Introduction to Macroeconomics

An investigation of individuals making CHOICES in a world of scarcity:

THE FOLLOWING ARE THE TYPE OF CHOICES studied in the domain of ECONOMICS
1. CONSUMPTION: the act of individuals with limited incomes choosing to acquire and use things that generate
satisfaction. These things are called products (goods and services)
2. PRODUCTION: the act Individuals choosing to use things called resources to continuously produce products and make the
products continuously available for people to consume. The following is a classification of the resources necessary to produce
products
a. labor- the innate ability of people to use the body to work with other resources to produce products
b. land- natural resources
c. Capital- human made resources, both physical and human
d. entrepreneurial ability – the ability of people to manage and organize productive processes
3. EXCHANGE: the act of individuals choosing to trade (exchange) items that place less value on for items they place greater
value on
a. exchanges can be monetary (exchange a units of money for an item)
b. Exchanges can be in-kind (exchange units of one item for units of another item)

a.
SCARCITY OF RESOURCES (definition)
• a. An item (such as a resource) is defined as SCARCE: if the
quantity of the item available is less than the quantity of
the item people are willing and able to use if the item
were priced at zero
• b. this definition requires all resources to be scarce, since
the quantity of any resource available for people to use will
always be less than the quantity of any resource will always
be less than the quantity of that resource people are
willing and able to use if the resource were priced a zero
Scarcity of Resources (consequences):
• Consequences of resources being scarce are:
1. Scarce resources mean products produced from those scarce resources will
also be scarce
2. Scarce resources mean, if more of the scarce resources are used to produce
more of one product, there will be smaller quantity of the scarce resources
available to produce another product and the quantity of the other product
producible will become smaller (called the opportunity cost of producing more of
one product)
3. Scarce resources and scarce products will have to be allocated
4. people will have to invent an allocation mechanism to allocate scarce
resources and scarce products to individuals in the economy.
• A. one allocation mechanism is called a price allocation mechanism
• B. other allocation mechanisms are called non price allocation mechanism
• for example, first come- first served, most violent- first served, least fit-first served, etc
Three Key Economic assumptions made
about the individuals making choices:
1.People in general make rational choices
2.People respond to economic incentives
3.Peoples’s Optimal decisions are made at
the margin
1.People in general make Rational choices
a .People are rational if they allocate their limited income to
acquire and consume a basket of products they assume will
generate the greatest amount of utility (satisfaction) for them
b. People are rational if they produce products and allocate (sell)
those products they produce, so that the profits they earn will be c
maximum or in the event of losses, the loses they incur will be a
minimum
d. People are rational if they allocate the scarce resources they
possess to earn the greatest amount of income.
e.If people are rational, their behavior can be predicted
2. People Respond to Economic Incentives
a.If the price of an item decreases, then some buyers would
be willing and able to purchase more of that item. It is
expected some people will respond to the lower price. The
lower price is the incentive to buy more of the product
b. If people are rewarded for working harder and better,
some people will work harder and better. The reward is the
incentive to work harder and better
c. If people are rewarded the same, regardless of effort and
effectiveness, some of those individuals that would work
harder and more effectively, will not work harder or more
effectively, since the incentive to do so is absent
3.Optimal Decisions Are Made at the
Margin
a. Economists think about decision making in terms of the marginal cost
and marginal benefit (MC and MB) of making decisions: the additional
cost of making a decision is called Marginal Cost of the decision and the
additional benefit of making a decision is called Marginal Benefit of the
decision
b. Comparing MC and MB is known as marginal analysis.
For example, comparing the extra cost of selling an additional unit of a
product (MC) and the extra benefit (MB) of selling an additional unit of a
product. As an example of marginal analysis
(1). an individual will sell an additional unit if MB is greater than
MC
(2). an individual will not sell an additional unit if MB is less than MC
The Economic Problem That Every Society
Must Solve if resources are scarce
1. What Products(Goods and Services) Will Be Produced?
2. How Will the products (Goods and Services) Be Produced?
3. Who Will Receive the poducts ( Goods and Services) Produced?
(allocation of products)
4. Trade-off have to occur: The idea that, because of scarcity, producing
more of one product ( good or service) means producing less of
another product (good or service).
Types of Economies where these decisions
are made
1. Centrally planned economy: An economy in which the people in
government decides how economic resources will be allocated.
2. Market economy: An economy in which the decisions of individual
households and individuals managing firms interact in markets to
allocate economic resources and products.
3. Mixed economy: An economy in which most economic decisions
result from the interaction of buyers and sellers in markets but in which
the some individuals in government plays a significant role in the
allocation of resources and products.
Positive and Normative Analysis
When analyzing choices of individuals, we can analysis them in terms
of:
• Positive analysis: analysis concerned with what are the choices
available and what are the consequences of making specific choices
• For example: Adding an additional 40 million high risk individuals to the
health care system will cost taxpayers an additional $1 trillion in taxes
• Normative analysis: analysis concerned with what choices ought to
be made, without regard to the consequences of the choices
for example, an additional 40 million people should be covered
by the health care system
The focus of this course is to focus on the Positive Analysis, not
Normative analysis
Economic Models used to study economic
behavior
economic model often follows these steps:
1. Decide on the assumptions to use.
2. Formulate a testable hypothesis.
3. Use economic data to test the hypothesis.
4. Revise the model if it fails to explain the economic data well.
5. Retain the revised model to help answer similar economic questions
in the future.
 Economic Models (Mathematical models that
explain basic principles of economic processes)
• Mathematical models: At the introductory level, mathematical models
are relationship between two variables:
• Mathematically stated as some variable (y) is a function of another variable (x) or
an if, then statement that states if variable x changes, then variable y will change
in a predictable manner
a. Mathematical notation is y= f(x, all else constant) or x = f(y, all else constant)
b. If a mathematical relationship exists between the two variables, then there two ways these
two variables can be related
1. Varialbe (y) is positively related to variable (x) or variable (x) is positively related to variable y
2. variable (y) is negatively related to variable (x) or variable (y) is negatively related to variable (X)
Positive relationship between 2 variables
(1)
1. Varialbe (y) is positively related to variable (x)
a. If the size of variable (x) increases, then the size of variable (y) will also increase
b. Or if the size of variable (x) decreases, then the size of variable (y) will also
decrease
c. Examples of positive relationship between two variables
(i) if the x variable was the quantity of a product produced and the y
variable was the total cost of producing the product. Hopefully, you would
assume, if the quantity of a product is produced increases, then the total
cost of producing the product would also increase
(ii) if the x variable is the unit price of an item and the y variable is the quantity
of the item sellers are willing and able to sell. Hopefully, you would assume,
if the unit price of an item increases, then the quantity of the item sellers are
willing and able to sell would also increase.
 Positive relationship between 2 variables (2)
• 2. Graphically expressing a Positive relationship between two variables
using a curve. y

