Macro Notes: PPF, Growth, Markets, Demand, Public vs Private Goods, Perfect Competition

Production Possibility Frontier and Economic Growth

  • Production Possibility Frontier (PPF): the maximum combinations of goods and services an economy can produce with available resources and technological knowledge.

    • Points on the frontier represent efficient (maximum) production given resources.

    • Points inside the frontier imply underutilization or inefficiency; points outside are unattainable with current resources/tech.

  • Growth defined: expansion of the production possibility frontier, i.e., outward shift of the frontier.

    • If the frontier expands outward, the economy can produce more of at least one good (capacity has increased).

    • Balanced growth: both goods increase by the same amount. Mathematically, if goods are A and B, balanced growth implies \Delta QA = \Delta QB\ (for the same period).

    • Biased (unbalanced) growth: one good increases by more than the other (e.g., biased toward good A: \Delta QA > \Delta QB\$). We will discuss more details in Chapter 3.

  • Economic growth vs. growth in the definition: growth is the expansion of the PPF, not just higher output along the same frontier.

  • Preview: Chapter 3 will cover mechanisms of growth (resources, technology, investment, etc.).

Market Concepts in Macro Context

  • Market: a place (physical or abstract) where buyers and sellers interact to exchange a good or a service.

    • Not every product Market contains every good: markets are specialized (e.g., bread market, money market, computer market).

    • Final good vs. intermediate good:

    • Final good or service: used for consumption (e.g., a loaf of bread).

    • Intermediate good or service: used in production of another good (e.g., flour used to bake bread).

    • Product market vs. Factor market:

    • Product market trades final goods/services (e.g., car market).

    • Factor market trades inputs like labor, capital (e.g., labor market).

  • This course focuses on macro concepts and, specifically, the perfect competition market structure.

  • Micro vs. macro scope:

    • Microeconomics dives into market structures, price formation, and competition details.

    • In this course, we emphasize macro-level concepts and primarily a simplified view of markets under perfect competition.

  • Perfect competition: characteristics include symmetric information and long-run freedom of entry and exit.

  • In a perfectly competitive market, we analyze the behavior of a single buyer and a single seller to determine equilibrium price and output.

Demand: Effective Demand and the Law of Demand

  • Demand vs. quantity demanded:

    • Demand in economics means quantity demanded (effective demand) at a given price, not just a desire.

    • Effective demand requires three conditions to be met simultaneously:

    • Want/need/desire (taste or preference).

    • Ability to buy (money available).

    • Willingness to spend money (intent to purchase now).

    • Example: buying an airplane requires that you want it, you have $30,000,000, and you are willing to spend it now.

  • Factors affecting quantity demanded (holding all else constant):

    • Price of the good itself (price changes move along the demand curve).

    • Income (higher income tends to increase quantity demanded; lower income tends to decrease it).

    • Prices of related goods:

    • Substitutes: goods that can satisfy the same need (e.g., Tim Horton vs Starbucks coffee).

    • Complements: goods consumed together (e.g., bread and eggs).

    • Tastes/preferences and expectations about future prices or income.

    • Population size: more buyers means higher quantity demanded.

    • Time available to decide: more time generally makes demand more elastic (greater responsiveness).

  • Substitutes and complements (recap):

    • Substitutes: if the price of good A rises, demand for good B tends to rise as buyers switch.

    • Complements: if the price of good A rises, demand for good B tends to fall because they are often consumed together.

  • Bread market example in a macro context:

    • Bread is a market example with many sellers; consumers compare prices across sellers and also consider substitutes (e.g., other staples) and complements (e.g., eggs for a sandwich).

    • In real life, markets include stores (Walmart, etc.), but the market concept remains about interaction between buyers and sellers, not a single store.

  • Law of demand: price and quantity demanded are inversely related, holding all else constant.

    • When price rises, quantity demanded falls; when price falls, quantity demanded rises.

    • This inverse relationship is graphically shown by a downward-sloping demand curve.

  • Demand curve and schedule:

    • Demand schedule: a table showing price on the vertical axis and quantity demanded on the horizontal axis.

    • Demand curve: a downward-sloping curve reflecting the inverse relationship between price and quantity demanded.

    • Movement along the demand curve vs. shift of the demand curve:

    • Movement along the curve occurs when the price of the good changes (other factors constant).

    • Shift of the demand curve occurs when any non-price determinant changes (income, tastes, prices of related goods, expectations, population, etc.).

  • Key economic explanations for the downward slope (two main ones discussed):

    • Income effect: a price drop increases real purchasing power, increasing quantity demanded; a price rise reduces real purchasing power, decreasing quantity demanded.

