Econ214 Macroeconomics Chapter 1 & 2

1. Chapter 1
Introduction:
What Is
Economics?
Economics is the science of
choice, exploring the choices
made by individuals and
organizations.

2. 1-2
Learning Objectives
1. List the three key economic questions
2. Discuss the insights from economics for a
real-world problem such as congestion
3. List the four elements of the economic way
of thinking
4. List three ways to use macroeconomics
5. List three ways to use microeconomics

3. 1-3
1.1 DEFINING ECONOMICS?
● economics (definition #1)
The study of choices when there is scarcity.
● economics (definition #2)
The science of choice, exploring the choices
made by individuals and organizations.
● economics (definition #3)
The study of how human beings coordinate their
wants and desires, given the decision-making
mechanism, social customs, and political realities
of the society.
● economics (definition #4)
The study of how to get people to do things they
are not wild about and not to do things they are
wild about.

4. 1-4
1.1 WHAT IS ECONOMICS?
● scarcity
The resources we use to produce goods and services are limited.
● economics
The study of choices when there is scarcity.
Here are some examples of scarcity and the trade-offs associated with making
choices:
• You have a limited amount of time. Each hour on the job means one less
hour for study or play.
• A city has a limited amount of land. If the city uses an acre of land for a park,
it has one less acre for housing, retailers, or industry.
• You have limited income this year. If you spend $17 on a music CD, that’s
$17 less you have to spend on other products or to save.

5. 1-5
• factors of production
The resources used to produce goods and services; also known as
production inputs, or resources.
• natural resources
Resources provided by nature and used to produce goods and services.
• labor
Human effort, including both physical and mental effort people, used to produce
goods and services.
• physical capital
The stock of equipment, machines, structures, and infrastructure that is used to
produce goods and services.
• human capital
The knowledge and skills acquired by a worker through education and experience
and used to produce goods and services.
• entrepreneurship
The effort used to coordinate the factors of production—natural resources, labor,
physical capital, and human capital—to produce and sell products.
1.1 WHAT IS ECONOMICS? (cont.)

6. 1-6
Positive versus Normative Analysis
● positive analysis
Answers the question “What is?” or “What will be?”
● normative analysis
Answers the question “What ought to be?”
1.1 WHAT IS ECONOMICS? (cont.)

7. 1-7
The Three Key Economic Questions: What, How, and Who?
The choices made by individuals, firms, and governments
answer three questions:
1 What products do we produce?
2 How do we produce the products?
3 Who consumes the products?
1.1 WHAT IS ECONOMICS? (cont.)

8. 1-8
Economic Models
● economic model
A simplified representation of an economic
environment, often employing a graph.
1.1 WHAT IS ECONOMICS? (cont.)

9. 1-9
Economic View of Traffic Congestion
To an economist, the diagnosis of the problem is straightforward.
▪ Your car takes up space and decreases the distance
between the vehicles on the highway.
▪ The normal reaction to a shorter distance between moving
cars is to slow down.
▪ So when you enter the highway, you force other
commuters to spend more time on the highway.
▪ One possible solution to the problem is to force people to
pay for using the road, just as they pay for gasoline and tires.
▪ The job for the economist is to compute the appropriate
congestion tax and predict the consequences of imposing the tax.
1.2 ECONOMIC ANALYSIS AND
MODERN PROBLEMS

10. 1-10
Use Assumptions to Simplify
Economists use assumptions to make things simpler and focus
attention on what really matters.
Isolate Variables—Ceteris Paribus
Economic analysis often involves variables and how they affect
one another.
• variable
A measure of something that can take on different values.
• ceteris paribus
A Latin expression meaning that other variables are held fixed.
1.3 THE ECONOMIC WAY OF
THINKING

11. 1-11
Think at the Margin
How will a small change in one variable affect another variable
and what impact that has on people’s decision making.
Rational People Respond to Incentives
A key assumption of most economic analysis is that people act
rationally, meaning that they act in their own self-interest.
• marginal change
A small, one-unit change in value.
1.3 THE ECONOMIC WAY OF
THINKING (cont.)

12. 1-12
• macroeconomics
The study of the nation’s economy as a
whole; focuses on the issues of inflation,
unemployment, and economic growth.
Using Macroeconomics to Understand Why Economies Grow
Macroeconomics explains why resources increase over time
and the consequences for our standard of living.
Macroeconomics explains why economies grow and change
and why economic growth is sometimes interrupted.
1.4 MACROECONOMICS

13. 1-13
Using Macroeconomics to Understand Economic Fluctuations
All economies, including ones that experience a general trend
of rising per capita income, are subject to economic
fluctuations, including periods when the economy shrinks.
Using Macroeconomics to Make Informed Business Decisions
A manager who studies macroeconomics will be better
equipped to understand the complexities of interest rates and
inflation and how they affect the firm.
1.4 MACROECONOMICS (cont.)

14. 1-14
• microeconomics
The study of the choices made by
households, firms, and government and how
these choices affect the markets for goods
and services.
Using Microeconomics to Understand Markets and Predict Changes
One reason for studying microeconomics is to better
understand how markets work and to predict how various
events affect the prices and quantities of products in markets.
1.5 MICROECONOMICS

15. 1-15
Using Microeconomics to Make Personal and Managerial Decisions
On the personal level, we use economic analysis to decide
how to spend our time, what career to pursue, and how to
spend and save the money we earn. Managers use economic
analysis to decide how to produce goods and services, how
much to produce, and how much to charge for them.
Using Microeconomics to Evaluate Public Policies
We can use economic analysis to determine how well the
government performs its roles in the market economy.
1.5 MICROECONOMICS (cont.)

