Principles Of Macroeconomics

Today’s Outline  Introduction  Syllabus  Points of Order  Lecture one

Introduction  Dr Michael J. Oliver  10th year of teaching in UK and US  Macroeconomic historian  Currently have three books in print, another two due out this year.

Syllabus  The course is ‘electronic’.  Lectures will be available for downloading AFTER the lecture.  Emphasis is on YOUR contribution in class and outside.

Points of Order  Huge difference between school and college.  Take a risk!  I do not have all the answers.

Lecture One Introduction to Economics

Economics A Definition of “Economics” Economics Economics is the study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided.

Economics Another Definition of “Economics” Economics Economics is the study of how scarce resources are allocated among conflicting demands.

Four Main Reasons to Study Economics...  To learn a way of thinking  To understand society  To understand global affairs  To be an informed voter

1. To Learn a Way of Thinking... Three Fundamental Concepts of Economic Thinking: Opportunity Cost Marginalism Efficiency

Opportunity Costs opportunity cost The opportunity cost of something is that which we give up when we make that choice or that decision. Opportunity costs imply that nearly all decisions involve trade-offs

What do we mean by Opportunity Costs? “There’s no such thing as a free lunch!”

Opportunity Cost Question… What is the opportunity cost of your attending college?

Marginalism In weighing the costs and benefits of a decision, it is important to weigh only the costs and benefits that arise from the decision. (That is, the additional costs/benefits that are added as a result of that decision.)

Efficient Markets An efficient market is one in which any and all profit opportunities are eliminated instantaneously.

“The study of economics is an essential part of the study of society” 2. To understand society...

Past and present economic decisions have an enormous effect on the character of life in a society! 2. To understand society...

3. To understand global affairs...  Collapse of the Soviet Union  The European Union  NAFTA and GATT  The Gulf War  Starvation & Poverty in Africa

4. To be an informed voter...  The number one issue on people’s minds in recent elections has been the economy.  Clinton’s main focus during his presidency has been primarily on economic issues such as: deficit reduction, economic growth, international trade agreements and health-care reform

The Scope of Economics MACROECONOMICS The branch of economics that examines economic behavior of the aggregates - income, employment, aggregate output, and so on.

The Scope of Economics MICROECONOMICS The branch of economics that examines the functioning of individual industries and the behavior of individual decision- making units such as business firms and households.

The Method of Economics Positive Economics An approach to economics that seeks to understand behavior and the operation of systems without making judgements. It describes what exists and how it works.

The Method of Economics Normative Economics An approach to economics that analyzes outcomes of economic behavior, evaluates them as good or bad, and may prescribe courses of action. Normative economics will many times apply value judgements.

Economic Theories & Models economic theory An economic theory is a statement or set of related statements about cause and effect, action and reaction.

Economic Theories & Models economic model An economic model is a formal statement of an economic theory. Usually a mathematical representation of a presumed relationship between two or more variables.

Economic Theories & Models Inductive Reasoning Inductive Reasoning is the process of observing regular patterns from raw data and drawing generalizations from them.

Economic Theories & Models Ceteris Paribus Ceteris Paribus is a device (i.e.an assumption) used to analyze the relationship between two variables while the values of other variables are held unchanged. It may be interpreted to mean “everything else equal or constant.”

Economic Theories & Models - Cautions & Pitfalls - Post hoc, ergo propterhoc Post hoc, ergo propter hoc, literally means “after this, therefore because of this.” It refers to a common error made in thinking about causation. If Event A happens before Event B, it is not necessarily true that A caused B. The Post Hoc Fallacy

Economic Theories & Models - Cautions & Pitfalls - Two variables are correlated if one variable changes when the other variable changes. This does not mean that changes in one variable cause changes in the other. Correlation vs. Causation

Economic Theories & Models - Cautions & Pitfalls - fallacy of composition The fallacy of composition implies that what is true for a part is necessarily true for the whole. The Fallacy of Composition

Economic Theories & Models Empirical Economics Empirical Economics is the collection and use of data to test economic theories.

