Macroeconomics - 1,4,10

Chapter 1

1.1- people’s decision making

• Behavior of an economy reflects the behavior of the individuals. There are 4 principles.

• 1. Trade offs: To get one thing you want, you usually have to give up another thing you want. Making decisions requires trading off one goal for another.

  • Another societal trade-off is between efficiency and equality, which can be conflicting.

  • Efficiency: society is getting the greatest benefits from its scarce resources. 

  • Equality: benefits are distributed uniformly among society’s members. 

• 2. Opportunity cost: of an item is what you give up to get it. When making decisions, it’s smart to take opportunity costs into account, and people often do.

  • example: Consider the decision to attend college, and the cost of attending vs not attending is not a straightforward calculation

• 3. Rational people: systematically and purposefully do the best they can to achieve their goals, given the available opportunities. Human behavior is complex and sometimes deviates from rationality.

• Marginal change: describes an incremental adjustment to an existing plan of action. 

• Rational people make decisions by comparing marginal benefits and marginal costs.

• Marginal benefit: determines a person’s willingness to pay for a good, which depends on how many units a person already has

• Example: A situation with water and diamonds. Water is essential but plentiful, so the marginal benefit of an extra cup is small. By contrast, no one needs diamonds to survive, but because they are so rare, the marginal benefit of an extra gem is large.

• 4. Incentive: is something that induces a person to act, such as the prospect of a punishment or reward. 

  • Because people respond to incentives, policymakers can alter outcomes by changing punishments or rewards, policies can have unintended consequences, and society faces a trade-off between efficiency and equality.

1.2- people’s interactions

• The first four principles discussed how individuals make decisions. The next three concern how people interact with one another.

• 1. Trade: between two countries, trade can make each country better off. Even when it's  competitive, it can lead to a win–win outcome for the countries involved. 

• Trade allows countries to specialize in what they do best and to enjoy a greater variety of goods and services. 

  • People benefit too (buy a lot for cheaper) 

• 2. Market economy: an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services

  • Despite decentralized decision making and self-interested decision makers, market economies have proven remarkably successful in organizing economic activity to promote prosperity.

• Prices: determined by the interactions between buyers and sellers, and they not only reflect the good’s value but also the cost of production. 

• Adam Smith’s invisible hand: prices adjust to guide market participants to reach outcomes that maximize the well-being of society

• 3. Government: One reason we need a government is that the invisible hand can work its magic only if the government enforces the rules and maintains the institutions that are key to a market economy. Another reason is that the invisible hand, while powerful, is not omnipotent. 

  • property rights: the ability of an individual to own and exercise control over scarce resources. 

  • Most importantly, market economies need institutions to enforce property rights so individuals can own and control scarce resources. 

• market failure: a situation in which the market does not produce an efficient allocation of resources on its own. 

  • Externality: the impact of one person’s actions on the well-being of a bystander.

  • Market power: which refers to the ability of a single person or firm (or a small group of them) to unduly influence market prices. 

1.3- function of economy

• We started by discussing how individuals make decisions and then looked at how people interact. All these decisions and interactions together make up “the economy.” The last three principles concern the workings of the economy as a whole.

• 1. Living standards: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services

• Productivity: the amount of goods and services produced by each unit of labor input, and almost all variation in living standards is attributable to differences in countries’ productivity.

  • The relationship between productivity and living standards has profound implications for public policy.

• 2. Inflation: an increase in the overall level of prices in the economy. When a government creates large quantities of the nation’s money, the value of the money falls. 

  • High inflation imposes various costs on society, so economic policymakers try to keep it at a reasonable rate. 

• 3. Trade off with inflation and unemployment: in the short run, many economic policies push inflation and unemployment in opposite directions. Other factors can make this trade off more or less favorable, but the trade off is always present. 

Chapter 4

Insert Title: 

• Supply and demand refer to the behavior of people as they interact in competitive markets

• Market: a group of buyers and sellers of a good or service

  • Buyers determine the demand for the product

  • Sellers determine the supply of the product

  • Different forms: organized and less organized

    • Buyers and sellers meet at a time and place and know what they want to buy and sell, auctioneers

    • More common to be less organized where sellers set their own prices and buyers look at different locations to choose

    • Buyers and sellers are interconnected and compete + respond to one another

      • Supply and demand

• Competitive Market: a market in which there are so many buyers and sellers that each has little effect on the market price

  • No single participant can influence price

    • Buyers and sellers are so numerous that no one can influence price.

