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Scarcity & Choice (Chapter 3)

11/15/15 6:40 PM

**Economics is about the choices peoples and the society makes**
Test 1 on Chapter 2 and Chapter 6
Multiple choice (30) 60%
Short answer (5) 40%
Scarcity & Choice (Chapter 3)
• GDP – gross domestic product
• Unemployment rate was 5
...
Scarcity, Choice, and Opportunity Costs
• Resources: inputs, factors of production
o Instruments provided by nature of people
o Used to create goods & services
o Land (natural resources)
• Scarcity
o Resources are always limited
• All resources are scarce
• Labor – scarce
o Time limitations
o Number of skilled workers – limited
• Economics
o The study of how best to use limited means to pursue unlimited
ends
• Opportunity costs of any decision being made
• When the market functions well
o Goods with high opportunity costs
§ Have high money costs
o Goods with low opportunity costs
§ Have low money costs
• Opportunity costs vs
...
How much does it really costs
• Options available
o Households & businesses
o Governments & entire societies
• Given – limited resources
• Logic of
o How people can make optimal decisions
o From among competing decisions
III
...
e
...
Scarcity & Choice: Entire Society
• Economy – constrained by
o Resources and technology
• Production possibilities frontier – society

o Position and shape
o Determined by economy’s
§ Physical resources, skills, and technology
§ Willingness to work
§ Past: construction of factories and intelligence
• Three economic concepts within a PPF framework
o Efficiency and tradeoffs
o Unemployed resources
o Economic growth
V
...
Demand and quality demanded
• Demand – the willingness and ability of buyers to purchase different
quantities of a good at different prices during a specific time
• Quantity demanded
o Number of units of a good
o That consumers are willing and can afford to be
o Over a specified period of time
• Demand schedule
o For a given period of time
II
...
The Market: Supply and Demand Equilibrium
• Supply-demand diagram
o Graphs the supply and demand curves
o Determines
§ Equilibrium price
§ Equilibrium quantities
** Surplus – when quantity supplied is greater than the quantity demanded (when
there is access supply and the price will decrease)
P dec
...

à Q supply à dec
...
à Q demanded à dec
...


IV
...
Demand inc
...
and Quantity inc
...
The Market Fights Back
• Battling the invisible hand
• Legally imposed constraints on prices
o Price ceilings – legal maximum
§ Price – below it
o Price floors – legal minimum
§ Price – above it
VI
...
The American Economy
• U
...
= private-enterprise economy
• America’s economy
• Gross domestic product (GDP)
o Measure of the size of the economy
o Total amount it produces in a year
• Real GDP
o Adjusted GDP
• U
...
= relatively “closed” economy
o Exports: $1
...
S
...
S
...
Drawing a Line
• Aggregation
o Combine many individual markets into one overall market
• Foundations of aggregation
o Composition
X
...
Makes things more
expensive and the value of the dollar goes down
o Recession and unemployment
o Economic growth
XI
...
If it was included, it
would technically be counted twice
o Production: geographic boundaries of U
...

o Organized markets
• Three general categories of purely financial transactions
o Securities
o Government transfer payments
o Private transfer payments
• Limitations of GDP: What GDP is NOT
o Not a measure of the nation’s economic well-being
§ Then what would be a good measure?
o Includes only market activity
o Places no value on leisure
o Counted: “bads” and goods”
o Ecological costs are not netted out of the GDP
XII
...
S
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Goals of Macroeconomic Policy
• Economic growth – ingredients
o Aggregate supply
§ Inputs
ú Labor, machinery, other resources
ú Used to produce outputs
§ Output
ú Goods and services
ú Produced in economy
o Aggregate demand
• Low unemployment
• Low inflation
II
...
Unemployment
• Unemployment rate
o Number of unemployed people
o As percentage of labor force
• If GDP grows slower than the economy’s potential
o Unemployment rate rises
• If GDP grows faster than the economy’s potential
o Unemployment rate falls
Unemployment rate = # of unemployed
labor force**

(labor force = unemployed + employed)

