Econ+102+lecture+5%2C+1-19-12+-+Macro+Choice+2 copy

Econ+102+lecture+5%2C+1-19-12+-+Macro+Choice+2 copy -...

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Lecture 5: Macroeconomic choice 2:  Resource allocation via markets Econ 102, Winter 2012 1/19/2012 1 Suggested reading : Ch 4: (all) pp. 93-113 (if you are not familiar with price and quantity restrictions in the S&D context)
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Outline 1. Market macroeconomic choice: relative prices 2. Markets and economic efficiency 3. Planning vs markets 4. Price distortions and aggregate welfare loss 1/19/2012 2
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Market macroeconomic choice Last class, we modeled economic choice as if the  economy had a utility (or “social welfare”) function Allows us to discuss growth and the intertemporal  tradeoff in welfare Allows us to model macroeconomic choice (of  production and resource allocation) as if  we were  ruled by a benevolent, all-knowing social planner. Social planning plus “custom” were two of the three  ways given to make such choices Method 3: markets (the market system) 1/19/2012 3
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Market macroeconomic choice Method 3: markets As we’ve discussed, markets determine the  relative  prices of goods. I.e., the price of one good when compared to the  prices of others When the relative price of one good rises (e.g., as  D rises), then  ceteris paribus  that good’s  production becomes more profitable relative to  other goods Ł   The price system  signals to firms what they  should produce, and how much, at any given time. 1/19/2012 4
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Market macroeconomic choice Relative prices Suppose a situation (in our cars v wheat example)  where after a year a. Many safety concerns about cars arise (Dcar  ) b. Scientists discover increased health benefits to  consumption of whole grains (Dwheat  ) Then what happens to the price of each? What happens to quantity? 1/19/2012 5
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Market macroeconomic choice Q P Wheat Q P Cars 6
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Macroeconomic choice Relative prices Suppose Dc  , Dw  The price of wheat rises, the price of cars falls The quantity of wheat rises, the quantity of cars  falls. 1. Cars became relatively less valuable in the eyes of  consumers, so 2. the relative price of cars fell, so 3. the relative profitability of cars fell (given  production costs and technology), so 4. producers make fewer cars in equilibrium. 1/19/2012 7
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Macroeconomic choice The big question: WHY are fewer cars produced? A: producers observe the signal of relative economic  value (via prices), and so the economy pulls social  resources out of car production, and puts them into  wheat    Markets serve as a guide to the allocation of  aggregate resources. Recall again that when we draw supply and demand, 
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This note was uploaded on 02/10/2012 for the course ECON 102 taught by Professor Rossana during the Winter '08 term at University of Michigan.

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Econ+102+lecture+5%2C+1-19-12+-+Macro+Choice+2 copy -...

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