ECON 2301 Notes - Luba Ketsler, UTD PDF

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Luba Ketsler, UTD...

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PRI NCI PLESOFMACROECONOMI CS ANUSHAALAMGI R–SPRI NG2 02 1

Table of Contents SECTI ON 1................................................................................................... 2 Chapter 1: Scope and Method of Economics.....................2 Chapter 2: The Economic Problem - Scarcity and Choice....................................................................................................... 5 Chapter 3: Demand, Supply, & Market Equilibrium.......7 Chapter 4: Demand and Supply Applications.................11 SECTI ON 2................................................................................................. 12 Chapter 5: Introduction to Macroeconomics...................13 Chapter 6: Measuring National Output and National Income.................................................................................................... 15 Chapter 7: Unemployment, Inflation, and Long-Run Growth................................................................................................... 18 SECTI ON 3................................................................................................. 21 Chapter 8: Aggregate Expenditure & Equilibrium Output.................................................................................................... 21 Chapter 9: The Govt & Fiscal Policy.....................................23 SECTI ON 4................................................................................................. 25 Chapter 10: The Money Supply & Federal Reserve System................................................................................................... 25 Chapter 11: Money Demand & the Equilibrium Interest Rate...................................................................................... 28

SECTI ON 5................................................................................................. 30 Chapter 12........................................................................................... 30 Chapter 13........................................................................................... 31 Chapter 14........................................................................................... 32

SECTI ON 1 Chapter 1: Scope and Method of Economics 

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Economics - The study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided. o the study of how people make choices. Choices added up = societal choices. Scarce - limited 3 fundamental concepts: o Opportunity cost o Marginalism o Efficient markets Opportunity cost – best alternative that we forego, or give up, when we make a choice or a decision Marginalism – process of analyzing the additional or incremental costs or benefits arising from choice or decision. o With each additional unit, marginal utility (satisfaction) diminishes (e.g. pizza slices) Efficient market - A market in which profit opportunities are eliminated almost instantaneously. Producing what people want at lowest cost o Competitive system.  E.g., grocery store – checkout line packed – new aisle opens so you move there and then another line forms behind you  Company A vs. company B compete in widget market  better marketing one wins Industrial Revolution - The period in England during the late eighteenth and early nineteenth centuries in which new manufacturing technologies and improved transportation gave rise to the modern factory system and a massive movement of the population from the countryside to the cities. Microeconomics - The branch of economics that examines the functioning of individual industries and the behavior of individual decision-making units—that is, business firms and households. o looks at the individual unit—the household, the firm, the industry. It sees and examines the “trees.”

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Macroeconomics - The branch of economics that examines the economic behavior of aggregates—income, employment, inflation, price levels, output, and so on—on a national scale. o looks at the whole, the aggregate. It sees and analyzes the “forest.” Economics is broad and diverse discipline with special fields  including economic history, international economics, and urban economics. FIELDS IN ECONOMICS o Behavioral economics - uses psychological theories relating to

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emotions and social context to help understand economic decision making and policy. Focuses on the biases that individuals have that affect the decisions they make. Comparative economic systems - examines the ways alternative economic systems function Econometrics - applies statistical techniques and data to economic problems in an effort to test hypotheses and theories Economic development - focuses on the problems of low-income countries. Important concerns of development for economists include population growth and control, provision for basic needs, and strategies for international trade. Economic history - traces the development of the modern economy (Industrial revolution, post-WW2 Japan, Great Depression) Environmental economics - studies the potential failure of the market system to account fully for the impacts of production and consumption on the environment and on natural resource depletion Finance - examines the ways in which households and firms actually pay for, or finance, their purchases. It involves the study of capital markets (including the stock and bond markets), futures and options, capital budgeting, and asset valuation Health economics - analyzes the health care system and its players: government, insurers, health care providers, and patients. It provides insight into the demand for medical care, health insurance markets, cost-controlling insurance plans (HMOs, PPOs, IPAs), government health care programs (Medicare and Medicaid), variations in medical practice, medical malpractice, competition versus regulation, and national health care reform. History of economic thought - studies the development of economic ideas and theories over time, from Adam Smith in the eighteenth century to the works of economists such as Thomas Malthus, Karl Marx, and John Maynard Keynes. Because economic theory is constantly developing and changing, studying the history of ideas helps give meaning to modern theory and puts it in perspective. Industrial organization - looks carefully at the structure and performance of industries and firms within an economy

o International economies - studies trade flows among countries and international financial institutions

o Labor economics - deals with the factors that determine wage rates, employment, and unemployment

o Law and economics - analyzes the economic function of legal rules and institutions

o Public economies - examines the role of government in the economy o Urban and regional economics - studies the spatial arrangement of economic activity

