Macroeconomics

Krugman & Wells

Introduction

Alfred Marshall, who described economics as a study of the

"ordinary business of life”

- Economy: is a system for coordinating society's productive activities

and consumption activities ( leisure times, watching movies).ex.
communist, capitalism, socialism.
- Economics: is the study of economies, at the level both of individuals
and of society as a whole.
o Economist study people who make choices
o How those scarce resources ( like steel) are allocated among
competing ends.
o Science of choice
- Market Economy (capital free capitalized system): is an economy
in which decisions about production and consumption are made by
individual producers and consumers. (are able to coordinate even
highly complex activities and to reliably provide consumers with the
goods and services they want)
- Command economy: in which there is a central authority making
decisions about production and consumption. (mostly used in Soviet
Union, but didn’t work because they did not have crucial raw materials,
or they succeeded in producing but then found that nobody wanted
their products)
- The invisible hand refers to the way in which the individual pursuit of
self-interest can lead to good results for society.
- Microeconomics is the branch of economics that studies how people
make decisions and how these decisions interact. (One of the key
themes in microeconomics is the validity of Adam Smith's insight:
Individuals pursuing their own interests often do promote the interests
of society as a whole)
- Market Failure: When the individual pursuit of self-interest leads to
bad results for society as a whole.
- A recession: is the downturn the economy. (The US. economy
experienced serious recessions beginning in 1973, 1980, 1981, 1990,
and 2001.
- Macroeconomics is the branch of economics that is concerned with
overall ups and downs in the economy. (you will learn how economists
 explain recessions and how government policies can be used to
minimize the damage from economic fluctuations.)
- Economic growth is the growing ability of the economy produce
goods and services. (extreme poverty in the beginning of the American
period Economic growth is the growing ability of the economy produce
goods and services.)

CHAPTER 1 - FIRST PRINCIPLES:

Principles that Underlie Individual Choice: The Core of Economics:

 every economic issue involves individual choice

o individual choice → the decision by an individual of what to do,
which necessarily involves a decision of what not to do
 Principle #1: Choices are Necessary Because Resources are
Scarce
o People must make choices because resources are scarce.
o resource → anything that can be used to produce something
else
 ex. land, labor (the time of workers), capital (machinery,
buildings, other man-made productive assets), human
capital (educational achievements and skills of workers)
 scarce resource → where there is not enough of the
resource available to satisfy all various ways a society
wants to use them
 ex. natural resources (minerals, lumber, petroleum),
human resources (labor skill, intelligence), clean air
and water
o one way a society in a market economy makes choices is by
allowing them to emerge as the result of many individual choices
 Principle #2: The True Cost of Something is Its Opportunity
Cost
o opportunity cost → the real cost of an item; what you must give
up in order get an item
o The opportunity cost of an item - what you must give up in order
to get it – is its true cost.
o all costs are opportunity costs
o the opportunity cost of a choice is what you forgo by not
choosing your next best alternative
 o sometimes the money you have to pay for something can be a
good indication of its opportunity cost, but not always

economic system (murderer) – communism (rejecting the economic

framework or political strictures that goes with fascism, communism,
socialism, etc.)

homicide - a person killing another person

matricide – sibling killing their mother

democide – killing government

 Principle #3: “How Much” is a Decision at the Margin

o trade-off → a comparison of the costs and benefits of doing
something
o marginal decisions → decisions about whether to do a bit more or
a bit less of an activity
o “How much” decisions require making trade-offs at the margin:
comparing the costs and benefits of doing a little bit more of an
activity versus doing a little bit less.
o marginal analysis → the study of marginal decisions
o ex. How many minutes should I exercise? How many workers
should I hire? What is an acceptable rate of negative side effects
from a new medicine?
 Principle #4: People Usually Respond to Incentives, Exploiting
Opportunities to Make Themselves Better Off
o incentive → anything that offers rewards to people to change
their behavior
o can be characterized as a negative too (work hard by
whipping-slavery); usually incentives are seen as positives
o People usually respond to incentives, exploiting
opportunities to make themselves better off.
o individuals will continue to exploit opportunities to make
themselves better off until they have been fully exhausted
o the principle that people will exploit opportunities to make
themselves better off is the basis of all predictions by economists
about individual behavior
o economists tend to be skeptical of any attempt to change
behavior that doesn’t change incentives

