Macroeconomics: Introduction to Economics

MacroeconomicsWeek 1

Everyday Economics

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“ECONOMICS IS LIFE IN GRAPHS”Economics relates to your everyday lives.

Economics is the study of our choices.POP QUESTION

How Economics can help you as a person or student?

Why study and understand Economics?

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FOUR (4) REASONS

1. Learn a Way of Thinking- opportunity cost- marginalism and sunk costs- efficient markets

2. To understand the society- Industrial and dot.com revolutions- Front page analysis

3. To understand global affairs4. To be an informed citizen

What is ECONOMICS?

ECONOMICSis social science that studies how individuals, governments, firms, and nations make optimal choices on allocating scarce resources to satisfy their unlimited wants1

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Economic Way of Thinking

Limits, Alternatives, and Choices

SCARCITYis the limitation of economic resources to fulfill infinite human needs and wants. Why is there scarcity? The main explanation lies in the fact that man’s wants and needs are unlimited, while the actual goods and services that can satisfy those needs are limited.

Economic Way of Thinking

Limits, Alternatives, and ChoicesMARGINALISMIn economics, “marginal” means “extra,” “additional,”, or a “change in.”MARGINAL BENEFIT (MB)refers to what people are willing to give up in order to obtain one more unit of a good.MARGINAL COST (MC)refers to the value of what is given up in order to produce the additional unit.

Additional units of a good should be produced as long

as MB > MC

Efficient level is where:

MB = MC

Theories, Principles, and ModelsScientific Method

Observation of real-

world behavior

and outcomes

Formulation of

hypothesis or possible explanation

of cause and effect

Testing of hypothesis

The acceptance, rejection,

or modificatio

n of the hypothesis

The continued testing of

the hypothesis against the

facts

Economic Way of Thinking

Economic PrinciplesECONOMIC LAW OR PRINCIPLEis a well-tested and widely accepted theory. It is a statement about economic behavior or the economy that enables prediction of the probable effects of certain actions.Other-Things-Equal Assumption is an assumption that factors other than those being considered do not change. It is also called in Latin ceteris paribus.

FIELDS OF ECONOMICS

TABLE 1.1 Examples of Microeconomic and Macroeconomic Concerns

Divisionsof Economics Production Prices Income Employment

Microeconomics Production/output in individual industries and businesses How much steelHow much office spaceHow many cars

Price of individual goods and services 

Price of medical carePrice of gasolineFood pricesApartment rents

Distribution of income and wealth

Wages in the auto industryMinimum wageExecutive salariesPoverty

Employment by individual businesses and industries

Jobs in the steel industryNumber of employees in a firmNumber of accountants

Macroeconomics National production/output 

Total industrial outputGross domestic productGrowth of output

Aggregate price level 

Consumer pricesProducer pricesRate of inflation

National income

Total wages and salaries  Total corporate profits

Employment and unemployment in the economy

Total number of jobsUnemployment rate

Microeconomics and Macroeconomics (from Economics by Case and Fair, 9th Ed.)

FIELDS OF ECONOMICS

MICROECONOMICSBranch of economics concerned with individual units of such as a person, a household, a firm, or an industry.

FIELDS OF ECONOMICS

MACROECONOMICSBranch of economics that examines either the economy as a whole or its basic subdivisions or aggregates, such as government, household, and business sectors.

Positive and Normative Economics

POSITIVE ECONOMICSfocuses on facts and cause-and-effect relationships. It concerns the description and explanation of economic phenomena and includes description, and theory testing.

NORMATIVE ECONOMICSincorporates value judgments about what economy should be like or what particular policy actions should be recommended to achieve a desirable goal. It is that which makes a resolution about what should or ought to be.

Minimum wage laws

cause unemployme

nt.

The government should raise the minimum

wage.

INDIVIDUAL’s ECONOMIZING PROBLEM

LIMITED INCOMEWe all have finite amount of income, even the wealthiest among us.

UNLIMITED NEEDS AND WANTSMan has infinite needs and wants that keep on evolving over time. We desire various goods and services that provide utility.

BASIC NEEDS

ESSENTIAL NEEDS

LUXURY NEEDS

CREATED WANTS

INDIVIDUAL’s ECONOMIZING PROBLEM

TRADE OFFS and OPPORTUNITY COSTSIt is the value of the next best alternative forgone as the result of making a decision. To obtain more of one thing, one should forgo the opportunity of getting the next best thing. That sacrifice is the opportunity cost of the choice.

