Exam 2 Chapters 4-7

Notes

MARKETS

• Market

  • A group of economic agents that trade goods and services and their rules for trading

• This chapter explains how markets allocate prices to goods and services

• Market price

  • All sellers and buyers face the same price

• Perfectly competitive markets

  • Sellers sell an identical good or service

  • An individual agent (buyer/seller) cannot influence market price

  • Buyers and sellers are price takers

BUYER BEHAVIOR

• Demand

  • Quantity demanded

    • The amount that buyers or sellers are willing to buy at a certain price

  • Demand schedule

    • A table of the quantity demanded at various prices

  • Demand curve

    • Graph relationship between prices and quantity demanded

    • Does not have to be a straight line

  • Law of demand

    • Price and quantity are negatively related

    • The quantity demanded rises when price falls

  • All this is assuming that all else is held equal or constant, or that other factors are not changing (which we know they are in reality but simplify it for models)

  • Excess demand

    • Consumers want more than suppliers can provide

  • Excess supply

    • Suppliers provide more than consumer want at a given price

• Willingness to pay

  • The highest price that a buyer is willing to pay is also known as the reserve price

  • Diminishing marginal benefit states that your willingness to pay decreases for each additional unit as you consume more of a good

• Individual to Aggregate

  • Can be aggregated individually or for an entire market

  • Price stays fixed while you add quantities demanded

• Shifting demand

  • Demand shifts due to changes in

    • Tastes and preferences

      • Movement of curve vs movement along curve

      • Movement of curve indicates change in quantity demanded

      • Movement along curve indicates change in price

    • Income and wealth

    • Availability and prices of related goods

    • Number and scale of buyers

    • Buyer beliefs about the future

SELLER BEHAVIOR

• How do sellers behave

• Willingness to accept

  • The lowest price that a seller is willing to get paid to sell an extra unit of a good

• Market supply curve

  • Plots the relationship between total quantity supplied and market price

  • Sum of individual supply curves of firms

  • Shifts

    • Prices of inputs used to produce a good

    • Technology used to produce a good or service

    • Number and scale of sellers

    • Sellers beliefs about the future

    • Quantity supplied changes at a given price

    • Changes in price of the good itself causes movement along the curve

EQUILIBRIUM

• Where supply and demand curves cross

• Quantity demanded is equal to the quantity supplied

• Excess supply results in a surplus

• Excess demand results in a shortage

• Sometimes both curves shift at the same time

• There are many possible combinations of shifts

• Price caps tend to result in shortages

Practice Questions

MACROECONOMIC QUESTIONS 

• Macroeconomic analysis uses past patterns to try to predict future changes in aggregate economic activity 

• Income per capita 

  • Average income per person 

• Government policies can augment patterns of economic growth

• Unemployment 

  • Unemployed 

    • He or she does not have a job, is actively available for work, and has looked for work in the past 4 weeks 

    • The unemployment rate fluctuates from month to month and quarter to quarter 

• National income accounts

  • Measure the level of aggregate economic activity in a country 

• National income and product accounts

  • The system of national income accounts used by the US government 

NATIONAL INCOME ACCOUNTS

• Production = expenditure = income 

  • This is an identity 

  • The variables are related so that they are mathematically identical

• Gross domestic product 

  • The market value of final goods and services produced in a country within a given time 

  • Components to make a final product are not counted separately 

  • Goods in inventory are part of this measurement 

• Expenditure 

  • Tot total amount of money spent on goods and services produced within an economy during a specific time period

  • Represents payments for goods and services 

• Circular Flows

  • Factors of production 

    • Inputs to the production process; primarily capital (phiscal goods) and labor

  • Firms demand labor and capital. Households supply this labor and capital

  • Firms supply services and products that households demand.

  • Does not account for factors such as international trade patterns

• Income 

  • Represents the payments made from firms to households for their labor and capital

• Production based accounts measure the firms value added 

• Value added 

  • Firms sales revenue minus the firms purchases of intermediate goods from other firms

• The ability for firms to mark up prices comes from the value it addes through indirect services like reputation and convenience 

• Adding up the value of all firms by a country will sum its GDP

• Exports

  • Market value of all domestically produced goods that are sold to households and firms both domestically and internationally

• Imports

  • Total market value of all foreign goods and services that are sold to domestic markets 

• GDP formula 

  • Y = c + i + g + x - m

  • Total expenditure of domestic economic agents, plus the expenditure of foreign agents on exports from the domestic economy, minus the value of expenditure imported 

WHAT DOESN'T GDP MEASURE?

