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Summary Macroeconomics Chapter 1 t/m 12
Summary Macroeconomics Chapter 1,2,3,4,5,6,7,8,9,10,11,12 Midterm material
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1Introduction
The economy is a well-functioning system for coordinating productive activities – the activities
that create the goods and services people want and get them to the people who want them.
Economics is the social science that studies the production, distribution, and consumption of
goods and services.
A market economy is a market in which production and consumption are the result of
decentralized decisions by many firms and individuals. Each individual producer makes what
he or she thinks will be most profitable and each consumer buys what he or she chooses.
A command economy is an economy in which there is a central authority making decisions
about production and consumption.
The term invisible hand is used to refer to the way a market economy manages to harness the
power of self-interest for the good of society.
Microeconomics is the study of how individuals make decisions and how these decisions
interact. Promoting: individuals pursuing their own interests often do promote the interests of
society as a whole(Adam Smith).
A market failure exists when the individual pursuit of one’s own interest, instead of promoting
the interests of society as a whole, can actually make society worse off.
A recession is a downturn in the economy.
Macroeconomics is concerned with the overall ups and downs of the economy.
Economic growth is the growing ability of the economy to produce goods and services.
Chapter 1
All economic analysis is based on a set of common principles that apply to many
different issues.
Although all economics at a basic level is about individual choices, in order to
understand how market economies behave we must also understand economic
interaction, how my choices affect your choices.
Individual choice are decisions by an individual about what to do and what not to do.
All economic activities involve individual choice.
Principles of Individual Choice
Choices are necessary because resources are scarce
- Limited income is something that keeps people from everything they want.
- But time is also a limited supply(choosing to spend time on one activity also means
choosing not to spend time on a different activity).
- People must make choices because resources are scarce.
- A resource is anything that can be used to produce something else (land, labor, capital
and human capital).
- A resource is scarce when there’s not enough of the resource available to satisfy all
the ways a society wants to use it. Natural resources(minerals) and human
resources(intelligence).
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- The scarcity of resources means that society as a whole must make choices.
The true cost of something is its opportunity cost
- The opportunity cost is what you must give up in order to get an item you want.
- The opportunity cost of an item- what you must give up in order to get it – is its true
cost.
- In the end, all costs are opportunity costs.
- The opportunity cost of a choice is what you forgo by not choosing your next best
alternative.
‘How much’ is a decision at the margin
- A trade-off is a comparison of costs and benefits.
- Marginal decisions are decisions about whether to do a bit more or less of an activity,
like what you do with your next hour, your next dollar etc. The study of such decisions
is known as marginal analysis.
- ‘How much’ decisions require making trade-offs at the margin; comparing the costs and
benefits of doing a little bit more of an activity versus doing a little bit less.
People usually respond to incentives, exploiting opportunities to make themselves better off
- An incentive is anything that offers rewards to people who change their behaviour, an
opportunity to make themselves better off.
- People usually respond to incentives, exploiting opportunities to make themselves
better off.
An economy is a system for coordinating the productive activities of many people.
Interaction of choices- my choices affect your choices and vice versa- is a feature of most economic
situations. The results of this interaction are often quite different from what the individuals intend.
Principles of the interaction of individual choices
There are gains from trade
- The key for a much better standard of living is trade, in which people divide tasks
among themselves and each person provides a good or service that other people
want in return for different goods and services that he or she wants.
- Gains from trade: by dividing tasks and trading, two people can each get more of what
they want than they could get by being self-sufficient.
- There are gains from trade.
- Gains from trade arise from this division of tasks called specialization, a situation in
which different people each engage in a different task, specializing in those task that
they are good at performing.
- The economy, as a whole, can produce more when each person specializes in a task
and trades with others.
- Markets are what allow a doctor and a pilot to specialize in their own fields.
Markets move toward equilibrium
- People will exploit opportunities to make themselves better off.
- An equilibrium is a situation in which individuals cannot make themselves better off by
doing something different. An economic situation is in equilibrium when no individual
would be better off doing something different.
- Because people respond to incentives, markets move toward equilibrium.
- Markets usually reach equilibrium via changes in prices, which rise or fall until no
opportunities for individuals to make themselves better remain.
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- The concept of equilibrium is extremely helpful in understanding economic
interactions because it provides a way of cutting through the sometimes complex
details of those interactions.
- The fact that markets move toward equilibrium is why we can depend on them to
work in a predictable way.
Resources should be used efficiently to achieve society’s goals
- An economy’s resources are used efficiently when they are used in a way that has
fully exploited all opportunities to make everyone better off.
