Macroeconomics

Chapter 1

v People Face Tradeoffs

Ø There is no such thing as a free lunch!

Ø Every choice has a tradeoff. These can range from the government tradeoff between national defense and consumer goods (guns vs. butter) to your tradeoff between sleeping and attending class.

Ø Frequently we encounter a tradeoff between efficiency and equity

v The Cost of Something is What You Give Up to Get IT

Ø Making good decisions means knowing the full costs, including the opportunity costs, of making one choice over another.

Ø What is an opportunity cost? Can you cite examples in your life?

v Rational People Think at the Margin

Ø How does a small incremental adjustment or a marginal change affect your existing plan?

Ø Why should we ignore the costs or benefits that occurred in the past?

v People Respond to Incentives

Ø When marginal benefits or marginal costs change your incentives will change.

Ø Provide some examples where your incentives have changed

v Trade Can Make Everyone Better Off

Ø Even though there is competition among consumers and among producers in different countries, countries can benefit from specializing in what they do best and trade with each other.

v Markets are Usually a Good Way to Organize Economic Activity

Ø Compare the planned economy of the former Soviet Union to the market economy of the United States

Ø Adam Smith explained this invisible hand in 1776, The Wealth of Nations.

§ When household and firms do what is best for themselves, they end up doing what is best for society, as if guided by an invisible hand or market forces

Ø When the government interferes with markets by changing prices through taxation or price controls, the invisible fails and resources are not allocated in the best possible way. That is social welfare is not maximized when the government interferes.

v Governments can sometimes improve market outcomes

Ø There are two reasons for government intervention: to change the (i) Efficiency, the size of the economic pie or (ii) Equity, how the economic pie is divided.

Ø Sometimes the invisible hand fails. Markets can fail to allocate resources efficiently if the economy has externalities or an economic player has market power.

v A country’s standard of living depends on its ability to produce goods and services

Ø Differences in standard of living in nations around the world can be attributed to differences in productivity.

Ø What is productivity?

Ø How can the government use public policy to change productivity?

v Prices Rise when the Government Prints Too Much Money

Ø Examples: The German Hyperinflation and the inflation of Latin America and South America

Ø What is inflation?

v Society Faces a Short-Run Tradeoff Between Inflation and Unemployment

Ø Reducing inflation is often thought to cause a rise in unemployment.

Ø Are there public policy implications based on the tradeoff? How does the structures of the US affect your answer?

Chapter 2

Chapter 3

Chapter 10

Measuring a Nation's Income

1. National Income Accounting:

            National income accounts are an accounting framework useful in measuring economic activity.

1. Three approaches--all produce the same measurement of the production of the economy.
   • Product approach: how much is produced.
   • Income approach: how much is created by production.
   • Expenditure approach: how much purchasers spend.
2. Why are all three approaches the same:  We assume no unsold goods (at this point) then the market value if goods and services must equal the amount buyers spend to purchase them. (production =expenditure)  What the sell receives (income) must equal to what is spent (expenditure).

2. Gross Domestic Product

• GDP vs. GNP

    GNP=output produced by domestically owned factors of production.

    GDP=ouput produced with the borders of a country

The market value if a final goods and services produced within a country in a given time period

•     market value: allows comparisons between different goods.  Has some problems--ignores some goods, underground economy,
•     Final
•     G&S
•     Within a Country
•      Time Period

Chapter 11

Consumer Price Index

• how the consumer price index (CPI) is constructed.

1. The consumer price index shows the cost of a basket of goods and services relative to the cost of the same basket in the base year. The index is used to measure the overall level of prices in the economy. The percentage change in the price level measures the inflation rate.
2. The consumer price index is an imperfect measure of the cost of living for three reasons. First, it does not take into account consumers’ ability to substitute toward goods that become relatively cheaper over time. Second, it does not take into account increases in the purchasing power of a dollar due to the introduction of new goods. Third, it is distorted by unmeasured changes in the quality of goods and services. Because of these measurement problems, the CPI overstates annual inflation by about 1 percentage point.
3. Although the GDP deflator also measures the overall level of prices in the economy, it differs from the consumer price index because it includes goods and services produced rather than goods and services consumed. As a result, imported goods affect the consumer price index but not the GDP deflator. In addition, while the consumer price index uses a fixed basket of goods, the GDP deflator automatically changes the group of goods and services over time as the composition of GDP changes.
4. Dollar figures from different points in time do not represent a valid comparison of purchasing power. To compare a dollar figure from the past to a dollar figure today, the older figure should be inflated using a price index.
5. Various laws and private contracts use price indexes to correct for the effects of inflation. The tax laws, however, are only partially indexed for inflation.
6. A correction for inflation is especially important when looking at data on interest rates. The nominal interest rate is the interest rate usually reported; it is the rate at which the number of dollars in a savings account increases over time. By contrast, the real interest rate takes into account changes in the value of the dollar over time. The real interest rate equals the nominal interest rate minus the rate of inflation.

How to calculate the CPI

1. Fix the basket.

a. The Bureau of Labor Statistics uses surveys to determine a representative bundle of goods and services purchased by a typical consumer.

b. Example: 100 hot dogs and 50 hamburgers.

2. Find the prices.

a. Prices for each of the goods and services in the basket must be determined for each time period.

b. Example:

 

Year	Price of Hot Dogs	Price of Hamburgers
2001	$1	$2
2002	$2	$3
2003	$3	$4

3. Compute the basket’s cost.

a. By keeping the basket the same, only prices are being allowed change. This allows us to isolate the effects of price changes over time.

b. Example:

Cost in 2001 = ($1 × 100) + ($2 × 50) = $200.

Cost in 2002 = ($2 × 100) + ($3 × 50) = $350.

Cost in 2003 = ($3 × 100) + ($4 × 50) = $500.

4. Choose a base year and compute the index.

a. The base year is the benchmark against which other years are compared.

b. The formula for calculating the price index is:

5. Compute the inflation rate.

a. Definition of Inflation Rate: the percentage change in the price index from the preceding period.

Chapter 4

Does that mean you need to memorize all of the factors? No!   I will not ask you to list them.  However, if I state that one on the factors has changed, you should know whether supply of demand has changed and in which direction.