Lecture 1 Intro to Macro.pdf - Lecture 1-050919 Introduction to Macroeconomics Reference Chapter 1(pages 14-16 Chapter 2(pages 44-49 and Chapter 6

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Unformatted text preview: Lecture 1 -050919 Introduction to Macroeconomics Reference: Chapter 1 (pages 14-16), Chapter 2 (pages 44-49), and Chapter 6 Outline: Economics – Macroeconomics- Questions *Principles *Society’s problem: PPF *Three important variables to assess the economy: GDP, unemployment, and inflation. * Economic growth -sustained increases in living standards are historically recent phenomena *Saving and investment are key factors in promoting rising living standards. *Expectations, shocks, and sticky prices are responsible for business cycles *Prices have greater flexibility in the LR - use different macroeconomic models for different time ^long run horizons. We use Economics to answer: • How prices are determined? • How government can influence the economy? • Why some countries are wealthier than other? - there is no consensus Three important principles in Economics: ex. people choose more goods over less 1. People are rational ex. they don't choose something that will harm you; rather they try to enhance happiest 2.People respond to economic incentives ex. giving $1000 to people, expect to lead to lower poverty 3.Optimal decisions are made at the margin ex. we don't study 24hrs or zero hours, rather a few more or few less hours the additional ^decisions made by comparing marginal benefits to The Economic Problem That All Societies Must Solve: marginal costs 1. What goods and services will be produced? <- ex. Canada good at producing machinery dictated by resources and technology available China good at producing clothing 2. How will the goods and services be produced? Who will receive the goods and services produced? <- Canada, high income inequality -so it is difficult since difference between efficiency and economist not good at answering this question equity Microeconomics examines -something that may be equitable may not be efficient • Individual units (household, firm or industry) and their decision making process 3. 1 Macroeconomics examines • The whole economy. The subdivisions or aggregates. Society’s problem: to allocate scarce resources efficiently in order to obtain the maximum benefit. Scarce Resources (factors of production) are: -economics allows people to allocate scarce resources efficiently and to benefit people -ex. income, economist knows how to spend income to maximize • LAND utility • LABOUR • • Human Capital skills CAPITAL • Investment buildings, machinery, etc -anything that helps production costs • ENTREPRENEURIAL ABILITY -use economic ability to maximize profits Entrepreneurs’ economic functions: -for full employment to be possible, the unemployment % has to under a certain number ▪ takes initiative -full employment; economy experiences frictional ▪ makes business decisions unemployment -Frictional unemployment occurs during a period when ▪ innovates workers are searching for new employment or transitioning from their old jobs to new ones. It can also be referred to as ▪ bears risk natural unemployment because it is not directly related to factors that lead to an underperforming economy Production Possibilities Model -compare to structural unemployment; unemployment because skills are obsolete • Illustrates production choices -unrealistic; Canada, 5.7% unemployment, historically low To represent the Production Possibilities Curve we need to make the following assumptions: ex. demand stays same over time in economics we make specific assumptions; often are not realistic but needed for analysis • Full employment ( all labour is employed) • Fixed resources (scarce resources are in limited supply and it is not possible to increase the amount) • Fixed technology (the technology used in the production process is fixed) • Two goods (there are only two goods produced) to see all possible combinations of attainment/production Below is a simple example of a Production Possibilities Frontier (or Curve) (PPF). • A Production possibilities frontier (PPF) is a curve showing the maximum attainable combinations of two products that may be produced with available resources and current technology. We start with a table that shows different combinations of quantities in which the two goods can be produced. 2 A production possibilities table lists the different combinations of two products that can be potentially produced with a specific set of resources, assuming full employment. We can represent points A,B,C,D,E, F and G graphically: -graph would be a downward straight-line since slope is constant (see next slide) -is a curve showing the maximum attainable combinations of two products that may be produced with available resources and current technology -PFF, shows the trade-off between 1 good to the other good each point on the production possibilities curve represent some output combination of two products Points inside the graph (F) are attainable but they indicate that full employment and productive efficiency are not being realized 3 -PFF may not always be a straight line -in the case of increasing marginal opportunity costs -Assume two types of goods: public goods provided by the government (operations) and private goods (cars) provided by private firms -highly specialized people from operations can produce a lot of cars, as the number of cars produced increases, less specialized people are used, so less cars are made proportionally and more people are required -as you increase production of one good, more opportunity cost of other goods are given up PPF are not always straight lines! Bowed out PPF’s imply increasing marginal opportunity costs. See the example below: • Assume two types of goods: public goods provided by the government (operations) and private goods (cars) provided by private firms. not all resources are adaptable to alternative uses more rapid economic growth at steeper points of PPF Gives up more operations in a successively larger amount to acquire equal increments of cars ^(textbook) Law of increasing opportunity costs: the opportunity cost of each additional unit is greater than the opportunity cost of the preceding one The Circular Flow Model ^ie. as production of a particular good rise, the opportunity cost of producing an additional unit rise Households • One or more persons occupying a housing unit. • Buy the goods and services provided by businesses in the product market. • Obtain the income needed to buy the products by selling resources in the factor market. • Wages, rents, interest, and profits flows to households for their labour, land, capital, and entrepreneurial ability. Businesses Economic entities that purchase factors of production in the resource market and sell goods and services in the product market. • Sole Proprietorship: an unincorporated business owned and operated by a single person. • Partnership: two or more individuals pool their financial resources and business skills to operate the business and share the profits/losses. 