UNIT 1: INTRODUCTION TO ECONOMICS AP Macroeconomics
Dec 23, 2015
UNIT 1: INTRODUCTION TO ECONOMICS
AP Macroeconomics
Chapter 1:The Ten Principles of Economics
How People Make Decisions (1-4)How People Interact (5-7)How the Economy as a Whole Works (8-10)
The Mankiw Rap
What is Economics?
The social science that studies the choices that individuals, businesses, and governments make as they cope with scarcity and the incentives that influence and reconcile those choices.
The Micro and Macro Views of the World Microeconomics~ The study of the
choices that individuals and businesses make and the way these choices interact and are influenced by governments.
Macroeconomics~ The study of the
aggregate effects on the national economy and global economy of the choices that individuals, businesses and government make.
TEN PRINCIPLES OF ECONOMICS5
HOW PEOPLE MAKE DECISIONS
All decisions involve tradeoffs.
Examples….
Principle #1: People Face Tradeoffs
Principle #2: The Cost of Something is What You Give Up to Get It
Principle #3: Rational People Think at the Margin
Principle #4: People Respond to Incentives
Principle #1: People Face Tradeoffs
Principle #2: The Cost of Something is What You Give Up to Get It
Principle #3: Rational People Think at the Margin
Principle #4: People Respond to Incentives
TEN PRINCIPLES OF ECONOMICS6
HOW PEOPLE MAKE DECISIONS
Types of trade-offs Society faces an important tradeoff:
efficiency (self interest) vs. equality (social interest)
Efficiency: when society gets the most from its scarce resources
Equality: when prosperity is distributed uniformly among society’s members
Impact of redistribution?
Principle #1: People Face TradeoffsPrinciple #1: People Face Tradeoffs
TEN PRINCIPLES OF ECONOMICS7
HOW PEOPLE MAKE DECISIONS
Making decisions requires comparing the costs and benefits of alternative choices.
The opportunity cost of any item is whatever must be given up to obtain it.
It is the ONLY relevant cost for decision making.
Principle #2: The Cost of Something Is
What You Give Up to Get It
Principle #2: The Cost of Something Is
What You Give Up to Get It
Paul Solman: Opportunity Cost
TEN PRINCIPLES OF ECONOMICS8
HOW PEOPLE MAKE DECISIONS
Rational people systematically and purposefully do the best
they can to achieve their objectives. make decisions by evaluating costs and
benefits of marginal changes – incremental adjustments to an existing plan.
MB >MC Examples
Principle #3: Rational People Think at the MarginPrinciple #3: Rational People Think at the Margin
TEN PRINCIPLES OF ECONOMICS9
HOW PEOPLE MAKE DECISIONS
Incentive: something that induces a person to act, i.e. the prospect of a reward or punishment.
Rational people respond to incentives. Impact on policy makers? Do people always respond to incentives?
Principle #4: People Respond to IncentivesPrinciple #4: People Respond to Incentives
Freakonomics Reading
You are selling your 1996 Mustang. You have already spent $1000 on repairs.
At the last minute, the transmission dies. You can pay $600 to have it repaired, or sell the car “as is.”
In each of the following scenarios, should you have the transmission repaired? Explain.
A. Blue book value is $6500 if transmission works, $5700 if it doesn’t
B. Blue book value is $6000 if transmission works, $5500 if it doesn’t
A C T I V E L E A R N I N G 1
Applying the principles
10
Cost of fixing transmission = $600
A. Blue book value is $6500 if transmission works, $5700 if it doesn’tBenefit of fixing the transmission = $800($6500 – 5700). It’s worthwhile to have the transmission fixed.
B. Blue book value is $6000 if transmission works, $5500 if it doesn’tBenefit of fixing the transmission is only $500.Paying $600 to fix transmission is not worthwhile.
A C T I V E L E A R N I N G 1
Answers
11
TEN PRINCIPLES OF ECONOMICS12
HOW PEOPLE INTERACT
Rather than being self-sufficient, people can specialize in producing one good or service and exchange it for other goods.
Countries also benefit from trade & specialization: Get a better price abroad for goods they
produce Buy other goods more cheaply from abroad than
could be produced at home Comparative Advantage vs. Absolute Advantage
Principle #5: Trade Can Make Everyone Better Off
Principle #5: Trade Can Make Everyone Better Off
TEN PRINCIPLES OF ECONOMICS13
HOW PEOPLE INTERACT
Market: a group of buyers and sellers (need not be in a single location)
“Organize economic activity” means determining of the core economic questions based on economic goals/values. What goods and services should be produced?
