Introduction to Macroeconomics ECON2105

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Introduction to Macroeconomics (ECON2105)

• Text Macroeconomics A Contemporary
• Introduction 7th Ed.
• Syllabus
• 4 midterms and a final (scantron 882-E), they
  cost about .25I do not sell them at test time.
• Test Coverage
• Test 1 (Midterm) Chapters 1, 2, 4
• Test 2 (Midterm) Chapters 5-7
• Test 3 (Midterm) Chapters 8-10
• Test 4 (Midterm) Chapters 11, 12, 17
• Test 5 (Final) Chapters 13-15

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What I expect you already know

• Algebra-Functions, solving equations, etc.
• Graphing-Slope/intercept, plotting, lines.
• Arithmetic-add, subtract, multiply, divide and
  other stuff.

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The Art and Science of Economics

• Chapter 1

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The Economic Problem

• Economics examines how people use their scarce
  resources to satisfy their unlimited wants
• Scarce resource
• Not freely available ? when its price exceeds
  zero
• Resources
• Inputs
• Factors of production
• Used to produce goods and services
• Name some specific resources

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Resources

• Goods and services are scarce because resources
  are scarce
• Four general categories
• Labor
• Capital
• Land
• Entrepreneurial Ability

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Labor and Capital

• Labor broad category of human effort
• Physical and mental
• Time
• Scarcity of time ? scarcity of labor
• Capital Human creations used to produce goods
  and services
• Physical capital factories, machines, tools,
  buildings, airports, highways and other
  manufactured items employed to produce goods and
  services
• Human capital consists of the knowledge and
  skill people acquire to enhance their labor
  productivity
• Goodwill Capital Not mentioned in the text, this
  type of capital is sometimes referred to as
  brand capital in business and marketing. Its
  the asset value of a company name or a brand name.

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Land Entrepreneurial Ability

• Land
• Land and other natural resources
• Gifts of nature including bodies of water, trees,
  oil reserves, etc.
• Entrepreneurial Ability
• Special kind of human skill
• Talent required to dream up a new product or find
  a better way to produce an existing one

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Allocation of Resources

• how does our society typically allocate its
  resources?
• ... By pricing (i.e., though markets)
• Lets think of some examples
• Can you think of other ways to allocate
  resources?
• By need (during emergencies)
• Equally (dividing up mms)
• By merit (HOPE Scholarship)

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Payments for Resources

• Wages ? payment for use of labor
• Interest ? payment for the use of capital
• Rent ? payment for use of land
• Profit ? reward for entrepreneurs reward
• Revenue from sales minus cost of resources
  employed

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Goods and Services

• Goods
• Tangible itemsgive me an example
• Services
• Intangible itemsgive me an example
• Is the following a good or a service???
• Groceries
• Haircut
• MP3 download
• A night at the movies
• A boring economics lecture

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Blurring the line between goods and services?

• A music cd is a good, but a concert is a service.
• Books are goods, but instruction is a service.
• A software package is a good, but
• can you think of a service that goes along with
  this???

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Goods and Services

• A Good or a service is scarce if the amount
  people desire exceeds the amount that is
  available at a zero price ? we must continually
  choose among them
• Choices in a world of scarcity implies we must
  pass up some goods and services to consume others

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Free Goods

• Goods that are available at a zero pricecan you
  name a good that is truly free?
• Even these goods that are advertised as free may
  come with strings attached
• buy one-get one free, yeah right! Or, you get a
  free trip, you just have to listen to a 4-hour
  infomercial about our time-share condos. You pay
  either way
• What about air and water???
• While air and water may appear to be free, clean
  air and clean water have become scarce.

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Economic Decision Makers

• Four types of decision-makers in the economy
• Households
• They demand the goods and services produced
• They supply labor, capital, labor, and sometimes
  entrepreneurial ability
• Firms, governments, and the rest of the world
• They demand the resources (land, labor, capital,
  entrep.)
• They make and supply the goods and services
• Rest of the world ? foreign households, firms and
  governments

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Markets

• Markets are simply where buyers and sellers meet
  and carry out exchanges
• Product markets
• Markets in which goods and services are bought
  and sold
• Resource Markets
• Markets in which the resources are exchanged
• Labor, or job, market is the most important of
  the resource markets

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Markets

• A market CAN be a physical location, e.g., the
  NYSE, a grocery store, an auction.
• But, it doesnt HAVE to be physical at allEbay.

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Exhibit 1 Circular-Flow Model

• Households supply resources in the resource
  market and demand goods and services in the
  product market
• Firms supply goods and services in the product
  market and demand resources in the resource
  market
• Money flows in resource markets determine wages,
  interest, rents and profits which flow as income
  to households
• Product markets determine the prices for goods
  and services which flow as revenue to firms

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Rational Self Interest

• What does Rational Self Interest mean?
• People act in their own best interest.
• Why is it very often good?
• People vote with their money for goods that give
  the most benefit relative to the cost.

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Rational Self Interest

• Maximizing the expected benefit achieved with a
  given cost or minimizing the expected cost of
  achieving a given benefitevery consumer gets the
  biggest bang for their buck.
• Rational people try to make the best choices
  they can, given the available information.
• Self Interest does not rule out concern for
  others.