- An economy is efficient if it takes all opportunities to make some people better off
without making other people worse off.
- When an economy is efficient, it is producing the maximum gains from trade possible
given the resources available.
- Resources should be used as efficiently as possible to achieve society’s goals.
- Equity means that everyone gets his or her fair share. Since people can disagree about
what’s fair, equity isn’t as well defined as a concept as efficiency.
- Policies that promote equity often come at a cost of decreased efficiency in the
economy.
Markets usually lead to efficiency
- No branch of the U.S. government is entrusted with ensuring the general economy
efficiency of our market economy.
- In a market economy, in which individuals are free to choose what to consume and
what to produce, people normally take opportunities for mutual gain, gains from
trade.
- Because people usually exploit gains from trade, markets usually lead to efficiency.
- In cases of market failure- the market income is inefficient.
When markets don’t achieve efficiency, government intervention can improve society’s welfare
- When markets don’t achieve efficiency, government intervention can improve society’s
welfare.
- When markets go wrong, an appropriately designed government policy can
sometimes move society closer to an efficient outcome by changing how society’s
resources are used.
- How society’s fail:
Individual actions have side effects that are not properly taken into account
by the market.
One party prevents mutually beneficial trades from occurring in an attempt to
capture a greater share of resources for itself.
Some goods, by their very nature, are unsuited for efficient management by
markets.
The principles of economy-wide interactions
One person’s spending is another person’s income
- In a market economy, people make a living selling things- including their labor to
other people. If some group in the economy decides, for whatever reason, to spend
more, the income of other groups will arise. If some groups decide to spend less, the
income of other groups will fall.
- Cut in business investment spending > reduced family incomes > reducing consumer
spending > income cuts > and so on.
Overall spending sometimes gets out of line with the economy’s productive capacity
, 4
-The amount of goods and services that consumers and businesses want to buy
sometimes doesn’t match the amount of goods and services the economy is capable
of producing.
- Inflation is the rise in prices throughout the economy.
Government policies can change spending
- Government policies can dramatically affect spending.
- The government does a lot of spending on everything from military equipment to
education.
- Government spending, taxes and control of money are the tools of macroeconomics
policy.
Chapter 2
A model is any simplified representation of reality that is used to better understand real-life
situations.
Tax models are large mathematical computer programs.
Models are important because their simplicity allow economists to focus on the effects of only
one change at a time. They allow us to hold everything else constant and study how one
change affects the overall economic outcome
The other things equal assumption, means that all other relevant factors remain unchanged.
The most effective form of economic modelling is the construction of ‘thought experiments:
simplified hypothetical versions of real-life situations.
The production possibility frontier, is a model that helps economists think about the trade-off
every economy faces.
Comparative advantage is a model that clarifies the principle of gains from trade, trade both
from individuals and between countries.
The circular flow diagram is a schematic representation that helps us understand how flows of
money, goods and services are channelled through the economy.
Trade-offs: the production possibility frontier (PPF)
The production possibility frontier illustrates the trade-offs facing an economy that produces
only two goods. It shows the maximum quantity of one good that can be produced for any
given quantity produced of the other.
If a production line lies inside or on the frontier, it is feasible.
A production point that lies outside the frontier, isn’t feasible.
The production possibility frontier helps us understand efficiency, opportunity cost and
economic growth.
Efficiency
The PPF can illustrate efficiency, an economy is efficient if there are no missed opportunities.
There are no missed opportunities in production – there is no way to produce more of one
good without producing less of other goods.
Inefficient: could be producing more.
If the economy as a whole could not produce more of any one good without producing less of
something else – if it is on the production possibility frontier – then we say that the economy
is efficient in production.
Efficiency in production is only a part of what’s required for the economy as a whole to be
efficient.
, 5
If an economy allocates its resources so that consumers are as well off as possible; efficient in
allocation.
Efficiency for the economy as a whole requires both efficiency in production and efficiency in
allocation; an economy must produce as much of each good as it can give the production of
other goods, and it must also produce the mix of goods that people want to consume.
Opportunity Cost
The PPF is also useful as a reminder of the fundamental point that the true cost of any good
isn’t the money it costs to buy, but what must be given up in order to get that good- the
opportunity cost.
Whenever we assume that the opportunity cost of an additional unit of a good doesn’t change
regardless of the output mix, the production possibility frontier is a straight line.
Increasing/constant opportunity cost.
Economic Growth
Economic growth is the growing ability of the economy to produce goods and services.
Economic growth results in an outward shift of the PPF because production possibilities are
expanded. The economy can now produce more of everything.
Two sources of economic growth
Factors of production: the resources to produce goods and services.
