Macroeconomics 2

Front 1

The Economist as a Scientist

Back 1

-they devise theories, collect data, analyze data to verify/refute their theories
-use of the scientific method

Front 2

The scientific method: observation, theory, and more observation

Back 2

-interplay between theory and observation
-economics: conducting experiments often difficult, sometimes impossible
-economists must make do with whatever the world gives them
-Ex: war in middle east -> oil prices skyrocket -> depresses living standards -> how to respond?
-past historical events allows us to illustrate, evaluate economic theories of the present

Front 3

The role of assumptions

Back 3

-Ex: assuming 2 countries, 2 goods, focus thinking on essence of the problem (simple before complex)
-art of scientific thinking is deciding which assumptions to make
-Ex: want to know how economy changes -> must know how prices change (different assumptions when studying short-run, long-run effect of change in quantity of money; marble/beach ball)

Front 4

Economic models

Back 4

-models usually composed of diagrams, equations (omit details to allow us to see what's truly important)
-economists assume away many details of economy that are irrelevant for studying question at hand

Front 5

Define: circular-flow diagram

Back 5

a visual model of the economy that shows how dollars flow through markets among households and firms (p25)

Front 6

Our first model: the circular-flow diagram

Back 6

-how the economy is organized, how participants interact with one another
-firms produce goods/services using input/factors of production (labor, land, capital)
-markets for goods and services: households are buyers, firms are sellers
-markets for factors of production: households are sellers, firms are buyers
-inner loop: inputs/outputs, outer loop: flow of dollars
-households -> markets for goods and services -> firms -> markets for factors of production (for $ loop)
-more realistic: roles of gov't and international trade

Front 7

Our second model: the production possibilities frontier

Back 7

-this model shows all possible production combinations (ex: computers, cars)
-outcome efficient if economy is getting all it can from scarce resources available (points ON frontier)
-trade-offs: only way to produce more of one is to produce less of the other (ex: opportunity cost of each car is 2 computers- slope of frontier)
-higher slope = higher opportunity cost
-can change over time (technological advance) -> economic growth (production moves to new frontier)

Front 8

Define: production possibilities frontier

Back 8

graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology

Front 9

Define: microeconomics

Back 9

the study of how households and firms make decisions and how they interact in markets

Front 10

Define: macroeconomics

Back 10

the study of economy-wide phenomena, including inflation, unemployment, and economic growth

Front 11

Microeconomics and Macroeconomics

Back 11

-micro: effects of rent control on housing in NYC, impact of foreign competition on US auto industry, effects of compulsory school attendance on workers' earnings
-macro: effects of borrowing by fed gov't, changes over time in economy's rate of unemployment, alternative policies to promote growth in nat'l living standards
-closely intertwined, impossible to understand macro developments without considering associated micro decisions

Front 12

Positive versus normative analysis

Back 12

-positive=scientist, normative=policy adviser
-evaluate positive statements by analyzing data
-cannot judge normative statements by data alone (ethics, religion, political philosophy)
-normative statements involve positive analysis and value judgment
-much of economics is positive, with normative goals

Front 13

Define: positive statements

Back 13

claims that attempt to describe the world as it is

Front 14

Define: normative statements

Back 14

claims that attempt to prescribe how the world should be

Front 15

Economists in Washington

Back 15

-trade-offs (efficiency vs. equality): economic advice not always straightforward
-tax policy, labor-market policy, antitrust laws, monetary policy, etc.

Front 16

Why economists' advice is not always followed

Back 16

-many other factors to take into account (Congress, public opinion, misunderstandings, amendments, how it will affect electorate and other policy initiatives)

Front 17

Why Economists Disagree: differences in scientific judgments

Back 17

-scientists disagree about which way the truth lies
-different hunches about validity of theories and size of important parameters
-Ex: tax household's income or spending? -> different views of responsiveness of saving to tax initiatives

Front 18

Why Economists Disagree: differences in value

Back 18

-some people taxed higher than others: fair?
-does it matter why some people are more poor? = conflicting ideas

Front 19

Why Economists Disagree: perception vs. reality (1/3)

Back 19

Propositions about which most Economists agree:
1. Ceiling on rents reduces the quantity/quality of housing available
2. Tariffs and import quotas usually reduce general economic value
3. Flexible and floating exchange rates offer an effective international monetary agreement
4. Fiscal policy (e.g. tax cut/gov't expenditure increase) has significant stimulative impact on less than fully employed economy

Front 20

Why Economists Disagree: perception vs. reality (2/3)

Back 20

Propositions about which most Economists agree:
5. US should not restrict employers from outsourcing work to foreign countries
6. US should eliminate agricultural subsidies
7. Local/state gov'ts should eliminate subsidies to professional sports franchises
8. If fed budget to be balanced, should be done over business cycle rather than yearly
9. Gap between social security funds and expenditures will become unsustainably large within next 50 years if current policies remain unchanged

Front 21

Why Economists Disagree: perception vs. reality (3/3)

Back 21

Propositions about which most Economists agree:
10. Cash payments increase welfare of recipients to greater degree than do transfers-in-kind of equal cash value
11. Large federal budget deficit has adverse effect on economy
12. Minimum wage increases unemployment among young and unskilled workers
13. Gov't should restructure welfare system along the lines of a "negative income tax"
14. Effluent taxes and marketable pollution permits represent better approach to pollution control than imposition of pollution ceilings

Front 22

Graphing overview

Back 22

-same direction: positive correlation, opposite directions: negative correlation (ex: studying/partying vs. grades)
-demand curve: traces effect of a good's price on quantity customers want to buy (cheap: buy more, expensive: buy less, higher income: buy more)
-Ex: books- when Emma's income rises, demand curve shifts right (more books can be bought)
-when a variation that is not names on either axis changes, the curve shifts
-Ex: slope steep, same # of novels regardless of price
-reverse causality: we think A causes B when actually B causes A
-look for omitted variables
-people change behavior in response to change in expectations