PRIN MACROECONOMICS ECON 102
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This 10 page Class Notes was uploaded by Ms. Ari Lesch on Saturday September 26, 2015. The Class Notes belongs to ECON 102 at Iowa State University taught by Staff in Fall. Since its upload, it has received 9 views. For similar materials see /class/214454/econ-102-iowa-state-university in Economcs at Iowa State University.
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Date Created: 09/26/15
The Production Possibilities Frontier Model The PPF model is a simple but powerful device that 1 Graphically illustrates the concepts of scarcity and choice along with the important related concepts of opportunity costs and efficiency 2 Provides valuable insights into a variety of important economic issues eg economic growth and development and the potential gains from trade The PPF The PPF is a boundary that divides all conceivable output combinations into three groups 1Unattainabe because of resource constraints 2Attainabe and efficient 3Attainabe and inefficient The PPF Graph for the Two Commodity Case Example Capital Goods vs Consumption Goods 1 Downward Sloping 2 Concave PPF Slope and Opportunity Cost The slope of the PPF dydx at a given point is the amount of good y that would have to be sacrificied to get an additional unit of good x That is it is the opportunity cost of getting an additional unit of good x If the PPF is concave the slope is increasing in absolute value increasing opportunity cost If the PPF is linear the slope is constant constant opportunity cost VERY IMPORTANT FACT The opportunity cost of getting one more unit of good x is the reciprocal of the opportunity cost of getting one more unit of good y So for example suppose that when the economy is producing at point A on the PPF the cost of getting 1 more unit of good x is 2 units of good y Then at point A the cost of getting 1 more unit of good y is 12 unit of good x Allocative Efficiency What feasible output bundle does the economy select and how is this selection made An output bundle is allocatively efficient if 1 it is production efficient ie on the PPF and 2 meets the MCMB condition The idea is simply that an ideal output bundle is the most preferred feasible bundle Application 1 Growth and Development Economic growth and development refer to the expansion of economic choices ie rightward or outward shifts in the PPF Growth is typically discussed in terms of the richer ie more developed and development is typically discussed in terms of the poorer ie less developed economies An economy s PPF shifts over time in response to technological change resource increments government policies An economy somehow chooses how much of its resources to allocate toward the production of consumption goods which provides immediate satisfaction and how much of its resources to allocate to the production of physical and human capital which will provide future benefits Problem for subsistencelevel economies Can t afford to divert resources away from the production of consumption goods but can t escape from this situation without additional investment in capital Macroeconomics I 02 A SHORT NOTE ON INFLATION UNEMPLOYMENT AND PHILIPS CURVE Macroeconomic policies are implemented in order to achieve govemment s main objectives of full emplovment and stable economv through low in ation We can use PhiliQs Curve as a tool to explain the tradeoff between these two objectives Philips Curve describes the 39 quot quot between in ation and unemployment in an economy You already know that the In ation is de ned by increase in the average price level of goods and services over time When there is in ation value of money falls A low in ation rate indicates that average price of goods would not rise as high Unemployment exist when someone is actively seeking for job but unable to nd any despite their willingness to accept the going market wage rate we discussed it many times right See Ch5 New Zealandbom economist AW Philips rst put this theory forward in 1958 gathered the data of unemployment and changes in wage levels in the UK from 1861 to 1957 He observed that one stable curve represents the tradeoff between in ation and unemployment and they are inverselynegatively related In other words if unemployment decreases in ation will increase and vice versa Macroeconomics I 02 The original Philips Curve wage in ation against unemployment In ation Unemployment For example after the economy has just been in recession the unemployment level will be fairly high This will mean that there is a labor surplus As the economy has just started growing the aggregate demand AD will increase and therefore leading to an increase in employment In the beginning there will be little pressure for a raise in wages However as the economy grows faster and more people are employed wages will start rising slowly This will increase the firm s cost of production and the high costs are usually passed on to the customers in the form of higher prices Therefore a decrease in unemployment has led to an increase in in ation and Vice versa Not only that unemployed might suffer from money illusion as they thought the increase in wages offered to them represented a real wage Sloman 2000 They underestimate in ation by not realizing that higher wages will be eaten up by higher prices Thus they will accept job more readily and this will reduce the frictional unemployment we discussed this in Ch5 right in the short run Macroeconomics I 02 The relationship we discussed above is a phenomenon in the shon I39un But in the long run since unemployment always returns to its natural rate unemployment rate at which GDP at its fullemployment level that is with no cyclical unemployment we discussed this in Ch5 right there is no such tradeoff Remember that When unemployment rate is below natural rate GDP is greater than potential output 7 Economy s selfcorrecting mechanism will then create in ation When unemployment rate is above natural rate GDP is below potential output 7 Selfcorrecting mechanism will then put downward pressure on price level Using the data from the 1950s and 1960s where the world economy tend to be stable Philips Curve relationship proved to be true for many economies such as United States and UK Griffiths and Wall 1999 However during 19671970 most countries such as US Britain and France had doubled their in ation Ormerod 1995 This was the first sign that the downward relationship in Philips Curve was not always true In 70 s the concept of a stable Philips Curve shows a break down as the economy suffered from both high in ation and high unemployment simultaneously The economists refer this kind of situation as stag atitm where stagnant economies and rising in ation occurs together
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