  • Sellers offer similar products, limiting their control over pricing

    • Goods are identical across sellers.

• Price Takers: buyers and sellers in perfectly competitive markets must accept the price the market determines

• Monopoly: one seller sets the price and controls the market

  • Most markets are perfectly competitive and markets, and in between.

• Quantity Demanded: of any good is the amount that buyers are willing and able to purchase

• Law of Demand: all else being equal, when the price of a good rises, the quantity demanded falls, and when the price falls, the quantity demanded rises

  • EXAMPLE: If the price of ice cream rose to $20 per scoop, most people would buy less. They might buy frozen yogurt instead. If the price of ice cream fell to $0.50 per scoop, they might buy more. 

• Demand Schedule: the relationship between the price of a good and the quantity demanded, holding constant everything else that influences how much of the good a consumer wants to buy

  • Shows the quantity of a good demanded at different prices

  • EXAMPLE: If ice-cream cones are free, Catherine buys 12 cones per month. At $1 per cone, she buys 10 per month. As the price rises further, she buys fewer and fewer cones. When the price reaches $6, Catherine doesn’t buy any ice cream at all.

• Demand Curve: a graphical representation of the demand schedule, which slopes downward, showing that a lower price increases the quantity demanded

  • EXAMPLE: the price of ice cream is on the vertical axis, and the quantity demanded is on the horizontal axis. The line relating price and quantity demanded

• Market Demand: the sum of all the individual demands for a particular good or service.

  • The quantity demanded in a market is the sum of the quantities demanded by all the buyers at each price.

  • Market demand curve is found by adding the individual demand curves horizontally

    • EXAMPLE: At a price of $4, Catherine demands 4 cones, Nicholas demands 3, and the market demand is 7 cones.

  • Shows how total quantity demanded changes with price, combining the individual demands for each buyer

• Increase in Demand: A change that increases the quantity demanded at every price, such as this wondrous but imaginary discovery, shifts the demand curve to the right

• Decrease in Demand: A change that reduces the quantity demanded at every price shifts the demand curve to the left

• Shifts in the demand curve: factors other than the price of a good change. These factors include:

  • Income: If income falls, demand for normal goods decreases, but demand for inferior goods may increase.

  • Prices of related goods: Substitutes (e.g., frozen yogurt for ice cream) cause a decrease in demand for the original good when their price falls. Complements (e.g., hot fudge for ice cream) cause an increase in demand for the original good when their price falls.

  • Tastes: A shift in preferences can lead to an increase or decrease in demand.

  • Expectations: If consumers expect higher future income or lower prices, they may increase current demand.

  • Number of buyers: An increase in the number of buyers leads to an increase in demand.

• Movement along the demand curve: A change in the price of the good itself causes a movement along the demand curve, not a shift. 

  • EXAMPLE: a tax on cigarettes may raise their price, causing a decrease in the quantity demanded, which is represented by a movement to a higher price on the same demand curve.

  • Variables influencing demand:

    • Price: Movement along the curve.

    • Income, prices of related goods, tastes, expectations, number of buyers: Shifts the demand curve.

• Quantity Supplied: The quantity supplied refers to the amount that sellers are willing and able to sell at various prices.

• Law of Supply: This law states that when the price of a good rises, the quantity supplied also rises, and when the price falls, the quantity supplied falls. Sellers are more inclined to produce more of a good when it is profitable (i.e., when the price is high), and less when it is not.

• Supply Schedule: This is a table that shows the relationship between the price of a good and the quantity that producers are willing to supply at each price.

• Supply Curve: The supply curve graphs the data from the supply schedule and shows how quantity supplied changes with the price. Since the law of supply indicates that higher prices lead to a higher quantity supplied, the supply curve slopes upward. An increase in price increases the quantity of ice cream cones supplied, which is represented by a movement along the supply curve

  • The supply curve slopes upward, showing the positive relationship between price and quantity supplied.

