ECON1020 Intro to Macroeconomics Exam 1 Study Guide

Where does Macroeconomics focus?

Chapters 1-3 & 5

Chapter 1 The Scope and Method of Economics

Objectives:

1. Describe the purpose of economics and its two main divisions

2. Distinguish between positive and normative economics

3. Distinguish between the four criteria for assessing economic policy

4. Explain the importance of models and data in economic analyses

5. Utilize the concepts of opportunity cost and marginalism to make optimal choices

OBJECTIVE 1: Economics

Economics: studies how agents make choices among scarce resources and how those choices  affect society If you want to learn more check out tulane eens

Economics agent: individual or group that makes choices  

• Ex: consumer, boss, kids, parent, pitcher, thief, family, political party, firm, etc

OBJECTIVE 5: The Economic Way of Thinking

People are Rational

Economists assume people try to optimize (choose best available option)

What kind of economic system roles is limited in protecting and enforcing property rights and providing public goods?

People consider opportunity costs, use marginal thinking, and respond to incentives Weigh cost vs benefits

Opportunity Cost

Opportunity cost: the best alternative that we forgo when we make a choice • Ex: money in alternative projects, next-best alternative, time on other things, better  results on another activity

• The optimal level of crime is 0, but we can’t achieve 0 crime because we can’t control  everyone. Resources from taxes are needed to reduce crime. When taxes are constant and  budget is limited, we need to allocate resources responsibly (economics). If you want to learn more check out hlth1000

Implicit costs: opportunity costs; not incurred and can’t be measured accurately for accounting  purposes

Explicit costs: expenses paid with a company’s own tangible assets; recorded in financial  statements

What is the importance of "Circular flow diagram"?

Optimal Decisions are Made at the Margins

Marginal analysis: comparing the marginal benefit (MB) of a choice to the marginal cost (MC)  of the choice

Marginal means additional, so consider only additional costs/benefits  

from a given decision

Proceed only if MB >/= MC; optimal decision is where MB = MC

• 5th slice of pizza worth $1 to me, but costs $3, so purchasing it  If you want to learn more check out asl notes

makes me worse off  

• 3rd slice optimal because what I pay for the 3rd slice is the same  

amount I value it

Savings are savings, no matter the percentage of the product  

Value of doing something is the price, doesn’t include sunk costs

OBJECTIVE 1: Microeconomics vs Macroeconomics

Microeconomics: focuses on individual entities

• Households and firms are like trees

• Ex: Sports industry

Macroeconomics: focuses on the aggregate  If you want to learn more check out laws2301

• Economy as a whole is like forest

• Ex: US economy

OBJECTIVE 2: Normative vs Positive Economics

Economics deal with two kinds of questions:

Normative economics:  

• Analyzes outcomes of economic behavior; evaluates them as good or bad, and may  prescribe courses of action

• Opinion

• Subjective

• “Should”

Positive economics:  

• Seeks to understand behavior without making judgment; describes what exists and how it  works

• Facts, can be tested with data

• Objective

• “Would”

OBJECTIVE 3: Economics Policy

Four criteria in judging economic outcomes:

1. Efficiency: producing what people want at the least possible cost; objective 2. Equity: fairness; subjective  

3. Growth: increase in total output of an economy; goods and services produced 4. Stability: steady growth in national output; Can we maintain rate of growth? Or go into  recession?

OBJECTIVE 4: Theories and Models

Model: a simplified depiction of reality, often showing the relationship between two or more  variables; formal statement of theory

Variable: something that changes (Ex: over time) or differs across observations (Ex: people or  groups) If you want to learn more check out hot water bath chemistry

Two important features of models:

1. They are not exact

2. Their prediction (and assumptions) can be tested with data. Models may be updated to  improve predictions

The most common method for graphing the relationship between two variables is by drawing  two perpendicular lines

Time series: graph that measures how a singular variable changes over time

Ceteris Paribus Assumption

Ceteris paribus: used to analyze the relationship between two variables while the values of other  variables are held unchanged

• Means all else equal We also discuss several other topics like How a river changes as it gets closer to the sea?