    • Substitution effect: when relative prices change, consumers substitute toward relatively cheaper goods.

    • Diminishing marginal utility: another microeconomic explanation for the downward slope (not covered in depth here).

Real Income, Income Effect, and Relative Prices

  • Real income concept: money income expressed in terms of goods you can buy; real income reflects purchasing power as prices change.

    • Example (pizza): Money income $M; price of pizza $ppizza; RealIncome in pizzas = \frac{M}{p{pizza}}</p></li><li><p>IfM=900andppizza=20,youcanbuy45pizzasperweek.</p></li><li><p>Ifpricerisesto30,RealIncomebecomes30pizzasperweek(assumingMfixed).</p></li></ul></li><li><p>Relationshiptodemand:</p><ul><li><p>Whenpricerises,realincomefalls,reducingquantitydemanded(incomeeffect).</p></li><li><p>Whenpricefalls,realincomerises,increasingquantitydemanded.</p></li></ul></li><li><p>Relativepriceandsubstitutioneffect:</p><ul><li><p>Apricechangealterstherelativepriceofgoods,promptingsubstitutiontowardrelativelycheapergoods.</p></li><li><p>Ifpizzapricerisesrelativetoanothergood(e.g.,sandwich),consumerssubstituteawayfrompizzatowardthecheaperalternative.</p></li></ul></li><li><p>Summary:pricechangesaffectdemandviatwochannels(incomeeffectandsubstitutioneffect)withrealincomeandrelativepricesdrivingchangesinquantitydemanded.</p></li></ul><h3id="a2510db2−d145−4487−bb4c−eff9015a9d14"data−toc−id="a2510db2−d145−4487−bb4c−eff9015a9d14"collapsed="false"seolevelmigrated="true">MovementvsShiftofDemand;Non−PriceDeterminants</h3><ul><li><p>Movementalongthedemandcurve:</p><ul><li><p>Causedbyachangeinpriceofthesamegood;otherdeterminantsheldconstant.</p></li><li><p>Example:pizzapricefalls,quantitydemandedincreasesalongthesamedemandcurve.</p></li></ul></li><li><p>Shiftofthedemandcurve:</p><ul><li><p>Causedbychangesinnon−pricefactors:income,pricesofsubstitutes/complements,tastes,expectations,population,time.</p></li><li><p>Example:afallinincomeshiftsthedemandcurveforbreadtotheleft(lowerquantitydemandedateachprice)ifbreadisanormalgood.</p></li></ul></li><li><p>Keytake−away:demandcurvesshiftwhennon−pricedeterminantschange;movementsalongoccurwhenpricechangesalone.</p></li></ul><h3id="7fd5b429−20ed−49fa−a1db−9bcac3f4b80d"data−toc−id="7fd5b429−20ed−49fa−a1db−9bcac3f4b80d"collapsed="false"seolevelmigrated="true">PublicGoodsvsPrivateGoods</h3><ul><li><p>Excludabilityandrivalry(rivalryinconsumption):</p><ul><li><p>Excludable:individualscanbepreventedfromusingthegood(e.g.,aprivatechair).</p></li><li><p>Non−excludable:difficulttopreventothersfromusingthegood(e.g.,apublicgoodlikelightinaclassroom).</p></li><li><p>Rivalry:consumptionbyonepersonreducestheamountavailabletoothers(privategoodsaretypicallyrival).</p></li><li><p>Non−rivalry:oneperson’sconsumptiondoesnotreduceanother’s(manypublicgoodsarenon−rival).</p></li></ul></li><li><p>Definitionsinpractice:</p><ul><li><p>Publicgood:non−excludableandnon−rival(e.g.,basicclassroomlighting,nationaldefense).</p></li><li><p>Privategood:excludableandrival(e.g.,achair,asandwich).</p></li></ul></li><li><p>Classroomexamplesfromthelecture:</p><ul><li><p>Light:non−excludableinconsumption;non−rivalacrossstudentsinaclassroom.</p></li><li><p>Chair:excludableandrival;onlyonestudentcanoccupybeforeothersareexcludedormustwait.</p></li></ul></li><li><p>Noteonreal−worldnuance:somegoodscanhavemixedcharacteristics(e.g.,apublicbusisnon−rivalbutexcludableviafare;capacityconstraintscanintroducerivalry).</p></li></ul><h3id="92095ddf−dcda−430b−b66c−8960efccdc2f"data−toc−id="92095ddf−dcda−430b−b66c−8960efccdc2f"collapsed="false"seolevelmigrated="true">MarketStructure:PerfectCompetition(MacroFocus)</h3><ul><li><p>Perfectcompetitionfeatures(long−runperspective):</p><ul><li><p>Symmetricinformationamongbuyersandsellers.</p></li><li><p>Freeentryandexitinthelongrun(nobarrierstoenterorleavethemarket).</p></li></ul></li><li><p>Inmacroterms:westudyhowarepresentativebuyerandsellerbehaveundertheseconditionsandhowequilibriumpriceandquantityaredetermined.</p></li><li><p>Distinction:thismacrocourseemphasizestheaggregateimplicationsofmarketsunderperfectcompetitionratherthanallmicro−marketdetails.