4 • Corporation: an independent legal entity that can acquire resources, own assets, produce, sell, incur debts, extend credit, etc. Product Market • Where the goods and services produced by businesses are bought and sold. • Households use the income they receive from the sale of resources to buy goods and services. • The money spent on goods and services flows to businesses as revenue. Factor MarketThe factor market is the place where factors of production or the services of resource suppliers are bought and sold • • • Where households sell resources to businesses. households sell resources such as • Households sell resources to generate income. labour, to businesses • Businesses buy resources to produce goods and services. Productive resources flow from households to businesses. continuous, repetitive flows of goods and services, resources and money The money flows from businesses to households as wages, rents, interest, and profits. factor market also known as resource market, labour market Textbook Factors of production flow from households to businesses through the factor market, and products flow from business to households through the product market Opposite these real flows are monetary flows: Households receive income from business (their costs) through the factor market, and businesses receive revenue from household (household consumption expenditures) through the product market The counterclockwise flow of economic resources and finished product in the Circular Flow Model is paid for by the clockwise flow of money income and consumption expenditure. Households obtain income in the factor market in order to buy the goods and services that businesses produce in the product market. Assessing the Health of the Economy: Performance and Policy In assessing the health and development of an economy, macroeconomists focus on: • Real GDP • Unemployment 5 -Real GDP: affected by inflation nominal GDP uses the prices in place in the year the -Nominal GDP does not show if increase in GDP is due to increase in output was produced, it suffers from a major problem: quantity or price; nominal GDP is not affected inflation price or quantity can increase from one year to the next -Nominal GDP includes both prices and growth, while real GDP is pure even if no increase in output has occurred (textbook 6.1)growth • Inflation -Nominal GDP reflects current GDP at current prices. Conversely, Real GDP reflects current GDP at past (base) year prices. Real GDP (real gross domestic product) • measures the value of final goods and services produced within the borders of a given country during a given time period, typically a year. • To calculate real GDP, nominal GDP must first be calculated -measured by Statistics Canada Unemployment -available and measured monthly -measured using a survey from 55,000 households -sample is small to minimize expensive and costly time-wise -representative sample • A failure of the economy to fully employ its labour force • Occurs when a person cannot get a job despite being willing to work and actively seeking work <-prices do not increase simultaneously across all sectors -salary are usually last to increase -inability of government to claim taxes since people cannot pay -inflation should be steady and predictable • An increase in the overall level of prices. -so government cannot supply society will their needs (roads etc.) -compare to deflation: good -people will purchase things that keep their value (gold) becomes cheaper as time passes will not save as much, since the price of things increase, they -demand for items will lower, • Can cause decreases in standard of living -people have to spend their money quickly corporations will be less successful Inflation -If you can purchase something • cheaper later on, you will wait -ex. Japan surprise jump in inflation reduces the purchasing power of people’s savings Macroeconomics Models Help Clarify Government Economic Policies. Government’s role: • Can governments promote long-run economic growth? • Can governments reduce the severity of recessions? • Are certain government policy tools, more effective than others, e.g. monetary policy versus fiscal policy? • Is there a trade-off between lower rates of unemployment and higher rates of inflation? • Does government policy work best when it is announced in advance or when it is a surprise? High inflation associated with low employment and vice versa -common, not always true Economic Growth is the ability of the economy to increase the production of goods and services. • Modern economic growth refers to an increase in output per person as compared with earlier times in which output (but not output per person) increased. • The vast differences in living standards seen today between rich and poor countries are almost entirely the result of the fact that only some countries have experienced modern economic growth. Savings, Investment, and Modern Economics Growth • To raise living standards over time an economy must devote at least some fraction of its current output to increasing future output • Savings The accumulation of funds that results when people in an economy spend (consume) less than their incomes during a given time period 6 • Savings fund Investment • Investment refers to spending for the production and accumulation of capital and additions to inventories. • Economists distinguish between financial investment and economic investment. • Financial