Macroeconomics Notes Unit 1
Macroeconomics Notes Unit 1 Introduction, Opportunity Cost, Elasticity Peter Simon, Principles of Macroeconomics, ECON 1115 MWR 9:15am What’s the definition of economics? 1. Economics is the study of decision-making 2. Of all the decisions that have to be made in life, the biggest one is “What are we going to do with our scarce resources?” How should we allocate resources? Individuals, companies, and governments ask these questions. How you decide -> opportunity cost All decisions require you to consider opportunity cost. The reason we ask is because of limited time & money, you can’t do everything (too many choices can be bad) Allocation of scarce resources (aka factors of production) 1. Land (natural resources, area we build on) paid in rent 2. Labor (us, physical labor, talents, mental capacity) paid in wages 3. Capital (factories, machines, equipment) paid in interest to lender 4. Entrepreneurship (factors to be successful despite risks) paid in profit What are the three methods by which countries allocate their scarce resources? 1. 2. 3. 4.
Tradition Government Markets (Fourth method will exist one day)
Capitalism is efficient: least wasteful because opportunity cost is always considered With profit as goal, there is efficiency.
Production Possibilities Curve Used to compare two goods/two groups of goods Models opportunity cost, give up over gain The next best alternative is the opportunity cost The opportunity cost of producing wartime goods and winning the war is producing peacetime goods but losing the war. Consumer goods (C) are bought by consumers Capital goods (K) are bought by businesses If you are trying to maximize profit, market system is best. What are the characteristics of the PPC? It bows outward, unless opportunity costs are constant, because there is a trade-off that increases. It features two possibilities. It is assumed that the possible choices share factors of production (ex. labor). You want production to stay on the production possibilities curve because it is the efficient amount that is still feasible. If more capital goods are produced, the PPC will expand faster. If more consumer goods are produced, there will be a high standard of living today. The Soviet Union chose to produce more capital goods. Models are simplifications of reality. Why isn’t opportunity cost constant? Once resources are specialized, it costs to convert them to another production outcome. There are shared resources that aren’t as perfectly specialized. Not all resources are equally good are everything (specialization of resources). What explains the law of increasing opportunity cost? Specialization of resources
The Market System (Supply and Demand) Market: where people buy and sell goods and services Demand: depends on willingness and ability to buy something What does demand depend on? ***Price, taste & preferences, number of buyers, price of related goods, income, and expected future prices What is the relationship between quantity demanded and prices of substitute and complementary goods? Price of substitute good goes up, quantity demanded goes up Price of complementary good goes up, quantity demanded goes down A change in demand -> shift of demand curve A change in quantity demanded -> movement along demand curve / shift in supply curve There is an inverse relationship between the price of pizza and quantity demanded. (Law of Demand) What does supply depend on? ***Price, number of sellers, technology, costs of production (rent, wages, interest, profit), taxes/regulation, expected future prices Price is an endogenous variable (can be seen on graph) Income is an exogenous variable (is outside of model) Endogenous variables: price, quantity demanded, quantity supplied What will shift the demand curve? Change in demand
What market(s) are free from government intervention? You must always draw both supply and demand curves. They can be nonlinear. The demand curve is derived from an average of all buyers, and by assuming that there is perfect competition making all goods the same. Companies survey consumers to find demand curves. How does the price and quantity find the new equilibrium? Ask yourself: What is true at the original price, P1? What happens to demand as price goes up? Nothing What happens to supply as price goes up? Nothing Exam will ask two types of problems: 1. Tells you P, Q, or both and then you must determine the reason. 2. You know the reason, now you must determine the effect. Stability: equilibrium is reached eventually – price and quantity is stable in free market; equilibrium has to be reached because of laws of perfect competition Causation is always exogenous variable, then a shift of supply or demand curve, then a change in price, then a change in quantity When government is involved, they interfere Without government involvement, there is no reason equilibrium wouldn’t be reached Price Elasticity of Demand Elasticity (aka responsiveness) affects market phenomena Why did price increase? What will happen to price and quantity? How responsive is our quantity demanded to a change in price? If the price goes down, will we buy more? A little more or a lot more?
Inelastic (not responsive) goods like gas have quantities demanded that are very unaffected price. Over a longer period of time we can get a more fuel-efficient car or other decision-making to avoid buying gasoline. Most goods and their demand curves can be categorized as elastic or inelastic based on three things: If you complain about the price and keep buying it, it’s inelastic If you don’t know the price, it’s probably inelastic. 1. Substitute goods (lots of substitutes = elastic) 2. Time (more time to deliberate/shop around = elastic) 3. More money in budget (less proportion of budget = elastic) Don’t draw inelastic demand curve as a perfectly vertical line. Demand can be drawn as very steep or relatively flat/normal. Water is an elastic good if you think about all the ways we can cut back our consumption. Elasticity of Supply Some firms can respond very quickly (like a lemonade stand). Inelastic supply example: Rembrandt paintings Elastic supply example: Peter Simon paintings
Chengyan Style: TA Review of Chapters 1 and 3 Economic problem: allocation of scarce resources 1. Tradition 2. Government 3. Market: most efficient because it minimizes opportunity cost The invisible hand, Adam Smith Opportunity cost: exists because resources are scarce, trade-off is necessary Resources/factors of production: land, labor, capital, entrepreneurship Production possibilities curve: models trade-off The outward shift of the PPC indicates economic growth. Law of increasing opportunity cost: resources are not equally efficient to produce every product (specialization) Assumptions about PPC model:
1. 2. 3. 4.