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Positive Economics - An approach to economics that seeks to understand behavior and the operation of economies without making judgments. 2 types o Descriptive – compilation of data that accurately describes economic facts/events (e.g., Texas unemployment rate is 8.5%) o Economic theory – generalize and explains what is observed. Involves statement of cause and effect (action and reaction) Normative economics - An approach to economics that analyzes results of economic behavior, evaluates them as good or bad and if they can be improved, and may prescribe courses of action. Also called policy economics. o “We should…to lower unemployment rate”  making policy o “we need to increase access to healthcare for better outcomes” Model- A formal statement of an economic theory, usually a mathematical statement of a presumed relationship between two or more variables. Models simplify and abstract from reality. Models and theories expressed in words, graphs, equations. Variable - A measure that can change from time to time or from observation to observation. (e.g., more people wear masks, less spread) Ockham’s razor - The principle that irrelevant detail should be cut away o E.g., in spouse murder case, look at most obvious answers and eliminate irrelevant details (neighbor 2 miles away) ceteris paribus, or all else equal - A device used to analyze the relationship between two variables while the values of other variables are held unchanged o one part of the process of abstraction. In formulating economic theory, the concept helps us simplify reality to focus on the relationships that interest us. o Basics  useful to isolate effects of one variable on another while holding “All else equal” post hoc, ergo propter hoc - Literally, “after this (in time), therefore because of this.”

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o A common error made in thinking about causation: If Event A happens before Event B, it is not necessarily true that A caused B. o E.g., wearing team shirt whenever they win (but you wear it and they lose. Not related) fallacy of composition - The erroneous belief that what is true for a part is necessarily true for the whole. empirical economics - The collection and use of data to test economic theories. In principle, the best model is the one that yields the most accurate predictions. 4 criteria in judging economic outcomes: o Efficiency o Equity o Growth o Stability efficiency - In economics, allocative efficiency. An efficient economy is one that produces what people want at the least possible cost. equity - Fairness. economic growth - An increase in the total output of an economy stability - A condition in which national output is growing steadily, with low inflation and full employment of resources. APPENDIX o graph - a two-dimensional representation of a set of numbers, or data. o time series graph - shows how a single measure or variable changes over time. o Cartesian coordinate system - constructed by drawing two perpendicular lines: a vertical axis (the Y-axis) and a horizontal axis (the X-axis) o Positive relationship – X increases, Y increases, vice versacom o Negative relationship – X increases, Y decreases, vice versa o slope - A measurement that indicates whether the relationship between variables is positive or negative

Chapter 2: The Economic Problem - Scarcity and Choice    

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capital Things that are produced and then used in the production of other goods and services. factors of production (or factors) The inputs into the process of production. Another term for resources production The process that transforms scarce resources into useful goods and services. inputs or resources Anything provided by nature or previous generations that can be used directly or indirectly to satisfy human wants. outputs Goods and services of value to households. theory of comparative advantage Ricardo’s theory that specialization and free trade will benefit all trading parties, even those that may be “absolutely” more efficient producers. See SI Handout (Ch.2) for example o absolute advantage A producer has an absolute advantage over another in the production of a good or service if he or she can produce that product using fewer resources (a lower absolute cost per unit). o comparative advantage A producer has a comparative advantage over another in the production of a good or service if he or she can produce that product at a lower opportunity cost. consumer goods - Goods produced for present consumption investment The process of using resources to produce new capital. production possibility frontier (ppf) A graph that shows all the combinations of goods and services that can be produced if all of society’s resources are used efficiently marginal rate of transformation (MRT) / opportunity cost - The slope of the production possibility frontier (ppf)  always increasing o increasing opportunity cost – cost per bushel of corn measured in lost wheat has increased (more corn produced at the expense of ignoring wheat growing, but you earn 100 mil corn even while losing 50 mil wheat. So, increasing cost) example explained at 20:30 in Ch.2, part 1. o Unemployment - During economic downturns or recessions, industrial plants run at less than their total capacity. When there is unemployment of labor and capital, we are not producing all that we can.