• Increase in Supply: A change that raises the quantity supplied at every price, such as a fall in the price of sugar, shifts the supply curve to the right

• Decrease in Supply: A change that reduces the quantity supplied at every price shifts the supply curve to the left

• The supply curve can shift due to changes in various factors that influence the production process:

  • Input Prices: If the cost of inputs, such as sugar for ice cream, increases, it becomes more expensive to produce ice cream. As a result, producers will supply less at each price, shifting the supply curve to the left. Conversely, if input prices fall (like sugar becoming cheaper), production becomes more profitable, and the supply curve shifts to the right.

  • Technology: Technological improvements can make production more efficient. For instance, a new ice cream machine that reduces labor costs would allow producers to supply more ice cream at any given price, shifting the supply curve to the right. A lack of technological advancement can have the opposite effect, reducing supply.

  • Expectations: If producers expect the price of ice cream to rise in the future, they might hold back some of their current supply to sell later at the higher price. This would reduce the supply in the present, shifting the supply curve to the left. If they expect the price to fall, they might increase current supply to sell before prices drop.

  • Number of Sellers: If more producers enter the ice cream market, the total market supply increases, shifting the supply curve to the right. If producers exit the market, supply decreases, shifting the supply curve to the left.

• Equilibrium: a situation in which the market price has reached the level at which the quantity supplied equals the quantity demanded

• Equilibrium price (Market-clearing Price): the price that balances the quantity supplied and the quantity demanded

  • At this price, everyone in the market has been satisfied: Buyers have bought all they want to buy, and sellers have sold all they want to sell

• Equilibrium quantity: the quantity supplied and the quantity demanded at the equilibrium price

• At the equilibrium price, the quantity of the good that buyers are willing and able to buy exactly balances the quantity that sellers are willing and able to sell.

• Market equilibrium: the supply curve and demand curve intersect.

  • At the equilibrium price, the quantity supplied equals the quantity demanded.

  • EXAMPLE: the equilibrium price is $4.00 per ice-cream cone, and the equilibrium quantity is 7 cones.

• Surplus (Excess Supply): the market price is above the equilibrium price.

  • EXAMPLE: If the price is $5 per cone, quantity supplied is 10 cones, but quantity demanded is only 4 cones.

  • There is more supply than demand, and producers cannot sell all the cones at this price.

    • To resolve the surplus, producers lower prices, which:

      • Increase quantity demanded (more buyers want to buy at the lower price).

      • Decrease quantity supplied (producers may not want to sell as much at the lower price).

      • This price adjustment moves the market toward the equilibrium.

• Shortage (Excess Demand): the market price is below the equilibrium price.

  • EXAMPLE: If the price is $3 per cone, quantity demanded is 10 cones, but quantity supplied is only 4 cones.

  • There is more demand than supply, and buyers cannot buy all the cones they want.

    • To resolve the shortage, sellers raise prices, which:

      • Decrease quantity demanded (some buyers are no longer willing to buy at the higher price).

      • Increase quantity supplied (producers are willing to supply more at the higher price).

      • This price adjustment moves the market toward the equilibrium.

• Law of Supply and Demand: prices adjust to bring the quantity supplied and quantity demanded into balance.

  • Markets typically return to equilibrium through price adjustments.

  • Surpluses and shortages are usually temporary because prices quickly move toward their equilibrium levels.

• Supply: the position of the supply curve

• Quantity supplied: the amount producers want to sell

• Three Steps to Analyze Equilibrium Changes:

  • Identify: Which curve shifts (supply, demand, or both)?

  • Direction: Determine if the curve shifts right (increase) or left (decrease).

  • Diagram: Use a supply-and-demand graph to see how shifts change price and quantity.

• Example 1: Shift in Demand

  • Scenario: Hot summer increases demand for ice cream.

  • Demand Curve: Shifts right (higher demand at every price).

  • Effect:

    • Excess demand at the old price raises prices.

    • Equilibrium price rises from $4 to $5.

    • Quantity increases from 7 to 10 cones.

• Example 2: Shift in Supply

  • Scenario: Hurricane raises sugar prices, increasing ice cream production costs.

  • Supply Curve: Shifts left (lower supply at every price).

  • Effect:

    • The price rises from $4 to $5.

    • The quantity sold decreases from 7 to 4 cones.

• Example 3: Both Supply and Demand Shift

  • Scenario: Heat wave increases demand, hurricane reduces supply.

  • Demand Curve: Shifts right (higher demand).

  • Supply Curve: Shifts left (lower supply).

  • Effect:

    • Price increases in both cases.

