Macroeconomics Final Exam Notes

Chapter 7 - Consumers, Producers, and the Efficiency of Markets

WELFARE ECONOMICS

• The study of how the allocation of resources affects economic well-being

  • Benefits that buyers and sellers receive from market transactions

  • How society can make these benefits as large as possible

  • Equilibrium maximizes total benefit of buyers and sellers

  • (WILLINGNESS TO PAY vs CONSUMER SURPLUS)

AT ANY QUANTITY, THE PRICE GIVEN BY THE DEMAND CURVE

Consumer surplus is the area below the demand curve and above the price

• A lower price raises consumer surplus

  • EXISTING BUYERS INCREASE IN CONSUMER SURPLUS

= Consumer surplus =

• Benefit that buyers receive from a good as the buyers themselves perceive it 

• GOOD MEASURE OF ECONOMIC WELL-BEING

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Cost is a measure of willingness to sell

• Producer surplus

  • Amount a seller is paid for a good minus the seller’s cost of providing it

  • Price received minus willingness to sell 

Total surplus = Willing to buy - Cost

Consumer Surplus = Willing to buy - amount paid

Producer Surplus = Amount received - Cost

Efficiency:

• Property of resource allocation

• Maximizing the total surplus received by all members of society

       Equality:

         -  Property of distributing economic prosperity uniformly among the members of society 

• Market outcomes

• Free markets allocate the supply of goods to the buyers who value them most highly

  • Measure by their willingness to pay

• Free markets allocate the demand for goods to the sellers who can produce them at the least cost

  • Producer surplus is all space below demand curve

• Market failures:

  • Market power - monopoly, single group controls market

  • Externalities - extras leftover from economic activity (pollution)

• Invisible hand = everyone involved in the market

A tax on a good levied on buyers shifts the demand curve downward

A tax on a good levied on sellers shifts the demand curve upward

These are price wedges. As price paid increases, the quantity sold decreases. 

Flashcard 1:

Q: What is welfare economics?

A: The study of how the allocation of resources affects economic well-being, including the benefits buyers and sellers receive from market transactions and how to maximize those benefits.

Flashcard 2:

Q: What does equilibrium in a market achieve?

A: It maximizes the total benefit of both buyers and sellers.

Flashcard 3:

Q: What is consumer surplus?

A: The benefit buyers receive from a good, as they perceive it, and it is the area below the demand curve and above the price.

Flashcard 4:

Q: How does a lower price affect consumer surplus?

A: A lower price raises consumer surplus, particularly increasing the surplus for existing buyers.

Flashcard 5:

Q: What is producer surplus?

A: The amount a seller is paid for a good minus the seller’s cost of providing it, or price received minus willingness to sell.

Flashcard 6:

Q: How is total surplus calculated?

A: Total surplus = Willingness to buy - Cost

Flashcard 7:

Q: How is consumer surplus calculated?

A: Consumer surplus = Willingness to buy - Amount paid

Flashcard 8:

Q: How is producer surplus calculated?

A: Producer surplus = Amount received - Cost

Flashcard 9:

Q: What is efficiency in economics?

A: The property of resource allocation that maximizes total surplus received by all members of society.

Flashcard 10:

Q: What is equality in economics?

A: The property of distributing economic prosperity uniformly among all members of society.

Flashcard 11:

Q: How do free markets allocate resources?

A: They allocate goods to buyers who value them most (measured by willingness to pay) and allocate demand to sellers who can produce at the least cost.

Flashcard 12:

Q: What are market failures?

A: Market failures include situations like market power (e.g., monopolies) and externalities (e.g., pollution).

Flashcard 13:

Q: What is the "invisible hand" in economics?

A: The concept that everyone involved in the market, acting in their self-interest, contributes to overall market efficiency.

Flashcard 14:

Q: How does a tax on buyers affect the demand curve?

A: A tax on buyers shifts the demand curve downward.

Flashcard 15:

Q: How does a tax on sellers affect the demand curve?

A: A tax on sellers shifts the demand curve upward.

Flashcard 16:

Q: What happens to quantity sold when price paid increases due to taxes?

A: As the price paid increases, the quantity sold decreases.

