MACRO Exam 1 Ch.1-4

Scarcity

The limited nature of society’s resources. Resources are limited, wants are not. Not the same as poverty - everybody faces it

Economics

The study of how society manages its scarce resources; equivalently, the study of choice under constraint

Microeconomics

The study of individual decision-makers (households and firms) and how they interact in specific markets

Macroeconomics

The study of the economy as a whole and aggregate outcomes - GDP, inflation, unemployment

Microfoundations

The idea that macroeconomic outcomes are built from the decisions of individual agents, so you need micro to do macro (subject of Exam 1)

Agent

A decision-maker - an individual or a firm

Opportunity Cost

Whatever must be given up to obtain some item - the difference the decision caused, plus any individual cost (like the value of your time) that appears on no receipt (invisible cost or added cost)

Marginal Change

An incremental, one-unit adjustment to a plan of action

Margin

“One more” or “the next one”

Marginal Benefit (MB)

The value to you of the next unit

Marginal Cost (MC)

What the next unit costs you, including opportunity cost

Average Cost

Total cost divided by the number of units, not the cost of the next unit

Rational Decision Rule

Take the action if and only if marginal benefit is equal or greater than marginal cost (MB > MC). If exactly equal, do it

Incentive

Something that induces an agent to act, works by changing marginal benefit or marginal cost

Second-Order Effects

What happens once agents respond to a policy - not what the policy intends. The textbook calls these unintended consequences

Model

A simplified framework that explains how something happens, built from assumptions, that can be tested against data

Simplifying Assumption

A deliberate simplification that lets a model focus on what matters. Judged not by whether it is literally true, but by whether it lets you examine what you want to examine

Tractable

Usable; workable. What simplifying assumptions buy you

Ceteris Paribus

“All else equal.” Move one thing at a time, with it, a relationship can be casual; without it, it may only be correlation

Declining (diminishing) Marginal Benefit

Each additional unit adds less than the one before, because you use the most productive unit first

Production Possibilities Frontier (PPF)

A graph of the combinations of two outputs that can be produced with the available resources. Outputs go on the axes, not inputs

Efficient

A point on the PPF - all available resources are being used. Every point on the frontier is efficient; none is “most productive”

Inefficient

A point inside the PPF - some resources are not being used

Unattainable

A point outside the PPPF - cannot be reached with the resources available (scarcity)

Slope of the PPF

The opportunity cost of the good on the horizontal axis

Bowed-Out PPF

Reflects rising opportunity cost: as you devote more resources to one good, each additional unit costs more of the other

Linear PPF

Assumes constant opportunity. Less realistic, easier to work with; used in the trade model

Shift of the PPF

The whole frontier moves - caused by more resources or better technology

Reasons Econommists Disagree

Differences in scientific judgment (how the world works, how big an effect is) and differences in values (how to weigh winners and losers)

Absolute Advantage

Producing a good using fewer inputs (hours) than the other producer. Compares within the same good. A country can have it in both goods

Comparative Advantage

Producing a good at a lower opportunity cost than the other producer. Compares across goods. No country can have it in both

Specialization

Devoting resources to the good in which you have the comparative advantage

Gains from Trade

The increase in total output made possible by comparative advantage, with the same resources

Terms of Trade

The price at which the two parties - determined by negotiation, not theory. Must fall between the two parties’ opportunity costs

Market

A group of buyers and sellers of a particular good or service. Buyers determine demand; sellers determine supply; price connects them

Competitive Market

So many buyers and sellers that no single one can move the price - everyone is a price taker

Perfectly Competitive Market

A competitive market (price takers) in which the goods are also identical. A subset of competitive markets - the extreme case

Price Taker

A buyer or seller who takes the market price as given and cannot set it

Identical Goods

Goods alike enough that buyers do not care who they buy from, so no seller can charge more than the going price

Quantity Demanded

The amount buyers are willing and able to purchase at a given price. One point on the demand curve

Demand

The whole relationship between price and quantity demands - the entire curve

Law of Demand

All else equal, when price rises, quantity demanded falls (and vice versa)

Demand Schedule/Curve

A table (schedule) or graph (curve) of quantity demanded at each price. Price on the vertical axis, quantity on the horizontal axis

Market Demand

The sum of individual quantities demanded at each price (horizontal summation)

Demand Shifters

Tastes, prices of related goods (substitutes and complements), income, number of buyers, and expectations

Quantity Supplied

The amount sellers are willing and able to sell at a given price. One point on the supply curve

Supply

The whole relationship between price and quantity supplied - the entire curve

Law of Supply

All else equal, when price rises, quantity supplied rises. When price falls, quantity supplied falls

Market Supply

The sum of individual quantities supplied at each price

Supply Shifters

Input prices, technology, number of sellers, and expectations of future prices

Movement Along a Curve

Caused by a change in the price of this good. You slide to a different point on the same curve

Shift of a Curve

Caused by a change in anything that was held constant when the curve was drawn. The whole curve moves

Equilibrium

The price at which quantity demanded equals quantity supplied. The equilibrium quantity is the amount bought and sold at that price (where the two sides agree)

Surplus

Quantity supplied exceeds quantity demanded. Occurs when price is above equilibrium. Sellers cut prices

Shortage

Quantity demanded exceeds quantity supplied. Occurs when price is below equilibrium. Sellers raise prices

Three-Step Method

1. Which curve shifts?

2. Which direction?

3. Compare old and new equilibrium P and Q

Why is scarcity the starting point for everything else in this course?