Economic Policy and the Criteria for Judging Economic Outcomes 1. Efficiency 2. Equity 3. Growth 4. Stability

Economic Policy and the Criteria for Judging Economic Outcomes allocative efficiency Efficiency in economics means allocative efficiency. An efficient economy is one that produces what people want at the least possible cost. 1. Efficiency

Economic Policy and the Criteria for Judging Economic Outcomes Equity Equity means fairness. Equity lies in the eye of the beholder…few people agree on what is fair and what is unfair. 2. Equity

Economic Policy and the Criteria for Judging Economic Outcomes Economic Growth Economic Growth refers to the increase in total output of an economy. 3. Growth

Economic Policy and the Criteria for Judging Economic Outcomes Economic Stability Economic Stability refers to a condition in which output is steady or growing with low inflation and full employment of resources. 4. Stability

The Great Depression Great Depression The Great Depression was a period of severe economic contraction and high unemployment that began in 1929 and continued throughout the 1930’s.

Macroeconomic Concerns  Aggregate Price Level  Aggregate Output  Total Employment  Rest of the World

Inflation and Prices  Price level  Price level: a measure of the behavior of all prices in the economy  Price level is a yardstick -- a tool for comparison of prices over time.  Inflation  Inflation: the rate of change in the price level

Aggregate Output (GDP) Gross Domestic Product final Gross Domestic Product (GDP) is the dollar value of all final goods and services produced. Final good Final good: a product which is ready to be used by consumers Final good Final good: a product which is ready to be used by consumers

Business Cycle  Periodic movements in output, prices, and employment  Business cycles are not created equal. –Duration –Severity

Business Cycle  GDP rises and falls over short spans of time  At any point in time, it may be above or below its long run trend business cycle  These fluctuations define the business cycle

Unemployment unemployment rate The unemployment rate refers to the percentage of people in the labor force who can’t find a job. Labor Force Labor Force: people who are actively seeking or are currently holding a job Labor Force Labor Force: people who are actively seeking or are currently holding a job

Government Policies for Influencing the Macroeconomy  Fiscal Policy  Fiscal Policy: Government policies regarding taxes and expenditures  Monetary Policy  Monetary Policy: The tools used by the Federal Reserve to control the money supply  Supply-side Policies  Supply-side Policies: policies that focus on aggregate supply and increasing production

The Circular Flow Diagram The Players  Households  Firms  Government  Rest of the World

Consume (C) Save (S) Work (N) Pay taxes (T) Households The Circular Flow Diagram

Produce (GDP) Invest (I) Buy inputs (N) Pay taxes (T) Firms The Circular Flow Diagram

Buys goods (G) Borrows (B) Taxes (T) Issues money (M) Government

The Circular Flow Diagram Rest of the World Exports (X) Imports (IM)

The Circular Flow Diagram Firms Households

The Circular Flow Diagram Firms Households Purchases of Goods and Services Wages, Interest, Dividends, and rent

The Circular Flow Diagram Government Purchases of Goods and Services Taxes

The Circular Flow Diagram Government Purchases of Goods and Services Taxes Wages, Interest, Transfer Payments

The Circular Flow Diagram Rest of the World Purchases ofExports Imports

Three Market Arenas  Goods and services market  Labor market  Money (financial) market

Goods and Services Market Household, Firms and Government purchase purchase goods and services supply Firms supply goods and services

Labor Market Firms and Government demand demand labor supply Households supply labor

Financial Markets Households, Firms and Government demand demand funds supply Households supply funds

Aggregate Demand Aggregate demand Aggregate demand represents the total demand for goods and services in an economy.

Aggregate Demand Curve Price Level Aggregate Output P 1 Y1Y1 AD

Aggregate Supply Aggregate supply Aggregate supply represents the total supply of goods and services in an economy.

Aggregate Supply Curve Price Level Aggregate Output P1P1 Y1Y1 AS

Equilibrium equilibrium Aggregate equilibrium is a level of prices and GDP such that the quantity of goods and services purchased equals the overall quantity of goods and services produced

Equilibrium Price Level Aggregate Output P*P* Y*Y* AS AD Equilibrium

Parts of the Business Cycle Peak Trough Recession Expansion Aggregate Output time

1994

Recession  Growth rate of GDP falls  Firms decrease production  Unemployment rises GDP Unemploy- ment

Recessions 1994

Expansion  GDP growth rate rises  Firms increase production  Unemployment falls GDP Unemploy- ment

Percentage Deviation of GDP from Trend, Year Percentage Deviation of GDP Expansions 1994

Real GDP in the U.S., , , , , , , , , , Year Real GDP 1994

Real GDP in the U.S., , , , , , , , , , Year Real GDP Trend Line 1994