Macroeconomics

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economics

Back 1

The way resources are allocated among alternative uses to satisfy human wants.

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economic resources versus free resources

Back 2

Economic resources are scarce, free resources are so abundant they can be obtained without charge.

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Four central economic questions

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1) What determines what and how much is produced?
2) What determines how it is produced?
3) What determines how the society's output is distributed among the members?
4) What determines the rate at which the society's per-capita income will grow?

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opportunity cost

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The value of what a resource could have produced if it was used in the best alternative way.

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positive economics

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Uses descriptive statements, propositions, and predictions about the world.

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normative economics

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Makes statements about what ought to be or what a person, organization, or nation ought to do.

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model

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A theory composed of a number of assumptions from which conclusions or predictions are deduced.

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direct relationship

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The line of average relationship slopes upward as the variable measured on the horizontal axis increases.

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inverse relationship

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The variable measured on the vertical axis tends to decrease as the variable on the horizontal axis increases.

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Adam Smith and the "invisible hand"

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Described how a free, competitive economy can function to allocate resources efficiently. Recognized the virtues of the "invisible hand" that leads the private interest of firms and individuals toward socially desirable ends.

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production possibilities curve

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A curve showing the combinatiosn of amounts of various goods that a society can produce with given (fixed) amounts of resources.

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economic growth

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The rate at which the economy's total real output of goods and services is expanding.

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How can economic growth be achieved?

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Can be acheived by developing improved processes and products, and also by increasing the production of capital goods.

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What are the tasks (4) of an economics system?

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1) Determine the level and composition of society's output
2) Determine how each good and service is to be produced
3) Determine how the goods and services produced are to be distributed among the members of society
4) Determine the rate of growth of per capita income

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Why would a country be operating inside the production possibilities curve?

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A high unemployment rate, low demand for products.

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How can a country operate outside of the production possibilities curve?

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Produce more efficiently through R&D and produce more capital goods.

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consumers

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Purchase the goods and services that are the end products of the economic system.

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firm

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An organization that produces a good or service for sale.

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market

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A group of firms and individuals in touch with each other to buy or sell some good.

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market demand curve

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A curve that shows the amount of a commodity buyers would like to purchase at various prices.

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market supply curve

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A curve that shows the amount of a commodity sellers would offer at various prices.

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What would cause the market demand curve to shift to the right?

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increasing consumer preference,
change in per capita income, more consumers in the market, the cost of a substitue increases

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What would cause the market demand curve to shift to the left?

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decreasing consumer preference, change in per capita income, fewer consumers in the market, the cost of a substitute decreases

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What is the difference between 'demand' and 'quantity demanded'?

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A change in 'demand' would indicate a change in the relationship between price and quantity demanded and a right or left shift in the demand curve. A change in the 'quantity demanded' simply indicates a move from point A to point B on the given demand curve.

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What is the difference between 'supply' and 'quantity supplied'?

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A change in 'supply' would indicate a change in the relationship between price and quantity supplied and a right or left shift in the supply curve. A change in the 'quantity supplied' simply indicates a move from point A to point B on the given supply curve.

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What would cause the market supply curve to shift to the right?

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Improvements in technology, decrease in the cost of commodity production

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What would cause the market supply curve to shift to the left?

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Loss of technology, increase in the cost of commodity production

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equilibrium price

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A price that can be maintained. The price where quantity demanded equals quantity supplied. This is a fixed price compared to the actual price.

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excess supply

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Surplus. The rate at which a commodity supplied exceeds demand. Actual prices quickly drop to below the equilibrium price to sell off excess inventory. The area to the right of the demand curve and to the left of the supply curve.

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excess demand

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Shortage. The rate at which a commodity supplied does not meet the demand. Actual prices quickly rise to above the equilibrium price in order to increase profit and inventory. The area to the left of the demand curve and to the right of the supply curve.

