Global Macroeconomics ECO 120

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Global MacroeconomicsECO 120

• Taggert J. Brooks
• Spring 2007

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Introduction

• Useful Links
• http//www.uwlax.edu/faculty/brooks/macro/
• Useful Blogs
• http//www.marginalrevolution.com/
• GMU Economists Tyler Cowen/Alex Tabarrok
• http//www.j-bradford-delong.net/movable_type/
• Berkley Economist Brad DeLong
• http//arandomwalk.blogspot.com/
• Taggert J. Brooks
• It is important to read economics.

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A Note on Learning Economics

• Economists - like many in other disciplines -
  have their own language.
• I will spend very little time in class reading
  definitions.

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What is Economics?

• Incentives matter.
• The law of unintended consequences.

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What is Economics?

• Economics is the study of the allocation of
  scarce resources in an attempt to satisfy
  unlimited wants
• More generally it is the study of human decision
  making particularly as it relates to markets.
• A set of tools used for analysis, and a way of
  thinking.

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Scarcity, Choice, and Opportunity Cost

• Human wants are unlimited, but resources are not.
• Three basic questions must be answered in order
  to understand an economic system
• What gets produced?
• How is it produced?
• Who gets what is produced?

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Scarcity, Choice, and Opportunity Cost

• Every society has some system or mechanism that
  transforms that societys scarce resources into
  useful goods and services.

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Microeconomics and Macroeconomics

• Microeconomics is the study of the economic
  behavior of decision makers
• Macroeconomics is the study of the behavior of
  entire economies

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Some Sub-Fields (disciplines)

• Micro
• International Trade
• Industrial Organization
• Labor Economics
• Health Economics
• Macro
• International Finance
• Money and Banking
• Economic Development
• Growth Theory

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Broad Learning Objectives

• Compare and contrast the performance of an open
  economy in terms of the short-run and the
  long-run.
• Evaluate the impact of macroeconomic policies on
  the long-run growth path of an economy and
  short-run business cycle fluctuations.
• Develop an informed interest in an economy
  interacting in a global environment.
• Accept responsibility for learning and develop
  the desire for life-long learning in order to
  become an active citizen.
• It is expected that comparisons will be made
  between the US and other countries when
  discussing unemployment, inflation, output,
  cyclical fluctuations, and economic growth.

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Specific Objectives of Chapters 1,2

• Explain the fundamental economic problem.
• Define and provide an example of opportunity
  costs.
• Explain how the production possibilities curve
  illustrates the concepts of scarcity, choice, and
  opportunity cost.

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Scarcity (The Fundamental Problem)

• Economic Good (or service) is scarce if there is
  not enough to satisfy all wants at a zero price
  (free). This is often called a good for short.
• Free Good there is enough to satisfy all wants at
  a zero price. Examplesnone?
• Economic Bad is something you would pay to have
  less of.

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Economics is a Way of Thinking

• Three fundamental concepts
• Opportunity cost
• Marginalism, and
• Efficient markets

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Opportunity Cost

• Opportunity cost is the best alternative that we
  forgo, or give up, when we make a choice or a
  decision.
• All decisions involve trade-offs.
• No Free Lunch

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Opportunity Cost

• You won a free ticket to see an Eric Clapton
  concert (which has no resale value). Bob Dylan is
  performing on the same night and is your
  next-best alternative activity. Tickets to see
  Dylan cost 40. On any given day, you would be
  willing to pay up to 50 to see Dylan. Assume
  there are no other costs of seeing either
  performer. Based on this information, what is the
  opportunity cost of seeing Eric Clapton?
• (a) 0, (b) 10, (c) 40, or (d) 50.

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Marginalism

• In weighing the costs and benefits of a decision,
  it is important to weigh only the costs and
  benefits that arise from the decision.

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Marginalism

• For example, when a firm decides whether to
  produce additional output, it considers (should
  consider) only the additional (or marginal cost),
  not the sunk cost.
• Sunk costs are costs that cannot be avoided,
  regardless of what is done in the future, because
  they have already been incurred.

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Efficient Markets

• An efficient market is one in which profit
  opportunities are eliminated almost
  instantaneously.
• Profit opportunities are rare because, at any one
  time, there are many people searching for them.

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Some Non-standard Economic Research

• Economists have done research into areas not
  normally considered economics, by asking
  questions such as
• Why are Americans so obese?
• What is more dangerous a gun or a pool?
• Why did crime rates fall in the 1990s?
• The Economics of Ecstasy (not the drug).
• Toilet seat etiquette. Always down?
• What is the relationship between Religion and
  Economic Growth?

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Some Non Traditional Economic Research

• Economists have done research into areas not
  normally considered economics, by asking
  questions such as
• Matching models
• Looking at how employers and employees find
  matches.
• Husband and wives
• Speed Dating.
• Sexual Partners

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Positive Versus Normative Economic Analysis

• A positive economic statement can be proved or
  disproved by reference to facts
• The unemployment rate is 4.1"
• A normative economic statement represents a value
  judgment, which cannot be proved or disproved
• "The government should pay down the debt"

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Identify these statements as normative or
positive economic statements

• Sales Taxes are inefficient and should be
  eliminated.
• Social security will run out of money in 2042.
• Poverty inhibits economic growth.
• The Unemployment Rate is 4.5

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The Scientific Method

• Recognize the problem
• Make assumptions
• Develop Model (theoretical work)
• Make Predictions
• Test Model (empirical work)

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Theories and Models

• Theories involve models, and models involve
  variables.
• A model is a formal statement of a theory.
  Models are generally simplified descriptions of
  the relationship between two or more variables. A
  Model can often be represented graphically or in
  a mathematical model.