• Helps simplify reality to focus on relationships of interest

• Helps identify cause-effect relationships, though this is not easy

Causation vs Correlation

Causation: one thing directly affects another  

• Ex: price changes purchasing

Correlation: when two things are related; change in the same direction or in opposite directions  • Ex: wearing shorts is associated with good economic conditions, actually wearing shorts  because it’s warmer outside then they go outside and spend more money and improves  the economy

Chapter 2 Scarcity and Choice

Objectives:

1. Explain whyy people specialize and trade

2. Distinguish between absolute and comparative advantage

3. Relate the concepts of scarcity, opportunity cost, growth, and efficiency to production  possibility frontiers (PPFs)

4. Interpret PPFs to identify who will produce a product under what terms, and the  resulting gains from trade

Fundamental Questions of Economics

Resources = inputs = factors of production

Resources include land, labor, and capital

Output refers to goods/services that are produced

What gets produced? How is it produced? Who gets what is produced?

Resources ???? Allocation of resources ???? Producers ???? Distribution of output ???? Households

Constrained Choice

Households, firms, and governments continually face decisions about how best to use their scare  resources

Scarcity required trade-offs. Economics teaches us tools to help make good trade-offs Efficiency: all resources are fully employed and every firm in the economy is producing its  output using the best available technology 

• The mix of output must reflect the desires of consumers 

• The only way to produce more of one good is to produce less of another • Maximum combinations of output must be produced 

• FALSE: All resources must be devoted to the production of a single good 

Production Possibilities Frontier

Production possibilities frontier (PPF): a curve showing the maximum attainable combinations of  two goods that can be produced with available resources and current technology • On PPF: production at full capacity with current resources; trade-off in production producing more of Product 1 decreases ability to produce as many Product 2 • Inside PPF: production attainable but inefficient because not all resources are being used;  inefficient production at full employment, unemployment, or underemployment; lack of  the best possible technology  

• Outside PPF: production unattainable with current resources

• Slope (marginal rate of transformation) = Δy/Δx = opportunity cost of making 1 more of  Product 2 

Deciding point on PPF depends on the value society puts on the two products Bowed Out PPF: curved PPF showing that resources are not equally suited for both goods • Hump: increasing opportunity costs 

• Concave: decreasing opportunity costs 

Shifting the PPF: economic growth means more resources and better technology enables the  production of more goods and services

• Area between original PPF and new PPF: represents formally unattainable and now  feasible (yet inefficient) combinates 

• Both industries: full shift 

• One industry: half shift where max of one product increases and other is unchanged • Up and right: Increase in production capacity ???? education (adding “human capital” as an  added resource), increase in workers (increasing labor force increases production  capacity of nation), technical innovation (produce more with existing resources) • Inside PPF: Increase in unemployed workers (does not change PPF) 

• Down and left: Reduction in production capacity

Economic Systems & The Role of Government 

Three possible systems to decide what to produce, how to produce it, and who gets it: 1. Command economy: central government controls output, incomes, and prices 2. Free market economy: buyers and seller engage in voluntary exchange with output,  incomes, and prices dictated by the market 

3. Mixed economy: combines markets with government intervention at varying degrees Laissez-Faire Economic System: the government’s role is limited to protecting and enforcing  property rights and providing public goods 

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)  

Free enterprise: the freedom of individuals to start and operate private businesses in search of  profits  

Consumer sovereignty and free enterprise most likely seen in a mixed economy U.S. is a mixed economy 

International Trade 

Trade increased drastically over past 50 years in part due to technological advancements and  reductions in tariffs 

In U.S., imports and exports as portion of gross domestic product (GDP) has risen since 1970 U.S. has small independence on international trade compared to other countries 

The PPF and Trade 

Person trades with another person who has a lower cost of production 

Can use PPF to examine differences in cost of production using two methods: 1. Absolute advantage: compares the productivity of producers; the number of inputs  required to produce one unit of a given good; person who can produce more in given time 2. Comparative advantage: compares the opportunity cost of production; what is given up to  produce an additional unit of a good; gains from specialization and trade are based on  comparative advantage; lower opportunity cost ???? should produce product Comparative Advantage is Based on Opportunity Cost 

Opportunity cost = giving up/producing  

Opportunity cost of Product 1 = Total Product 2/Total Product 1 

Lower opportunity cost of product mean you have the comparative advantage of it 

Production 

Production: process of converting inputs into useful outputs

Factors of production: inputs (land, labor, capital; NOT energy) 

No trade:  

• Each country has X labor hours and devotes ¾ to Product 1 and ¼ to Product 2 • Low amount of both products produced 