    • The effect on quantity depends on the magnitude of the shifts:

    • If demand rises more than supply falls, quantity increases.

    • If supply falls more than demand rises, quantity decreases.

• Shifts in supply and/or demand predict changes in equilibrium price and quantity.

  • The direction of the shifts determines the outcome:

  • Rightward shift (increase) → higher price/quantity.

  • Leftward shift (decrease) → lower price/quantity.

  • The impact on quantity is ambiguous if both supply and demand shift.

• Summary of "The Law of Supply and Demand Isn’t Fair" by Richard Thaler:

  • Crisis Shortages: During the COVID-19 pandemic, essential goods like toilet paper, masks, and hand sanitizer became scarce, but prices didn’t rise as expected due to fairness concerns.

  • Fairness vs. Economics: Thaler’s research shows that people view price increases during crises as unfair. For example, 82% found raising snow shovel prices after a blizzard unfair.

  • Retailers vs. Entrepreneurs: Large retailers maintain fairness to keep customer loyalty, while some entrepreneurs exploit crises for profit, raising prices on essentials.

  • Medical Supplies: Hospitals couldn’t get masks at normal prices due to long-term contracts, while some suppliers profited by selling at inflated prices.

  • Market Efficiency vs. Fairness: Though higher prices could reduce panic buying and allocate goods more efficiently, fairness norms often prevent this during emergencies.

  • Conclusion: Businesses that prioritize fairness gain long-term trust, while price gouging can harm reputations, even if it might be economically efficient

• Conclusion

  • Market Functioning: Individuals contribute to the demand for goods and the supply of labor. The interaction of supply and demand determines prices, which guide the allocation of resources.

  • Price Mechanism: Prices act as signals, guiding who receives resources. For example, beachfront property goes to those who can afford it, and farming labor is allocated based on wage incentives.

  • Coordination Without Central Planning: Prices coordinate the decisions of millions of individuals, ensuring that the economy runs smoothly and efficiently without the need for government intervention.

  • Conclusion: Prices adjust to balance supply and demand, helping resources flow where they are most needed, without causing disorder in the market.

• CHAPTER REVIEW

  • Supply and Demand Model: The model of supply and demand is essential in analyzing competitive markets, where numerous buyers and sellers participate. In these markets, individual buyers or sellers have minimal influence on the price, making the overall market price a result of the collective behavior of all participants.

  • Demand Curve:

    • The demand curve illustrates how the quantity demanded of a good changes in response to its price. According to the law of demand, when the price of a good falls, the quantity demanded increases, and vice versa. This results in a downward-sloping demand curve.

    • Several factors besides price can influence demand. These include:

      • Income: As consumers’ income increases, the demand for certain goods may rise or fall, depending on whether the goods are normal or inferior.

      • Prices of Substitutes and Complements: If the price of a substitute rises (e.g., butter when the price of margarine increases), demand for the original good may rise. Conversely, if the price of a complement rises (e.g., gas for cars), demand for the good may decrease.

      • Tastes and Preferences: Changes in consumer preferences can shift demand. For example, a health trend could increase the demand for organic food.

      • Expectations: If consumers expect prices to rise in the future, they may purchase more now, increasing current demand.

      • Number of Buyers: An increase in the number of buyers (e.g., due to population growth) will typically shift the demand curve to the right, increasing demand at each price level.

  • Supply Curve:

    • The supply curve shows the relationship between the price of a good and the quantity supplied. According to the law of supply, as the price of a good increases, the quantity supplied increases, leading to an upward-sloping supply curve.

    • Several factors influence supply beyond price:

      • Input Prices: If the cost of production inputs (e.g., labor, raw materials) rises, the quantity supplied may decrease, shifting the supply curve leftward.

      • Technology: Technological improvements can reduce production costs, increasing supply and shifting the supply curve to the right.

      • Expectations: If producers expect future prices to rise, they may reduce supply now to sell later at higher prices.

      • Number of Sellers: More sellers in the market can increase supply, shifting the supply curve to the right.

  • Market Equilibrium:

    • The market equilibrium is the point where the supply and demand curves intersect. At this price, the quantity demanded by consumers equals the quantity supplied by producers.

    • The equilibrium price is the price at which this balance occurs. If the price is above equilibrium, a surplus occurs, leading producers to lower prices. If the price is below equilibrium, a shortage occurs, and prices tend to rise as consumers compete for the limited supply.