(Consumption Goods and Services, Capital Goods, Government Goods and Services, Export Goods and Services)
How should these goods and services be produced? (Combination of FOP)
Who consumes these goods and services? (Public vs. private ownership)
A market economy allocates resources through the decentralized decisions of many households and firms as they interact in markets. Other types of economic systems (centrally planned,
traditional, mixed)
Principle #6: Markets Are Usually A Good Way to Organize Economic Activity
Principle #6: Markets Are Usually A Good Way to Organize Economic Activity
NPR
Adam Smith (1723-90)
Father of modern economic theory
Scottish social philosopher/professor
“An Inquiry into the Nature and Causes of the Wealth of Nations” (1776)
Laissez Faire principle 10 years to write / 5 volumes Established Economics as its own
discipline
On the Division of Labor
Increase in quantity of work
1. Dexterity of workers
2. Saves time: no switch from one activity to the next
3. Machines replace manual labor Division of physical and mental labor: professional
specialization; expertise
Increased productivity = increased wealth for everyone
Motivation for labor
Disposition to barter
Invisible Hand of the Marketplace: highest quality and quantity of goods produced
Core Principles of Adam Smith
Adam Smith and the Invisible Hand
In every transaction, the buyer and seller consider only their self-interest, or their own personal gain. Self-interest is the motivating force in the free market.
Producers in a free market struggle for the dollars of consumers. This is known as competition, and is the regulating force of the free market.
The interaction of buyers and sellers, motivated by self-interest and regulated by competition, all happens without a central plan. This phenomenon is called “the invisible hand of the marketplace.”
The Role of Prices in the Marketplace
Friedman: Wage and Price Controls
Prices are the instrument of the invisible hand in the marketplace
Natural rates of wages, profits and commodities: supply = demand
Prices always move toward natural price and will efficiently allocate resources
When the government intervenes in the marketplace, prices are distorted and resources are not effectively distributedFriedman:
Capitalism vs. Socialism
Karl Marx (1818-1883) German philosopher, political economist and
historian Developed radical approach to understanding
and coping with the problems that occurred in free market systems, namely the Industrial Revolution
Published the Communist Manifesto in 1848 with close friend Frederick Engels
Marxism is rooted in an analysis of modern, Western thought. 18th century Enlightenment Classical Economics Utopian Socialism
Marxism in Theory
Dialectical materialism Materialism
Philosophical doctrine that matter is the only reality and everything in the world (thought, will, and feeling) can be explained only in terms of matter.
Opposite of idealism Dialectical
The theoretical process in the social sciences in which change occurs based on contradictory, interacting forces
The forces are based on existing class struggles
Stages of economic development Pre-determined Tribal, Slave-Owning, Feudal, Capitalist, Socialist,
Communist
Thesis Antithesis
Synthesis
Frederick Engels Karl Marx
TEN PRINCIPLES OF ECONOMICS21
HOW PEOPLE INTERACT
Important role for government: enforce property rights (with police, courts)
People are less inclined to work, produce, invest, or purchase if large risk of their property being stolen.
Principle #7: Governments Can Sometimes Improve Market OutcomesPrinciple #7: Governments Can Sometimes Improve Market Outcomes
TEN PRINCIPLES OF ECONOMICS22
HOW PEOPLE INTERACT
Market failure: when the market fails to allocate society’s resources efficiently
Causes: Externalities, when the production or
consumption of a good affects bystanders (ex. pollution)
Market power, a single buyer or seller has substantial influence on market price (ex. monopoly)
In such cases, public policy may promote efficiency.
Principle #7: Governments Can Sometimes Improve Market OutcomesPrinciple #7: Governments Can Sometimes Improve Market Outcomes
TEN PRINCIPLES OF ECONOMICS23
HOW PEOPLE INTERACT
Government may alter market outcome to promote equity
If the market’s distribution of economic well-being is not desirable, tax or welfare policies can change how the economic “pie” is divided.
Principle #7: Governments Can Sometimes Improve Market OutcomesPrinciple #7: Governments Can Sometimes Improve Market Outcomes
TEN PRINCIPLES OF ECONOMICS25
HOW THE ECONOMY AS A WHOLE WORKS
Huge variation in living standards across countries and over time: Average income in rich countries is more
than ten times average income in poor countries.
The U.S. standard of living today is about eight times larger than 100 years ago.
Principle #8: A country’s standard of living depends on its ability to produce goods & services.
Principle #8: A country’s standard of living depends on its ability to produce goods & services.
TEN PRINCIPLES OF ECONOMICS26
HOW THE ECONOMY AS A WHOLE WORKS
The most important determinant of living standards: productivity, the amount of goods and services produced per unit of labor.
Productivity depends on the equipment, skills, and technology available to workers.
Other factors (labor unions, competition from abroad) have far less impact on living standards.
Principle #8: A country’s standard of living depends on its ability to produce goods & services.
Principle #8: A country’s standard of living depends on its ability to produce goods & services.
TEN PRINCIPLES OF ECONOMICS27
HOW THE ECONOMY AS A WHOLE WORKS
Inflation: increases in the general level of prices.
In the long run, inflation is almost always caused by excessive growth in the quantity of money, which causes the value of money to fall.
The faster the government creates money, the greater the inflation rate.
Principle #9: Prices rise when the government prints too much money.Principle #9: Prices rise when the government prints too much money.