investment refers to the purchasing of financial assets (stocks, bonds, mutual funds) or real assets (houses, land, factories), or building such assets, in the expectation of financial gain. • Economic investment refers to spending for the production and accumulation of capital and additions to inventories. Banks and Other Financial Institutions • Households are the principal source of savings, but businesses are the main economic investors. • These institutions collect the savings of households, rewarding savers with interest and dividends and sometimes capital gains (increases in asset values). • The banks and other financial institutions then lend the funds to businesses, which invest in equipment, factories, and other capital goods. Uncertainty, Expectations, Shocks, and Short-Run Fluctuations The Importance of Expectations and Shocks • Expectations The anticipations of consumers, firms, and others about future economic changing expectations have an effect on current behaviour conditions. -ex. if firm is pessimistic about future returns, they will have less current investment and subseqiently, less future • Expectations have a large effect on economic growth • Expectations can become unmet due to shocks • Shocks Situations in which one thing is expected to occur but in reality something different occurs. positive demand shock; demand turns out to be • consumption higher than expected • Demand shocks Sudden, unexpected changes in demand. negative demand shock; demand turns out to be • Supply shocks Sudden, unexpected changes in aggregate supply lower than expected Economists believe that most short-run fluctuations are the result of demand shocks • FULL EMPLOYMENT IF THERE ARE NO SHOCKS 7 The Effect of Unexpected Changes in Demand under Flexible Prices Textbook 6.4: Buzzer is selling cars and does research -expected profits will be maximized if the firm builds a factory that has optimal output rate of 900 cars per week -at this rate, the factory can produce cars for $36500 per vehicle and sell for $37000 -Dm is the expected demand medium level of demand -DL is low demand -DH is high demand -The expected equilibrium price at Dm is $37000 how markets usually if the prices of goods and services could always adjust behave in the long run quickly to unexpected changes in demand, then the economy could always produce at it optimal capacity since prices would adjust to ensure that the quantity demanded of each good and service would always equal the quantity supplied ^ units produced based on expected profits -there would be no short-run fluctuations in output -production levels would remain relatively constant -prices are flexible based on demand The Effect of Unexpected Changes in Demand under Fixed Prices -unemployment levels would not change much because firms would always need the same number of workers to produce the same amount of output In contract, they had a fixed price policy, then the quantity demanded will vary with the level of demand -at a fixed price of $37000 per vehicle, the demanded quantity will be 700 cars per week ^ how markets usually behave in the short-run Demand Shocks and Flexible Prices If the prices of goods and services could always adjust quickly to unexpected changes in demand, then the economy could always produce at its optimal capacity since prices would adjust to ensure that the quantity demanded of each good and service would always equal the quantity supplied. Demand Shocks and Sticky Prices • In reality, many prices in the economy are inflexible and do not change rapidly when demand changes unexpectedly. 8 • Manufacturing firms typically attempt to deal with unexpected changes in demand by maintaining an inventory. • Inventory Goods that have been produced but remain unsold. • If demand falls for many goods and services across the entire economy for an extended period of time, then many firms will find inventories piling up and will be forced to cut production resulting in recession, with GDP falling and unemployment rising. • If demand is unexpectedly high for a prolonged period of time, the economy will boom and unemployment will fall. How Sticky Are Prices? • Inflexible prices (sticky prices) Product prices that remain in place (at least for a while) even though supply or demand has changed. economy is forced to respond in the short run to demand shocks primarily through changes in output and employment rather than through changes in prices (tb 6.4) • Flexible prices Product prices that react within seconds to changes in supply and demand. Price stickiness depends on the type of good or services. See table 6-1 in your textbook. ^since people do not respond well to changes in price What Causes Sticky Prices? • Companies selling final goods and services know that consumers prefer stable, predictable volatile prices make planning more difficult, and in addition, prices that do not fluctuate rapidly with changes in demand. consumers who come in to buy the product on a day when the price • In certain situations a firm may be afraid that cutting its price may be counterproductive because its rivals might simply match the price cut - a situation often referred to as a price war. happens to be high will likely feel they are being take advantage of during price war, the firm is not better have since it will not pick up any more buiness (due to the fact the competiot also cut its price) and it will also be receiving less money due to the price cut Categorizing Macroeconomic Models Using Price Stickiness 6.6: firms that choose to use a fixed-price policy in the short run do not have to use that policy In particular, if unexpected changes in demand begin to look permanent, many time. permanently. firms will allow their prices to change so that price changes (in addition to quantity changes) can help to equalize quantities supplied with quantities demanded • Price stickiness moderates over • If unexpected changes in demand begin to look permanent, many firms will allow their prices to change so that price changes (in addition to quantity changes) can help to equalize quantities supplied with quantities demanded. • Prices go from stuck in the extreme short run to fully flexible in the long run. 9 ...
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