Consumption Possibilities: The Case of Pizza and Pasta

SCHEDULE OF CONSUMPTION POSSIBILITIESAlternative Pizza

(Price=Php20.00/slice)

Pasta(Price=Php10.00/

plate)

Total Expenditure (in

Php)

A 6 0 120B 5 2 120C 4 4 120D 3 6 120E 2 8 120F 1 10 120G 0 12 120

INDIVIDUAL’s ECONOMIZING PROBLEM

TRADE OFFS and OPPORTUNITY COSTSIt is the value of the next best alternative forgone as the result of making a decision. To obtain more of one thing, one should forgo the opportunity of getting the next best thing. That sacrifice is the opportunity cost of the choice.

BUDGET LINE

SOCIETY’s ECONOMIZING PROBLEM

FACTORS OF PRODUCTION

LAND LABOR

CAPITAL ENTREPRENUR

LAND consists of all natural resources (or gifts of nature) and all other forms of these raw materials used in production of resources.

LABOR comprises all human beings (physical and mental talents) who extract raw materials, process these materials into finished consumption or investment goods, transport and sell raw materials or finished products, or are engaged in services.

CAPITAL materials such as tools, machinery, and equipment which man uses to extract and process raw materials into finished goods.

ENTREPRENEUR is a person who puts together or organizes the other factors of production to make a needed goods and services.

SOCIETY’s ECONOMIZING PROBLEM

PRODUCTION POSSIBILITY MODELis a macroeconomic model of production possibilities. It begins with the following assumptions:

Full employment or use of all available resources. Fixed resources. Fixed technology or constant technology. Two goods are only produced in the economy.

SOCIETY’s ECONOMIZING PROBLEM

PRODUCTION POSSIBILITY TABLE AND CURVEshow the different combinations of two products that can be produced by an economy with specific resources, assuming full employment. At any point in time, a fully employed economy must sacrifice some of one good to obtain more of another good.

Production Possibilities Table

  Production Alternatives

Type of Good A B C D E

Butter (in hundred '000) 0 1 2 3 4

Guns (in '000) 10 9 7 4 0

SOCIETY’s ECONOMIZING PROBLEM

PRODUCTION POSSIBILITY CURVErepresents “constraint” or limitation of attainable outputs. Points along the curve are attainable as long as the economy uses all its available resources. Points lying inside the curve are also attainable but they reflect less total output and could have produced more goods if it achieved full employment of resources.

Points outside the curve represent greater output that the current output but it is not attainable given the availability of resources.

SOCIETY’s ECONOMIZING PROBLEM

LAW OF INCREASING OPPORTUNITY COSTillustrates as the production of a particular good increases, the opportunity cost of producing an additional unit rises. OPTIMAL ALLOCATIONadditional benefit is equal to additional cost

OPTIMAL ALLOCATION:

MB = MC

GRAPHS AND THEIR MEANINGCONSTRUCTION OF A GRAPHGRAPH is a visual representation of the relationship between two variables.

Independent Variableis the presumed to affect or determine the dependent variable or the source.

Dependent Variableis one that changes accordingly to any change in the independent variable or the effect or outcome.

GRAPHS AND THEIR MEANINGRELATIONSHIPS

Direct Relationshipor Positive Relationship means that two variables move in the same direction. This has an upward sloping line.

Inverse Relationship or Negative Relationship means the two variables move in opposite direction. This has a downward sloping line.

GRAPHS AND THEIR MEANINGSLOPES of GRAPHSis the ratio of the vertical change (rise) to the horizontal change (run) (or rise over run)

Slope = vertical change horizontal change

b = y2 – y1

x2 – x1

Positive Slopevariables change in the same directionNegative Slopevariables change in different direction

GRAPHS AND THEIR MEANING

SLOPES of GRAPHSis the ratio of the vertical change (rise) to the horizontal change (run) (or rise over run)

Infinite SlopeNegative Slope

VERTICAL INTERCEPTof a line is where the line meets the vertical axis.

GRAPHS AND THEIR MEANING

EQUATION OF A LINEAR RELATIONSHIP

y=a + bx

where:y =dependent variablea =vertical interceptb = slope of linex = independent variable

GRAPHS AND THEIR MEANING

SLOPE AND MARGINAL ANALYSIS

To measure the slope at a specific point, we draw a straight line tangent to the curve at one point. A line is tangent at a point if it touches, but does not intersect, the curve at that point.

