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Textbook Notes for Quiz 1

by: Tiffany Notetaker

Textbook Notes for Quiz 1 ECON 202

Tiffany Notetaker
Cal State Fullerton
GPA 3.62
Principles of Macroeconomics
Feng Xiao

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Chapter 1, 2, 5, and 6 (7 coming soon) Textbook Notes.
Principles of Macroeconomics
Feng Xiao
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This 11 page Bundle was uploaded by Tiffany Notetaker on Monday September 28, 2015. The Bundle belongs to ECON 202 at California State University - Fullerton taught by Feng Xiao in Summer 2015. Since its upload, it has received 16 views. For similar materials see Principles of Macroeconomics in Economcs at California State University - Fullerton.

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Date Created: 09/28/15
Chapter 1 The Scope and Method of Economics Saturday August 22 2015 510 PM A Why Study Economics a Economics study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided how people make choices choices that people make societal choices b The most important reason for studying economics is to learn a way of thinking Fundamental concepts that can change the way you look at everyday choices i Opportunity Cost the best alternative that we forgo give up when we make a choice or decision The full quotcostquot of making a specific choice includes what we give up by not making the best alternative choice Opportunity costs arise because resources are scarce limited ii Marginalism the process of analyzing the additional or incremental costs or benefits arising from a choice or decision iii Ef cient Market a market in which profit opportunities are eliminated almost instantaneously Profit opportunities loosely refer to quotgood dealsquot or riskfree ventures TINSTAAFL b Another reason for studying economics is to understand societv better Past and present economic decisions have an enormous in uence on the character of life in a society i Industrial Revolution period in which new manufacturing technologies and improved transportation gave rise to the modern factory system and a massive movement of the population from the countryside to the cities ii The study of economics is an essential part of the study of society b A knowledge of economics is essential to being an informed citizen it helps citizens understand what happens in a recession and what the government can and cannot do to help in a recovery It helps us understand a range of other everyday government decisions at the local and federal levels B The Scope of Economics a Microeconomics branch of economics that examines the functioning of individual industries and the behavior of individual industries and the behavior of individual decisionmaking units firms and households i Macroeconomics branch of economics that examines the economic behavior of aggregates national income employment output etc on a national scale ii Microeconomics looks at individual units household the firm the industry Macroeconomics looks at the whole the aggregate b Individual economists focus their research and study in many different areas They also differ in the emphasis they place on theory B The Method of Economics a Positive economics an approach to economics that seeks to understand behavior and the operation of systems without making judgments it describes what exists and how it works i Normative economics an approach to economics that analyzes outcomes of economic behavior evaluates them as good or bad and may prescribe courses of action policy economics b Model formal statement of a theory usually a mathematical statement of a presumed relationship between two or more variables simplifies reality by stripping part of it away abstractions i Variable a measure that can change from time to time or from observation to observation ii Ockham39s razor principle that irrelevant detail should be cut away b Ceteris paribus all else equal a device used to analyze the relationship between two variables while the values of other variables are held unchanged This concept helps us simplify reality to focus on the relationships that interest us c Both graphs and equations are used to capture the quantitative side of our economic observations and predictions d In formulating theories and models it is especially important to avoid two pitfalls post hoc fallacy and fallacy of composition i Post hoc ergo propter hoc a common error made in thinking about causation If Event A happens before Event B it is not necessarily true that A caused B ii Fallacy of composition the erroneous belief that what is true for a part is necessarily true for the whole b A theory is rejected when it fails to explain what is observed or when another theory better explains what is observed Empirical economics the collection and use of data to test economic theories c Four criteria are frequently applied in judging economic outcomes efficiency equity growth and stability i Ef ciency allocative efficiency an efficient economy is one that produces what people want at the least possible cost ii Equity fairness lies in the eye of the beholder It implies a more equal distribution of income and wealth iii Economic growth increase in the total output of an economy iv Stability a condition in which national output is growing steadily with low in ation and full employment of resources Chapter 2 The Economic Problem Scarcity and Choice Wednesday August 26 2015 1058 AM A Chapter Opener a f Economics explores how individuals make choices in a world of scarce resources and how those individual39s choices come together to determine three key features of their society i What gets produced ii How is it produced iii Who gets what is produced Capital things that are produced and then used in the production of other goods and services Factors of production the inputs into the process of production resources Production the process that transforms scarce resources into useful goods and services Inputs or resources anything provided by nature or previous generations that can be used directly or indirectly to satisfy human wants Outputs goods and services of value to households B Scarcity Choice and Opportunity Cost a b Opportunity cost the best alternative that we give up or forgo when we make a choice or decision Theory of comparative advantage Ricardo39s theory that specialization and free trade will benefit all trading parties even those that may be quotabsolutelyquot more efficient producers i Absolute advantage a producer has an absolute advantage over another in the production of a good or service if he or she can produce that product using fewer resources a lower absolute cost per unit ii Comparative advantage a producer has comparative advantage over another in the production of a good or service if he or she can produce that product at a lower opportunity cost iii Consumer goods goods produced for present consumption Investment the process of using resources to produce new capital creation of capital purchase or putting in place equipment roads houses education etc Production