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Macroeconomics Chapter 2

by: Henry Notetaker

Macroeconomics Chapter 2 ECON 2133

Marketplace > East Carolina University > Economcs > ECON 2133 > Macroeconomics Chapter 2
Henry Notetaker
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In this chapter we cover economists and scientists, different models and economic factors. Then it's on the Production Possibilities Frontiers and how they move and end with gains from trade and ho...
Nehad Elsawaf
Class Notes
Macroeconomics, Graphs




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This 6 page Class Notes was uploaded by Henry Notetaker on Tuesday February 9, 2016. The Class Notes belongs to ECON 2133 at East Carolina University taught by Nehad Elsawaf in Spring 2016. Since its upload, it has received 23 views. For similar materials see Macroeconomics in Economcs at East Carolina University.


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Date Created: 02/09/16
Chapter  2:  How  Do  Economists  Study  the  Economy?     I)   Scientific  Method  in  Economics   a)   First,  researchers  observe  a  phenomenon  that  interests  them.   i)   Based  on  these  observations  they  base  a  hypothesis  (explanation).   b)  Then  they  construct  a  model  to  test  the  hypothesis.   c)   After  that  they  construct  experiments  to  test  the  hypothesis.   i)   The  economist’s  lab  is  the  world  around  us.     II)   Positive  and  Normative  Analysis     a)   Economists  strive  to  approach  their  subject  objectively.   i)   Meaning,  they  try  to  keep  all  opinions,  beliefs,  and  values  to  themselves   when  producing  an  outcome.   b)  Positive  Statement:  Can  be  tested  and  validated.  “What  is”   i)   “The  unemployment  rate  is  7.0%”-­‐  can  be  tested.   c)   Normative  Statement:  An  opinion  that  cannot  be  tested  or  validated.   “What  ought  to  be  (done)”   i)   “An  unemployed  worker  should  receive  financial  assistance  to  help   make  ends  meet”  –  opinion  on  fixing  a  problem.   d)  Economists  should  be  concerned  with  positive  statements.   i)   Normative  statements  are  the  realm  of  policy-­‐makers,  voters,  and   philosophers.     III)   Economic  Models   a)   Able  to  understand  complicated  issues,  economists  use  different  models.   i)   A  good  model  should  be  easy  and  produce  solid  predictions.   b)  1:  Ceteris  Paribus  (other  things  being  equal)     i)   Ceteris  Paribus:  The  concept  under  which  economists  examine  a  change   in  one  variable  while  holding  everything  else  constant.   (1)  Supply  and  Demand  models=  “Holding  #  of  resources  constant”   c)   2:  Endogenous  vs.  Exogenous  Factors   i)   Models  must  account  for  factors  we  can  and  cannot  control   ii)   Endogenous  Factors:  The  variables  that  can  be  controlled  for  in  a  model.   (1)  Using  a  wind  tunnel   iii)  Exogenous  Factors:  the  variables  that  cannot  be  controlled  for  in  a   model.   (1)  Gusting  wind  making  first  during  flight  testing.   iv)  Business  Models=  3  Things  to  be  mindful  of   (1)  What  we  include   (2)  The  assumptions  we  make  when  choosing  what  to  include.   (3)  The  outside  conditions  that  can  affect  our  models  performance.   d)  The  Danger  of  Faulty  Assumptions   i)   No  matter  what  we  include,  using  a  model  that  contains  faulty   assumptions  can  lead  to  spectacular  policy  failures.   (1)  Ex:  Great  Recession  of  2007  (housing  market  collapse)   ii)   Because  a  model  is  so  simple,  decision  makers  must  be  careful  about   assuming  a  model  can  present  a  solution  for  complex  problems.       Chapter  2  (cont.):  What  is  a  Production  Possibilities  Frontier?     •   Production  Possibilities  Frontier  (PPF):  A  model  that  illustrates  the   combinations  of  outputs  that  a  society  can  produce  if  all  of  its  resources  are   being  used  efficiently.   o   Models  for  trade-­‐offs   o   Holding  technology  available  for  production  and  quantity  of   resources  constant.  (Ceteris  Paribus)   EXAMPLE:  Nation  1  when  when  focusing  all  it’s  resources  on  pizza   other  than  wings  can  make  100  pizzas  and  0  wings.   When  focusing  on  wings  not  pizza  the  can  produce  300  wings  and  0   pizza.  (specialization)   120 A 100 A   0   100   80 B 60 C B   90   70   E C   150   50   40 D   300   0   20 D E   70   40   0 0 100 200 300 400       §   All  points  on  the  PPF  line  are  using  all  of  their  resources  in  the   most  productive  way.     §   The  point  not  on  the  line  shows  inefficient  use  of  resources.   §   At  the  two  middle  points  the  society  can  choose  which  to   produce  more  of  as  it’s  down  to  preference  and  which  you   want  to  make  less  or  more  of  (Trade-­‐offs).     I)   The  PPF  and  Opportunity  Cost   a)   The  trade-­‐offs  that  occur  along  the  PPF  represent  the  opportunity  cost.   i)   From  example  1,  going  from  B  to  C  it  gives  up  20  pizzas   (1)  Going  from  C  to  B  it  gives  up  60  wings.   b)  Not  all  resources  are  perfectly  adaptable  for  use  in  making  pizza  &  wings.   i)   i.e.  some  people  are  better  at  making  pizza  than  wings.   (1)  That  factor  makes  the  PPF  Curved     Example  2:  Not  all  resources  are  adoptable.  Not  Everyone  is  as  skilled  a   pizza  maker  as  others.  Making  the  graph  curved.     Y-­‐Value  1 120 100 A 80 +20 -­‐80 B 60 C +20 -­‐50 40 +20 D -­‐30 20 0 0 50 100 150 200 250 300 350     •   Note  the  OP  of  producing  an  extra  20  pizzas  rises  from  30  wings  (D-­‐C)  to  80   wings  (B-­‐A)     •   *The  curve  represents  the  increasing  opportunity  cost  of  production.*   •   Law  of  Increasing  Relative  Cost:  The  opportunity  cost  of  a  good  rises  as  a   society  produces  more  of  it.             II)   The  PPF  and  Economic  Growth   a)   Economic  growth  is  the  process  that  enables  a  society  to  produce  more   output  in  the  future.     b)  Example  3:  Say  a  new  technology  is  made  to  increase  pizza  production   using  same  #  of  workers.   140 120 100 80 60 40 20 0 0 100 200 300 400     c)   Example  4:  Say  the  population  grows,  increasing  #  of  workers.   i)   That  pushes  all  points  outward  unlike  example  3  where  one  of  the  axis   move.   ii)   The  growth  in  population  allows  more  workers  to  the  workforce   increasing  #’s  to  produce  both  goods.   140 120 100 80 60 40 20 0 0 100 200 300 400                         Chapter  2  (cont.):  What  are  the  Benefits  of  Specialization  and  Trade?     I)   Gains  from  Trade   a)   In  simple  terms,  2  people,  2  goods:  one  specializes  in  which  ever  they  are   best  at  producing  and  use  it  to  trade  with  the  other  person  for  the  they  are   not  as  skilled  in  producing.   b)  Example  5:  Take  Debra  Winger  and  Mike  Piazza.  When  specializing  their   resources  Debra  produces  60  pizzas  or  120  wings  at  a  ratio  of  1:2;  Mike   produces  24  pizzas  or  72  wings  at  a  ratio  of  1:3.   Person   Good   W/out  Trade   W/  Trade   Gains   Pro.            CoPro.          Con.  from   Trade   Debra   Pizza   40              60          41(keep)   +1     Wings   40              0              47(+7     Mike   Pizza   18              0              19(+1       Wings   18              72          25(keep)   +7   c)   Absolute  Advantage:  The  ability  of  one  producer  to  make  more  than   another  producer  with  same  quantity  of  resources.   i)   Debra.   d)  Comparative  Advantage:  When  one  producer  can  give  up  less  of  one  good   to  make  another.     i)   In  our  example  Debra  has  a  CA  in  making  pizza  (2:1).  But  does  not  in   producing  wings.   ii)   ***Cannot  have  CA  with  both  goods  like  with  absolute  advantage.***   II)   Finding  the  Right  Price  to  Facilitate  Trade   a)   Similar  to  the  trading  done  at  lunches  in  school.   i)   If  you  agreed  to  trade  an  apple  for  3  Oreo’s  that  apple  is  worth  3  Oreo’s.   b)  From  our  example  Debra  will  benefit  from  any  exchange  lower  than  her  OP   (1:2/50%)   c)   For  Mike,  trade  will  be  beneficial  the  ratio  of  amount  exchanged  must  fall   between  the  ratio  of  Debra’s  OP  and  Mike’s  (19:47=40%)   d)  Trade  creates  value           Chapter  2  (cont.):  Trade-­‐Offs  from  Having  Some  Now  or  Later     I)   Consumer/Capital  Goods,  and  Investment   a)   Consumer  Goods:  Produced  for  present  consumption.   b)  Capital  Goods:  Help  produce  other  valuable  goods  and  services  for  in  the   future.   c)   Investments:  The  process  of  using  resources  to  create  or  buy  new  capital.   d)  Every  investment  in  capital  goods  has  an  OP  of  forgone  consumer  goods.   i)   Laptop?  Or  money  for  Spring  Break?   e)   The  decision  whether  to  consume  or  invest  has  a  significant  impact  on  the   economic  growth  of  the  future.   i)   When  producing  more  consumer  goods  in  the  short-­‐run,  new  capital   increases  only  slightly.  Graph  A   ii)   When  investment  in  new  capital,  the  long-­‐run  PPF  expands  largely.   Graph  B   Graph  A Gragh  B 14 20 12 10 15 8 10 6 4 5 2 0 0 0 5 10 15 0 5 10 15 20             f)   All  societies  face  trade-­‐offs  between  producing  for  today  and  investing  for   tomorrow.              


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