x x
The downward movement along the curve states: if the size
The upward movement along the curve states: if the size of variable x
of variable x decreases , then the size of variable y will also
increases then size of variable y will also increase (look at the
decrease (look at the direction of the arrows on the
direction of the arrows on the horizontal axis and vertical axis)
horizontal axis and vertical axis) )( leftward movement along
( rightward movement along x axis means the size of variable x is
x axis means the size of variable x is decreasing, and
increasing, and upward movement along vertical axis means the size
downward movement along vertical axis means the size of
of variable y is increasing)
variable y is decreasing)
Negative relationship between 2 variables(1)
1. Varialbe (y) is negatively related to variable (x)
• If the size of variable (x) increases, then the size of variable (y) will decrease
• if the size of variable (x) decreases, then the size of variable (y) will increase
c. Examples of negative relationship between two variables
(i) if the x variable was the quantity of a product produced and the y
variable is the Marginal product of producing the product. Hopefully,
you would assume, if the quantity of a product is produced increases, then
the Marginal product of producing the product will decrease
(ii) if the x variable is the unit price of an item and the y variable is the
quantity of the item buyerss are willing and able to buy. Hopefully, you
would assume, if the unit price of an item increases, then the quantity
of the item buyers are willing and able to buy would decrease.
 Negative relationship between 2 variables
• 2. Graphically expressing a Negative relationship between two
variables with a movement along a curve
y
y

x x
The downward movement along the curve states: if
The upward movement along the curve states: if the the size of variable x increases then the size of
size of variable x decreases then the size of variable variable y will decrease (look at the direction of the
y will increase (look at the direction of the arrows on arrows on the horizontal axis and vertical axis)
( rightward movement along x axis means the size of
the horizontal axis and vertical axis)( leftward
variable x is increasing, and downward movement
movement along x axis means the size of variable x along vertical axis means the size of variable y is
is decreasing, and upward movement along vertical decreasing)
axis means the size of variable y is increasing)
 Real Part of an Economy and financial part of an economy
A. Real Part of the economy: where people are engaged in these activities:
1.Production: people choosing to continuously use resources to make products continually available for people to consume
2. Consumption: people choosing to acquire products and use those products to gain satisfaction (utility)
3. Exchange: people trading(exchanging) a lower valued item for a higher valued item
B. Financial part (paper) of the economy: where people are engaged in these activities:
1.People buying and selling documents that identify ownership
a deeds
b. stocks
2.People buying and selling documents that identify debt
a. promissory notes
b. mortgages, student loans, bills and bonds
c. FEDERAL RESERVE NOTES (debts of our country’s Central Bank, The Federal Reserve Banks to the holders of the FEDERAL
RESERVE NOTES)
d. checking account balances of households, firms and governments (debts of the commercial banks to the households, firms
and governments that have a checking account balance at a commercial bank
1. ..