Interaction: How Economies Work:

 economy → a system for coordinating the productive activities of
many people
 interaction of choices → each individual’s opportunities, and hence
choices, depend to a large extent on the choices made by other people
o a feature of most economic situations
o the results of this interaction are often quite different from what
the individuals intend
 Principle #5: There are Gains from Trade
o the key to a much better standard of living for everyone is trade
o trade → people divide tasks among themselves, and each
person provides goods and services to others and receives
goods and services in return
o economy exists because there are gains from trade
o gains from trade → people can get more of what they
want through trade than they could if they tried to be self-
sufficient
o There are gains from trade.
o gains from trade arise from specialization
o specialization → a situation in which different people
each engage in a different task, specializing in those tasks
that they are good at performing
o the economy as a whole can produce more when each person
specializes in a task and trades with others
 Principle #6: Markets Move Toward Equilibrium
o equilibrium → an economic situation in which no individual
would be better off doing something different
o Because people respond to incentives, markets move
toward equilibrium
o markets usually reach equilibrium via changes in prices, which
rise or fall until no opportunities for individuals to make
themselves better off remain
o any time there is a change, the situation will move to an
equilibrium
 Principle #7: Resources Should Be Used Efficiently to Achieve
Society’s Goals
o an economy’s resources are used efficiently when they are used
in a way that has fully exploited all opportunities to make
everyone better off
 o an economy is efficient if it takes all opportunities to make
some people better off without making other people worse
off
o when an economy is efficient, it is producing the maximum gains
from trade possible given the resources available
o Resources should be used as efficiently as possible to
achieve society’s goals.
o in most societies, people also care about issues of fairness or
equity
o equity → everyone gets his or her fair share
o Typically, a trade-off between equity and efficiency: policies that
promote equity often come at a cost of decreased efficiency in
the economy and vice versa
 Principle #8: Markets Usually Lead to Efficiency
o government doesn’t need to enforce the efficient use of
resources because in most cases the invisible hand does the job
o in a market economy, in which individuals are free to choose
what to consume and what to produce, people normally take
opportunities for mutual gain (gains from trade)
o Because people usually exploit gains from trade, markets
usually lead to efficiency.
o in cases of market failure, the individual pursuit of self-interest
found in markets makes society worse off
o the market outcome is inefficient
o markets are a remarkably good way of organizing an economy
 Principle #9: When Markets Don’t Achieve Efficiency,
Government Intervention Can Improve Society’s Welfare
o When markets don’t achieve efficiency, government
intervention can improve society’s welfare.
o When markets go wrong, an appropriately designed government
policy can sometimes move society closer to an efficient
outcome by changing how society’s resources are used

Economy-Wide Interactions:

 Principle #10: One Person’s Spending is Another Person’s

Income
o One person’s spending is another person’s income.
o In a market economy, people make a living selling things,
including their labor, to other people
 o If some group in the economy decides to spend more, the
income of other groups will rise; if some group decides to
spend less, the income of other groups will fall
o A chain reaction of changes in spending behavior tends to
have repercussions that spread through the economy
 Principle #11: Overall Spending Sometimes Gets Out of Line
with the Economy’s Productive Capacity
o Overall spending, the amount of goods and services that
consumers and businesses want to buy, sometimes doesn’t
match the amount of goods and services the economy is
capable of producing
o Shortfalls in spending are responsible for most, though not
all, recessions
o when overall spending is too high, the economy
experiences inflation
o inflation → a rise in prices throughout the economy
o Overall spending sometimes gets out of line with
the economy’s productive capacity.
 Principle #12: Government Policies Can Change Spending
o Government policies can change spending.
o Government spending, taxes, and control of money are the
tools of
o macroeconomic policy

CHAPTER 2 - ECONOMIC MODELS: TRADE-OFFS AND TRADE:

Models in Economics: Some Important Examples:

- model → a simplified representation of a real situation that is used to

better understand real-life situations
o allow us to hold everything else constant and study how one
change affects the overall economic outcome
o other things equal assumption ->> assumption that all other
relevant factors remain unchanged
 o ex. production possibility frontier, comparative advantage,
circular-flow diagram
o Finance theorists often become highly paid “rocket scientists”
- Trade-offs: The Production Possibility Frontier
o production possibility frontier (PPF) → illustrates the trade-
offs facing an economy that produces only two goods
 shows the maximum quantity of one good that can be
produced for any given quantity produced of the other
 points inside or on the PPF are FEASIBLE vs. points outside
the PPF are NOT FEASIBLE

o the PPF helps us understand some aspects of the real economy

better than we could without the model
 efficiency
 to be efficient, an economy must produce as much of
each good as it can give the production of other
goods (efficient in production) and it must also
produce the mix of goods that people want to
consume (efficient in allocation)
 opportunity cost
  PPF is a straight line if we assume that the
opportunity cost of an additional unit of a good
doesn't change regardless of the output mix
 slope of a straight-line PPF = opportunity cost
 opportunity costs can be constant or increasing
o in real life, typically increasing
 economic growth → an expansion of the economy's
production possibilities
 two sources of economic growth
o an increase in the economy's factors of
production
 factors of production → resources used
to produce goods and services
 land, labor, physical capital, human
capital
 progress in technology
 technology → the technical means for producing
goods and services