** Those who don’t know qualify as labor force – children under 16, retired,
discouraged workers, volunteers (working for non-profit company), disabled,
people who don’t want to works, convicts, institutionalized, military**

Population as of Jan 2015: 320 million
Civilians non-institutionalized: 248 million
Labor force: 157 million
Employed: 148 million
Unemployed: 9 million
IV
...
3 Types of Unemployment
• Frictional unemployment
o Due to normal turnover in the labor market
o People who are temporarily between jobs
§ Moving or changing occupations
§ Unemployed for similar reasons
• Structural Unemployment
o Due to structural unemployment
§ Due to structural change either on the demand side of the
supply side
§ Their skills are no longer in demand
• Cyclical unemployment
o The level of demand in the entire economy goes down
o Rises during recessions
o Falls as prosperity is restored
VI
...
Unemployment Insurance
• Unemployment insurance
o Government program
o Replaces some wages lost by eligible workers who lose their jobs
o Helps prop up aggregate demand during recessions
o Benefits the unemployed
§ And the economy – greater spending
VIII
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Inflation: Myth and Reality
• Inflation – increase in “average price”
o Not to blame when some goods become more expensive relative to
some other goods
• Costs of inflation
o Inflation as a redistributor
§ Inflation as a redistributor of income and wealth
§ Redistribution caused by inflation
ú Harm: lenders
• Relative price of an item – its price in terms of some other item
**Class Formulas** (sample numbers)
Nominal interest rate = i =$110-$110 x 100% = 10%
$100
Real interest rate = r = 1 pair – 1 pair x 100% = 0%
1 pair

π = 110-100
100

X
...
Inflation Distorts Measurement

i=r+π

• Capital gain
o Difference between the price at which an asset is sold and the price
at which it was bought
• Malfunctioning tax system
o Taxes on nominal interest
o Taxes on nominal capital gain
o High tax rates when inflation is high
Costs of Low vs
...
Potential GDP
• Potential GDP – the real GDP that the economy would produce if its
labor and other resources were fully employed
o Fully employed meaning – does not mean 100% employment,
everyone who wants to work is working
• Estimate potential GDP
o Count up the available supplies of labor, capital, and other
productive resources
§ Estimate how much output these inputs could produce if
they were all fully utilized
o Transformation of inputs into outputs
§ Assessment of the economy’s technology
Inputs à Economy à Output
^Technology
• ** It is possible to exceed potential GDP **
II
...
Goals of Macroeconomic policy
• Make the economy grow faster in the long-run
o Growth policy
§ Potential real GDP
• To stabilize the fluctuation of the real GDP each year to be as close as
possible to potential real GDP
o Stabilization policy
§ Low unemployment
§ Low inflation
IV
...
Production Curve
• Is plotting the relationship between labor supply and potential real GDP
• Along the production curve
o Constant capital and technology
o If labor force grows, the output would grow
• Better technology or more capital
o Shift upward the production function
o Raise the potential GDP
VI
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Three pillars of productivity growth

1
...
Rate at which technology improves
3
...
Macroeconomic Policy
• Growth policy
o Economy sustains a high long-run growth rate of potential GDP
§ Not necessarily the highest possible growth rate
• Stabilization
IX
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Growth Policy
• Growth policy encourages capital formation
• Nationals capital
o Its available supply of plant, equipment, and software
o The result of past decisions to make investments in these items
• Investment
o The flow of capital
• Capital formation
o Investment
o Process of building up the capital stock
• Trade-off
o More capital formation
§ Quicker growth and consume less today
o More consumption today
§ Less capital formation and slower growth

• Property rights
o Laws and/or conventions
Homework 2
Index = basket in 2009/basket in 1982 X 100
= (all numbers from graph added up) = 303

