combinations of output society can choose from. When
society wants more of one item then it must give up some of another
item.
ASSUMPTIONS:
1. Full employment of all resources (in this case labor)
2. The level of technology is constant
3. Resources are interchangeable w/out inefficiency
4. Society prefers more to less
5. Society produces only tacos & tequila/no
trade
hrs. Labor Tacos hrs. Labor Tequila
20 200 0 0
15 150 5 15
10 100 10 30
5 50 15 45
0 0 20 60
Opportunity Cost of tacos for tequila
50 tacos/15 tequila (3.33 tacos for 1 tequila)
* if society wants tacos it must give up tequila -- just reverse the numbers
* There is an inverse relation: to get more of one thing you must give up something else
ABSOLUTE ADVANTAGE: producing a level of output using less resources than the competition -- Adam Smith
U.S. Saudi Arabia
food oil food oil
100 10 10 100
*show PPF
world
output before & after trade
Now we will drop the
assumption
that resources are interchangeable, because some resources are better
suited
for the production of one good than another
COMPARATIVE ADVANTAGE (narrowly defined): To be better suited for the production one good than the production of another
Basketball Players & Jockeys
&
World’s fastest typist
Production Possibilities Table
Point Missiles
Big Macs
A
3
0
B 2 10 billion
C 1 14 billion
D 0 15 billion
This implies... Increasing Marginal Opportunity Cost:
to
get more of something you have to give up ever increasing quantities of
something else
Efficiency: achieving a goal as cheaply as possible
Inefficiency & Unattainable
Shifts in the PPF
1. Technology improves
2. Resources discovered/destroyed (Kobe)
3. Efficiency of economic institutions
4. Population / workforce
COMPARATIVE ADVANTAGE &
TRADE
if a country has an
absolute
advantage in the production of every good, can there be gains from
trade.
Yes, if opportunity costs differ, then both countries have a
comparative
advantage (David Ricardo) and there can be gains from trade
U.S.
Japan
hamburgers
20
200
CH. 5: Introduction to Macroeconomics
Micro vs. Macro
Aggregate
Behavior=> The Sum of all Households and Firms
The Roots of Macroeconomics
The Great
Depression
the
labor force was 51m
1929 1.5m U
1933 13m U
11.5m
lost jobs
Classical Economics
self regulating mechanism, the price
system
Keynesian Revolution
Short-Run Market Failure
The Rise of the Welfare State
Employment Act of 1946
creation of: The Council of Economic Advisors
60's
economy, go-go economy
70's
economy, stagflation
80's
economy, smooth sailing after two recessions in 80-82 period
90's
economy, early mild recession and explosive growth in the end
2k,
Fall of 2k brought a recession just before the last election
2nd Q 2003 U hit 6.2%, now
at 5.6% as the recovery takes hold
MACRO CONCERNS:
inflation
growth
unemployment
Macro Components
1. Households
2. Firms
PRIVATE SECTOR
3. Government
PUBLIC SECTOR
4. Rest of the
world INTERNATIONAL SECTOR
The
Circular
Flow of Income
Households ultimately own all the factors of production
Firms pay households in the FACTOR MARKET
the amount they are paid is equal to the value of what
is produced
PAYMENT TO HOUSEHOLDS FACTOR
WAGES
(73%)
LABOR
RENT
LAND
INTEREST
CAPITAL
PROFIT
ENTREPRENEURS
Households now have enough to purchase all that is sold in the
GOODS MARKET
BUSINESS
Coolidge, "The business of America is business."
Businesses decide what, how & for whom
based on Consumer
Sovereignty
FINANCE & BUSINESS
Venture Capital & IPOs
GOVERNMENT
as an actor=> state local & federal account for 20% of GDP
as referee=> keeps the playing field level
MICROSOFT vs. THE U.S. GOVERNMENT
GLOBAL SETTING
The
U.S.
accounts for 5% of the world population
and
over 30% of
world consumption
BUSINESS CYCLES:the rise & fall in the general level of business activity around the long-run secular gowth trend
these fluctuations vary in length & intensity
the long-run secular growth trend over the
last 100 years
is estimated to be between 3 to 3.5% annually
The Four Phases of the Business Cycle
trough.............bottom
expansion........upturn
peak.................top..............boom
contraction......downturn
*measured by the NBER, from trough to trough
RECESSION DEFINED: two consecutive quarters of negative economic growth
DEPRESSION: Severe
reduction
of the economy's output and employment lasting more than a year. Actually
there is no strict definition of a depression
LEADING ECONOMIC
INDICATORS: Imperfect
predictors of future
economic activity
Leading indicators, move in advance of the economy
Average weekly hours,
manufacturing
Average weekly initial claims
for unemployment insurance total U.S.,
Manufacturers' new orders,
consumer
goods and materials 92$*
Vendor performance, slower
deliveries
diffusion index
Manufacturers' new orders,
nondefense
capital goods, 92$*
Building permits, new private
housing units in millions
Change in manufacturers'
unfilled
orders, durable goods deleted --
Change in sensitive materials
prices
Stock prices, 500 common
stocks
none
Money supply, M2 92$*
Interest rate spread, 10-year
Treasury bonds less federal funds added
Index of consumer expectations
Index standardization factor
Coincident indicators
, move with the business
cycle
Employees on nonagricultural
payrolls
Personal income less transfer
payments adjusted for accruals
Industrial production none
Manufacturing and trade sales
none
Index standardization factor
1.000
Measures of production, consumption & investment etc.