  • Analyzing Shifts:

    • When an event impacts a market, it can shift either the demand or the supply curve (or both). To analyze the shift, follow these steps:

      • Determine the curve that shifts: Does the event change demand, supply, or both?

      • Direction of the shift: Does the curve shift to the right (increase) or to the left (decrease)?

      • Compare the new equilibrium: After the shift, examine how the equilibrium price and quantity change compared to the initial situation.

  • Prices as Signals:

    • Prices serve as crucial signals in market economies. They guide the decisions of consumers and producers, ensuring that scarce resources are allocated efficiently.

    • At the equilibrium price, buyers choose how much to consume, and sellers decide how much to produce. The price acts as the coordinating mechanism that balances supply and demand, directing resources where they are most valued. If prices are too high, demand falls; if prices are too low, supply falls.

Chapter 10

Definitions: 

• Microeconomics: the study of how households and firms make decisions and how they interact in markets

• Macroeconomics: the study of economy wide phenomena, including inflation, unemployment, and economic growth

• Gross Domestic Product (GDP): the market value of all final goods and services produced within a country in a given period of time

  • Does not include illegally sold items such as drugs, does not include services done for free

  • Does not include intermediate goods (ex: chip that goes inside a computer- the final good)

• Investment: spending on business capital, residential capital, and inventories

• Government Purchases: spending on goods and services by local, state, and federal governments 

  • Does not include social security

  • Does include paying federal employees (teachers, police, etc)

• Consumption: spending by households on goods and services, with the exception of purchases of new housing

• Net Exports: spending on domestically produced goods by foreigners (exports) minus spending on foreign goods by domestic residents (imports)

  • imports are subtracted from exports

• Nominal GDP: the production of goods and services valued at current price

• Real GDP: the production of goods and services valued at constant price

• GDP Deflator: a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100

• Gross national product (GNP): GNP measures the income or production of a nation’s permanent residents or “nationals” (both people and their factories) no matter where they are located.

• Net national product (NNP): NNP is the total income of a nation’s residents (GNP) minus depreciation. Depreciation is the value of the wear and tear on the economy’s capital stock.

• National income: National income is the total income earned by a nation’s residents. It differs from NNP because of the statistical discrepancy from data collection.

• Personal income: Personal income is the income of households and noncorporate businesses. It excludes retained earnings (corporate income not paid out as dividends) and subtracts indirect business taxes, corporate income taxes, and contributions for social insurance. It includes interest income households receive from government debt and government transfer payments (welfare and Social Security).

• Disposable personal income: This is the income of households and nonincorporated businesses after they pay their obligations to the government (taxes, traffic tickets).

Concepts: 

• GDP is measured by summing expenditures on final goods and services, divided into four components:

  • Consumption (C) (68%): Household spending on goods and services, excluding new housing.

  • Investment (I) (18%): Spending on business capital, residential capital, and inventories (excluding stocks, bonds, and mutual funds).

  • Government Purchases (G) (18%): Government spending on goods and services, excluding transfer payments.

  • Net Exports (NX) (-4%): Exports minus imports, adjusting for foreign-produced goods included in other categories.

  • The GDP identity is Y = C + I + G + NX, ensuring only domestic production is counted.

• The GDP deflator = (nominal GDP/real GDP) × 100. The GDP deflator is a price index that measures the level of prices in the current year relative to the level of prices in the base year. The percentage change in the GDP deflator is a measure of the rate of inflation.

  • In the United States, real GDP has grown, on average, at about 3 percent per year since 1970. Occasional periods of decline in real GDP are known as recessions.

• GDP measures two things at once: the total income of everyone in the economy and the total expenditure on the economy’s output of goods and services. GDP can perform the trick of measuring both total income and total expenditure because these two things are the same. For an economy as a whole, income must equal expenditure.

• GDP measures the value of production that takes place within a specific interval of time. Usually, that interval is a year or a quarter (three months). GDP measures the economy’s flow of income, as well as its flow of expenditure, during that interval.

• If total spending rises from one year to the next, at least one of two things must be true:

  • the economy is producing a larger output of goods and services, or

  • goods and services are being sold at higher prices.

• Nominal GDP uses current prices to value the economy’s production of goods and services. Real GDP uses constant base-year prices to value the economy’s production.