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Chapter 8 - The cost of taxation 

A tax on a good levied on buyers shifts the demand curve downward

A tax on a good levied on sellers shifts the demand curve upward

Tax on a good levied on buyers or on sellers 

• Same outcome: a price wedge

• Price pair by buyers rises 

• Price received by sellers falls

• Lower quantity sold

Tax burden

• Distributed between producers and consumers

• Determined by elasticity of supply and demand 

Economic welfare

–Buyers: consumer surplus

–Sellers: producer surplus

–Government: total tax

revenue

• Tax times quantity sold

• Public benefit from the tax

Losses of surplus to buyers and sellers from a tax

• Exceed the revenue raised by the government 

DWL - fall in total surplus that results from a market distortion such as a tax

TAX DISTORTS INCENTIVES because markets allocate resources inefficiently 

Price elasticities of supply and demand

–More elastic supply curve

• Larger deadweight loss

–More elastic demand curve

• Larger deadweight loss

• The greater the elasticities of supply and

demand

–The greater the deadweight loss of a tax

Here are the flashcards based on the provided information:

Front:
Tax on a good levied on buyers
Back:

• Demand curve shifts downward by the size of the tax.

Front:
Tax on a good levied on sellers
Back:

• Supply curve shifts upward by the size of the tax.

Front:
Outcome of a tax on buyers or sellers
Back:

• Creates a price wedge.

• Price paid by buyers rises.

• Price received by sellers falls.

• Lower quantity sold.

Front:
Distribution of tax burden
Back:

• Distributed between producers and consumers.

• Determined by elasticities of supply and demand.

Front:
Effect of a tax on the market for a good
Back:

• The market becomes smaller.

Front:
Tax wedge definition
Back:

• A tax places a wedge between the price buyers pay and the price sellers receive.

Front:
Quantity of good sold after a tax is imposed
Back:

• The quantity of the good sold falls.

Front:
Economic welfare components
Back:

• Buyers: consumer surplus

• Sellers: producer surplus

• Government: total tax revenue (tax × quantity sold)

• Public benefit from the tax.

Front:
Welfare without a tax
Back:

• Consumer surplus: areas A, B, and C

• Producer surplus: areas D, E, and F

• Total tax revenue: 0

Front:
Welfare with a tax
Back:

• Smaller consumer surplus: area A

• Smaller producer surplus: area F

• Total tax revenue: areas B and D

• Smaller overall welfare

Front:
Deadweight loss due to a tax
Back:

• Taxes cause deadweight losses by preventing buyers and sellers from realizing some gains from trade.

Front:
When a deadweight loss occurs
Back:

• Gains from trade (difference between buyers’ value and sellers’ cost) are less than the tax.

• Some trades are not made after the tax is imposed, causing a deadweight loss.

Front:
Effect of elastic supply curve on deadweight loss
Back:

• More elastic supply curve results in a larger deadweight loss.

Front:
Effect of elastic demand curve on deadweight loss
Back:

• More elastic demand curve results in a larger deadweight loss.

Front:
Relationship between elasticities and deadweight loss
Back:

• The greater the elasticities of supply and demand, the greater the deadweight loss of a tax.

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Chapter 9 - Application: International Trade

The Equilibrium without trade

• Only domestic buyers and sellers 

Producers hurt from international trade

If domestic price < world price = export the good, country has comparative advantage

If domestic price > world price = import the good, world has comparative advantage 

Exporting country with international trade

• Domestic producers are better off

• Domestic consumers are worse off

Importing country with international trade

• Domestic producers are worse off

• Domestic consumers are better off

Tariff

• Tax on goods produced abroad and sold domestically 

Tariffs raise price by amount of the tariff 

Domestic quantity demanded increases 

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Second paper notes

Examine United States fiscal policy, taxes and spending

Describe current debt to GDP ratio 

Is federal government going in the right direction? Describe yes or no.

Argumentative 

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Chapter 23 - Measuring a Nation’s Income

Determinants of size of DWL 

• Tax rates

• Elasticity 

Why split the payroll tax?

• Government wanted to equally burden the employee and employer 

GDP = Gross Domestic Product - measures everything that’s domestically produced within a country. The Market Value. All items produced and services in the economy in a given time (yearly or quarterly) except illicit or homemade products. Income must equal expenditure.

GNP = Gross national product - measures everything produced by a country’s citizens, can be produced outside a country as long as it is of the country’s citizens. No one uses this anymore 

CPI = Consumer price index -

GDP = Consumption + Investment + Government Spending + Net Exports

Y.  =   C.   +.    I.   +.    G.     +.   NX

Consumption

• Spending by households on goods and services 

Investments

• Purchase of capital goods that will be used to purchase other goods and services in the future 

Government purchases 

• Government consumption expenditure and gross investment 

Net exports

• Exports are spending on domestically produced goods by foreigners 

• Imports are spending on foreign goods by domestic resident 

REAL GDP = removes inflation from the equation. Valued at a constant price. Designate one year as a base, not affected by change in prices. 

