Macro Test 1 Notes Part 1

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Today’s Outline
Welcome!
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• Introduction
• Policies, etc.
• What is economics?
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• More Introduction, Policies, etc.
• Prof. M’s Top 10 Principles of Macro Econ!
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A brief economic history tour

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(1) We Can’t Have Everything We Want
(2) Supply and Demand Determine Prices and Output
(3) Capitalism Generates Wealth
(4) Capitalism Can Fail
(5) Stimulate during Recessions with Tax Cuts, Government
Spending, and Increases in the Money Supply
(6) Too Much Money Causes Inflation
(7) Real Values are More Important than Nominal Values
(8) Beware of a Rising National Debt
(9) Worker Productivity is Key to Long-Term Growth
(10) International Trade and Immigration Benefit our Economy
Prof. M.’s Top 10 Macro Econ Lessons

Principle #1: We Can’t Have Everything We Want.

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Because resources are scarce, most
decisions involve trade-offs. We must
make choices.
Examples:
• Guns (Military) vs. Butter (Consumer Goods)
• Spend vs. Save for the Future
• Unemployment vs. Inflation
• Equality vs. Wealth
Macroeconomics can help us make public
policy decisions to achieve society’s goals.
Principle #1: We Can’t Have Everything We
Want.

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• The Forces of Supply and Demand
Determine Market Prices and
Quantities.
• Shortages and surpluses are automatically
eliminated.
• Changes in the Overall Price Level
(Inflation) and National Output (RGDP)
are Determined by Aggregate Supply
and Demand.
Principle #2: Supply and Demand Determine
Prices and Output in a Capitalist Economy

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• A free-market economy allocates
resources through the decentralized
decisions of households and firms as they
interact in markets guided by prices.
• Unregulated markets are usually a good
way to organize economic activity to
determine:
• What and how many goods to produce,
how to produce, and (perhaps) who gets
them.
• Central Planning (e.g., Socialism)
Principle #3: Capitalism Generates Wealth

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Our “free-market” capitalist economy efficiently
organizes economic activity without an organizer!
Principle #3: Capitalism Generates Wealth

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Principle #3: Capitalism Generates Wealth
Man is “led by an invisible hand to promote an
end which was no part of his intention.” . . . “By
pursuing his own interest, he frequently promotes
that of society more effectually than when he
really intends to promote it. - Wealth of Nations, 1776
Adam Smith

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• Markets may not materialize or work if
needed government institutions are not
established.
• Markets can fail under certain
circumstances.
• Economies can get “off-track” and need
government assistance.
• Capitalism may generate excessive
inequality.
Appropriate Government Policy can
Principle #4: Capitalism Can Fail

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• Congress can pass tax cuts or
spending increases.
• President could veto
• The Federal Reserve can increase
the money supply
• Money supply increase -> Lower interests
rates -> More borrowing -> More spending
Principle #5: Stimulate Economies During
Recessions and Slowdowns

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• More Money Chasing Same Goods ->
Inflation
• Modest inflation (e.g., 2%) is not
problematic
• High and varying inflation harms the
economy
• “Hyperinflation” can destroy an economy
• The Federal Reserve can control
inflation by controlling the money
supply.
Principle #6: Too Much Money Causes
Inflation

• The Real Value of Money = What you
can buy with the money.
• The Nominal Value of Money = The face
value.
• The real value of money depends on
when and where the money is spent.
Principle #7: Real Values Matter More than
Nominal Values

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Politicians tend to overspend and under
tax!
• Annual Spending > Taxes Collected ->
Deficit
• Sum of Deficits Over Time = National Debt
• Higher Debt -> Higher Annual Interest
Payments
• Higher Debt -> Higher Interest Rates
Principle #8: Beware of a Rising National
Debt

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Why Do We Almost Always Run Budget Deficits?

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• More productive workers -> More and more
valuable goods and services -> A greater
standard of living
Policies to increase worker productivity:
• Investments in Education, Health Care, Capital,
Infrastructure, Research and Technology Development
• Institutions that promote an economy where people
can benefit from working harder and smarter (e.g.,
private property rights, a good legal / criminal justice
system, stable political system, free markets, etc.)
Principle #9: Worker Productivity is the Key
to Long-Term Economic Growth

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• “Protectionist” policies such as import
tariffs or quotas:
• May “protect” certain industries and workers
• Harm other industries that import factors of
production
• Harm U.S. consumers
• Harm trading partners
• Are usually met with retaliation which harm U.S.
exporting industries
• Result in lower global standards of living
• More immigrants are needed into the U.S.
to mitigate labor shortages caused by
baby boomer retirements.
Principle #10: International Trade and Immigration
Generally Benefit our Economy