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Mankin Principles of Macroeconmics Chapter 2

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hi class

and welcome to chapter two thinking like

an economist

there are two schools of thought in

economics micro which is a study of how

households and firms make decisions and

how they interact with the market

micro being small so we're talking about

households and firms we're talking about

small groups of

economics macro the study of the economy

as a whole

we're looking into phenomenons we're

looking at things like

inflation unemployment and economic

growth and this is where we're going to focus

focus

most of our time this semester is on the macro

macro

now an economy as a whole can be very

very large like the united states economy

economy

or can be small like a small country

states do have macro issues of course

because states do

calculate their own unemployment and

economic growth statistics so they do

look at macro

but they also do look at micro because

in economics we have two types of

statements we have the positive and the

normative statement

positive statements in economics attempt

to describe the world as it is

they're descriptive they can be

confirmed or refuted by

examining evidence we like to think of

these a lot of times or

i do especially as data driven

normative statements are an attempt to

basically describe how the world

should be they're prescriptive they

basically are kind of writing a

prescription for the world

they're saying this is the way we'd like

economists play two roles in

in the united states and in the world

today they play the role of a scientist

because they're always trying to explain

the world and what's happening

and they also play a role as political advisors

advisors

they try to improve the world by using

what they find out about the world

to help policymakers understand the

so where in washington do you see these

policy advisors well you see them

obviously in the council economic

advisers that's the

reason why they're called the council of

economic advisors they're also in the

office of budget

and management or management and budget

they're in the department of treasury

they're in the department of labor

they're in the department of justice

they're in the congressional budget

office and then they of course are in

so back to the statements so as you imagine

imagine

these economists that are in washington

may be using both kinds of statements

they may be using these

positive descriptive statements

attempting to describe the world

as is like for instance minimum wage

laws cause unemployment

they can go out and they can find statistics

statistics

and data that would basically whether we believe

believe

or want to believe the statistic or not

that show that this statistically is

true normative statements are much more prescriptive

prescriptive

they attempt to show what the world

should do so the government should raise

the minimum wage now notice the word

should in there should does not mean

that we have

any way of proving what would happen

with that if this

was a positive statement it would say

the government

in raising the minimum wage would cause unemployment

unemployment

so let's try a few okay i'm going to go

through these statements

and you guys are going to decide whether

they're positive or their normative

prices rise when the government

increases the quality money

the government should print less money

tax cuts a tax cut is needed to

stimulate the economy

an increase in the price of burritos

will cause an increase in

which way they download all right the

first one prices

rise when the government increases the

quantity of money

that's a positive statement we can use

data to show

that this is a true statement or is not

a true statement

the government should print less money

notice the word should

unfortunately for that one it's a

normative statement right because

well fortunately it is a normative

statement you cannot necessarily there

is no data

to confirm that you could make it a

positive statement by saying that

by printing less money the government

will stabilize the economy

and gdp and then we could prove that

this is a value judgment though this

particular statement

it can't be confirmed or refuted but it

is a value judgment

political candidates use a lot of these

don't they we should do this we should

do this we should do this

tax cut is needed to stimulate the

it is a judgment call unless you can go

out and prove

that the tax cut will stimulate the economy

economy

which by the way is very difficult to do

we'd have to be much more specific to

get this to be

a positive statement we would need to be

able to say a tax cut

in this sector will do this this this

and increasing the price of burritos

will cause an increase in consumer demand

demand

for music downloads believe it or not

this is a positive statement why

because it describes a relationship

burrito prices

consumer demand for music downloads

we can measure those relationships we

can look at the price of burritos in the

market we can look at how many music downloads

downloads

we can put a correlation between the two

it may not be true

but it is a positive statement that we

can measure

hopefully this helped a little bit on

economists are very much scientists in a

lot of ways and we employ

scientific methods to

basically test theories of how the world works

works

we also use them to make assumptions

about a very very complex world and make

them easier

for instance when we study international

trade especially in microeconomics and principles

principles

we'll only be using two countries in two

goods now that's

not necessarily the entire model of

trade within

the world but by taking two major goods

and two major countries

that trade in these goods you can start

to understand

trade very very clearly

which is a very complex issue but can be

clearly looked at by just simplifying a tag

tag

so economists tend to use these types of

models to simplify

the relationship between things that may

be fairly complex in reality

but the overriding

issues can be seen by looking at them

with these very simplistic models we're

the first model we're going to look at

is the circular flow model

this is a visual model of the economy it

shows how dollars flow through the

market among households and firms

this model has two decision makers firms

and households and two interacting markets

markets

the market for goods and services and

then markets for factors of production

inputs things that go into creating

things i'll show you how this works

so if you imagine the two

decision makers the households they own

the factors of production why do they

own them

because in the economy especially in our economy

economy

the factors of production such as labor

forests somebody has to own them right

they either sell or rent them to firms

for income

now the households are also involved in

the opposite side

they are buying consumer consuming goods

and services

firms on the other hand are buying or

hiring those factors of production right

they're either buying those trees

or buying that land that have those

trees on it or buying the land to put

the factory on

and they're also buying labor when you

pay a wage you are actually buying labor

and they're using those to produce goods

and services

and then they're selling those goods and

this comes out to be this so remember we

have the firms on one side and the

households on the other

the top and the bottom are the two

markets one is the markets for goods and

services so these are the things that

are finished goods

and the others is the market for factors

of production

so if we follow this around in a green

method you'll start to see what happens

so for instance if you start off with a

household the household

spends money follow the green to buy

what goods and services in that market

those goods and services that the

household buys become

revenue for the firms the firms and then

take that revenue and do what they have

to pay wages they have to rent or they

have to

they own things they have to they use it

for profit that's the green line in there

there

but they by having to pay rent

and wages etc what are they doing that's

going into the factors

the market for the factors of production

that in turn becomes what

income to the households so if they're renting

renting

um lands or they're

buying timber from from land the

household owns

what are they doing they're gonna have

to pay

in income to those households

this also of course includes the stock

market right because when we invest

into a company we are what we are providing

providing

and we are basically providing income

into that

um company in terms of the purchase of stocks

stocks

that becomes factors of production that

becomes income is the households the

income that has

gets spent by the household et cetera it

becomes revenue goes around their

amounts that's where the money is coming from

from

at the same point in time the households

have land labor and capital

that's going into the factors of production

that market right they are factors of

production that basically then goes to

the firms who use them

as inputs into their production of goods

and services

those goods and services are sold we buy

them as households and we go around the circles

circles

so what happens when something shrinks

and here's where we start to look at

the fact that the economy is all

interactive so the circular flow diagram

although you're probably saying to

yourself it's fine

it's really a great way of describing

how an economy shrinks in groups

for instance if you take a look at the very

very

right hand corner that income that green

line is going up

if income in the entire united states

starts to shrink

then that green line is going to shift

where inward right

well if that green line shifts inward

then what happens to spending

spending shifts inward well if spending

shifts inward then

revenue shifts inward if revenue shifts

similar then wages and profits and rents

shift inward and then etc

and you keep shrinking the economy so

this is how recessions occur

because as income shrinks

and households are spending less

especially in a consumer market like the

united states

that green line shrinking inward

and it doesn't matter which one happens

first if the income happens first or the

wages happen first

doesn't matter as that starts to shrink

inward it shrinks the entire economy and

vice versa

as income wages profits etc and revenue

go outward or

companies start to make more money the

economy starts to expand so you can

start to see how everybody's

interactively working together

as an economy so people start to

point fingers oh it's the household

sponsors the firm's fault it's obviously