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Example, cell phone service

• Would you buy a cell phone and service from this
  guy???
• If you dont he will eventually go out of
  business.
• Should you buy?!
• Is this self-interest?is it rational?
• Why might his going out of business be good for
  the overall economy???

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Time and Information

• Time and information are both scarce and valuable
• Often willing to pay others to gather and digest
  it for us
• Decision-makers will continue to acquire
  information as long as the additional benefit
  expected from that information exceeds the
  additional cost of gathering information

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Marginal Analysis

• Comparison of expected marginal cost and the
  expected marginal benefit of the action under
  consideration
• Marginal
• Incremental
• Additional
• Extra

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Marginal Analysis Put to the Test

• Joeys pizza problemnote, you like pizza
• Suppose the UC is running a special on pizza, 1
  per sliceand you have 20.
• Slice 1 (mmm!)
• Slice 2 (mm!)
• .
• Slice 20 (Uhhhhhhhhhhhhhhhhhhhhhh!!!!)
• When do you stop?!?!
• You keep eating until the value of that NEXT
  slice is less than 1.
• The NEXT slice is the marginal slice, thus you
  are making the decision to eat until the marginal
  value of a slice of pizza is less than 1.

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A Scary thought!!!

• When would you stop eating at an ALL YOU CAN EAT
  PIZZA BAR!!!
• When the value of that next slice is 0
• Do you feel you need to eat more at an all you
  can eat bar than at a place where you pay by the
  dish?

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Micro and Macro economics

• Microeconomics
• Examines the factors that influence individual
  economic choices
• Studies the individual pieces of the economic
  puzzle
• Macroeconomics
• Studies the performance of the economy as a whole
• Focuses on the big picture

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Science of Economic Analysis

• Economic theory or model
• Simplification of economic reality
• Used to make predictions about the real world
• Focuses on the important elements of the problem
  under study
• More details ? more unwieldy

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Exhibit 2 The Scientific Method
1. Identify the Question and Define Relevant
Variables
2. Specify Assumptions
3. Formulate a hypothesis
Modify Approach
4. Test the hypothesis
or
Use the hypothesis until a better one shows up
Reject the hypothesis
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Scientific Method

• Identify the Question and Define the relevant
  variables
• Variable is a measure that can take on different
  values
• Specify Assumptions
• Other-things-constant assumption ceteris
  paribus
• Behavioral Assumption refer to how people behave
  ? rational self-interest? consumers maximize
  satisfaction and firm maximizes profits

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Formulate and Test Hypothesis

• Statement about how the key variables relate to
  each other
• Provides the predictions of interest based on
  cause and effect relationships
• Test involves comparing these predictions with
  real world
• This is where the validity of theory is tested
• We reject the theory if it predicts worse than
  the best alternative
• We accept the theory until a better one comes
  along

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Normative versus Positive

• Positive economic statement
• Assertion about economic reality
• Supported or rejected by reference to the facts
• Normative economic statement
• Opinions
• Cannot be shown to be true or false by reference
  to the facts

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Positive

• The state of GA experienced an increase of 6 in
  sales tax collections from 2005 to 2006.
• On average, about half of HOPE Scholarship
  recipients lose it in the first two years.
• The average income for someone living in Carroll
  County is 23,649.

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Normative

• We should increase the sales tax and decrease the
  income tax.
• Too many people are losing their HOPE
  scholarship.
• Carroll County income is lower than it ought to
  be.

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Predicting Average Behavior

• Because the unpredictable actions of numerous
  individuals tend to cancel one another out, the
  average behavior of a group of individuals can be
  predicted more accurately than the actions of any
  one individual

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Pitfalls of Economic Analysis

• Three possible sources of mistakes in reasoning
  leading to faulty conclusions
• Fallacy that Association is Causation
• Fallacy of Composition
• Mistake of Ignoring Secondary Effects

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Pitfalls of Economic Analysis

• Fallacy that Association is Causation
• Event A caused event B simply because the two are
  associated in time
• The fact that one event precedes another or that
  the two events occur simultaneously does not
  necessarily mean that one event caused the other
• Fallacy of Composition
• Erroneous belief that what is true for the
  individual or the part, is also true for the
  group, or the whole
• Suppose one persons stands up at a football game
  to get a better viewwhat does the person behind
  them have to do to see? Does this action work if
  everyone stands up?

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Ignoring Secondary Effects

• Unintended consequences of policies or choices
• Primary Effects
• Effects that are felt relatively quickly
• Easily observed
• Secondary Effects
• Tend to develop more slowly
• Frequently not obvious

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Policy Minimum Wage

• Increasing the minimum may help some, but ...
• employers may hire fewer people, if the min. wage
  goes upthis hurts the next person that would
  have been hired, but now isnt.
• If this does happen, its an unintended secondary
  effect.

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Policy Price floor for crops

• Increasing the amount farmers are guaranteed for
  their crops helps farmers maintain their income,
  but.
• Farmers now grow more crops, because they know
  they will get that price, and we get too much, so
  market prices for crops fall.

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Policy Rent Control (NYC)

• The price people pay for rent is held down to
  keep housing affordable, but.
• Landlords dont build enough new apartments
  because they cant earn enough from their
  investment.