Two goods Fixed technology Fixed resources Full employment of all resources
DEMAND Change in demand -> shift of curve Change in quantity demanded -> movement along curve Demand Shifters: 1. 2. 3. 4.
Tastes and preferences Income Number of buyers Price of related goods (complementary goods, substitute goods)
When the price changes, only then does the quantity demanded change. SUPPLY Change in supply -> shift of curve Change in quantity supplied -> movement along curve Supply Shifters: 1. 2. 3. 4. 5.
Cost/price of inputs Technology Number of sellers Expectations Taxation/regulation (type of cost)
Tradition Government Markets (Fourth method will exist one day)
Capitalism is efficient: least wasteful because opportunity cost is always considered With profit as goal, there is efficiency.
Production Possibilities Curve Used to compare two goods/two groups of goods Models opportunity cost, give up over gain The next best alternative is the opportunity cost The opportunity cost of producing wartime goods and winning the war is producing peacetime goods but losing the war. Consumer goods (C) are bought by consumers Capital goods (K) are bought by businesses If you are trying to maximize profit, market system is best. What are the characteristics of the PPC? It bows outward, unless opportunity costs are constant, because there is a trade-off that increases. It features two possibilities. It is assumed that the possible choices share factors of production (ex. labor). You want production to stay on the production possibilities curve because it is the efficient amount that is still feasible. If more capital goods are produced, the PPC will expand faster. If more consumer goods are produced, there will be a high standard of living today. The Soviet Union chose to produce more capital goods. Models are simplifications of reality. Why isn’t opportunity cost constant? Once resources are specialized, it costs to convert them to another production outcome. There are shared resources that aren’t as perfectly specialized. Not all resources are equally good are everything (specialization of resources). What explains the law of increasing opportunity cost? Specialization of resources
The Market System (Supply and Demand) Market: where people buy and sell goods and services Demand: depends on willingness and ability to buy something What does demand depend on? ***Price, taste & preferences, number of buyers, price of related goods, income, and expected future prices What is the relationship between quantity demanded and prices of substitute and complementary goods? Price of substitute good goes up, quantity demanded goes up Price of complementary good goes up, quantity demanded goes down A change in demand -> shift of demand curve A change in quantity demanded -> movement along demand curve / shift in supply curve There is an inverse relationship between the price of pizza and quantity demanded. (Law of Demand) What does supply depend on? ***Price, number of sellers, technology, costs of production (rent, wages, interest, profit), taxes/regulation, expected future prices Price is an endogenous variable (can be seen on graph) Income is an exogenous variable (is outside of model) Endogenous variables: price, quantity demanded, quantity supplied What will shift the demand curve? Change in demand
What market(s) are free from government intervention? You must always draw both supply and demand curves. They can be nonlinear. The demand curve is derived from an average of all buyers, and by assuming that there is perfect competition making all goods the same. Companies survey consumers to find demand curves. How does the price and quantity find the new equilibrium? Ask yourself: What is true at the original price, P1? What happens to demand as price goes up? Nothing What happens to supply as price goes up? Nothing Exam will ask two types of problems: 1. Tells you P, Q, or both and then you must determine the reason. 2. You know the reason, now you must determine the effect. Stability: equilibrium is reached eventually – price and quantity is stable in free market; equilibrium has to be reached because of laws of perfect competition Causation is always exogenous variable, then a shift of supply or demand curve, then a change in price, then a change in quantity When government is involved, they interfere Without government involvement, there is no reason equilibrium wouldn’t be reached Price Elasticity of Demand Elasticity (aka responsiveness) affects market phenomena Why did price increase? What will happen to price and quantity? How responsive is our quantity demanded to a change in price? If the price goes down, will we buy more? A little more or a lot more?
Inelastic (not responsive) goods like gas have quantities demanded that are very unaffected price. Over a longer period of time we can get a more fuel-efficient car or other decision-making to avoid buying gasoline. Most goods and their demand curves can be categorized as elastic or inelastic based on three things: If you complain about the price and keep buying it, it’s inelastic If you don’t know the price, it’s probably inelastic. 1. Substitute goods (lots of substitutes = elastic) 2. Time (more time to deliberate/shop around = elastic) 3. More money in budget (less proportion of budget = elastic) Don’t draw inelastic demand curve as a perfectly vertical line. Demand can be drawn as very steep or relatively flat/normal. Water is an elastic good if you think about all the ways we can cut back our consumption. Elasticity of Supply Some firms can respond very quickly (like a lemonade stand). Inelastic supply example: Rembrandt paintings Elastic supply example: Peter Simon paintings
Chengyan Style: TA Review of Chapters 1 and 3 Economic problem: allocation of scarce resources 1. Tradition 2. Government 3. Market: most efficient because it minimizes opportunity cost The invisible hand, Adam Smith Opportunity cost: exists because resources are scarce, trade-off is necessary Resources/factors of production: land, labor, capital, entrepreneurship Production possibilities curve: models trade-off The outward shift of the PPC indicates economic growth. Law of increasing opportunity cost: resources are not equally efficient to produce every product (specialization) Assumptions about PPC model:
1. 2. 3. 4.
Two goods Fixed technology Fixed resources Full employment of all resources
DEMAND Change in demand -> shift of curve Change in quantity demanded -> movement along curve Demand Shifters: 1. 2. 3. 4.
Tastes and preferences Income Number of buyers Price of related goods (complementary goods, substitute goods)
When the price changes, only then does the quantity demanded change. SUPPLY Change in supply -> shift of curve Change in quantity supplied -> movement along curve Supply Shifters: 1. 2. 3. 4. 5.
Cost/price of inputs Technology Number of sellers Expectations Taxation/regulation (type of cost)