Aggregate Demand and its importance for the Economy (8) 11/15/15 6:40 PM
I
...
Why National output = national income?
• The value of the total output of firm #1
o V(1) = P(1)Q(1)
• What does firm #1 do with its revenue they earn?
• V(1) = P(1)Q(1) = W(1) + R(1) + Interest(1) + PC(1) + Profits(1)
• V(2) = P(2)Q(2) = W(2) + R(2) + Interest(2) + PC(2) + Profits(2)
• V(3) = P(3)Q(3) = W(3) + R(3) + Interest(3) + PC(3) + Profits(3)
NGDP = Wages (income for people) + R (income for landlords) + Interest + Profit
= national income
TEST 2: Lectures 5,6,7,8 on test (chapters 6,7,8, 9)
DI = GDP – Taxes + Transfers
= GDP – (Taxes – Transfers)
= GDP – T
Where T = (Taxes – Transfers) = net taxes
III
...
Why Study the circular flow diagram
• Aggregate demand that determines economic boom or recession
• Three important variables in the economy
o National income
o Domestic output
o Total spending or aggregate demand

Lecture 8: What Effects AD?

11/15/15 6:40 PM

I
...
Real Wealth
• ** NGDP(2014) = P(2014) x Q(2014)
Real wealth = N wealth
PI
nominal wealth increases à C increases?
PI increases à C decreases?
• **Why when price levels increase, C decreases?
Real wealth decreases (not b/c real Disposable Income decreases)
DI = disposable incomes (salary)
III
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The Consumption (C) and the MPC (Marginal Propensity to Consume)
• Consumption function, C
o Relationship between
§ Total consumer expenditures
§ Total disposable income in the economy
o Holding all other determinants of consumer spending constant
o DI is always out of dollar (or whatever currency economy is in)
• To estimate the initial effect of a tax cut on consumer spending
o Estimate the MPC
o Multiply the amount of the tax cut by the estimated MPC

o Prediction – subject to some margin of error
• Marginal propensity to consume (MPC)
o Ratio of changes in consumption to changes in consumption to
changes in disposable income
o Slope of consumption function
o Slope = vertical change
horizontal change
o How much more consumers will spend if DI rises by $1
V
...

o Consumption function shifts upwards
• If expectations increase…
...
If not on the axis’s, move off the curve so
it will shift the curve
VI
...
Determinants of New Exports
• Exports, X
o Foreign purchases of U
...
goods
• Imports, IM
o Portion of domestic demand that is satisfied by foreign producers
• Net exports
o Exports minus imports

Lecture 9: Demand Side Equilibrium

11/15/15 6:40 PM

I
...
Income Determination
• Assumption
o I, G, and X-IM are fixed
• Expenditure schedule
o Shows the relationship between national income (RGDP) and the
total spending
• Total expenditure = C + I + G + (X-IM)

o C: consumption line
o C + I: above the C line
§ I is fixed
o C + I + G: above the C + line
§ G is fixed
o C + I + G + (X-IM): below the C + I + G line, but above C + I line
§ Net exports are negative and fixed
• Condition for equilibrium GDP (Y)
o Y = C + I + G + (X-IM)
• If Spending > Output
o Falling inventories
o Firms: produce more
• If Output > Spending
o Rising inventories
o Firms: produce less
III
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The Aggregate Supply Curve
• Aggregate Supply Curve
o Shows, for each possible price level
§ The quantity of goods and services
§ That all the nation’s businesses are willing to produce
§ During a specified period of time
§ All other determinants constants
• Firms max profits
o Per unit profit = price – per unit cost
• Determinants
o Price level
o Cost of production
§ Costs of inputs
ú Available supplies of labor and other inputs
§ Technology and capital
ú Available supplies of capital
o E
...
wage increases à cost increases à profits decrease
* The AD curve always shifts out the
in TS, not only the initial
but the also
the
that occurred in the multiplier process, assuming prices are fixed*
1) AS horizontal, forms don’t
price at all, they only change output
2) If AS is upward sloping as firms increase outputs but they also increase prices
3) If AS is perfectly vertical, firms respond only by increase in prices, not by the
increase in output or price level

Lecture 12: Money and Banking (Chapter 12)