SUMMARY MEASURES :post-depression era
Keynesian School =>Simon Kuznets, Nobel Prize
Using Prices
as
a Measure of Value - easier to relate to rather than units
Gross National Product (GNP): aggregate final output of all goods & services produced in a given year by U.S. citizens
1992 GDP (U.S. uses GDP instead of GNP)
Gross Domestic
Product
(GDP): aggregate final output of all goods & services
produced
w/in U.S. borders by anybody
The difference is called Net Foreign Factor Income: the difference between what U.S. citizens produce abroad and what foreigners produce on U.S. soil
Chain-Weighted GDP:
THIS IS THE CURRENT WAY OF
CALCULATING
GDP
*we will not use this method
in class or the exams - why? - it is not adequately covered in the text
& it is primarily of interest to just economists
Flow Concept (GDP) vs. a Stock Concept (wealth)
Two ways to determine final
output
1. Add all the value added at
each
level of production
2. Final sales to end user (preferred
method)
Important: GDP & GNP measure final output not intermediate goods -- problem of double counting
Two ways to calculate GDP
=>
National Income Identity **
Expenditure=Income
1. Income approach: add up Wages Rents Interest Profits (WRIP)
2. Expenditure approach: C+I+G+(X-M)
the expenditure approach is preferred because
Income
is
not accurately reported, so it is simply used as a check.
EXPENDITURE APPROACH: GDP=C+I+G+(X-M)=Y=Aggregate Demand
where:
C=Consumption 68% of GDP: durable (2yr>) & nondurable goods
I=Investment 14% of GDP: not stocks &
bonds
they are considered savings
investment in capital goods
1. Residential & nonresidential buildings & equip.
2. Changes in business inventory
remember the difference between: gross private investment & net private investment is depreciation (K consumption allowance)
GROSS INVESTMENT MUST BE > DEPRECIATION for
our
capital
stock to be growing
this the PPC shifts to the right
GDP=C+I+G+(X-M) - depreciation =NDP=C+net I+G+(X-M)
G=Government Spending 19% of GDP, transfer payments not included -- they don’t contribute to GDP
*Transfer Payments: payments to individuals by the Federal Gov. that aren’t for goods & services
(X-M)=Net Exports which is -1% of GDP
INCOME APPROACH: WRIP
1. wages & salaries 74%
2. rents (negative/1990) -8%
3. interest 11%
4. profits 7%
GDP
-
depreciation
NDP
+net foreign factor income
NNP
-indirect business taxes
NI
-corporate profits
- undistributed profits
- social security contributions
+transfer payments
PI
-personal
taxes
DPI (disposable personal
income)(Yd)
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ECONOMIC WELFARE: guns, switchblades & prozac?????????
UNDERGROUND ECONOMY
20% - 25% of GDP
Ch.
7: GROWTH,
PRODUCTIVITY, UNEMPLOYMENT & INFLATION
GROSS DOMESTIC PRODUCT (GDP): the final value of all goods and services produced within U.S. borders, during a given time period, usually a year.
REAL GDP:These values are measured in constant purchasing so there is no influence of inflation. The problem with inflation is that it distorts comparisons over different years.
EXAMPLE: An Economy that only makes bikes
YEAR OUTOUT x PRICE = GDP
2K 100 Bikes x $100 each = $10,000
NOW PRICES DOUBLE
2.001K 100 Bikes x $200 each = $20,000
This society produced the
same
amount of output but GDP looks twice as large.
Nominal (current prices) vs. Real (constant dollars)
subtracting the influence of gp, this eliminates the problem of using prices so that we can determine if unit output is growing (lost jobs?)
Formula:
real GDP = nominal GDP/price index (base)
MEASURING gp:
Price Index=>
cost of goods as a % compared to a base year
ÄA
year chosen to compare other years against ( = 100)
Price index = (cost of today’s goods / cost of goods in base yr.) x 100
PRODUCTIVITY
PRODUCTIVITY DEFINED: output per worker hour
output/worker hour
HOW CAN WE BECOME WEALTHIER PER PERSON (called per capita GDP)?
We crave Wealth , It raises our standard of living
How can we consume more per person?
1. Put more people to work as a % of the workforce
but the workforce has
limits
2. Make less Investment and produce less capital
if we don’t produce
capital
goods eventually we will run out of consumer goods
4 peanut butter & jelly sandwiches
4 glasses of orange juice
2,000 orders of chili cheese fries
8,000 tacos
20,000 shots of tequila
let’s say they work the same amount of hours every year & produce the same amount of output
THEIR CONSUMPTION STAYS
THE
SAME
during the past couple of years there has been a dramatic improvement in productivity, as opposed to a dramatic drop in productivity during the period of 1973 - 1995
Why? There is probably multiple reasons for the fall in productivity over the above period. Yet, it appears one reason correlates more strongly than others over this period.
Capital
Formation slowed during the 73-95 period because large
government
deficits crowded out borrowers in the credit markets.
goverment
demands to finance their deficit spending forced interest
rates
higher than some borrowers were willing to pay
Computers & Productivity
Does Technological Change lead to Unemployment? Ned Ludd
Per
Capita GDP = GDP/population
UNEMPLOYMENT & INFLATION
Labor Force:
all
persons over 16 who are working for pay or seeking paid employment
U.S. population = 270.3 m
out of labor force => 131.2 m
in civilian labor force => 137.7 m
employed 131.5m
unemployed 6.2 m
unemployment rate -- % of labor force who can’t finnd a job
#u
/ labor force = 6.2m / 137.7 m X 100 = 4.5% (BLS)
DURATION: varies with economic performance
target rate of unemployment -- lowest sustainable rate of u w/out gp
potential output
-- output @ the target rate of u & capacity
utilization
rate
************************************************************************
KINDS OF UNEMPLOYMENT
seasonal u: u in periods of low demand
cyclical u: u over the business cycle
structural u: u resulting f/ technological change
full
employment: everyone who wants a job has one
Employment Act of 1946
frictional u: quitting to look for a better job
underemployment: working below qualifications
discouraged workers / phantom unemployment
***********************************************
skills gap widening
*today 60% of all families are dual income
*Largest private employer? Walmart, then
Manpower
Inc.
temps & permatemps
How good are the stats?
15hrs a week/part-time is considered fully
employed
people who give up are not counted
CLASSICALS: u over reported
KEYNESIANS: u is under reported
INFLATION
SOME DEFINITIONS OF INFLATION (gp)
INFLATION: a continual rise in the price level ( or, said another way, the average price of all goods & services is rising)
*A sustained increase in
the
general price level
DEFLATION: a
continual
fall in the price level ( or, the average price of all goods &
services
is falling)
DISINFLATION:
the
price level is increasing at a decreasing rate
*********************************************************
gp eats away at purchasing power
Take $100 today & over the next year there is 3% gp
It
will
take $103 next year to buy what $100 buys this year
COMPARING PRICES
Nominal & Real Prices
MONEY ILLUSION
What happens if all prices double including your wages?
Has your purchasing power
changed?
What if prices go up 10% & your wage goes up 5%?
Nominal
wages up but real wages are down!
Inflation is 3% for the yr. & your wages 5%
Nominal
prices are up but real wages
2%
*show 30
We need to deflate
nominal
items to make comparisons of GDP in different years.
As consumers we need to understand money
illusion,
i.e.
nominal prices can be deceiving, so, we must compare real prices
to see if there are D s in relative prices.
***********************************************************
IMPORTANT PRICE INDICES MEASURING gp:
Consumer Price Index (CPI): the weighted average of prices for a market basket of goods, that is representative of the average family of four (400 items, BLS)
over estimated? Ignores new products, cassette tapes vs. CDs, prices ¯ for computers & quality
Producer Price Index
(PPI):
weighted
average of prices for commodities, used as inputs, that producers buy
from
other firms.
GDP Deflator: Price index measuring price Ds of all goods & services produced in a given year, compared to a base year.
***********************************************************
GIVEN: 1967 = Base Year
1997 CPI = 300 (measured from base year)
PP$ = $1.00 X 100 = .33
300
Ä A dollar
today
only buys .33 worth of stuff you could buy in 1967. Said another way:
it
takes $3 today to buy what would cost $1 in 1967 (what
about wages)
*********************************************************
HYPERINFLATION:
Rapid
rise in the price level => 200% or > (for exam)?
Post WWI
Germany, Argentina & Brazil
Cost of Inflation
redistributes
Y & distorts price information
Speculation
Anticipated vs. Unanticipated Inflation
Does gp hurt anyone? Creditors & Borrowers (unanticipated)
Fixed Income & COLAS