</p></li></ul><h3id="b3e5cd41−0c37−4395−9210−c55d723984b5"data−toc−id="b3e5cd41−0c37−4395−9210−c55d723984b5"collapsed="false"seolevelmigrated="true">QuickRecap:KeyConceptstoRemember</h3><ul><li><p>PPFandgrowth:</p><ul><li><p>Growth=outwardexpansionofthePPF;balancedvsbiasedgrowthoutcomes.</p></li></ul></li><li><p>Markettypesandstructure:</p><ul><li><p>Productmarketvsfactormarket;finalvsintermediategoods;perfectcompetitionassumptions.</p></li></ul></li><li><p>Demandfundamentals:</p><ul><li><p>Demandmeansquantitydemanded(effectivedemand)definedby:desire,ability,andwillingnesstospend.</p></li><li><p>Lawofdemand:priceandquantitydemandedmoveinoppositedirections,otherthingsequal.</p></li><li><p>Movementalongvsshiftofthedemandcurve;determinantsincludeincome,pricesofsubstitutesandcomplements,tastes,expectations,population,andtime.</p></li></ul></li><li><p>Realincomeandtheincomeeffect:</p><ul><li><p>Pricechangesaffectrealincome;higherpricesreducebuyingpower,reducingdemand;lowerpricesincreasebuyingpower,increasingdemand.</p></li></ul></li><li><p>Substitutesandcomplements:</p><ul><li><p>Substitutes:priceincreaseinoneraisesdemandfortheother.</p></li><li><p>Complements:priceincreaseinonereducesdemandfortheother.</p></li></ul></li><li><p>Time,population,andelasticity:</p><ul><li><p>Timeaffectselasticityofdemand;moretimegenerallyyieldsgreaterresponsiveness.</p></li><li><p>Populationchangesshifttheoveralldemandlevel.</p></li></ul></li><li><p>Publicvsprivategoods:</p><ul><li><p>Excludabilityandrivalrydeterminewhetheragoodispublicorprivate;socialcoordinationimplicationsfollowfromtheseproperties.</p></li></ul></li><li><p>Perfectcompetitionessentials(macrolens):</p><ul><li><p>Symmetricinformation,freeentry/exit;focusonequilibriumoutcomesforbuyersandsellersundertheseconditions.</p></li></ul></li></ul><p></p></li><li><p>If M = 900 and p_pizza = 20, you can buy 45 pizzas per week.</p></li><li><p>If price rises to 30, RealIncome becomes 30 pizzas per week (assuming M fixed).</p></li></ul></li><li><p>Relationship to demand:</p><ul><li><p>When price rises, real income falls, reducing quantity demanded (income effect).</p></li><li><p>When price falls, real income rises, increasing quantity demanded.</p></li></ul></li><li><p>Relative price and substitution effect:</p><ul><li><p>A price change alters the relative price of goods, prompting substitution toward relatively cheaper goods.</p></li><li><p>If pizza price rises relative to another good (e.g., sandwich), consumers substitute away from pizza toward the cheaper alternative.</p></li></ul></li><li><p>Summary: price changes affect demand via two channels (income effect and substitution effect) with real income and relative prices driving changes in quantity demanded.</p></li></ul><h3 id="a2510db2-d145-4487-bb4c-eff9015a9d14" data-toc-id="a2510db2-d145-4487-bb4c-eff9015a9d14" collapsed="false" seolevelmigrated="true">Movement vs Shift of Demand; Non-Price Determinants</h3><ul><li><p>Movement along the demand curve:</p><ul><li><p>Caused by a change in price of the same good; other determinants held constant.</p></li><li><p>Example: pizza price falls, quantity demanded increases along the same demand curve.</p></li></ul></li><li><p>Shift of the demand curve:</p><ul><li><p>Caused by changes in non-price factors: income, prices of substitutes/complements, tastes, expectations, population, time.</p></li><li><p>Example: a fall in income shifts the demand curve for bread to the left (lower quantity demanded at each price) if bread is a normal good.</p></li></ul></li><li><p>Key take-away: demand curves shift when non-price determinants change; movements along occur when price changes alone.</p></li></ul><h3 id="7fd5b429-20ed-49fa-a1db-9bcac3f4b80d" data-toc-id="7fd5b429-20ed-49fa-a1db-9bcac3f4b80d" collapsed="false" seolevelmigrated="true">Public Goods vs Private Goods</h3><ul><li><p>Excludability and rivalry (rivalry in consumption):</p><ul><li><p>Excludable: individuals can be prevented from using the good (e.g., a private chair).