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Theories and Models

• Ockhams razor is the principle that irrelevant
  detail should be cut away. Models are
  simplifications, not complications, of reality.

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Theories and Models

• A variable is a measure that can change from
  observation to observation.
• The ceteris paribus device is part of the process
  of abstraction.
• Using the ceteris paribus, or all else equal,
  assumption, economists study the relationship
  between two variables while the values of other
  variables remain constant.

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Behavioral Assumptions

• A behavioral assumption describes the expected
  behavior of economic actors

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Rational Self-Interest

• Individuals rationally select alternatives they
  perceive to be in their best interests
• Alternatives
• Bounded Rationality
• Behavioralists (Ultimatum Game)

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Common Mistakes

• Pitfalls to avoid in formulating economic theory
• Fallacy of Composition
• The belief that what is true of one is true of
  the whole.
• "Every player on the team is a superstar and a
  great player, so the team is a great team." This
  is fallacious since the superstars might not be
  able to play together very well and hence they
  could be a lousy team.

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Common Mistakes

• The post hoc, ergo propter hoc fallacy refers to
  a common error made in thinking about causation
  If event A happened before event B, it is not
  necessarily true that A caused B.
• Sometimes called Coincidental Correlation

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Correlation does not equal Causation

• http//clcpages.clcillinois.edu/home/soc455/psycwe
  b/research/correlation.htm
• Causation requires not just a correlation, but
  also a theory to support it.
• Drugs, Alcohol and Risky Sex among teenagers
• How do we establish causality?
• Develop theory, and eliminate alternative
  explanations through empirical tests.

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Scientific Truth

• We dont prove things to be true we falsify
  things. We show everything else to be false.
  (Popper)
• Theories are just explanations that we havent
  falsified. Or maybe weve proved most of the
  alternatives false, and it is what remains.

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Macro Model 1

• Lets develop a simple little model to understand
  a few more economic concepts.
• Opportunity Cost
• Economic Efficiency

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Capital Goods and Consumer Goods

• Capital goods are goods used to produce other
  goods and services.
• Consumer goods are goods produced for present
  consumption.

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Capital Goods and Consumer Goods

• Investment is the process of using resources to
  produce new capital. Capital is the accumulation
  of previous investment.
• The opportunity cost of every investment in
  capital is forgone present consumption.

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The Production Possibility Frontier

• The production possibility frontier (ppf) is a
  graph that shows all of the combinations of goods
  and services that can be produced if all of
  societys resources are used efficiently.

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The Production Possibility Frontier

• The production possibility frontier curve has a
  negative slope, which indicates a trade-off
  between producing one good or another.

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The Production Possibility Frontier

• Points inside of the curve are inefficient.

• At point H, resources are either unemployed, or
  are used inefficiently.

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The Production Possibility Frontier

• Point F is desirable because it yields more of
  both goods, but it is not attainable given the
  amount of resources available in the economy.

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The Production Possibility Frontier

• Point C is one of the possible combinations of
  goods produced when resources are fully and
  efficiently employed.

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The Production Possibility Frontier

• A move along the curve illustrates the concept of
  opportunity cost.
• From point D, an increase the production of
  capital goods requires a decrease in the amount
  of consumer goods.

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Economic Growth

• Economic growth is an increase in the total
  output of the economy. It occurs when a society
  acquires new resources, or when it learns to
  produce more using existing resources.
• The main sources of economic growth are capital
  accumulation and technological advances.

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Economic Growth

• Outward shifts of the curve represent economic
  growth.

• An outward shift means that it is possible to
  increase the production of one good without
  decreasing the production of the other.

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Economic Growth

• From point D, the economy can choose any
  combination of output between F and G.

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Appendix

• Slides after this point will most likely not be
  covered in class. However they may contain useful
  definitions, or further elaborate on important
  concepts, particularly materials covered in the
  text book.
• They may contain examples Ive used in the past,
  or slides I just dont want to delete as I may
  use them in the future.

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Appendix Understanding Graphs

• http//syllabus.syr.edu/cid/graph/book.html

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The Slope of a Line
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A Line with Positive Slope
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A Line with Negative Slope
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The Slope of a Curve
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Figure 1 Ratio of Median Incomes of College to
High School-Educated Workers
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Figure 2 Unemployment and Education
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Figure 3 Educational Attainment
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Figure 4 The Axes, the Coordinate System, and
the Positive Quadrant
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Resources

• Land
• Land used in the production of goods and services
• Labor
• The physical and mental effort of humans
• Capital
• Buildings and equipment
• Entrepreneurial Ability
• Managerial, organizational, and risk-taking
  skills

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Scarcity, Choice, and Opportunity Cost

• Production is the process that transforms scarce
  resources into useful goods and services.
• Resources or factors of production are the inputs
  into the process of production goods and
  services of value to households are the outputs
  of the process of production.

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Scarcity, Choice, and Opportunity Cost

• Capital refers to the things that are themselves
  produced and then used to produce other goods and
  services.
• The basic resources that are available to a
  society are factors of production
• Land
• Labor
• Capital
• Entrepreneurial ability

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Payment for Resources

• Rent (for land)
• Wages (for labor)
• Interest (for capital)
• Profit (for entrepreneurial ability)

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Markets

• A market is a set of arrangements through which
  buyers and sellers carry out exchange at mutually
  agreeable terms
• Product Market
• A market in which goods and services are
  exchanged
• Resource Market
• A market in which resources are exchanged

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Economic Actors

• Households
• Firms
• Government
• Rest of the World

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Another Example of Opportunity Cost in Practice

• Recently the TSA has decided to allow small
  scissors, knifes, etc.
• Why?