Principles Of Macroeconomics

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Principles Of Macroeconomics
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Todays Outline

• Introduction
• Syllabus
• Points of Order
• Lecture one

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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.

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Syllabus

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

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Points of Order

• Huge difference between school and college.
• Take a risk!
• I do not have all the answers.

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Lecture One

• Introduction to Economics

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A Definition of Economics

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

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Another Definition of Economics

• Economics is the study of how scarce resources
  are allocated among conflicting demands.

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Four Main Reasons to Study Economics...

• To learn a way of thinking
• To understand society
• To understand global affairs
• To be an informed voter

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1. To Learn a Way of Thinking...

• Three Fundamental Concepts of Economic Thinking

• Opportunity Cost
• Marginalism
• Efficiency

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Opportunity Costs

• 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
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What do we mean byOpportunity Costs?

• Theres no such thing as a free lunch!

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Opportunity Cost Question

• What is the opportunity cost of your attending
  college?

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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.)

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Efficient Markets

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

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The study of economics is an essential part of
the study of society

• 2. To understand society...

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

• 2. To understand society...

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3. To understand global affairs...

• Collapse of the Soviet Union
• The European Union
• NAFTA and GATT
• The Gulf War
• Starvation Poverty in Africa

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4. To be an informed voter...

• The number one issue on peoples minds in
  recent elections has been the economy.
• Clintons main focus during his presidency has
  been primarily on economic issues such as
  deficit reduction, economic growth, international
  trade agreements and health-care reform

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The Scope of Economics

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

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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.

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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.

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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.

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Economic Theories Models

• An economic theory is a statement or set of
  related statements about cause and effect, action
  and reaction.

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Economic Theories Models

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

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Economic Theories Models

• Inductive Reasoning is the process of observing
  regular patterns from raw data and drawing
  generalizations from them.

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Economic Theories Models

• 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.

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Economic Theories Models- Cautions Pitfalls -
The Post Hoc Fallacy

• 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.

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Economic Theories Models- Cautions Pitfalls -
Correlation vs. Causation

• 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.

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Economic Theories Models - Cautions Pitfalls
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The Fallacy of Composition

• The fallacy of composition implies that what is
  true for a part is necessarily true for the whole.

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Economic Theories Models

• Empirical Economics is the collection and use of
  data to test economic theories.

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Economic Policy and theCriteria for Judging
Economic Outcomes

• 1. Efficiency
• 2. Equity
• 3. Growth
• 4. Stability

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Economic Policy and theCriteria for Judging
Economic Outcomes
1. Efficiency

• Efficiency in economics means allocative
  efficiency. An efficient economy is one that
  produces what people want at the least possible
  cost.

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Economic Policy and theCriteria for Judging
Economic Outcomes
2. Equity

• Equity means fairness. Equity lies in the eye of
  the beholderfew people agree on what is fair and
  what is unfair.

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Economic Policy and theCriteria for Judging
Economic Outcomes
3. Growth

• Economic Growth refers to the increase in total
  output of an economy.

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Economic Policy and theCriteria for Judging
Economic Outcomes
4. Stability

• Economic Stability refers to a condition in which
  output is steady or growing with low inflation
  and full employment of resources.

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The Great Depression

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

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Macroeconomic Concerns

• Aggregate Price Level
• Aggregate Output
• Total Employment
• Rest of the World

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Inflation and Prices

• 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 the rate of change in the price level

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Aggregate Output (GDP)

• Gross Domestic Product (GDP) is the dollar value
  of all final goods and services produced.

Final good a product which is ready to be used
by consumers
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Business Cycle

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

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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
• These fluctuations define the business cycle

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Unemployment

• The unemployment rate refers to the percentage of
  people in the labor force who cant find a job.

Labor Force people who are actively seeking or
are currently holding a job
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Government Policies for Influencing the
Macroeconomy

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

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The Circular Flow Diagram

• The Players
• Households
• Firms
• Government
• Rest of the World

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The Circular Flow Diagram
Households
Pay taxes (T)
Consume (C)
Work (N)
Save (S)
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The Circular Flow Diagram
Firms
Produce (GDP)
Pay taxes (T)
Invest (I)
Buy inputs (N)
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The Circular Flow Diagram
Government
Buys goods (G)
Issues money (M)
Borrows (B)
Taxes (T)
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The Circular Flow Diagram
Rest of the World
Exports (X)
Imports (IM)
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The Circular Flow Diagram
Households
Firms
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The Circular Flow Diagram
Purchases of Goods and Services
Households
Firms
Wages, Interest, Dividends, and rent
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The Circular Flow Diagram
Purchases of Goods and Services
Taxes
Government
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The Circular Flow Diagram
Purchases of Goods and Services
Taxes
Wages, Interest, Transfer Payments
Taxes
Government
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The Circular Flow Diagram
Purchases of Imports
Purchases of Exports
Rest of the World
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Three Market Arenas

• Goods and services market
• Labor market
• Money (financial) market

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Goods and Services Market
Firms supply goods and services
Goods and Services Market
Household, Firms and Government purchase goods
and services
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Labor Market
Households supply labor
Labor Market
Firms and Government demand labor
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Financial Markets
Households supply funds
Financial Markets
Households, Firms and Government demand funds
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Aggregate Demand

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

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Aggregate Demand Curve
Price Level
P1
AD
Y1
Aggregate Output
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Aggregate Supply

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

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Aggregate Supply Curve
Price Level
AS
P1
Aggregate Output
Y1
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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

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Equilibrium
Price Level
AS
Equilibrium
P
AD
Y
Aggregate Output
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Parts of the Business Cycle
Aggregate Output
Peak
Recession
Expansion
time
Trough
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1994
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Recession

• Growth rate of GDP falls
• Firms decrease production
• Unemployment rises

Unemploy- ment
GDP
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Recessions
1994
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Expansion

• GDP growth rate rises
• Firms increase production
• Unemployment falls

Unemploy- ment
GDP
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Real GDP in the U.S., 1959 - 1994
5,500.0
5,000.0
4,500.0
4,000.0
3,500.0
Real GDP
3,000.0
2,500.0
2,000.0
1,500.0
1959
1963
1967
1971
1975
1979
1983
1987
1991
1994
Year
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Real GDP in the U.S., 1959 - 1994
5,500.0
5,000.0
4,500.0
4,000.0
3,500.0
Real GDP
3,000.0
Trend Line
2,500.0
2,000.0
1,500.0
1959
1963
1967
1971
1975
1979
1983
1987
1991
1994
Year