- Comparative Advantage and Gains from Trade

o a particularly useful model of gains from trade is trade based on

comparative advantage
 ex. opportunity cost of 1 small jet is 3/4 of a large jet
o two parties are better off when they each specialize in what they
are good at and trade
 comparative advantage → when a party's opportunity
cost of producing a good or service is lower than other
parties'
o two parties (countries, firms, individuals) will be willing to trade
only if the "price" of the good each party obtains in the trade is
less than its own opportunity cost of producing the good
themselves
o comparative advantage model provides a clear illustration of the
gains from trade
 through specialization and trade, both parties produce
more and consume more than if they were self-sufficient
o everyone has a comparative advantage in something, and
everyone has a comparative disadvantage in something
 o absolute advantage → when a country can produce more
output per worker
o comparative NOT absolute advantage is the basis for
mutual gain.
- Comparative Advantage and International Trade, in Reality
o economists have a positive view of international trade because
they view it in terms of comparative advantage
- Transactions: The Circular-Flow Diagram
o barter → trade where people directly exchange goods or
services they have for goods or services that they want (no
money involved)
o circular-flow diagram → diagram which represents the
transaction in an economy by flows around a circle
 2 kinds of flows
 flows of physical things (goods, services, labor, raw
materials)
 flows of money (pay for the physical things)
 2 kinds of inhabitants
 household→ a person or a group of people that
share their income
 firm → an organization that produces goods and
services for sale employs members of households
 2 kinds of markets
 markets for goods and services → firms sell
goods and services that they produce to households
o produces a flow of goods and services to
households and a return flow of money to firms
 factor markets → firms buy the resources they
need to produce goods and services
o the factor market best known is the labor
market where workers sell their services
o ultimately determine an economy's income
distribution → the way in which total income
is divided among the owners of the various
factors of production

Using Models

- Positive versus Normative Economics

o 2 roles of economic analysis
 positive economics → the branch of economic analysis
that describes the way the economy actually works
 description
 occupies most of the time and effort of the
economics profession forecast → a simple prediction
of the future
 ex. How much revenue will the tolls on the state
turnpike yield
 next year?
 ex. How much would that revenue increase if the toll
were raised from $1 to $1.50?
 normative economics → the branch of economic analysis
that makes prescriptions about the way the economy
should work
 prescription
 ex. Should the toll be raised, bearing in mind that a
toll increase will reduce traffic and air pollution near
the road but will impose some financial hardship on
frequent commuters?
o models are especially useful for answering "what if" questions
- When and Why Economists Disagree
o media coverage tends to exaggerate the real differences in
views among economists
o economics is unavoidably often tied up in politics
o sources of differences
 values
 economic modeling

Notes from class

Questions:

CHAPTER 3 - SUPPLY AND DEMAND:

Supply and Demand: A Model of a Competitive Market:

- competitive market → a market in which there are many buyers and

sellers of the same good or service, none of whom can influence the
price at which the good or service is sold
- supply and demand model → a model of how a competitive market
behaves
5 key elements

The Demand Curve:

1. the demand curve

2. the supply curve

3. the set of factors that cause the demand curve to shift and the set of

factors that cause the supply curve to shift

4. the market equilibrium, which includes the equilibrium price and

equilibrium quantity

5. the way the market equilibrium changes when the supply curve or
demand curve shifts

the amount of any good or service that people want to buy depends upon
the price the higher the price, the less of the good or service people want to
purchase; the lower the price, the more they want to purchase

The Demand Schedule and the Demand Curve

demand schedule → a table that shows how much of a good or service

consumers will want to buy at different prices

quantity demanded → the actual amount of a good or service customers are

willing to buy at some specific price

demand curve → a graphical representation of the demand schedule

shows the relationship between quantity demanded and price

inverse relationship between price and quantity demanded

a higher price reduces the quantity demanded and a lower price increases
the quantity demanded
law of demand→ a higher price for a good or service, other things equal,
leads people to demand a smaller quantity of that good or service

Shifts of the Demand Curve

shift of the demand curve vs. a movement along the curve

shift of the demand curve → a change in the quantity demanded at any given
price, represented by the shift of the original demand curve to a new
position, denoted by a new demand curve\\

Salvador salazar