TEN PRINCIPLES OF ECONOMICS28
HOW THE ECONOMY AS A WHOLE WORKS
In the short-run (1 – 2 years), many economic policies push inflation and unemployment in opposite directions.
Other factors can make this tradeoff more or less favorable, but the tradeoff is always present.
Principle #10: Society faces a short-run tradeoff between inflation and unemployment
Principle #10: Society faces a short-run tradeoff between inflation and unemployment
Chapter 2
Thinking Like an Economist
THINKING LIKE AN ECONOMIST30
Our First Model: The Circular-Flow Diagram
The Circular-Flow Diagram: a visual model of the economy, shows how dollars flow through markets among households and firms
Two types of “actors”: households firms
Two markets: the market for goods and services (product
market) the market for “factors of production”
(factor market) Land, Labor, Capital (human and physical)
THINKING LIKE AN ECONOMIST31
FIGURE 1: The Circular-Flow Diagram
Households: Own the factors of production,
sell/rent them to firms for income
Buy and consume goods & services
Households: Own the factors of production,
sell/rent them to firms for income
Buy and consume goods & services Household
sFirms
Firms: Buy/hire factors of
production, use them to produce goods and services
Sell goods & services
Firms: Buy/hire factors of
production, use them to produce goods and services
Sell goods & services
THINKING LIKE AN ECONOMIST32
FIGURE 1: The Circular-Flow Diagram
Markets for Factors of Production
Households
Firms
IncomeWages, rent, profit
Factors of production
Labor, land,
capital
Spending
G & S bought
G & S sold
RevenueMarkets for
Goods & Services
Production Possibilities CurveUse of the Production Possibilities
CurveCost
Alternative good or service given up as
a result of a decision.
Every point on the PPF indicates a cost
in on item or another.
EfficiencyMaximum
production or output of goods and
services.Any point on the
PPFUnderutilization
GrowthExpanding the
ability to produce. Shift of the entire
PPF to the rightResources/
Technology
Growth
Underutilization
Efficiency
Production Possibilities
Curve~~~~~~~~~~
A graph that shows alternative
ways to use an economy’s resources.
Economics as a Social Science Economists seek to discover how the economic
world works. In order to best do this they must distinguish between positive and normative statements.
Positive statements A statement about “what is” Can be right or wrong Can be tested against facts
Normative statements A statement about “what ought to be” Depends on values, opinions Cannot be tested
Identify the following statements as positive or normative: 1. The gap between the lower class and upper class has grown
over the past three decades. 2. An increase in the minimum wage will bring more teenage
unemployment. 3. The minimum wage should not be increased. 4. The poor should pay less for housing.5. The number of farms has decreased over the last 50 years. 6. The population in rural areas has remained constant over
the past decade.7. An increase in the tax on cigarettes will decrease teen
smoking.8. An increase in the number of police on the inner-city streets
will reduce the crime rate. 9. The United States should place more emphasis on reducing
carbon emissions. 10.Healthcare should be provided to every American.
PPF Example Producing one computer requires 100 hours
labor. Producing one ton of wheat requires 10 hours
labor.
5,0000
4,000100
2,500250
1,000400
50,0000
40,00010,000
25,00025,000
10,00040,000
0500050,000
E
D
C
B
A
WheatComputersWheatComputers
ProductionEmployment of
labor hours
THINKING LIKE AN ECONOMIST36
Point on
graph
Production
Com-puters
Wheat
A 500 0
B 400 1,000
C 250 2,500
D 100 4,000
E 0 5,000 0
1,000
2,000
3,000
4,000
5,000
6,000
0 100 200 300 400 500 600
Computers
Wheat (tons)
A
B
C
D
E
PPF Example
A. On the graph, find the point that represents
(100 computers, 3000 tons of wheat), label it F. Would it be possible for the economy to produce this combination of the two goods?Why or why not?
B. Next, find the point that represents (300 computers, 3500 tons of wheat), label it G. Would it be possible for the economy to produce this combination of the two goods?
A C T I V E L E A R N I N G 1
Points off the PPF
37
A C T I V E L E A R N I N G 1
Answers
38
Point F:100 computers, 3000 tons wheat Point F requires 40,000 hours of labor. Possible but not efficient: could get more of either good w/o sacrificing any of the other.
0
1,000
2,000
3,000
4,000
5,000
6,000
0 100 200 300 400 500 600
Computers
Wheat (tons)
F
A C T I V E L E A R N I N G 1
Answers
39
0
1,000
2,000
3,000
4,000
5,000
6,000
0 100 200 300 400 500 600
Computers
Wheat (tons) Point G:
300 computers, 3500 tons wheat Point G requires 65,000 hours of labor. Not possible because economy only has 50,000 hours.
G
THINKING LIKE AN ECONOMIST40
The PPF: What We Know So Far
Points on the PPF (like A – E) possible efficient: all resources are fully utilized
Points under the PPF (like F) possible not efficient: some resources underutilized
(e.g., workers unemployed, factories idle)
Points above the PPF (like G) not possible