• Home Production 

  • Includes domestic work such as cleaning and childcare 

  • Home production in the US is estimated within the $3.5-$4 trillion range 

• The Underground Economy 

  • Can include illegal activities and professions

  • Can also include legal activities that are paid under the table 

  • Illegal drug sales are estimated at 1 percent of total US GDP

• Externalities

  • Both positive and negative ones are usually omitted from GDP calculations 

  • Negative externalities can lead to positive contributions to economic output 

• GDP vs GNP 

  • Gross national product includes the production of workers who normally resides in the US even though they may be working abroad 

  • Measures all production owned by a specific country 

              Gross national product=(Gross domestic product) = 

     +(Production of U.S.-owned capital and labor in foreign countries)

          −(Production of foreign-owned capital and labor in the United States)

• For some countries GNP and GDP vary widely 

• Increase in Income Inequality 

  • GDP does not measure how economic output is divided up among individual households

  • Two countries can have similar GDP but differing levels of wealth inequality 

  • High levels of inequality can create political unrest 

• Leisure

  • Does Not include whether all this is being done to optimize happiness/quality of life 

REAL VS NOMINAL 

• Real 

  • Uses prices from a base year that may be different from the year the quantities were produced 

  • More talked about in the news/daily life 

  • Includes things households didnt purchase 

• Nominal 

  • Market value of production using current prices to determine value per unit produced 

• The Consumer Price Index

  • 100 times the ratio of the consumer basket fog goods 

  • Studies a particular basket of consumer goods

  • Includes things that households purchase but are not counted in GDP 

  • Has more relevance for the personal consumer 

• Inflation 

  • Inflation rate is the rate of increases in prices 

  • Calculated as year over year percentage change in pricing index 

• Adjusting Nominal Variables 

  • Helps when making meaningful comparisons across time 

  • For example, how much money is worth changes over time so buying power needs to be taken into account 

Objective: 

• Convert income per person in different countries to a single currency to allow for comparison 

• Answer the question if the average person in the US is wealthier than China 

INEQUALITY AROUND THE WORLD 

• Income per capita = gdp per capita = (gdp / total population) 

  • This number results in average income per person 

• Exchange rate based measure

  • GDP’s can be converted into a single currency to be compared across countries 

  • Prices of goods can vary across countries 

• Purchasing power parity measure

  • The purchasing power parity (PPP) constructs the cost of a representative basket of commodities in each country and uses these relative costs for comparing income across countries.

  • Takes into account the relative changes in price of goods and services between countries 

  • Think of the big mac index, comparing the prices of big macs across the world 

• Gdp per capita varies across countries 

• GDP per worker 

  • Gdp / number of people in employment 

  • Tends to be higher than GDP per capita because not everyone is in the workforce 

• Productivity 

  • Value of goods and services generated per hour of work 

  • Labor may be more productive in some countries than others 

• All this data doesnt take into account other factors of living standards like education, healthcare, public safety, etc 

• One dollar a day per person poverty line 

• Poverty often brings poor health 

• HDI, or human development index, tries to provide a more holistic measure of the standard of living 

PRODUCTIVITY AND THE AGGREGATE PRODUCTION FUNCTION 

• Human capital

  • Each persons stock of skills to produce output/economic value 

• Physical capital 

  • machines/buildings used for production

  •  typically expressed in a dollar value

  • Physical capital stock is the aggregate measure in the economy

    • The larger the capital stock the more productive each worker can be 

• Technology 

  • devices/practices that determine efficiency of production 

• Aggregate production function 

  • Used to understand how GDP is determined

  • Explains why productivity varies across countries

  • Factors of production include land, capital, and technology 

  • H = L * h 

  • Labor = H

  • Capital/land = K

  • Technology = A 

  • Y = (A)(F(K, H)) 

    • Gdp is equal to the index of technology times the function of physical capital and labor

• Law of diminishing marginal product

  • Marginal contribution of a factor of production to GDP diminishes when we increase the quantity used of that factor of production 

  • The contribution of the factor of production to GDP gets smaller as you use more of it in the overall gdp 

THE ROLE THAT DETERMINANTS OF TECHNOLOGY

• When technology improves, it shifts the production curve outwards as there is more production possibilities

• Components of technology 

  • Knowledge

  • Efficiency 

• Research and development 

  • Research directed at finding new ways of using or applying technology and commercializing it into existing knowledge and products 

• Efficiency of production 

  • A society can produce a maximal amount of output at a given cost to current knowledge and factors of production levels 

• Greater values for A correspond with better technology, which increases gdp

• Entrepreneurship can be considered another factor of production 

  • Failure decreases economic efficiency

THE POWER OF ECONOMIC GROWTH

• As a result of the continued economic growth depicted in Exhibit 7.1, US real GDP per capita and standards of living are much higher today than they were in 1820

• Growth rate

  • Change in quantity (real GDP per capita) between two dates, relative to the baseline (beginning of the period) quantity

  • Formula 

    • Economic growth = (gdp2-gdp1) / gdp1

  • Economic fluctuations may also be visible in a GDP over time graph 

• Exponential growth 

  • The process by which a quantity grows at an approximately constant growth rate 

  • Exponential nature of growth explains GDP differences across countries 

  • A one percent difference in growth rates result in a more than seven fold difference due to rules of exponential growth 

  • Occurs because new growth builds on past growth and its affects compound 

• Growth patterns

  • GDP per capita has increased significantly in countries like the US, UK, and France since 1960 keeping growth rates relatively steady around 2 percent 

  • Things like wars and political instability can cause slowdowns or negative growth 

  • The growth of gdp across the glob remains normally distributed with most growth occurring between the 2-3% rate 

  • Patterns can be tracked using historical data and analysis 

• Catch up growth 

  • Nations are catching up with the technology and income of world leaders like the United States 

  • Technology can be a main factor in this catch up growth 

• Sustained growth 

  • Steady growth over long periods of time 

HOW DOES AN ECONOMY GROW

• Aggregate factors of production can affect economic growth 

  • An increase in capital 

  • Improvement in technology 

  • increasing the human capital of workers 

• Gdp is divided between consumption and investment

• All resources that households save will be allocated to firms that use them for investment 

  • High savings can increase gdp 

• Optimization occurs here when individuals and households choose what to do with their resources 

  • Different households do different things based on their needs 

• Saving rate 

  • Designates the fraction of income that is saved 

  • Saving rate = total saving / gdp (given as a decimal/percentage) 

• Sustained growth is obtained by combining increases in physical capital and human capital with technology 

• Technological change 

  • Process of new technologies and new goods and services being invented and used in the economy 

  • Enables higher level of gdp for given factors of production 

  • Also follows an exponential pattern 

  • Built from past technological innovations 

HISTORY OF GROWTH & TECHNOLOGY

• Period before 1800 lacks sustained growth 

  • Lack of technology 

  • However some economics like those of larger societies (greece, rome, venice when it became a trading port) 

  • However, this is also hard to prove due to limited data from these times 

• The industrial revolution created the technological progress necessary for sustained growth 

  • People moved from farm work and agriculture to work in the cities 

  • Manufacturing led to a drop in fertility rates 

• Recently, there have been dramatic changes in computers, transportation, communications, and electricity that has also helped to create sustained growth 

• Malthusian limits to growth 

  • Fertility adjusts so that income always remains close to a subsistence level 

  • Increased aggregate income would raise real GDP per capita down toward or below the subsistence level, fueling population growth 

  • That growth puts strain on resources and reduces GDP back to its initial level 

• Modern growth 

  • is enabled by transition to cities, as reliance on child labor went down 

  • Also helped by increased research and development activity to improve our collective knowledge base 

GROWTH, INEQUALITY, AND POVERTY 

• The relationship between GDP per capita and poverty is negative 

  • Increases in GDP per capita result in lower rates of poverty 

• The fact an economy is growing does not necessarily imply that all citizens are benefiting from that growth 

• Ways of reducing poverty 

  • International trade 

  • Improving overall technology and knowledge 

  • While many policies have worked, they have had downsides or some have not worked at all 

  • Advancements in technology has made it easier for poorer people to access more and more services they may not have before