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circular flow

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The flow of resources and products counter to the flow of money:
Consumers provide resources to firms, which in turn provide goods and services to consumers; firms pay money for resources to consumers who in turn use the money to buy goods and services from the firms.

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external economy

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Consumption or production by one person or firm results in uncompensated benefits to another person or firm. Example: research carried out by one firm is used by another firm.

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external diseconomy

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Consumption or production by one person or firm results in uncompensated costs to another person or firm. Example: a firm dumps pollutants into a stream making water unfit for use by firms and people downstream.

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free market

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An economic system in which prices and wages are determined by unrestricted competition between people/firms without government regulation or fear of monopolies.

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GDP

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gross domestic product

The value of the total amount of final goods and services produced by our economy during a particular period of time.

A key indicator of the health of a country's economy.

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real GDP

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GDP after being corrected for changes in the price system. Example: 3.2 billion in 1996 dollars

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price index

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The ratio of the value of a set of goods and services in current dollars to the value of the same set of goods and services in constant (base-year) dollars.

current $ / base-year $

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deflating

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Using price index to convert values expressed in current year dollars into values expressed in constant (base-year) dollars.

current $ / price index

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intermediate goods

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A final good that is used to produce another final good. Example: flour used to make bread.

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final goods

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Goods and services destined for the ultimate user.

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GDP expenditures approach

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- Personal consumption expenditures
- Gross private domestic investment
- Government purchases of goods and services
- Net exports (export minus import)

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personal consumption expenditures

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Includes spending by households on durable goods, non-durable goods, and services.

Example: food, drink, clothes, car, doctor, etc.

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gross private domestic investment

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Investment spending including tools, equipment, machinery, residential housing, construction expenditures, change in total inventory, etc.

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government purchases of goods and services

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Includes expenditures of the federal, state, and local governments.

Examples: police, fire, public schools, military, etc.

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GDP income approach

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- Compensation of employees
- Rents
- Interest
- Proprietors' income
- Corporate profits
- Depreciation
- Indirect business taxes

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aggregate supply curve

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A curve that shows the level of real national output supplied at various economy-wide price levels.

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aggregate demand curve

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A curve that shows the level of real national output demanded at various economy-wide price levels.

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Why would the aggregate demand curve shift to the left?

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Increase in unemployment, decrease in investment, decrease in the supply of money

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Why would the aggregate demand curve shift to the right?

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Decrease in unemployment, increase in spending, inflation

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four phases of the business cycle

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trough, expansion, peak, recession

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depression

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A phase when the national output is well below its potential level. A severe recession.

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frictional unemployment

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Occurs because people quit jobs, because ex-students are looking for their first job, or because of seasonal workers.

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structural unemployment

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Occurs when new goods and new technologies call for different skills than the old ones, and workers with older skills cannot find jobs.

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cyclical unemployment

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Occurs because of business fluctuations.

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potential GDP

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The level of gross domestic product that could be acheived with full employment.

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classical economics

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Supply creates its own demand. The total amount paid out by the producers of the goods and services to resource owners must equal the value of the goods and services. Investment restores to the spending stream what resource owners take out through the saving process. Holds the view that depressions are temporary and self-correcting aberrations of the business cycle.

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Karl Marx

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Marx felt that economic crises were a built-in feature of the capitlist system. He felt that workers were exploited by the capitalists, and that the capitalists, by by introducing new tehcnology, would throw more and more workers into unemployment. By competeing for jobs, this army of unemployed would drive the wages down. Inevitably the capitalist system would collapse and transition into socialism, then communism.

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John Maynard Keynes

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Keynes was similar to Marx in that he focused on unemployment and the collapse of the capitalist system. He disagreed with classical economists that depression was just a aberration of the business cycle - he did not agree that there was some automatic mechanism that would regenerate a high level of employment. He felt strongly that the government should use its power to spend and tax.

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What are the three ranges of the short run aggregate supply curve?

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The horizontal range, the vertical range and the positively sloped range.

