Lecture01 10 principles
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This document provides an overview of macroeconomics and the principles of economics. It discusses 10 key principles: (1) people face tradeoffs, (2) opportunity cost is the cost of something in terms of what you give up, (3) people think at the margin, (4) trade can make everyone better off, (5) markets are generally a good way to organize economic activity, (6) governments can improve market outcomes, (7) standard of living depends on production, (8) inflation results from too much money printing, (9) there is a short-run tradeoff between inflation and unemployment, and (10) rational people respond to incentives. It also introduces common economic models like the circular
Lecture01 10 principles
- 1. 1 An Overview of Macroeconomics 1.1 Principles of Economics Economy. . . . . . The word economy comes from a Greek word for “one who manages a household.” 1
- 2. PRINCIPLES OF ECONOMICS A household and an economy face many decisions: • Who will work? • What goods and how many of them should be produced? • What resources should be used in production? • At what price should the goods be sold? PRINCIPLES OF ECONOMICS Society and Scarce Resources: • The management of society’s resources is important because resources are scarce. • Scarcity. . . means that society has limited resources and therefore cannot produce all the goods and services people wish to have. As such, Economics is the study of how society manages its scarce resources. Principle #1: People Face Tradeoffs. “There is no such thing as a free lunch!” 2
- 3. Principle #1: People Face Tradeoffs. To get one thing, we usually have to give up another thing. • Guns vs. butter • Food vs. clothing • Leisure time vs. work • Efficiency vs. equity Making decisions requires trading-off one goal against another. Efficiency vs. Equity Principle #1: People Face Tradeoffs • Efficiency means society gets the most that it can from its scarce resources. • Equity means the benefits of those resources are distributed fairly among the members of society. • Decisions require comparing costs and benefits of alternatives. • Whether to go to college or to work? • Whether to study or go out on a date? • Whether to go to class or sleep in? • The opportunity cost of an item is what you give up to obtain that item. Principle #2: The Cost of Something Is What You Give Up to Get It. LA Laker basketball star Kobe Bryant chose to skip college and go straight from high school to the pros where he has earned millions of dollars. 3
- 4. Principle #3: Rational People Think at the Margin. • Marginal changes are small, incremental adjustments to an existing plan of action. • Marginal changes in costs or benefits motivate people to respond. • The decision to choose one alternative over another occurs when that alternative’s marginal benefits exceed its marginal costs! People make decisions by comparing costs and benefits at the margin. Principle #5: Trade Can Make Everyone Better Off. • People gain from their ability to trade with one another. • Competition results in gains from trading. • Trade allows people to specialize in what they do best. Principle #6: Markets Are Usually a Good Way to Organize Economic Activity. • A market economy is an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services. • Households decide what to buy and who to work for. • Firms decide who to hire and what to produce. 4
- 5. • Adam Smith (1723-1790) made the observation that households and firms interacting in markets act as if guided by an ‘invisible hand’. • Because households and firms look at prices when deciding what to buy and sell, they unknowingly take into account the social costs of their actions. • As a result, prices guide decision makers to reach outcomes that tend to maximize the welfare of society as a whole. Principle #7: Governments Can Sometimes Improve Market Outcomes. • Market failure occurs when the market fails to allocate resources efficiently. • When the market fails (breaks down) government can intervene to promote efficiency and equity. • Market failure may be caused by • an externality, which is the impact of one person or firm’s actions on the well-being of a bystander. • market power, which is the ability of a single person or firm to unduly influence market prices. Principle #8: The Standard of Living Depends on a Country’s Production. • Standard of living may be measured in different ways: • By comparing personal incomes. • By comparing the total market value of a nation’s production. • Almost all variations in living standards are explained by differences in countries’ productivities. • Productivity is the amount of goods and services produced from each hour of a worker’s time. 5
- 6. Principle #9: Prices Rise When the Government Prints Too Much Money. • Inflation is an increase in the overall level of prices in the economy. • One cause of inflation is the growth in the quantity of money. • When the government creates large quantities of money, the value of the money falls. • The Phillips Curve illustrates the tradeoff between inflation and unemployment: Inflation Unemployment It’s a short-run tradeoff! Principle #10: Society faces a short-run tradeoff between inflation and unemployment. • The Phillips Curve illustrates the tradeoff between inflation and unemployment: Inflation Unemployment It’s a short-run tradeoff! PRINCIPLES OF ECONOMICS How people make decisions? • P1: People face tradeoffs. • P2: The cost of something is what you give up to get it opportunity cost. • P3: Rational people think at the margin. • P4: People respond to incentives. 6
