Principles of MacroEconomics: Econ101

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Economics: Studies the choices that can be made when there is scarcity.

Scarcity: Is a situation in which resources are limited in quantity and can be used in different ways.

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Because our resources are limited, we must sacrifice one thing for another…………….

Trade-Offs:

The idea that because of scarcity, producing more of one good or service, means producing less of another good or service.

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Natural Resources: Land, mineral deposits, oil & gas deposits, water.

Labor

Physical Capital: Equipment, machines, structures, infrastructure

Human Capital: Knowledge & skills acquired through education & experience

Entrepreneurship: The effort used to coordinate the factors of production.

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Economic decisions are made at every level in society.

The choices made by individuals, firms, and governments answer three fundamental questions:

1. What goods & services will be produced?

2. How will the goods & services be produced?

3. Who will receive the goods and services produced?

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Three Important Assumptions in Economics:

People are Rational

People Respond to Economic Incentives

Optimal Decisions are made at the Margin

Marginal Analysis: Analysis that involves comparing marginal benefits

to marginal costs.

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Microeconomics:

The study of the choices made by households, firms, and government, and of how these choices affect the markets for goods or services.

We Can Use Microeconomic Analysis to:

Understand how markets work and predict changes

Make personal and managerial decisions

Evaluate public policies

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Macroeconomics:

The study of the nation’s economy as a whole.

We can use macroeconomic analysis to:

Understand why economies grow.

Understand economic fluctuations.

Make informed business decisions.

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Centrally planned economy: An economy in which the government decides how economic resources will be allocated.

Market economy: An economy in which the decisions of households and firms interacting in markets allocate economic resources.

Mixed economy: An economy in which most economic decisions result from the interaction of buyers and sellers in markets, but where the government plays a significant role in the allocation of resources.

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Positive Analysis / Economics: Predicts the consequences of alternative actions, answering the questions, “What is?” or “What will be?”

Normative Analysis / Economics: Answers the question, What ought to or should be? Normative questions lie at the heart of policy debates.

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Positive Analysis Questions: If the government increases the minimum wage, how many workers will lose

their jobs?

If two cable companies merge, will the cost of monthly cable services increase?

How do consumers respond to a cut in income taxes?

How does a college education affect a person’s productivity & earnings?

Normative Analysis Questions: Should the government increase the minimum wage?

Should the government block the merger of two cable giants?

Should the government cut taxes to stimulate the economy?

Should the government subsidize a college education?

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Economic Model: A simplified version of some aspect of economic life used to analyze an economic issue.

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Plotting Price and QuantityPoints in a Graph

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Graphing the Direct Relationship between Income and

Consumption Spending

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Showing a Firm’s TotalRevenue on a Graph

height x base rectanglea ofArea

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Principle of Opportunity Cost:

The highest valued alternative that must be given up in order to engage in an activity.

The opportunity cost of something is what you sacrifice to get it.

Most decisions involve several alternatives. The principle of opportunity cost incorporates the notion of scarcity.

There is no such thing as a free lunch.

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Production Possibilities Frontier: A curve showing all the attainable combinations of two products that may be produced with available resources. Illustrates the principle of opportunity cost for an entire economy.

The ability of an economy to produce goods and services is determined by its factors of production, including labor, land, and capital.

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Scarcity is represented by the frontier or curve. The shaded area within the frontier, shows all the possible combinations of the two goods that can be produced.

Economic Efficiency is represented as any point on the frontier that show the combinations of production that fully employ the economy’s resources.

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The notion of trade-offs is represented as we move downward along the curve, we must sacrifice more manufactured goods to get the same 10-ton increase in agricultural goods.

The curve is bowed outwards because resources are not perfectly adaptable for the production of both goods.

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As the economy moves down the production possibilities frontier, it experiences increasing marginal

opportunity costs because increasing automobile production by a given quantity requires larger

and larger decreases in aircraft carrier production.

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Economic growth is represented by an outward shift of the frontier and the ability of the economy to produce increasing quantities of goods and services.

An increase in the amount of resources available, or a technological innovation, causes the production possibilities to shift outward, allowing us to produce more output with a given quantity of resources.

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When we say marginal, we’re looking at the effect of only a small, incremental change.

The marginal benefit of some activity is the extra benefit resulting from a small increase in the activity.

The marginal cost is the additional cost resulting from a small increase in the activity.

Thinking at the margin enables us to fine-tune our decisions.

Therefore……

Increase the level of an activity if its marginal benefit exceeds its marginal cost; reduce the level of an activity if its marginal cost exceeds its marginal benefit. If possible,

pick the level at which the activity’s marginal benefit equals its marginal cost.

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Number of Movies

Marginal Benefit

Marginal Cost

1 $300 million $125 million

2 $210 million $150 million

3 $135 million $175 million

The marginal benefit exceeds the marginal cost for the first two movies, so it is sensible to produce two, but not three movies.

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Principle of Voluntary Exchange:A voluntary exchange between two people makes both people better off.

A market is an arrangement that allows people to exchange things.

If participation in a market is voluntary, both the buyer and the seller must be better off as a result of a transaction.

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