The GDP deflator

• Ratio of nominal GDP to real GDP times 100

Inflation in year 2 = (GDP in year 2-deflator in year 1 / GDP deflator in year 1) * 100

Deflator = (GDP nominal / GDP real)*100

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Calculate inflation rate or CPI (Consumer Price Index)

Inflation rate in year 2 = [(CPI in year 2 - CPI in year 1) /  (CPI in year 1)] x 100

Inflation rate is the change in percent in the price index

PPI = producer price index 

Shrinkflation = Keeping the same price, but reducing the portion size

The Time Machine equation 

Amount in today’s dollars = Amount in year T’s dollars x (price level today) / (Price level in year T)

Indexation = automatic correction by law or contract, of a dollar amount, for the effects of inflation, cost of living allowance 

Nominal interest rate = interest rate as usually reported 

Flashcard 1
Q: What does GDP stand for, and what does it measure?
A: GDP stands for Gross Domestic Product. It measures the market value of all items produced and services provided within a country in a given time period, excluding illicit or homemade products.

Flashcard 2
Q: What is the formula for GDP?
A: GDP = Consumption + Investment + Government Spending + Net Exports (Y = C + I + G + NX)

Flashcard 3
Q: What is GNP and how is it different from GDP?
A: GNP stands for Gross National Product. It measures the total production of a country's citizens, including production outside the country, whereas GDP only includes domestic production.

Flashcard 4
Q: Why did the government split the payroll tax?
A: To equally burden the employee and employer.

Flashcard 5
Q: What are the two main determinants of the size of the Deadweight Loss (DWL) caused by a tax?
A: Tax rates and elasticity.

Flashcard 6
Q: What does CPI stand for?
A: CPI stands for Consumer Price Index.

Flashcard 7
Q: Define Real GDP.
A: Real GDP removes inflation from the equation, valuing goods and services at constant prices to reflect true economic growth without the effects of price changes.

Flashcard 8
Q: What is the GDP Deflator, and how is it calculated?
A: The GDP Deflator is the ratio of nominal GDP to real GDP, multiplied by 100. It shows price level changes relative to base year prices.

Flashcard 9
Q: How do you calculate inflation in year 2 using GDP deflator values?
A: Inflation in year 2 = [(GDP Deflator in year 2 - GDP Deflator in year 1) / GDP Deflator in year 1] x 100.

Flashcard 10
Q: What does the formula "Amount in today's dollars = Amount in year T’s dollars x (Price level today / Price level in year T)" represent?
A: This is the "Time Machine" equation, used to adjust historical amounts for inflation to compare with today’s dollars.

Flashcard 11
Q: What is indexation?
A: Indexation is the automatic correction of a dollar amount, by law or contract, for inflation, such as cost-of-living adjustments.

Flashcard 12
Q: What is Shrinkflation?
A: Shrinkflation is when a product's price remains the same but the portion size is reduced.

Flashcard 13
Q: Define Nominal Interest Rate.
A: The nominal interest rate is the interest rate as typically reported, without adjustment for inflation.

Flashcard 14
Q: What are the components of Consumption in GDP?
A: Consumption includes household spending on goods and services.

Flashcard 15
Q: What is included in Investments for GDP calculation?
A: Investments include the purchase of capital goods to produce other goods and services in the future.

Flashcard 16
Q: What are Government Purchases in terms of GDP?
A: Government purchases encompass government consumption expenditure and gross investment.

Flashcard 17
Q: What does Net Exports represent in GDP?
A: Net Exports = Exports (domestically produced goods purchased by foreigners) - Imports (foreign goods purchased by domestic residents).

Flashcard 18
Q: What is PPI?
A: PPI stands for Producer Price Index, which measures the average change in selling prices received by domestic producers for their output.

Question #3 for the homework

Decide what year is our base year (2017)

Take year we’re in (2018), 

(2 - 2)/2 * 100 = 100

(6-4)/4 * 100 = 50%

(2-1)/1 * 100 = 100

Market basket:
2017 = (2 100) + (4 100) + (1 * 200) = 800

2018 = (2 100) + (6 100) + (2 * 100) = 1200

Raises by 50% because half of 800 = 400. Add that, you get 1200

CPI:

2017 - (800/800) * 100 = 100

2018 - (1200/800) * 100 = 150 

Inflation:

(150 - 100)/100 * 100 = 50%

2019 

Tennis Balls = 250/100

Golf Balls = 650/100

Gatorade = 2/200

Market Basket = 1300

CPI = 162.5

Inflation = 8.3%

IN TODAY’s DOLLARS EQUATION:

Today’s price = (Amount from year T (past year) * Price level today)/ Price level in year T

This equation removes the effect of inflation!