- 7. PRINCIPLES OF ECONOMICS How people interact with each other? • P5: Trade can make everyone better off. • P6: Markets are usually a good way to organize economic activities. • P7: Governments can sometimes improve economic outcomes. PRINCIPLES OF ECONOMICS The forces and trends that affect how the economy as a whole works. • P8: The standard of living depends on a country’s production. • P9: Prices rise when the government prints too much money. • P10: Society faces a short-run tradeoff between inflation and unemployment. 1.2 Approaching Economic Analysis 7
- 8. Approaching Economic Analysis • Every field of study has its own terminology • Mathematics • integrals vector spaces • Economics • supply opportunity cost elasticity consumer surplus demand comparative advantage deadweight loss Approaching Economic Analysis • Economics trains you to. . . . • Think in terms of alternatives. • Evaluate the cost of individual and social choices. • Examine and understand how certain events and issues are related. Approaching Economic Analysis • The economic way of thinking . . . • Involves thinking analytically and objectively. • Makes use of the scientific method. • Uses abstract models to help explain how a complex, real world operates. • Develops theories, collects, and analyzes data to evaluate the theories. 8
- 9. The Role of Assumptions • Economists make assumptions in order to make the world easier to understand. • The art in scientific thinking is deciding which assumptions to make. • Economists use different assumptions to answer different questions. •Economic Models models to simplify reality Economists use in order to improve our understanding of the world • Two of the most basic economic models include: • The Circular Flow Diagram • The Production Possibilities Frontier (PPF) Our First Model: The Circular-Flow Diagram The circular-flow diagram is a visual model of the economy that shows how dollars flow through markets among households and firms. 9
- 10. Figure 1 .The Circular Flow MARKETS Revenue FOR Spending GOODS AND SERVICES Goods •Firms sell Goods and and services •Households buy services sold bought FIRMS HOUSEHOLDS •Produce and sell •Buy and consume goods and services goods and services •Hire and use factors •Own and sell factors of production of production Factors of MARKETS Labor, land, production FOR and capital FACTORS OF PRODUCTION Wages, rent, •Households sell Income and profit •Firms buy = Flow of inputs and outputs = Flow of dollars • Firms • Produce and sell goods and services • Hire and use factors of production • Households • Buy and consume goods and services • Own and sell factors of production • Markets for GoodsCircular-Flow Diagram Our First Model: The and Services • Firms sell • Households buy • Markets for Factors of Production • Households sell • Firms buy • Factors of Production • Inputs used to produce goods and services • Land, labor, and capital 10
- 11. Our Second Model: The Production Possibilities Frontier - PPF The production possibilities frontier is a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology. Figure 2. The Production Possibilities Frontier Quantity of Computers Produced 3,000 D C 2,200 2,000 A Production possibilities frontier 1,000 B 0 300 600 700 1,000 Quantity of Cars Produced • Concepts Illustrated by the Production Possibilities Frontier (PPF) • Efficiency • Trade-offs • Opportunity Cost • Economic Growth 11
- 12. Figure 3. A Shift in the Production Possibilities Frontier Quantity of Computers Produced 4,000 3,000 2,100 E 2,000 A 0 700 750 1,000 Quantity of Cars Produced Microeconomics and Macroeconomics • Microeconomics focuses on the individual parts of the economy. • How households and firms make decisions and how they interact in specific markets • Macroeconomics looks at the economy as a whole. • Economy-wide phenomena, including inflation, unemployment, and economic growth THE ECONOMIST AS POLICY ADVISOR • When economists are trying to explain the world, they are scientists. • When economists are trying to change the world, they are policy advisor. 12
- 13. POSITIVE VERSUS NORMATIVE ANALYSIS • Positive statements are statements that attempt to describe the world as it is. Called descriptive analysis • Normative statements are statements about how the world should be. Called prescriptive analysis POSITIVE VS. NORMATIVE ANALYSIS • Positive or Normative Statements? • An increase in the minimum wage will cause a ? decrease in employment among the least-skilled. POSITIVE (THỰC CHỨNG) ? • Higher federal budget deficits will cause interest rates to increase. POSITIVE ? POSITIVE VS. NORMATIVE ANALYSIS • Positive or Normative Statements? • The income gains from a higher minimum wage ? are worth more than any slight reductions in employment. NORMATIVE (CHUẨN TẮC) ? • State governments should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor. NORMATIVE ? 13
- 14. WHY ECONOMISTS DISAGREE? • They may disagree about the validity of alternative positive theories about how the world works. • They may have different values and, therefore, different normative views about what policy should try to accomplish. Summary • Economists try to address their subjects with a scientist’s objectivity. • They make appropriate assumptions and build simplified models in order to understand the world around them. • Two simple economic models are the circular-flow diagram and the production possibilities frontier. Summary… • Economics is divided into two subfields: • Microeconomists study decision-making by households and firms in the marketplace. • Macroeconomists study the forces and trends that affect the economy as a whole 14
- 15. Summary… • A positive statement is an assertion about how the world is. • A normative statement is an assertion about how the world ought to be. • When economists make normative statements, they are acting more as policy advisors than scientists. Summary… • Economists who advise policy-makers offer conflicting advices either because of differences in scientific judgments or because of differences in values. • At other times, economists are united in the advice they offer, but policy-makers may choose to ignore it. 15