1. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Thinking Like An Economist Principles of Macroeconomics Dr. Gabriel X. Martinez Ave Maria University

2. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 1: Thinking Like an Economist2 Economics: Studying Choice In a World of Scarcity  The Scarcity Principle –Boundless wants cannot be satisfied with limited resources. –Therefore, having more of one thing usually means having less of another. –Because of scarcity we must make choices.

3. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 1: Thinking Like an Economist3 Economics: Studying Choice In a World of Scarcity Unlimited Wants vs. Limited Resources ScarcityChoices

4. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 1: Thinking Like an Economist4 Economics: Studying Choice In a World of Scarcity  Economics –The study of how people make choices under conditions of scarcity and of the results of those choices for society.

5. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 1: Thinking Like an Economist5 Economics: Studying Choice In a World of Scarcity  Economics –Alternatively, the study of how human being satisfy their wants and desires by coordinating the available material resources, given the decision-making mechanisms, social customs, and political realities of the society.

6. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 1: Thinking Like an Economist6 Applying The Cost-Benefit Principle  The Role of Economic Models –Economic models are abstract constructs (simplified descriptions) that allow us to analyze situations in a logical way –Other examples of abstract models  A computer model of climate change  A road map

7. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 1: Thinking Like an Economist7 Economics: Micro and Macro  M i croeconomics –The study of individual choice under scarcity and its implications for the behavior of prices and quantities in individual markets.

8. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 1: Thinking Like an Economist8 Economics: Micro and Macro  M a croeconomics –The study of the performance of national economies, and of the policies that governments use to try to improve that performance.  Because of scarcity, resources must be coordinated to satisfy wants. This coordination, on a grand scale, is what macroeconomics studies.

9. Macroeconomics: The Bird’s-Eye View of the Economy Macroeconomics: The Bird’s-Eye View of the Economy

10. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 10 Introduction The Recent U.S. Recession In the U.S.: The economy almost came to a standstill in 2001. The number of people without jobs increased by 50%  From one in every 25 Americans to one in every 16- 17 Americans. Scores of Internet-based businesses collapsed.

11. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 11

12. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 12 Introduction The Recent U.S. Recession The cause? The Stock market bubble? Irrational exuberance? Capitalism? Poor economic planning?

13. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 13 Introduction The Recent U.S. Recession The response: Macroeconomic policies  Government actions designed to affect the performance of the economy as a whole. The Fed cut interest rates dramatically. The Federal Government cut taxes and increased spending.

14. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 14

15. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 15 Introduction The Argentinian Collapse of 2001 The production of goods and services fell by nearly 20 percent between 1998 and 2002. About 1 of every 5 Argentinians was unemployed. The Argentinian peso lost two-thirds of its value.

16. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 16 Introduction The Response to the Argentinian Collapse Major Reforms to the State and the banking system. Fiscal austerity (control of spending by the provincial governments, higher taxes on exports). Fiscal: of, or relating to, government expenditures, revenues, and debt Massive loss of value of the currency made Argentinian goods attractive to foreigners. As a consequence, in 2003 Production seems to have grown by 8.4% (!!) in 2003. Inflation is (relatively) low, at 3.7% Unemployment has fallen from 18.80% to 14.50%.

17. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 17 Introduction From The Economist

18. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 18 Introduction The East Asian “Miracle” The Japanese economy became 12 times larger between the end of WWII and today. The Korean economy, in the same period, became 28 times larger. The US economy, in the same period, became only 4 times larger. The economy of Hong Kong became 10 times larger over the same period. Why?

19. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 19 The Major Macroeconomic Issues The Major Economic Issues Economic growth and living standards Productivity Recessions and expansions Unemployment Inflation Economic interdependence among nations 1 2 4 5 6 3

20. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 20 The Major Macroeconomic Issues Standard of Living The degree to which people have access to goods and services that make their lives easier, healthier, safer, and more enjoyable. Economic Growth A process of steady increases in the quantity and quality of the goods and services the economy can produce. 1

21. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 21 Output of the U.S. Economy, 1900-2001 In 2001 output of the U.S. economy was: 25 times the 1900 level 5 times the 1950 level

22. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 22 Economic growth and living standards In the U.S.: 60 million households own two or more automobiles. 98% of household own a television (95% a color TV). 67% of households subscribe to cable. In 2002, 60 % of adults were regular Internet users. 80% of the adult population has a high school diploma. 25% of the adult population has a college degree.

23. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 23 Economic growth and living standards Why did the US grow so fast during the 20 th century? Why did the East Asian nations grow faster than the US during the second half of the 20 th century? Is there something about “the nature of India” that makes it different from “the nature of France” so that they grow at a different pace? What can be done to make Africa grow faster?

24. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 24 The Major Macroeconomic Issues Productivity In 2001 the average U.S. worker could produce five times more than in 1900. Average labor productivity: Note Average Labor Productivity is NOT the same as output per person (there are people who aren’t workers). 2

25. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 25 Output per Person and per Worker in the U.S. Economy, 1900-2001 In 2001: Output/person was 7 times the 1900 level Output/worker was 5 times the 1900 level

26. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 26 Productivity Productivity and Living Standards in China and the United States 2001United StatesChina Output$10,200 billion$1,160 billion (U.S.) Population285 million1,262 million Employed135 million710 million Output/person$35,790$919 Average labor productivity$75,556$1,634

27. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 27 Productivity U.S. trends in output per employed worker 1950 - 1973: increased 2.1%/yr 1973 - 1995: increased less than 1%/yr 1995 - present: increased nearly 2%/yr Why did productivity slow down for 20 years? Why did it speed up? Is this worrisome / encouraging? Is there a government policy that can replicate US success (or avoid its mistakes) and make other people from other countries more productive?

28. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 28 Recessions and Expansions Secular growth trend 0 Jan.- Mar Total Output Apr.- June July- Sept. Oct.- Dec. Jan.- Mar Apr.- June July- Sept. Oct.- Dec. Jan.- Mar Apr.- June Expansion Recession 3

29. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 29 U. S. Business Cycles Civil War Recovery of 1895 World War I Panic of 1893 Panic of 1907 Great Depression Korean War Vietnam War World War II

30. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 30 Recessions and Expansions What causes recessions? Can they be avoided? Whom do they hurt? What causes prosperities? Do they have any costs? Should we use government policy to eliminate business cycles?

31. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 31 The U.S. Unemployment Rate, 1900-2001 The unemployment rate: % of the labor force that is out of work Observations: Rises during recessions Always greater than zero 4

32. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 32 Increases In Unemployment During Recessions Unemployment rate at beginning of recession (%) 4.8 (Nov. 1973)9.0 (May 1975)+ 4.2 6.3 (Jan. 1980)10.8 (Nov./Dec. 1982)+ 4.5 5.5 (July 1990)7.8 (June 1992)+ 2.3 Peak unemployment rate (%) Increase in unemployment rate (%)

33. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 33 Unemployment Unemployment rates differ from country to country: For the past 20 years, more than 10% of the European workforce has been unemployed. European unemployment is double the rate in the U.S. During the 1950s & ‘60s, the European unemployment rate was generally lower than in the U.S.

34. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 34

35. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 35 Unemployment What is the relation between output and unemployment? Why do some countries always have more unemployed people than others? Why is unemployment never zero, not even in the best of economic times? The lowest unemployment rate since WWII was 2.5% in 1953. And that’s even after government started intervening to reduce unemployment. Should unemployment be zero?

36. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 36 The U.S. Inflation Rate, 1900-2001 Inflation The rate prices in general are increasing over time Varies over time -- high in the ‘70s and low in the ‘90’s and today Varies between countries -- in 2001: 3% in U.S. & 400% in Ukraine 5

37. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 37 Inflation Inflation Rate The speed at which prices rise. Why is Inflation a problem? People who live on fixed incomes are able to buy less with the same income. What causes inflation? What can be done about it?

38. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 38

39. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 39

40. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 40 The Major Macroeconomic Issues National economies are becoming increasingly interdependent: In 2005 the U.S. (which is a pretty closed economy): Exported 13.56% of all goods and services produced. Imported 19.07% of the goods and services used by Americans. Countries like Hong Kong export and import more than 100% percent of what they produce. 6

41. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 41 Exports and Imports as a Share of U.S. Output, 1900-2001.

42. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 42 Economic interdependence among nations The international flows create political and economic issues: The impact of trade on jobs The steel and textile industries Trade agreements (NAFTA and CAFTA) Trade imbalances When exports and imports differ significantly Trade deficit: exports < imports Trade surplus: exports > imports Capital flows and financial crises.

43. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 43 Cost of a 3-minute phone call New York to London Transport and Communication Cost, 1930-1990 (Index 1930 = 100) 0 1930199019401950196019701980 20 40 60 80 100 120 Index (1930 = 100) Year Average air-transport cost per passenger mile Average ocean freight and port charges per short ton of cargo

44. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 44 The Major Macroeconomic Issues The Major Economic Issues Economic growth and living standards Productivity Recessions and expansions Unemployment Inflation Economic interdependence among nations

45. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 45 Macroeconomic Policy Monetary Policy Determination of the nation’s money supply Controlled by the central bank In the U.S., the Federal Reserve System (Fed) It affects the interest rate… …and through it, the cost of consuming, of buying a house, setting up a plant,… …and through it, the expansions and recessions of a country.

46. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 46 Every time unemployment rises, the Fed makes borrowing cheaper, in order to move the economy forward.

47. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 47 Fiscal Policy Decisions that determine the government’s budget, including the amount and composition of government expenditures and government revenues. It affects people’s income after taxes. It creates (and destroys) jobs. It alters the size of the government. Macroeconomic Policy

48. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 48 Fiscal policy influences the balance between government spending and taxes: A deficit occurs when government spending is greater than tax revenue. A surplus occurs when government spending is less than tax revenue. Macroeconomic Policy

49. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 49 Structural Policy Government policies aimed at changing the underlying structure, or institutions, of the nation’s economy. Best analyzed by microeconomics. But has major macroeconomic effects Remember the resolution of the Argentinian crisis. Macroeconomic Policy

50. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 50 Positive versus Normative Analyses of Macroeconomic Policy Positive Analysis Addresses the economic consequences of a particular event or policy, not whether those consequences are desirable. What are the facts? What is the production of a country? How fast are prices rising? How can we give jobs to more people? Macroeconomic Policy

51. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 51 Normative Analysis Addresses the question of whether a policy should be used; normative analysis inevitably involves the values of the person doing the analysis. These values are derived from disciplines other than economics: theology, philosophy, etc., and from one’s own reflection and experience. Should the country grow faster? Should inflation be stopped at the cost of a recession? Is unemployment too high? Macroeconomic Policy

52. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 52 Aggregation The adding up of the individual economic variables to obtain economy-wide totals Used to take a “bird’s-eye view” of the economy Aggregate measurements in dollar values allow economists to compare broad categories of goods and services, such as exports and imports. Aggregation often obscures the fine detail of an economic situation, but it simplifies the analysis.

53. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17: Macroeconomics:The Bird's-Eye View of the Economy 53 Aggregation M a croeconomics deals with aggregates. M i croeconomics deals with separate markets.