Are Your Smart Choices Smart for All?

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 Microeconomics
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 Macroeconomics
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 Adam Smith’s Invisible Hand

When an individual makes choices

“…he intends only his own gain, and

he is in this... led by an invisible hand
to promote an end which was no part
of his intention.... By pursuing his
own interest he frequently promotes
that of the society more effectually
than when he really intends to
promote it.”

Adam Smith, The Wealth of Nations,

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 RECONCILING MACRO AND MICRO

Macroeconomics examines if smart

microeconomic choices by individuals add
up to smart macroeconomic outcomes for
the economy as a whole.
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• The Global Financial Crisis
(2008–2009)
involved housing bubbles
that
burst, falling asset prices,
and failures of banks and
financial institutions

• Great Depression
(1929–1933)
involved financial bubbles
that burst, high
unemployment, falling
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• Macroeconomics
analyzes the
performance of the
whole Canadian
economy and global
economy —
the combined outcomes
of all individual
microeconomic choices
• Microeconomics
analyzes choices that
individuals in
households, businesses,
and governments make,
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• Fallacy of composition
what is true for one is not true for all;
the whole is greater than the sum of the
individual parts
– Paradox of thrift
attempts to increase saving cause total
savings
to decrease because of falling
employment and incomes

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 THINKING LIKE AN ECONOMIST

The circular-flow model, like all economic

models, focuses attention on what’s
important for understanding and shows how
smart choices by households, businesses,
and governments interact in markets.
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• An economic model is a simplified
representation
of the real world, focusing attention on
what’s important for understanding
• Circular flow model of economic life
reduces complexity of the Canadian
economy to three
sets of players who interact in markets —
households, businesses, and governments
– In input markets, households are
sellers, businesses are buyers
– In output markets, households are
buyers, businesses are sellers
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Circular Flow of Economic
Life

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• Input markets determine incomes
• Output markets determine the value of all
products and services sold
• Microeconomics focuses on interaction of
demand and supply in input markets
alone
or output markets alone
• Macroeconomics focuses on connections
between input and output markets
• Money, Banks, and Expectations are part
of
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• Governments set rules of the game and
can
choose to interact in any aspect of the
economy, including policy
• Economic models assume all other things
not in
the model do not change
– The mental equivalent of controlled
experiments in a laboratory

• Say’s Law — supply creates its own

demand © Pearson Education
Circular Flow Model and Say’s Law

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Education
Education
2018
Circular Flow or Break?

?
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Why Ben Bernanke
Chose Economics

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Education
Education
2018
 The Fundamental Macroeconomic Question

“If left alone by government, do the price

mechanisms
of market economies adjust quickly to
maintain
steady growth in living standards, full
employment,
and stable prices?”

• “Yes — Markets Self-Adjust” answer is

based on
Say’s Law — supply creates its own
demand (F. Hayek)© Pearson Education
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 ECONOMICS AND POLITICS

The “Yes” and “No” answers to the

question “If left alone, do markets
quickly self-adjust?” differ on the
fallacy of composition, causes of
business cycles, risk of government
failure versus market failure, role for
government, ©and political positions.
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• Like Say (and Hayek) and
Keynes, economists and
politicians today disagree
about the fundamental
macroeconomic question
• Market failure
market outcomes are
inefficient
or inequitable and fail to
serve
The “economic crisis was a
the public interest failure, not of the free market,
but of government”
• Government failure -- Charles Koch
government policy fails to
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• Yes — Left Alone, Markets Self-Adjust —
Hands Off camp believes
– Macroeconomic and microeconomic
outcomes are the same
– External events or government policy
cause business cycles
– Government failure is more
likely than market failure
– Government should be hands-off

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• No — Left Alone, Markets Fail Often —
Hands On camp believes
– Fallacy of composition —
macroeconomic and microeconomic
outcomes are different
– Markets cause business cycles through
connection failures between input and
output markets, roles of money,
banking, and expectations
– Market failure is more likely
than government failure
– Government should be hands-on
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• Politicians on the political right tend to be in
Yes — Markets Self-Adjust camp,
so government hands-off
• Politicians on the political left tend to be in
No — Markets Fail Often camp,
so government hands-on
• There are also agreements between camps
– Some role for government
– Markets eventually adjust, but how long do
they take?