possibility frontier ppf a graph that shows all the combinations of goods and services that can be produced if all of society39s resources are used efficiently YaXis quantity of capital goods Xaxis quantity of consumer goods i The slope of the ppf is negative Marginal rate of transformation MRT the slope of the production possibility frontier ii iii iv V The law of increasing opportunity cost the bowed out ppf curve tells us that the more society tries to increase production of one good rather than another the harder it is Output efficiency the economy produces what people want in addition to operating on the ppf the economy must be operating at the right point on the ppf Economic growth an increase in the total output of an economy Growth occurs when a society acquires new resources or when it learns to produce more using existing resources Economic growth arises from many sources accumulation of capital and technological advances b When a society consists of million of people the problem of coordination and cooperation becomes enormous but so does the potential for gain B Economic Systems and the Role of Government Command economy an economy in which a central government either directly or indirectly sets output targets incomes and prices Laissezfaire economy an economy in which individual people and firm pursue their own selfinterest without any central direction or regulation Market the institution through which buyers and sellers interact and engage in exchange a b 1 ii iii iv Consumer sovereignty the idea that consumers ultimately dictate what will be produced or not produced by choosing what to purchase and what not to purchase Profit selling goods or services for more than it costs to product them Free enterprise the freedom of individuals to start and operate private businesses in search of profits In a free market system the amount that any one household gets depends on its income and wealth Income amount the household earns each year Wealth amount that households have accumulated out of past income through saving or inheritance The basic coordinating mechanism in a free market system is price the amount that a product sells for per unit b All real market systems are quotmixedquot pure forms of economies do not exist Chapter 5 Introduction to Macroeconomics Wednesday August 26 2015 1059 AM A Chapter Opener a d Microeconomics examines the functioning of individual industries and the behavior of individual decisionmaking units typically firms and households Macroeconomics focuses on the determinants of total national output Aggregate behavior behavior of all households as well as the behavior of all firms refers to sums Sticky prices prices that do not always adjust rapidly to maintain equality between quantity supplied and quantity demanded B Macroeconomic Concerns a b Three maior concerns of macroeconomics output growth unemployment in ationde ation Business cycle the cycle of shortterm ups and downs in the economy usually not symmetrical i Aggregate output the total quantity of goods and services produced in an economy in a given period ii Recession a period during which aggregate output declines Conventionally a period in which aggregate output declines for two consecutive quarters Depression a prolonged and deep recession Expansion or boom the period in the business cycle from a peak down to a trough during which output and employment fall Unemployment rate the percentage of the labor force that is unemployed key indicator of economy39s health The existence of unemployment implies that the aggregate labor market is not in equilibrium In ation an increase in the overall price level low in ation rates are the goal of government policy Hyperin ation a period of very rapid increases in the overall price level i De ation a decrease in the overall price level The goal of policy makes is to avoid prolonged de ation as well as in ation in order to pursue the macroeconomic goal of stability iii iv B The Components of the Macroeconomy a b Divide the participants in the economy into four broad groups households rms the government and the rest of the world Households and firms are the private sector government is the public sector and the rest of the world is the foreign sector Circular ow a diagram showing the income received and payments made by each sector of the company p 101 Transfer payments cash payments made by the government to people who do not supply goods services or labor in exchange for these payments Social Security benefits veterans39 benefits and welfare payments c Divide markets into three broad arenas the goodsandservices market the labor market and the money financial market i GoodsandServices Market households and the government purchase goods and services from firms firms purchase goods and services from each other firms supply households the government and firms demand the rest of the world buys and sells ii Labor Market when firms and the government purchase labor from households households supply labor firms and the government demand labor labor is also supplied to and demanded from the rest of the world iii Money Market households purchase stocks and bonds from firms households supply funds to this market in the expectation of earning income households demand borrow funds from this market to finance various purchases 1 Treasury bonds notes and bills promissory notes issued by the federal government when it borrows money 2 Corporate bonds promissory notes issued by firms when they borrow money 3 Shares of stock financial instruments that give to the holder a share in the firm39s ownership and therefore the right to share in the firm39s profits Capital gain if the firm does well and the value of stock increases stockholders receive capital gain 4 Dividends the portion of a firm39s profits that the firm pays out each period to its shareholders Interest rate re ects the length of the loan and the perceived risk to the lender b The two main policies in government are fiscal policy and monetary policy i Fiscal policy government policies concerning taxes and spending federal government collects taxes from households and firms and spends those funds on goods and services Expansionary fiscal policy taxes are cut government spending increases Contractionary fiscal policy raise taxes government spending decreases ii Monetary policy the tools used by the Federal Reserve to control the shortterm interest rate B A Brief History of Macroeconomics a Great Depression the period of severe economic contraction and high unemployment that began in 1929 and continued throughout the 1930s b Classical economists believed that recessions were selfcorrecting microeconomics models Keynes set out to construct a different and expansionary theory that would explain the confusing economic events of his t1me c Finetuning the phrase used by Walter Heller to refer to the government39s rule in regulating in ation and employment 1 Stagnation a situation of both high in ation and high unemployment Chapter 6 Measuring National Output and National Income Wednesday September 9 2015 1210 PM A