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HOW TO READAND UNDERSTAND GRAPHS

A P P E N D I X

TIME SERIES GRAPHS

TABLE 1A.1 Total Disposable Personal Income in the United States, 1975–2006 (in billions of dollars)

Year

Total DisposablePersonal Income Year

Total DisposablePersonal Income

1975197619771978197919801981198219831984198519861987198819891990

1,181.41,299.9 1,436.01,614.8 1,808.2 2,019.8 2,247.9 2,406.82,586.02,887.63,086.53,262.53,459.53,752.44,016.34,293.6

1991199219931994199519961997199819992000200120022003200420052006

4,474.84,754.64,935.35,165.45,422.65,677.75,968.26,355.66,627.47,120.27,393.27,827.78,159.98,646.98,945.69,501.5 FIGURE 1A.1 Total Disposable

Personal Income in the United States: 1975–2006 (in billions of dollars)

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GRAPHING TWO VARIABLES ON A CARTESIANCOORDINATE SYSTEM

Appendix

FIGURE 1A.2 A Cartesian Coordinate System

HOW TO READ AND UNDERSTAND GRAPHS

A P P E N D I X

A Cartesian coordinate system is constructed by drawing two perpendicular lines: a vertical axis (the Y-axis) and a horizontal axis (the X-axis). Each axis is a measuring scale.

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A graph is a simple two-dimensional geometric representation of data. This graph displays the data from Table 1A.2. Along the horizontal scale (X-axis), we measure household income. Along the vertical scale (Y-axis), we measure household consumption.Note: At point A, consumption equals $19,120 and income equals $9,676. At point B, consumption equals $28,921 and income equals $25,546.

TABLE 1A.2 Consumption Expendituresand Income, 2005

Average IncomeBefore Taxes

Average ConsumptionExpenditures

Bottom fifth2nd fifth3rd fifth4th fifthTop fifth

$ 9,67625,54642,62267,813

147,737

$ 19,12028,92139,09854,35490,469

FIGURE 1A.3 Household Consumption and Income

PLOTTING INCOME AND CONSUMPTION DATAFOR HOUSEHOLDS

HOW TO READ AND UNDERSTAND GRAPHS

A P P E N D I X

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SLOPE

HOW TO READ AND UNDERSTAND GRAPHS

A P P E N D I X

A positive slope indicates that increases in X are associated with increases in Y and that decreases in X are associated with decreases in Y.

FIGURE 1A.4 A Curve with (a) Positive Slope and (b) Negative Slope

2 1

2 1

Y YY

X X X

A negative slope indicates the opposite—when X increases, Y decreases and when X decreases, Y increases.

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Refer to the figure below. The expression of the slope of the line between points A and B equals:

a.

b.

c.

d.

e.

Y Y

X X2 1

2 1

Y X

Y X2 2

1 1

X X

Y Y2 1

2 1

X Y

Y X2 1

2 1

X X

Y Y2 1

1 2

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Refer to the figure below. The expression of the slope of the line between points A and B equals:

a.

b.

c.

d.

e.

Y YX X

2 1

2 1

Y X

Y X2 2

1 1

X X

Y Y2 1

2 1

X Y

Y X2 1

2 1

X X

Y Y2 1

1 2

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HOW TO READ AND UNDERSTAND GRAPHS

A P P E N D I X

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Refer to the figure below. According to this graph, the relationship between hours of study time and points on the exam is as follows:

a. The relationship is first positive and then it turns negative.b. Positive but diminishing.c. Positive and increasing.d. Negative. e. Nonexistent.

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Refer to the figure below. According to this graph, the relationship between hours of study time and points on the exam is as follows:

a. The relationship is first positive and then it turns negative.b. Positive but diminishing.c. Positive and increasing.d. Negative. e. Nonexistent.

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It is important to think carefully about what is represented by points in the space defined by the axes of a graph. In this graph, we have graphed income with consumption, as in Figure 1A.3, but here each observation point is national income and aggregate consumption in different years, measured in billions of dollars.

TABLE 1A.3 Aggregate National Income and Consumption for the United States, 1930–2006 (in billions of dollars)

Aggregate National Income Aggregate Consumption

19301940195019601970198019902000200420052006

$ 75.681.1

241.0427.5837.5

2,243.04,642.17,984.4

10,306.810,887.611,655.6

$ 70.271.2

192.7332.3648.9

1,762.93,831.56,683.78,195.98,707.89,224.5

FIGURE 1A.6 National Income andConsumption

SOME PRECAUTIONS

A P P E N D I X

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Cartesian coordinate system

graph

negative relationship

origin

positive relationship

slope

time series graph

X-axis

X-intercept

Y-intercept

REVIEW TERMS AND CONCEPTS