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Explain the effects of an aggregate demand shift on the horizontal range of the short run aggregate supply curve.

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A shift left or right would affect the total real output, but not the price point. This may be caused by changes in level of employment. A decrease in employment will decrease the total real output even without a change in price.

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Explain the effects of an aggregate demand shift on the verical range of the short run aggregate supply curve.

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A shift left or right would change the price point, but woud not change the total real output. This is because the productive capacity is already at its max and is not affected despite an increase in price.

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inflation

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An increase in the general level of prices economy-wide.

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consumption function

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The relationship between consumption spending and disposable income.

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saving function

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The relationship between total saving and disposable income.

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average propensity to consume

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The fraction of disposable income spent on consumption.

personal consumption expenditure / disposable income

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marginal propensity to consume

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The fraction of an extra dollar of disposable income sent on consumption.The fraction of disposable income spent on consumption.

change in personal consumption expenditure / change in disposable income

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marginal propensity to save

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The fraction of an extra dollar of disposable income saved.

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investment function

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Firms are likely to invest only in projects where the expected rate of return exceeds the interest rate.

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equilibrium level of GDP

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If GDP is at its equilibrium, total intended spending must equal total output.

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personal consumption expenditure / disposable income

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average propensity to consume

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change in personal consumption expenditure / change in disposable income

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marginal propensity to consume

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income-expenditure analysis

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Uses the intersection of the C + I line and the 45-degree line to find the equilibrium level of GDP.

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aggregate demand-aggregate supply analysis

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Uses the intersections of the aggregate demand and supply curves to find the equilibrium level of GDP.

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Keynes's critique of classical economics

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1) There is no assurance that total intended spending will equal GDP at a level ensuring high employment.
2) It is unlikely that price and wage reduction can be depended on to maintain full employment.

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1/MPS

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the multiplier

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multiplier effect

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a $1 billion increase in intended investment results in an increase in equilibrium GDP of 1/MPS billion dollars.

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autonomous change in spending

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A change in spending that is NOT due to a change in the income or GDP.

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fiscal policy

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The government's power to increase/decrease government spending and increase/decrease taxes in order to stabilize the economy.

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recessionary gap

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The equilibrium output is less than the potential output.

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inflationary gap

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The equilibrium output exceeds the potential output.

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automatic stabilizers

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Structural features of our economy that tend to stabilize national output.
- Tax revenues: tax collected rises and falls with GDP
- Unemployment and welfare benefits: The amount spent on these increases with unemployment, and decreases with a rise in employment.

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discretionary fiscal policy

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The federal government has the power to change tax rates and expenditures in an attempt to cope with unemployment or inflation.
- The government can vary its expenditures for goods and services
- The government can vary welfare payments and other types of transfer payments
- The government can vary tax rates

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The Employment Act of 1946

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Signed by President Harry S. Truman, it instructed the federal government "to promote maximum employment, production and purchasing power."

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inflation

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A general upward movement of prices.

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consumer price index

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A measure of US inflation, calculated by the Bureau of Labor Statistics, measures changes in the prices of goods and services purchased by urban consumers.

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effects of inflation on lenders

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$1000 lent in 2000 is no longer worth the same $1000 when paid back years later after inflation.

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effects of inflation on savers

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$1000 put into savings in 2000 is no longer worth the same $1000 when spent years later after inflation.

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demand-side inflation

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An increase in the general price level that occurs because of right-ward shifts of the aggregate demand curve. There is too much spending, too much money chasing too few goods.

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supply side inflation

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An increase in the general price level that occurs because of left-ward shifts of the aggregate supply curve. Suppliers increase prices, and these increases are not set-off by price reductions elsewhere, ending in inflation.

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Phillips Curve

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Shows the relationship between that annual rate of change of the price level in an economy and the unemployment rate in that economy.

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NAIRU

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(the nonaccelerating inflation rate of unemployment)

The unemployment rate at which the labor market is exerting no upward or downward pressure on inflation.