Resources (time, money, labor, and raw materials) are limited and our wants are not, that gap is why choices have to be made at all

What is the difference between microeconomics and macroeconomics?

One looks at households, firms and single markets and the other looks at growth, inflation, unemployment, and recessions

What are examples of topics studied in microeconomics?

Individual decision-makers (households, firms, and single markets)

What are examples of topics studied in macroeconomics?

The economy as a whole (growth, inflation, unemployment, and recessions)

Why do we say “agent” rather than “person”?

A decision-maker can be an individual OR a firm

When you calculate the opportunity cost of a decision, which costs count?

Count only what the decision actually changed and forgone earnings are a real cost

When you calculate the opportunity cost of a decision, which costs do not count?

Resources that you have already spent and cannot recover

Why do economists think at the margin instead of in all-or-nothing terms?

Resources are usually scarce and divisible

Is marginal cost only the money you pay for the next unit?

No, it’s the additional economic cost, including relevant opportunity costs, not simply the price you pay

What is the decision rule for a rational decision maker?

If MB > MC, do it.

If MC < MC, don’t.

What if marginal benefit and marginal cost are exactly equal?

When MB =MC =marginal equilibrium or optimal quantity

What is the difference between an average and a marginal cost?

Average cost uses the total cost divided by units and marginal cost is about your next one

When deciding to use an average or marginal cost, which matters for your decision?

Average cost tells you what you’ve spent per unit on average and marginal cost tells you what the next unit will cost. Since most decisions are usually “Should I do one more?”, marginal cost is usually the relevant measure for the decision

How do incentives affect policy evaluation?

They change MC and MB. Policies change incentives so, any policy requires thinking through how it changes the costs and benefits agents face, and how they will respond

If one of the two outcomes becomes worth more to you, what happens to marginal benefit and marginal cost?

What you want more = MB goes up

What you’re giving up becomes better = MC goes up

Why can a policy produce effects its designers did not intend?

The incentives were not thought through

How do incentives affect policy evaluation?

It changes MB and MC and how agents will respond

What do we call effects that happen when policy produces effects its designers did not intend?

Second-order effects

Can you give an example of second order effects?

Gas prices go up, (second-order effect) people drive less. Then, fewer people go to restaurants and stores and those businesses make less money

Why do economists build models?

To build a framework that explains how something happens

Why do we make assumptions we know are not literally true?

Assumptions can always be challenged and changed

What does it mean for a model to be tractable?

Usable

Why does ceteris paribus matter?

Change A and B at once and you can’t tell what caused the change

Where have we used ceteris paribus?

If two variables move together, can you conclude that one caused the other?

Correlation does not equal causation

Why might two economists disagree with one another?

They’re weighing different incentives or because they do not view marginal benefit and marginal cost the same way like differences in scientific judgement and differences in values

Do economists disagree as much as the news suggests?

Economists agree far more than the news suggests

Given a table of totals, how do you calculate the marginal benefit of each additional unit?

By subtracting the previous total from the new total

Does marginal benefit usually stay the same as you do more of something? Why or why not? What is the pattern called?

No because MB usually decreases as you do more of something. This pattern is called the law of diminishing marginal benefit

When a resource has two uses, how do you calculate the marginal cost of putting one more unit towards one of them? In what units is it measured?

The MC of putting one more unit towards Use A is the amount of Use B you have to give up. It is measured in the other good

Given MB and MC, how do you calculate the MC of putting one more unit toward one of them? In what units is it measured? Should you expect it to be an even spilt? Can you check your answer against the totals?

The MC of putting one more unit toward one use is the benefit you give up from the other use. It is measured by the units of the other good you give up. No you should not expect an even spilt because the goal is to allocate the units where they produce the most benefit not 50/50. Compare the total benefit from your allocation with other possible allocations to check your answer against the totals

What goes on the axes of a PPF?

Outputs because it shows the difference combinations of two goods/services an economy can produce

What does a point on the frontier mean?

Use of resources efficiently (efficient)

What does a point inside the frontier mean?

Combination is possible, but you’re not using all your resources efficiently (possible but inefficient)

What does a point outside the frontier mean?

The combination is currently impossible with your available resources and technology (unattainable)

Is every point on the frontier efficient?

Yes because every point on the frontier uses resources fully but each point represents a different trade off

Is any one point most productive on the frontier?

What does the slope of the PPF represent?

Opportunity cost - it tells you how much of one good you have to give up to produce more of the other good

Where is the curve flatter and what does that tell you about the opportunity cost?

Lower opportunity cost of the x-axis good (give up less)

Where is the curve steeper and what does that tell you about the opportunity cost?

Higher opportunity cost of the x-axis good (give up more)

Why is the PPF usually bowed outward?

Increasing opportunity cost. As you produce more and more of one good, you have to give up more and more of the other good

Are all points on the frontier equally good?

No, they are all efficient, but they aren;t necessarily equally desirable

What causes the whole PPF to shift outward?

An increase in resources and technology that allows the economy to produce more (more workers, machines, technology, land)

What if you move from inside the PPF to the frontier?

You started using existing resources more efficiently, you did not get more resources or better technology