Factor of production: a resource that is not used up in production.
Main forces of production; land, labour, physical capital and human capital.
Technology: the technical means for the production of goods and services.
Comparative advantage and gains from trade
Gains from trade – the mutual gains that individuals can achieve by specializing in doing
different things and trading with one another.
A country has a comparative advantage in producing something if the opportunity cost of that
production is lower for that country than for other countries. (Look at example page 34).
This model illustrates the gains from trade: through specialization and trade, both countries
produce more and consume more than if they were self-sufficient.
And it applies that everyone has a comparative advantage in something, and everyone has a
comparative disadvantage in something.
A country has an absolute advantage in producing a good or service if the country can
produce more output per worker than other countries. Likewise, an individual has an absolute
advantage in producing a good or service if he or she is better at producing it than other
people.
Transactions: the circular-flow diagram
Trade takes the form of barter when people directly exchange goods or services that they
have for goods or services that they want (without using money)
The circular-flow diagram represents the transactions that take place in an economy by two
kinds of flows around a circle: flows of physical things and flows of money that pay for these
physical things.
A household consists of either an individual or a group of people (family) that share their
income.
, 6
A firm is an organization that produces goods and services for sale – and that employs
members of households.
Markets for goods and services : firms sell goods and services but they produce to households.
Factor markets: firms buy the resources they need to produce goods and services.
The capital market is the market in which capital is bought and sold.
An economy’s income distribution is the way in which total income is divided among the
owners of various factors of production.
Complications
In the real word, the distinction between firms and households isn’t always that clear-
cut.
Many of the sales firms make are not to households but to other firms.
The figure doesn’t show government.
Positive economics is the analysis that tries to answer questions about the way the world works, which
have definite right and wrong answers.
Normative economics is the analysis that involves saying how the world should work.
Forecast- prediction.
Models are especially used for ‘what if’ questions.
Value added tax(a national sales tax, which is the main source of government revenue in many
European countries).
Chapter 3
A competitive market is a market in which there are many buyers and sellers of the same good
or service. No individual’s actions have a noticeable effect on the price at which the good or
service is sold.
When a market is competitive, its behaviour is well described by the supply and demand
model.
The demand curve
The supply curve
The set of factors that cause the demand curve to shift and the set of factors that
cause the supply curve to shift
The market equilibrium, which includes the equilibrium price and equilibrium
quantity.
The way the market equilibrium changes when the supply curve or demand curve
shifts.
In general, the quantity of any good/service that people want to buy depends on the price.
The higher the price, the less of the good or service people want to purchase and vice versa.
Demand schedule: shows how much of a good or service consumers will want to buy at
different prices.
The quantity demanded: is the actual amount of a good or service consumers are willing to
buy at some specific price.
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The Demand Schedule and the Demand Curve
- A demand schedule is a table showing how much of a good or service consumers will want to
buy at different prices.
- As the price rises, the quantity demanded, the actual amount consumers are willing to buy at
some specific price, falls.
- The demand curve is a graphical representation of the demand schedule, another way of
showing the relationship between the quantity demanded and price.
- In the real world, demand curves almost always do slope downward.
- The proposition that a higher price for a good, other things equal, leads people to demand a
smaller quantity of that good is so reliable that economics are willing to call it the ‘law of
demand’.
Shifts of the Demand Curve
- Large population and the increased popularity of a good or service can have effect on the
quantity of a demanded good at any given price.
- The shift of the demand curve shows the change in the quantity demanded at any given price,
represented by the change in position of the original demand to a new position, denoted by a
new demand curve.
- A movement along the demand curve is a change in the quantity demanded of a good arising
from a change in the good’s price.
Understanding Shifts of the Demand Curve
- Increase in demand, means a rightward shift of the demand curve; at any given price,
consumers demand a larger quantity of the good or service than before.
- Decrease in demand, means a leftward shift of the demand curve; at any given price,
consumers demand a smaller quantity of the good or services than before.
- Factors that can shift the demand curve:
Changes in the prices of related goods or services.
Changes in income.
Changes in tastes.
Changes in expectations.
Changes in the number of consumers.
Changes in the prices of related goods and services
- A pair of goods are substitutes if a rise in the price of one good (jeans) makes consumers more
willing to buy the other good (khakis).
- Substitutes are usually goods that serve a similar function.
- Two goods are known as complements if a rise in the price of one good leads to a decrease in
the demand for the other good (cars and gasoline).
Changes in Income
- When a rise in income increases the demand for a good – the normal case- it is a normal good.
- When a rise in income decreases the demand for a good, it is an inferior good.
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