</p></li><li><p>Non-excludable: difficult to prevent others from using the good (e.g., a public good like light in a classroom).</p></li><li><p>Rivalry: consumption by one person reduces the amount available to others (private goods are typically rival).</p></li><li><p>Non-rivalry: one person’s consumption does not reduce another’s (many public goods are non-rival).</p></li></ul></li><li><p>Definitions in practice:</p><ul><li><p>Public good: non-excludable and non-rival (e.g., basic classroom lighting, national defense).</p></li><li><p>Private good: excludable and rival (e.g., a chair, a sandwich).</p></li></ul></li><li><p>Classroom examples from the lecture:</p><ul><li><p>Light: non-excludable in consumption; non-rival across students in a classroom.</p></li><li><p>Chair: excludable and rival; only one student can occupy before others are excluded or must wait.</p></li></ul></li><li><p>Note on real-world nuance: some goods can have mixed characteristics (e.g., a public bus is non-rival but excludable via fare; capacity constraints can introduce rivalry).</p></li></ul><h3 id="92095ddf-dcda-430b-b66c-8960efccdc2f" data-toc-id="92095ddf-dcda-430b-b66c-8960efccdc2f" collapsed="false" seolevelmigrated="true">Market Structure: Perfect Competition (Macro Focus)</h3><ul><li><p>Perfect competition features (long-run perspective):</p><ul><li><p>Symmetric information among buyers and sellers.</p></li><li><p>Free entry and exit in the long run (no barriers to enter or leave the market).</p></li></ul></li><li><p>In macro terms: we study how a representative buyer and seller behave under these conditions and how equilibrium price and quantity are determined.</p></li><li><p>Distinction: this macro course emphasizes the aggregate implications of markets under perfect competition rather than all micro-market details.</p></li></ul><h3 id="b3e5cd41-0c37-4395-9210-c55d723984b5" data-toc-id="b3e5cd41-0c37-4395-9210-c55d723984b5" collapsed="false" seolevelmigrated="true">Quick Recap: Key Concepts to Remember</h3><ul><li><p>PPF and growth:</p><ul><li><p>Growth = outward expansion of the PPF; balanced vs biased growth outcomes.</p></li></ul></li><li><p>Market types and structure:</p><ul><li><p>Product market vs factor market; final vs intermediate goods; perfect competition assumptions.</p></li></ul></li><li><p>Demand fundamentals:</p><ul><li><p>Demand means quantity demanded (effective demand) defined by: desire, ability, and willingness to spend.</p></li><li><p>Law of demand: price and quantity demanded move in opposite directions, other things equal.</p></li><li><p>Movement along vs shift of the demand curve; determinants include income, prices of substitutes and complements, tastes, expectations, population, and time.</p></li></ul></li><li><p>Real income and the income effect:</p><ul><li><p>Price changes affect real income; higher prices reduce buying power, reducing demand; lower prices increase buying power, increasing demand.</p></li></ul></li><li><p>Substitutes and complements:</p><ul><li><p>Substitutes: price increase in one raises demand for the other.</p></li><li><p>Complements: price increase in one reduces demand for the other.</p></li></ul></li><li><p>Time, population, and elasticity:</p><ul><li><p>Time affects elasticity of demand; more time generally yields greater responsiveness.</p></li><li><p>Population changes shift the overall demand level.</p></li></ul></li><li><p>Public vs private goods:</p><ul><li><p>Excludability and rivalry determine whether a good is public or private; social coordination implications follow from these properties.</p></li></ul></li><li><p>Perfect competition essentials (macro lens):</p><ul><li><p>Symmetric information, free entry/exit; focus on equilibrium outcomes for buyers and sellers under these conditions.</p></li></ul></li></ul><p>{\text{PPF growth is outward: } PPF{new} \;\uparrow}{\text{Balanced growth: } \Delta QA = \Delta QB}{\text{Biased growth: } \Delta QA > \Delta QB}{\frac{\partial Qd}{\partial P} < 0 \; \text{(holding other factors constant)}}<br><br>{\text{RealIncome}{g} = \dfrac{M}{pg}}$$