11/15/15 6:40 PM

I
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• Money – anything that is generally accepted as medium of exchange
II
...
Money as a Medium of Exchange
• Definition: a medium of exchange is any object that is accepted in
exchange for goods and services
• Examples of medium’s of exchange:
o Gold and silver
o Cigarettes (WWII POW Camp)
• Barter
o “Double Coincidence of Wants”
IV
...
The Banking System
• Fractional reserve banking system
o Bankers keep as reserves only a fraction of deposits
• Features of fractional reserve banking
o Bank profitability
§ Banks are in business to earn profits

o Exposure to bank runs
§ Keep prudent reserves and to lend out money carefully
• Banking – inherently risky business
o Safe only by cautious and prudent management
o Maximize profits
§ Low reserves
§ Make loans to borrowers with questionable credit standing –
higher interest rates
ú Many mortgages, 2003 – 2007
• Bank regulations – designed to ensure depositors’ safely and to control
the money supply
• Deposit insurance
o Guarantees that depositors will not lose money even if their bank
goes bankrupt
o Federal deposit insurance corporation/FDIC
o Moral hazard problem
• Moral hazard problem
o If insured against consequences of risk
o People engage in riskier behavior
• Bank supervision
o Periodic bank examinations
o Tighter regulation since 2006
§ Bureau of consumer financial protection
§ Mechanism for dealing with potential failure of giant banks
• Other laws and regulations
o Limit the kinds and quantities of assets in which banks may invest
§ Own only limited amounts of common stock
§ Restrictions on banks’ ability to engage in “proprietary
trading”
• Reserve requirements
o Minimum amount of reserves required by law
o Proportional to the volume of deposits
VI
...
Hyperinflations
• Hyperinflations – periods of extremely high inflation of more than 50%
per month
• Many economies – both poor and developed – have experienced
hyperinflation over the last century, but the United States has been spared
much turmoil
• One of the most extreme examples of hyperinflation throughout world
history occurred recently in Zimbabwe in the 2000’s
VIII
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Federal Reserve Banks
• Quasi-public (part of the government) institution owned by private
commercial banks in the district that are members of the Federal system
• Member banks elect six directors for each district; three more are
appointed by the Board of Governors
o Three A directors are professional bankers

o Three B directors are prominent leaders from industry, labor,
agriculture, or consumer sector
o Three C directors appointed by the Board of Governors are not
allowed to be officers, employees or stockholders
• Member banks elect six directors for each district; three more are
appointed by the Board of Governors
• Functions of the Federal Reserve Banks
o Clear checks
o Issue new currency
o Withdraw damaged currency from circulation
o Administer and make discount loans to banks in their district
o Evaluate proposed mergers and applications for banks to expand
their activities
• Act as liaisons between the business community and the Federal Reserve
System
• Examine bank holding companies and state-chartered member banks
X
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Member Banks
• All national banks are required to be members of the Federal Reserve
System
• Commercial banks chartered by states are not required but may choose to
be members
• Depository Institutions Deregulation and Monetary Control Act of 1980
subjected all banks to the same reserve requirements as member banks
and gave all banks access to Federal Reserve System
XII
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Federal Open Market Committee
• Meets eight times a year
• Consists of sever members of the Board of Governors, the president of
the Federal Reserve System
XIV
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S
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FOMC Meeting
• Report by the manager of system open market operations on foreign
currency and domestic open market operations and other related issues
• Presentation of Board’s staff national economic forecast
• Outline of different scenarios for monetary policy actions
• Presentation on relevant Congressional actions
• Public announcement about the outcome of the meeting
XVI
...
Tools of Monetary Policy
• Open market operations
• Changes in discount rate
• Changes in reserve requirements
• Changes in interest rate on reserves
XVIII
...
Discount Loan
• Discount rate
o Interest rate the Fed charges on loans that it makes to banks
• Discount rate – lower in 2007
XX
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Other Instruments of Monetary Policy
• Unconventional monetary policy
o Unusual forms (or volumes) of central bank lending and to unusual
types of open-market operations
§ Pushing the federal funds rate down to virtually zero
§ Lending to banks in unprecedented volume
• Quantitative easing
o Open-market purchases of assets other than Treasury bills
o Treasury bonds (longer dated)
o Other assets – in 2008 and 2009, to stabilize the mortgage market
XXII
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Money and the Price Level
• Expansionary monetary policy
o Increases aggregate quantity (more on PP)
** Look at HW 3



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