Chapter Opener a National income and product accounts data collected and published by the government describing the various components of national income and output in the economy B Gross Domestic Product a Gross domestic product GDP the total market value of all final goods and services produced within a given period by factors of production located within a country provides us with a country39s economic report card b Final goods and services goods and services produced for final use Intermediate goods goods that are produced by one firm for use in further processing by another firm used to avoid double counting i Value added the difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage In calculating GDP we can sum up the value added at each stage of production or we can take the value of final sales We do not use the value of total sales in an economy to measure how much output has been produced b GDP does not count transactions in which money or goods changes hands but in which no new goods and services are produced Sales of stocks and bonds are not counted in GDP these are transfers of ownership of assets 0 GDP is the value of output produced by factors of production located within a country Profits earned abroad by US citizens is not counted in US GDP because the output is not produced within the United States i Gross national product GNP the total market value of all final goods and services produced within a given period by factors of production owned by a country39s citizens B Calculating GDP a GDP can be computed two ways i Expenditure approach a method of computing GDP that measures the total amount spent on all final goods and services during a given period ii Income approach a method of computing GDP that measures the income wages rents interest and profits received by all factors of production in producing final goods and services iii Every payment expenditure by a buyer is at the same time a receipt income for the seller Income received expenditures made b Four main categories of expenditure Personal consumption expenditures C household spending on consumer goods Gross private domestic investment I spending by firms and households on new capital plant equipment inventory and new residential structures Government consumption and gross investment G Net exports EX1M net spending by the rest of the world or exports EX minus imports IM Expenditure approach equation GDPCIGEXIM i Personal consumption expenditures expenditures by consumers on goods and services there are three main categories of consumer expenditures durable goods nondurable goods and services 1 Durable goods goods that last a relatively long time such as cars and household appliances 2 Nondurable goods goods that are used up fairly quickly such as food and clothing 3 Services the things we buy that do not involve the production of physical things such as legal and medical services and education ii Gross private domestic investment total investment in capital the purchase of new housing plants equipment and inventory by the private or nongovernment sector 1 Nonresidential investment expenditures by firms for machines tools plants and so on 2 Residential investment expenditures by households and firms on new houses and apartment buildings 3 Change in business inventories the amount by which firms39 inventories change during a period Inventories are the goods that firms produce now but intend to sell later GDP final sales change in business inventories 4 Depreciation the amount by which an asset39s value fall sin a given period Gross investment total value of all newly produced capital goods produced in a given period New investment gross investment minus depreciation ii Government consumption and gross investment expenditures by federal state and local governments for final goods and services iii Net exports the difference between exports and imports it can be positive or negative Income approach looks at GDP in terms of who receives it as income rather than who purchases it i National income the total income earned by the factors of production owned by a country39s citizens ii Compensation of employees includes wages salaries and various supplements employer contributions to social insurances and pension funds paid to households by firms and by the government iii Proprietors39 income the income of unincorporated businesses iv Rental income the income received by property owners in the form of rent v Corporate profits the income of corporations viii xiii xiv Net interest the interest paid by business Indirect taxes minus subsidies taxes such as sales taxes custom duties and license fees less subsidies that the government pays for which it receives no goods or services in return Net business transfer payments net transfer payments by businesses to others Surplus of government enterprises income of government enterprises x Net national product NNP gross national product minus depreciation a nation39s total product minus what is required to maintain the value of its capital stock Statistical discrepancy data measurement error Personal income the total income of households Disposable personal incomeaftertax income personal income minus personal income taxes the amount that households have to spend or save Personal saving the amount of disposable income that is left after total personal spending in a given period Personal saving rate the percentage of disposable personal income that is saved If the personal saving rate is low households are spending a large amount relative to their incomes if it high households are spending cautiously vi vii ix xi xii XV B Nominal vs Real GDP a d Current dollars the current prices that we pay for goods and services Nominal GDP gross domestic product measured in current dollars Weight the importance attached to an item within a group of items Real GDP nominal GDP adjusted for prices changes Base year the year chosen for the weights in a fixedweight procedure Fixed weight procedure a procedure that uses weights from a given base year GDP deflator a price measurement price index Overall price increases can be sensitive to the choice of the base year There are many problems with fixedprice weights inaccuracy from year to year and not accounting for the responses in economy to supply shifts B Limitations of the GDP Concept a b Though increasing GDP is generally seen as a good thing in macroeconomics there are limitations to using GDP as a measure of welfare Some increases in social welfare are associated with a decrease in GDP Most nonmarket and domestic activities are not counted in GDP even though they amount to real production It also seldom re ects losses or social ills no adjustment for production that pollutes the environment Informal economy the part of the economy in which transactions take place and in which income is generated that is unreported and therefore not counted in GDP Gross national income GNI GNP converted into dollars using an average of currency exchange rates over several years adjusted for rates of in ation


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