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o Inefficiency - Waste and mismanagement are the results of a firm operating below its potential. Sometimes inefficiency results from mismanagement of the economy instead of mismanagement of individual private firms. economic growth An increase in the total output of an economy. Growth occurs when a society acquires new resources or when it learns to produce more using existing resources. 3 basic questions facing all economic systems: o (1) What gets produced? o (2) How is it produced? o (3) Who gets it? pure forms do not exist in the world; all real systems are in some sense “mixed.” o (no purely planned economies or laissez-faire. Individual enterprise, independent choice, and relatively free markets exist in centrally planned economies but govt involved significantly in market economies) o command economy An economy in which a central government either directly or indirectly sets output targets, incomes, and prices. o laissez-faire economy Literally from the French: “allow [them] to do.” An economy in which individual people and firms pursue their own self-interest without any central direction or regulation.  The behavior of buyers and sellers in a laissez-faire economy determines what gets produced, how it is produced, and who gets it. market The institution through which buyers and sellers interact and engage in exchange o free market – limited govt plan/directives. System operates on its own. Basic coordinating mechanism is price  produces what people want, competition forces firm to adopt efficient production techniques. Need for govt interventions arises b/c of inefficiencies and unequal distribution of income, and periods of inflation and unemployment. consumer sovereignty The idea that consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (and what not to purchase). free enterprise The freedom of individuals to start and operate private businesses in search of profits. Distribution of output in free market determined by:

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o Income is the amount that a household earns each year. It comes in a number of forms: wages, salaries, interest, etc. o Wealth is the amount that households have accumulated out of past income through saving or inheritance. In free market, the basic economic questions are answered without the help of a central government plan or directives. Some people go into business and others learn skills to work, invest, etc. Basic coordinating mechanism is price. That’s why microeconomic theory often called price theory.

Chapter 3: Demand, Supply, & Market Equilibrium  

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Firm: An organization that transforms resources (inputs) into products (outputs). Firms are the primary producing units in a market economy. entrepreneur A person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business. households The consuming units in an economy Input Markets and Output Markets: The Circular Flow o product or output markets The markets in which goods and services are exchanged. o input or factor markets The markets in which the resources used to produce goods and services are exchanged. Both markets connected by behavior of firms and household behaviors. o Firms – determine quantities, character of outputs produced, the types and quantities of inputs demanded. o Households – determines type and quantities of products demanded and the quantities and types of inputs supplied. DIAGRAM  Circular flow of economic activity o Blue – households o Red – firms o Green – monetary flow (money) labor market The input/factor market in which households supply work for wages to firms that demand labor. capital market The input/factor market in which households supply their savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods. land market The input/factor market in which households supply land or other real property in exchange for rent. factors of production The inputs into the production process. Land, labor, and capital are the three key factors of production.

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Demand in Product/Output Markets  Household decision about what quantity of output/product to demand depends on factors: o Price of product o Income available to household o Amount of accumulated wealth o Prices of other products available to the household o Tastes and preferences o Expectations about future income, wealth, and prices. quantity demanded The amount (number of units) of a product that a household would buy in a given period if it could buy all it wanted at the current market price. Changes in Quantity Demanded versus Changes in Demand o IMPORTANT RELATIONSHIP in individual markets: b/w market price & quantity demanded  Changes in price affect quantity demanded  Changes in other factors (income, preference, etc.) affect demand itself.  E.g., price of Coke increases, quantity of Coke demanded decreases  E.g., income increases, demand for most good increases Price and Quantity Demanded: The Law of Demand o demand schedule Shows how much of a given product a household would be willing to buy at different prices for a given time period. o demand curve A graph illustrating how much of a given product a household would be willing to buy at different prices (how much of a product a household would buy if it could buy all it wanted at the given price)  Have a negative slope, indicating that lower prices cause quantity demanded to increase  Intersect the quantity (x) axis, a result of time limitations ad diminishing marginal utility  Intersect price (Y) axis, a result of limited income and wealth  Actual shape of individual household demand curve depends on unique tastes and preferences and other factors o law of demand The negative relationship between price and quantity demanded: As price rises, quantity demanded decreases; as price falls, quantity demanded increases, ceteris paribus (given all else remains same) Other determinants of household demand o income The sum of all a household’s wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time. It is a flow measure. o wealth or net worth The total value of what a household owns minus what it owes. It is a stock measure. o normal goods: goods for which demand goes up when income is higher and for which demand goes down when income is lower.

inferior goods: goods for which demand tends to fall when income rises Prices of other goods and services o substitutes Goods that can serve as replacements for one another; when the price of one increases, demand for the other increases  SEE NOTES AT END OF CHAPTER [Price of X increases, Demand for Y increases and vice versa. (Price of Pepsi increases, quantity demanded for Pepsi decreases, demand for Coke increases)] o perfect substitutes Identical products  Tylenol at Walmart vs. Tylenol at Johnson & Johnson (price of JJ down, demand for Walmart brand decreases, and vice versa) o complements, complementary goods: Goods that “go together”; a decrease in the price of one results in an increase in demand for the other and vice versa  price of X increases, demand for Y decreases and vice versa (e.g., peanut butter and jelly) Tastes and preferences o Income, wealth, prices are the 3 factors that determine whether household is able to buy goods/services o Changes in preferences...