Specialization and trade: 

• Specialization allows Country 1 to produce 100% Product 1 and Country 2 to produce  100% Product 2 

• Total amount of each product increases, higher overall output 

• Export some of that product in exchange for product of other country 

Terms of Trade 

Terms of trade: ratio at which a country can trade exports for imports 

Trade is mutually beneficial if each party can buy a good at a price lower than his/her  opportunity cost 

Acceptable terms of trade (mutually beneficial): “price” fall between the opportunity costs of  both parties  

Gains and Losses from Trade 

The increases consumption made possible by trade represents the gains from trade; both  countries can consume bundles outside of their PPF 

Some individual firms and consumers will lose out due to international trade (Ex: workers in  market that is being traded for get international competition) 

These groups would likely ask their governments to implement protectionist measures like tariffs  and quotas in order to protect them from foreign competition  

Lower income consumers benefit from increased availability; so do the firms at which they  spend their saved money 

Why Don’t We See Complete Specialization? 

1. Not all products can be traded internationally (Ex: medical services) 

2. Production of many goods involved increasing opportunity costs (so small amounts of  production takes place in several countries) 

3. Tastes for product differ (Ex: cars) countries might have comparative advantages in  different subtypes of products 

Key Points 

The PPF shows all combinations of two goods that an economy can possibly produce, given its  resources and technology 

The PPF illustrates the concepts of trade-offs, efficiency, and economic growth Specializing and trading according to comparative advantage (not absolute advantage) is  mutually beneficial 

Though trade benefits society overall, some individuals may “lose” in the process 

Ch. 2 HW Notes 

Comparative Advantage

• If production of two products must be equal without trade, the number of workers in one  industry times their productivity must equal the number of workers in the other industry  times their productivity in that industry (given number of workers) 

• Number of workers A x Productivity A = Number of workers B x Productivity B • Number of workers A + Number of workers B = Total Workers

• (Total Workers − Number of workers A) × Productivity A = Number of workers B × Productivity B

• Do for both countries and add to get total units produced for both countries

Chapter 3 Supply and Demand

Objectives:

1. Describe the movement of inputs, outputs, and dollars in an economy using the circular flow diagram

2. Recall the laws of demand and supply

3. Distinguish between changes in quantity demanded (supplied) and changes in demand  (supply)

4. Explain the role of markets in determining prices and quantities sold

5. Illustrate how changes in economic factors affect markets using the supply-and-demand  model

OBJECTIVE 1: The Circular Flow Diagram 

Circular flow diagram: a simplified, visual representation of the economy that aims to answer the  questions “How is the economy organized?” and “How do participants in the economy interact?” Firms and households are the fundamental decision-making units in a market economy Product market: the market in which the consumer purchases the product from the producer Factor market: the market in which the resources used to produce goods and services are  exchanged

In a perfectly competitive market: 

• Goods are homogenous (exactly the same) 

• So many buyers and sellers that none have any influence on price 

• Buyers and sellers are price takers 

OBJECTIVES 2 & 3: Demand and Supply 

Demand 

Many factors influence what consumers buy; economists tend to focus on price Demand: tells us how much of a given product a household would be willing to buy at different  prices  

Quantity demanded: amount of a good buyers are willing and able to purchase • A change in quantity demanded has no direct effect on supply 

The Law of Demand: an inverse relationship between price and quantity demanded (cp) Demand schedule: table showing the quantity demanded of a good at a given price (cp)

Demand curve: the graph that corresponds to the demand schedule (cp) 

Substitution effect: the change in the quantity demanded from a change in price, making the  good more or less expensive relative to substitute goods 

Income effect: the change in quantity demanded from the effect of a change in the good’s price  on a consumers’ purchasing power 

Table and Graph Movements 

• Change in price (change in quantity demanded) ???? movement along the curve • Change in income, prices of related goods, tastes, expectations, number of buyers  (change in demand) ???? shifts the demand curve 

• Shift to the right is an increase in demand \????\ 

• Shift to the left is a decrease in demand \????\ 

Other Factors Influencing Demand 

Normal goods: goods for which demand is directly related to income 

• Ex: new clothes, restaurant meals, vacations 

Inferior goods: goods for which demand is inversely related to income 

• Ex: second-hand clothes, ramen noodles 

Substitutes: goods and services that can be used for the same purpose 

• Increase in the price of one good ???? increase in demand for the other • Increase in price of substitute ???? demand shifts to the right 