CPI and GDP measures price differences, not inflation 

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Chapter 25 - Production and growth

Productivity

• Quantity of goods and services

• Produced from each unit of labor input 

Determinants of productivity, TRHP:

Technology REALLY helps with productivity 

                          |              |                      |

                          |   Human capital       Physical capital (tools, buildings, transportation)

                  Resources             |

                           |                       \

                           |                        (Education, training, mentoring)

    (Develop existing/new resources, balanced with health of society)

Productivity is important because:

• Key determinant of living standards

• Growth in productivity is the key determinant of growth in living standards

• An economy’s income is the economy’s output

What helps a be productive? HUMAN AND PHYSICAL CAPITAL

• Tools, physical capital per worker

• Resources per worker

• Knowledge and skills, human capital per worker

• Technological knowledge

• Government (communist countries are more productive because they are forced to be)

• Trade

• Location, weather, climate
  
  Raise future productivity by investing! Invest current resources for bigger payoff in the future.

Investment from abroad:

–Foreign direct investment

• Capital investment that is owned and

operated by a foreign entity

–Foreign portfolio investment

• Investment financed with foreign money but

operated by domestic residents

Benefits of investment:
- Some flow back to foreign capital owners 

- Increase the economy’s stock of capital

- Higher productivity 

- Higher wages

- State-of-the-art technologies 

DOGE = Department of government efficiency 

Law of diminishing returns: a principle stating that profits or benefits gained from something will represent

a proportionally smaller gain as more money or energy is invested in it.

Countries that start off poor tend to grow more rapidly than countries that start off rich

R&D: research and development

• Lack of property rights

–Major problem

–Contracts are hard to enforce

–Fraud goes unpunished

–Corruption

• Impedes the coordinating power of markets

• Discourages domestic saving

• Discourages investment from abroad


Flashcards for Chapter 25 - Production and Growth

Flashcard 1

Q: What is productivity? 

A: The quantity of goods and services produced from each unit of labor input.

Flashcard 2

Q: Why is productivity important? 

A: Productivity is the key determinant of living standards and growth in productivity determines growth in living standards. An economy’s income is equal to its output.

Flashcard 3

Q: What factors help increase productivity? 

A:

• Tools and physical capital per worker

• Resources per worker

• Knowledge and skills (human capital per worker)

• Technological knowledge

• Government policies (e.g., in communist countries)

• Trade

• Geographic location, weather, and climate

Flashcard 4

Q: How can future productivity be raised? 

A: By investing current resources to achieve a bigger payoff in the future.

Flashcard 5

Q: What are the types of foreign investment? 

A:

• Foreign direct investment: Capital investment owned and operated by a foreign entity.

• Foreign portfolio investment: Investment financed with foreign money but operated by domestic residents.

Flashcard 6

Q: What are the benefits of foreign investment? 

A:

• Some returns flow back to foreign capital owners.

• Increases the economy’s stock of capital.

• Leads to higher productivity and wages.

• Provides state-of-the-art technologies.

Flashcard 7

Q: What is the law of diminishing returns? 

A: A principle stating that profits or benefits gained from an investment will represent proportionally smaller gains as more money or energy is invested.

Flashcard 8

Q: Why do poor countries tend to grow more rapidly than rich countries? 

A: Because they can adopt existing technologies and practices to catch up faster.

Flashcard 9

Q: What is R&D, and why is it important? 

A: Research and Development (R&D) helps drive innovation, leading to improvements in productivity and economic growth.

Flashcard 10

Q: How does a lack of property rights hinder economic growth? 

A:

• Contracts become hard to enforce.

• Fraud goes unpunished.

• Corruption impedes market coordination, discourages domestic saving, and deters foreign investment.

Flashcard 11

Q: What is DOGE, and what does it stand for? 

A: DOGE stands for the Department of Government Efficiency.

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Chapter 26 - Saving, investment, and the financial system 

Financial markets:

• Savers providing funds to borrowers

• Bond market - certificate of indebtedness from government

• Stock Market - claim to partial ownership in a firm, equity 

These methods are risky and even slightly inefficient