16. 1-16
K E Y T E R M S
ceteris paribus
economic model
economics
entrepreneurship
factors of production
human capital
labor
macroeconomics
marginal change
microeconomics
natural resources
normative analysis
physical capital
positive analysis
scarcity
variable

17. Chapter 2
The Key
Principles
of Economics

18. 1-18
Learning Objectives
1. Apply the Principle of Opportunity Cost
2. Apply the Marginal Principle
3. Apply the Principle of Voluntary Exchange
4. Apply the Principle of Diminishing Returns
5. Apply the Real-Nominal Principle

19. 1-19
The Cost of College
● opportunity cost
What you sacrifice to get something.
P R I N C I P L E O F O P P O R T U N I T Y C O S T
The opportunity cost of something is what you sacrifice to get it.
Opportunity cost of money spent on
tuition and books $ 40,000
Opportunity cost of college time
(four years working for
$20,000 per year)
80,000
Economic cost or total opportunity
2.1 THE PRINCIPLE OF
OPPORTUNITY COST

20. 1-20
The Cost of the Military Spending
● opportunity cost
What you sacrifice to get something.
P R I N C I P L E O F O P P O R T U N I T Y C O S T
The opportunity cost of something is what you sacrifice to get it.
The war in Iraq will cost $1 Trillion
Each $100 Billion could instead support
• Enroll 13 million preschool children in the Head Start program for one year.
• Hire 1.8 million additional teachers for one year.
• Immunize all the children in less-developed countries for the next 33 years.
2.1 THE PRINCIPLE OF
OPPORTUNITY COST

21. 1-21
Opportunity Cost and the Production Possibilities Curve
● production possibilities curve
A curve that shows the possible
combinations of products that an
economy can produce, given that its
productive resources are fully employed
and efficiently used.
FIGURE 2.1 Scarcity and the Production
Possibilities Curve
The production possibilities curve illustrates the
principle of opportunity cost for an entire
economy.
An economy has a fixed amount of resources. If
these resources are fully employed, an increase
in the production of wheat comes at the expense
of steel.
2.1 THE PRINCIPLE OF
OPPORTUNITY COST (cont.)

22. 1-22
FIGURE 2.2
Shifting the Production
Possibilities Curve
An increase in the quantity of
resources or technological
innovation in an economy shifts
the production possibilities curve
outward.
Starting from point f, a nation
could produce more steel (point
g), more wheat (point h), or more
of both goods (points between g
and h).
2.1 THE PRINCIPLE OF
OPPORTUNITY COST (cont.)

23. 1-23
● marginal benefit
The additional benefit resulting from a small increase in some activity.
● marginal cost
The additional cost resulting from a small increase in some activity.
M A R G I N A L P R I N C I P L E
Increase the level of an activity as long as its marginal benefit exceeds its
marginal cost. Choose the level at which the marginal benefit equals the
marginal cost.
2.2 THE MARGINAL PRINCIPLE

24. 1-24
FIGURE 2.3 The Marginal
Principle and Movie Sequels
The marginal benefit of movies in a
series decreases because revenue
falls off with each additional movie,
while the marginal cost increases
because actors demand higher
salaries.
The marginal benefit exceeds the
marginal cost for the first two
movies, so it is sensible to produce
two, but not three, movies.
2.2 THE MARGINAL PRINCIPLE
(cont)
How Many Movie Sequels?

25. 1-25
P R I N C I P L E O F V O L U N T A R Y E X C H A N G E
A voluntary exchange between two people makes both people better off.
Here are some examples.
▪ If you voluntarily exchange money for a college education, you must expect
you’ll be better off with a college education. The college voluntarily provides
an education in exchange for your money, so the college must be better off,
too.
▪ If you have a job, you voluntarily exchange your time for money, and your
employer exchanges money for your labor services. Both you and your
employer are better off as a result.
2.3 THE PRINCIPLE OF
VOLUNTARY EXCHANGE (cont.)

26. 1-26
P R I N C I P L E O F D I M I N I S H I N G R E T U R N S
Suppose output is produced with two or more inputs, and we increase one
input while holding the other input or inputs fixed. Beyond some point—called
the point of diminishing returns—output will increase at a decreasing rate.
The principle of diminishing returns is relevant when we try to product more output in an
existing facility by increasing the number of workers sharing the facility.
When we add a worker to the facility, each worker becomes less productive because he or
she works with a smaller piece of the facility:
More workers share the same machinery, equipment, and factory space. As we pack more
and more workers into the factory, total output increases, but at a decreasing rate.
It’s important to emphasize that diminishing returns occurs because one of the inputs to the
production process is fixed.
When a firm can vary all its inputs, including the size of the production facility, the principle
of diminishing returns is not relevant.
2.4 THE PRINCIPLE OF
DIMINISHING RETURNS

27. 1-27
● real value
The value of an amount of money in terms of what it can buy.
● nominal value
The face value of an amount of money.
R E A L - N O M I N A L P R I N C I P L E
What matters to people is the real value of money or income—its purchasing
power—not its “face” value.
2.5 THE REAL-NOMINAL
PRINCIPLE

28. 1-28
K E Y T E R M S
marginal benefit
marginal cost
nominal value
opportunity cost
production possibilities curve
real value