• Two normal goods can be substitutes for each other 

• Ex: Big Mac and Whopper; Ford F-150 and Dodge Ram 

Complements: goods and services used together 

• Increase in the price of one good ???? decrease in demand for the other • Increase in price of complement ???? demand shifts to the left 

• Ex: Big Mac and fries; hot dogs and buns 

Key Points 

• Each point on the demand curve represents the quantity demanded at a given price • The downward slope of the demand curve illustrates the law of demand • Changes in own-price result in movements along the demand curve 

• Changes in non-price variables result in shifts of the demand curve 

Supply 

Quantity supplied: amount of a good sellers are willing and able to sell 

• Quantity supplied in market = sum of firms’ quantity supplied 

Law of Supply: there is a direct relationship between quantity supplied and price Similar to demand, the relationship between price and quantity supplied can be depicted in a  table (supply schedule) or in a graph (supply curve) 

Table and Graph Movements 

• Price and quantity supplied move in same direction 

• Change in price (change in quantity supplied) ???? movement along the curve • Change in input prices, technology, expectations, number of sellers (change in supply) ???? shifts the curve 

• Shift to the right is an increase in supply /????/ 

• Shift to the left is a decrease in supply /????/

Key Points 

• Each point on the supply curve represents the quantity supplied at a given price • The upward slope of the supply curve illustrates the law of supply  

• Changes in own-price result in movements along the supply curve 

• Change in non-price variable result in shifts of the supply curve 

Supply and Demand Recap 

• The supply-and-demand model is used to analyze competitive markets • The law of demand states there is an inverse relationship between price and quantity  demanded (cp) 

• The law of supply states there is a direct relationship between price and quantity supplied  (cp) 

• Market supply (demand) equals the sum of the quantity supplied (demanded) by each  producer (consumer) at any given price 

OBJECTIVES 4 & 5: Market Equilibrium 

Market equilibrium: a situation in which quantity demanded  

equals quantity supplied; equilibrium price and quantity shown 

Dis-equilibrium: surplus and shortage; pushes on price 

Price support: government assistance in maintaining the levels of 

market prices regardless of supply or demand 

Surplus: lower demand, higher supply; push down price until 

equilibrium; triangle above equilibrium 

Shortage: higher demand, lower supply; push up price until 

equilibrium; triangle below equilibrium 

Price floor: a legally determined minimum price at which a good  

can be sold 

• Ex: Minimum wage- surplus of workers, reduction in employment, workers supplied by  households, workers demanded by businesses 

Price ceiling: a legally determined maximum price at which a good can be sold • Ex: Rent ceilings- shortage of apartments 

When calculating surplus or shortage, use difference between quantity demanded and quantity  supplied NOT the equilibrium quantity 

Change in equilibrium: events that shift the supply and/or demand curves Steps for Analyzing Market Changes 

1. Ask yourself: Does the supply and/or demand curves shift? 

2. If so, in which direction does the curve shift? Show the  

changes using a supply-and-demand diagram. 

3. What is the effect of the change on equilibrium price and 

quantity? Identify the new equilibrium point on the 

diagram. Use arrows to show the change in equilibrium 

price and quantity  

4. Use chart to help you see effect on price and quantity 

Ambiguous P or Q follows whichever curve shifts the most; shift  

exactly the same ???? no change

Chapter 5 Intro to Macro-Economics  

Objectives:

1. Describe the three primary concerns for macroeconomics

2. Explain the interactions among the four components of the macroeconomy using the  circular flow diagram

3. Recall key shifts in the study of macroeconomics

4. Explain key events in the US economy using the business cycle model

Linking Micro- and Macroeconomics

Microeconomics: focuses on individual industries and economic agents (individual decision making units)

Macroeconomics: focuses on aggregates ???? the economy as a whole; study of how fast prices in  general are rising  

The performance of the macroeconomy affects the job market, household incomes, and firm  profits

Macroeconomics studies the aggregate versions of microeconomic topics therefore the  conclusion from microeconomic theory serves as an important reference for macroeconomics

OBJECTIVE 1: Macroeconomic Concerns

Three major concerns:

• Output growth

• Unemployment

• Inflation and deflation  

OBJECTIVE 4: Output Growth

Aggregate Output: the total quantity of  

good and services produced in an economy  

in a given period

The Business Cycle

• Business cycles: short-term  

fluctuations in economic  

performance  

• Expansion ???? Peak ???? Contraction  

???? Trough

• Expansion: boom; increased output  

and decreased unemployment

• Contraction: recessions/slumps; reduced output and increased unemployment • Rate of change decreases as it approaches a peak/trough

• Despite short-term fluctuations, most experience positive economic growth in the long  run  

• Theory: smooth transitions from expansion to peak to recession to trough to expansion • Reality: small fluctuations along bigger transitions  

Recession: a significant decline in activity across the economy, lasting more than a few months,  visible in industrial production, employment, real income, and wholesale-retail trade

• Output falls, unemployment increases, and employment falls

Unemployment

Unemployed: searching for work but cannot find a job

Unemployment Rate = 100 X (#unemployed/size of labor force)

Big Questions

• What causes fluctuations in unemployment?

• Why is there any unemployment?

• Why don’t labor markets clear? Or, do they?

Mississippi above average in unemployment because bad education

Diagram of labor supply and labor demand

• Units of labor horizontal and wage rate vertical  

• Labor demand curve shows the number of workers that the firms want to hire at each  wage rate

• Labor supply curve shows the number of workers that want to work at each wage rate • The opportunity cost of holding a job is the leisure time that is given up

Inflation

Inflation: an increase in the overall price level (currently 1-3%); increase in supply of money Deflation: a decrease in the overall price level

Hyperinflation: a period of very rapid increases in the overall price level (100-1000%) Stagflation: a situation of high inflation, slow economic growth, and high unemployment The government aims to avoid prolonged periods of inflation/deflation

RECALL: The Circular Flow Diagram

Circular flow diagram: a simplified, visual representation of the economy that aims to answer the  questions

• How is the economy organized?

• How do participants in the economy interact?

OBJECTIVE 2: Updated Circular Flow Diagram

The circular flow diagram shows the income received and  

payments made by each sector (agent) of the economy

• 3 Markets: product, labor (factor), and money markets

• 4 Economic Agents: firms, households, government, and  

the rest of the world

• 3 Sectors: private, public, and foreign

Household Incomes and Payments

• If receipts > payments, then households save

• If receipts < payments, then households dissave

• Payments flow into and out of government  

Firm Revenues and Payments

• Seek from households and governments

• Exports

Government Revenues and Payments

Every transaction has two sides ???? everyone’s expenditure is someone else’s receipt

The Money (Financial) Market

Households supply funds to the money market expecting to earn income in the form of dividends  on stocks and interest on bonds

Households demand (borrow) funds to finance purchases

Firms borrow to build new facilities

The government borrows by issuing bonds (promissory notes)

The rest of the world also borrows and lends money

Fiscal vs Monetary Policy

Fiscal Policy: government policies concerning taxes and spending

Expansionary policy: cut taxes/increase government spending

Monetary Policy: the tools used by the Federal Reserve to control short-term interest rates To fund its budget deficit, the government can borrow by selling treasuring bills to the public

OBJECTIVE 3: Macroeconomic History in Brief

The Great Depression was pivotal; the length and severity necessitated a fundamental rethinking  of the operations of the macroeconomy because very high levels of unemployment persisted of  about 10 years, which is contrary to classical models

The classic model is based on the critical assumption that markets always clear Micro models were deemed unreliable (could not explain persistent unemployment) Many of the expansionary periods during the twentieth century occurred during wars because  increased government spending at wartime was responsible for economic expansion The Great Gatsby depicts a period during economic expansion and The Grapes of Wrath depicts  a period during economic recession

Much of modern macroeconomics has roots in the works of John Maynard Keynes Keynesian view: prices, wages, and aggregate demand affect unemployment and the government  can influence output and unemployment

Stagflation in the 1970s went against assumptions that inflation and unemployment must be  inversely related

Real GDP growth rate, employment level, and unemployment rate determine whether/when the  US economy is entering an economic expansion

US entered economic expansion in mid-2009 because real GDP growth rate went from negative  to positive  

Key Points

Macroeconomics are concerned about economic growth and stability

The simple circular flow diagram can be expanded to explain interactions in the public and  foreign sectors as well as transactions in the financial market

The field of macroeconomics has changed over time

The U.S. economy has seen long-term growth but not without experiencing periods of recession  and high inflation