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The Fundamental Macroeconomic Question

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 The Fundamental Macroeconomic Question

If left alone by government, do the price

mechanisms
of market economies adjust quickly to
maintain
steady growth in living standards,
full employment, and
stable prices ?”

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 MACROECONOMIC OUTCOMES
AND PLAYERS

Three key performance outcomes of the Canadian

economy are GDP, unemployment, and inflation;
produced by the choices of five macroeconomic
players — consumers, businesses, government,
Bank of Canada and the banking system, and the
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 OUTCOMES

• Good outcomes are

– higher gross domestic
product (GDP)

– lower unemployment

– low and predictable

inflation

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© Pearson Education
 PLAYERS

• Consumer choices
– Spend income or save
– Buy Canadian products
and services, or imports
• Business choices
– Investment spending
business purchases of new
factories
and equipment
– Hiring workers or not
– Buying inputs domestically or
importing © Pearson Education
• Government choices
– Buying products and services
– Fiscal policy
government purchases, taxes /
transfers to achieve the
macroeconomic outcomes
• Bank of Canada and banking
system choices
– Monetary policy
Bank of Canada changes
interest rates and supply of
money to achieve the
macroeconomic outcomes
– Making loans or not
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• Rest of World (R.O.W.) choices
– Buying Canadian exports or not,
selling imports to Canada or not
– Investing money in Canada or not,
accepting Canadian investments or
not

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 WHY YOU SHOULD THINK LIKE A
MACROECONOMIST

Macroeconomics affects your future —

GDP affects living standards,
unemployment affects the odds of your
finding a job, and inflation can reduce your
living standards. Macroeconomics also
informs your vote for politicians and
policies influencing economic performance,
and illuminates the important parts of
complex
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Education
• Your personal economic success is affected
by
– GDP
higher GDP per person allows higher living
standards
– Unemployment
affects odds of finding a job
– Inflation
reduces living standards if income does not
rise as fast as the prices of what you buy
– Interest rates, exchange rates, and
government taxes and transfer payments

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• Understanding
macroeconomics helps you
make smart choices and
informs your vote for
politicians whose economic
policies influence economic
performance and your
economic success
• Thinking like a
macroeconomist means
using the circular flow model
to focus on connections
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 THINKING LIKE AN ECONOMIST

“Economics does not furnish

a body of settled conclusions
immediately applicable to
policy.
It is a method rather than a
doctrine, an apparatus of the
mind, a technique of thinking
which helps its possessor to
draw correct conclusions.”
− John Maynard Keynes

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 IS ECONOMICS A SCIENCE ?

• Science is a systematic enterprise that builds

and organizes knowledge in the form of
testable explanations and predictions about
the universe
• Economics uses quantitative expression in
mathematics and concise statement of its
models in axioms and derived “theorems,” so
it looks a lot like the models of science from
physics
• “Nobel Prize” in Economics
(but see Controversies-
Criticisms in Wikipedia
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 Economics lacks the most important aspect
of science – “a record of improvement in
predictive range and accuracy”

A. Rosenberg & T. Curtain,

“What Is Economics Good
For?”
(New York Times 24
August 2013)

Paul Krugman,
“How Did Economists
Get It
So Wrong?” © Pearson Education
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“Professor (Max) Planck,
of Berlin, the famous
originator
of the Quantum Theory,
once remarked to me that
in early life he had
thought of studying
economics, but had found
it too difficult! ”
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“Economics is a science of
thinking in terms of models
joined to the art of choosing
models which are relevant
to the contemporary world.
It is compelled to be this,
because, unlike the typical
natural science,
the material to which it is
applied is, in too many respects,
not homogeneous through time.
The object of a model is to
segregate
the semi-permanent or
relatively constant factors from
those which are transitory or
fluctuating so as
to develop a logical way of
thinking about the latter …. ”
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THINKING LIKE AN ECONOMIST

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