ECO403 Handouts Lectures 1-45

LESSON 01 · INTRODUCTION TO MACROECONOMICS · COURSE DESCRIPTION

There are two major branches in economics:  Microeconomics  Macroeconomics

MACROECONOMICS

Macroeconomics provides a framework for the study of the determinants & movements of such key economic variables as unemployment, inflation, interest rates, exchange rate, productivity and growth, government budget deficit/surplus, foreign trade deficit etc. In Macroeconomics, we study the likely response of key economic variables to such public policies as fiscal policy, monetary policy, trade policies etc.

OBJECTIVE

The objective of studying macroeconomics is to:

•  Help you learn how the national economy works.
•  Enable you to understand such issues as: Why key economic variables are at their present levels? What may be the likely future paths of these variables? Causes and consequences of recessions, inflation, etc. What the government can do about these problems? Side effects of government actions. Pros and cons of free trade versus trade restrictions.

OUTLINE OF THIS COURSE

Introduction Scope of Macroeconomics Macroeconomic data and its measurement The Economy in the Long Run National Income Economic Growth

Money and Inflation Open Economy The Economy in the Short Run Economic Fluctuations Aggregate Demand Aggregate Supply Govt. Debt and Budget Deficits Microeconomic Foundations Consumption Investment Money supply and demand

ECONOMY

The word economy comes from a Greek word for “one who manages a household.”

TEN PRINCIPLES OF ECONOMICS

A household and an economy face many decisions like: Who will work? What goods and how many of them should be produced? What resources should be used in production? At what price should the goods be sold?

SOCIETY AND SCARCE RESOURCES

•  The management of society’s resources is important because resources are scarce.
•  Scarcity means that society has limited resources and therefore cannot produce all the goods and services people wish to have.

ECONOMICS IS THE STUDY OF HOW SOCIETY MANAGES ITS SCARCE RESOURCES How people make decisions?

The cost of something is what you give up to get it.

How people interact with each other?

Markets are usually a good way to organize economic activity. Governments can sometimes improve economic outcomes. The forces and trends that affect how the economy as a whole works.

Society faces a short-run tradeoff between inflation and unemployment.

LESSON 02 · PRINCIPLES OF MACROECONOMICS · PRINCIPLE #1

“There is no such thing as a free lunch!” To get one thing, we usually have to give up another thing e-g guns vs. butter, food vs. clothing, leisure time vs. work, efficiency vs. equity. Making decisions requires trading off one goal against another.

Efficiency vs. Equity

•  Efficiency means society gets the most that it can from its scarce resources.
•  Equity means the benefits of those resources are distributed fairly among the members of society.

PRINCIPLE #2

COST OF SOMETHING IS WHAT YOU GIVE UP TO GET IT

Decisions require comparing costs and benefits of alternatives e-g

•  Whether to go to college or to work?
•  Whether to study or go out on a date?
•  Whether to go to class or sleep in?

The opportunity cost of an item is what you give up to obtain that item.

PRINCIPLE #3

Marginal changes are small, incremental adjustments to an existing plan of action. People make decisions by comparing costs and benefits at the margin.

PRINCIPLE #4

Marginal changes in costs or benefits motivate people to respond. The decision to choose one alternative over another occurs when that alternative’s marginal benefits exceed its marginal costs!

PRINCIPLE #5

People gain from their ability to trade with one another. Competition results in gains from trading. Trade allows people to specialize in what they do best.

PRINCIPLE #6

MARKETS ARE A GOOD WAY TO ORGANIZE ECONOMIC ACTIVITY

A market economy is an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services e-g

•  Households decide what to buy and who to work for.
•  Firms decide who to hire and what to produce.

Adam Smith made the observation that households and firms interacting in markets act as if guided by an “invisible hand.” Because households and firms look at prices when deciding what to buy and sell, they unknowingly take into account the social costs of their actions. As a result, prices guide decision makers to reach outcomes that tend to maximize the welfare of society as a whole.

PRINCIPLE #7

GOVERNMENTS CAN SOMETIMES IMPROVE MARKET OUTCOMES

Market failure occurs when the market fails to allocate resources efficiently. When the market fails (breaks down) government can intervene to promote efficiency and equity. Market failure may be caused by: