Principles of Macroeconomics

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Principles of Macroeconomics

ECON203, (EA)Lecture 1: IntroductionInstructor: Turki Abalala

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Class Outline Key tools and Terms of Economics:

• Economics, microeconomics and macroeconomics.

• Economic Problem: Scarcity and Choice.

• Two Big Economic Questions.

• Goods and Services.

Circular-Flow Model

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Key Tools & Terms of Economics

Economics?

• A social science that studies how people use their scarce resources to satisfy their unlimited wants.

• It has tow major branches: Microeconomics and Macroeconomics.

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1. Microeconomics:

The study of choices that individuals and business make and the way they choices interact in markets and are influenced by governments.

2. Macroeconomics: The study of the aggregate effects on the national economy and the global economy of the choices that individuals , business and governments make.

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• Economic Problem:– Basic economic problem is wants are virtually unlimited

while the resources available to satisfy these wants are scarce.

• Scarcity:– Our inability to satisfy all our wants.– Human and property resources are scarce, hence the

goods and services we produce must be limited.• Choices:– The poor and rich alike face scarcity, so they must MAKE

CHOICES.

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Two Big Economic Questions

Q1. How choices determine what, how, and for whom goods and services get produced?

Q2. When do choices made in self-interest also promote the social interest ?

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What Do We Produce?

We divide the vast array of goods and services produced into:

• Consumption goods and services

• Capital goods

• Government goods and services

• Export goods and services

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• Consumption goods and services

Goods and services that are bought by individuals and used to provide personal enjoyment and contribute to a person’s standard of living.

• Capital goods

Goods that are bought by businesses to increase their productive resources.

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• Government goods and services

Goods and services that are bought by governments. Examples are missiles, bridges, and police protection.

• Export goods and services

Goods and services produced in one country and sold in other countries. Examples are airplanes produced by Boeing and Citicorp banking services sold to China.

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How Do We Produce?

Factors of productions are the productive resources used to produce goods and services. Factors of production are grouped into four categories:

• Land

• Labor

• Capital

• Entrepreneurship

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• Land

It does not refer only a plots of ground but also includes all other natural resources such as crude oil, water, air, and minerals etc.

• Labor

It is not simply the number of human bodies but it refers to the work time and work effort that people devote to producing goods and services. It categorized into two parts– physical and mental.

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• CapitalIn economics the term capital refers to final goods produced for use in further production. It also categorized into two parts. These are:

Physical capital: factories, machines, tools, buildings, airports, highways and other manufactured items employed to produce goods and services.

Human capital: consists of the knowledge and skill people acquire to enhance their labor productivity.

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• Entrepreneurial Ability:

• Special kind of human skill

• Talent required to dream up a new product or find a better way to produce an existing one.

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For Whom Do We Produce?

Factors of production are paid incomes:

• Rent Income paid for the use of land.

• Wages Income paid for the services of labor.

• Interest Income paid for the use of capital.

• Profit (or loss) Income earned by an entrepreneur for running a business.

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Choices made in self-interest also promote the social interest?

• Choices that are the best for the individuals who makes them are choices made in the pursuit of self-interest

• Choices that are the best for society as a whole are said to be in the social interest

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Goods and Services: Goods are:• Tangible items• Require scarce resources• Satisfy human wants

Services are:• Intangible items• Require scarce resources• Satisfy human wants

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Circular-Flow Model

Circular-Flow Model is a model of the economy that shows the

circular flow of expenditure and income that result from decision

makers’ choices and the way those choices interact to determine

what, how and for whom goods and services are produced.

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Circular-Flow Model Households: Individuals and group of people living together.

They own the factors of production.• As owners, they supply labor, capital, land, and

entrepreneurship to firms.• As consumers, households demand the goods and services

produced. Firms: Institutions that organize the production of goods and

services.• Demand the factors of production.• Supply the goods and services.

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Circular-Flow Model Markets: Any arrangement that bring buyers and sellers

together and enable them to get information and do business with each other.

• Goods markets: Markets in which goods and services are exchanged (bought and sold).

• Factors Markets: Markets in which the services of factors of production are exchanged (bought and sold). Labor, or job, market is the most important of the resource markets.

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Households supply resources in the factor markets and demand goods and services in the goods market.

Firms supply goods and services in goods market and demand resources in the factor market

Money flows in factor market determines wages (labor), interest (capital), rents (land), and profits (entrepreneurship) which flow as income to households

Factor markets determine the prices for goods and services which flow as revenue to firms

Circular-Flow Model

Rent, wages, interest, and profit

Expenditure on goods and services

Goods and services bought

Goods and services supplied

supplied

Labor, land, capital, entrepreneurship hired

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Circular-Flow Model Real Flows:

• The services of factors of production that go from households through factor markets to firms.

• The goods and services that go from firms through goods markets to households.

Money Flows:

• The income earned by the factors of production.

• The expenditure on goods and services.

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Circular-Flow Model Governments

Governments are divided into two broad levels:

• Federal Government

• State and local government

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Circular-Flow Model Federal Government

The federal government’s major expenditures are to provide

1. Goods and services (including legal system and national defense).

2. Social Security and welfare benefits (including income for retired people and transfers to households)

3. Transfers to state and local governments

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Circular-Flow Model The federal government finances its expenditures by

collecting taxes. The main taxes are

• 1. Personal income taxes

• 2. Corporate (business) taxes

• 3. Social Security taxes

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Circular-Flow Model State and Local Governments

State and local governments expenditures provide

1. Goods and services (including police, schools, roads…etc)

2. Welfare benefits (including unemployment benefits)

State and local governments finance these expenditures by collecting taxes. The main taxes levied are

3. Sales taxes

4. Property taxes

5. State income taxes

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Circular-Flow Model Governments In the Circular Flow• Households and firms pay

taxes and receive transfers. • Governments buy goods

and services from firms.

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Reference

• Chapter 1-3 “Foundations of Macroeconomics”: for circular-flow model see pages.48-51

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Now it’s over for today.

Any question?

Documents

Principles of Macroeconomics