it must be the market for goods and

services it must be the factors of

production you can start to see that

every single one is interactive on the other

other

and they all have to work together to

the other model that we're looking at is

the production possibilities

frontier ppf for short

and this is a graph that looks at the

combinations of outputs that the economy can

can

possibly produce and it's basically

production and technology as i mentioned

we're simplifying this in this

particular case

this entire economy can only produce

computers and wheat

they have one resource labor and it's

measured in hours

the economy in total has only

50 000 hours of labor per month

available for production

so then you can start playing around

with this and you can say okay

we know we can only make computers in wheat

wheat

so if we dedicate our employment hours

totally to computers

all 50 000 of them and we do no wheat

and we know that it takes

100 hours of labor to make one computer

and it takes 10 hours of labor to make

one ton of wheat

we can then say to ourselves okay if we dedicate

dedicate

everything to computers and we know it

takes 100 hours

to make a computer then we know that 50

000 divided by a hundred gives us

500 computers so we're going to end up

with 500 computers as an economy

that's going to be point a point b would

say okay

we want computers so we're going to go

with 40 000 computers but we're going to

have a little wheat we'd like to eat

something so now all of a sudden you

take that forty thousand times the

hundred because that's how much

labor hours it takes to produce produce

one computer

we get four hundred computers and then

you take the ten thousand

labor hours that we dedicated to we we

divide it by 10 hours and we're going to

get a thousand tons of wheat

we do the same thing where we do half

and half which is 25 25

so we get 250 computers and 2

500 wheat we do 10 and 40. we're gonna

flip it around

we get a hundred and four thousand and

then we just go totally we

and we get five thousand remember how i

said that

all economies are adjusting and deciding

how to re allocate their resources

which are scarce for the present and the future

future

the production possibility is looking at

the resource right

a resource is scarce labor they only

have so much of it and they're

allocating it across

two different production in this economy

they're trying to decide where they're

going to produce and what they're going

to produce

this then becomes this graph

so you can start to plot across the

graph all the points so we know now

that point a on this graph

means that we have 500 computers and

zero wheat

so that becomes point a you can draw

that on your graph

point b becomes 400 and a thousand

point c becomes 250 remember from the previous

and 2500 point d

becomes a hundred and four hundred and point

point

e becomes zero and five thousand

this becomes your production

possibilities for two and

obviously there are all sorts of

combinations in between like you could

say to yourself

okay what if we did three thousand world

wheat then we could

draw the line for three thousand and

what would we be at

a hundred and something so you can start

now that you've drawn find the point

that represents

3 000 tons of wheat and label it off

do you think that that's possible for

this economy to produce that combination

and why or why not what did you come up

with did you come up with a point that

looks something like this

viable if you calculate it out that would

would

basically be 40 000 hours of labor it's

definitely possible but

you have 50 000 why would you not use

all the resources that you have

available to you as an economy

it's possible but it's not efficient

because to be efficient

you want to use what you have available

right now find a point that's 300 computers

computers

and 3500 tons of wheat and label a g

anybody come up with this point slightly

off the graph

on the other side well

this actually requires 65 000

hours of labor not possible because how

many hours did you have 50

you don't have that many the economy

can't go over

the amount of labor they have this

particular point is not possible

it is off the production possibilities

so points like a b c d e

are efficient they're utilizing all the

resources which in this case is labor

points like f are possible but they're

not efficient

some resources are being underutilized

that means that you're gonna have

unemployed workers you're gonna have

factories i don't

so as you move along that production possibilities

possibilities

curve that we just looked at you're

shifting resources from wheat to

computers or computers to wheat

and this is really looking at that

trade-off that we talked about in

chapter one

to get more of one good this means that

you have to sacrifice another good

now remember what the trade-off was

called it was called the opportunity cost

cost

the opportunity of cost of one good is

in terms of the other good

so as you move towards more wheat

you are what you have an opportunity

cost of computers

and vice versa how do you calculate this

opportunity cost the way you calculate

this opportunity cost is by using the slope

slope

now the slope is calculated by the rise

over the run

so in this particular case if you look

at two points

and you look at point a and point b you

can see that if you go from point a to

point b

your rise is gonna be a thousand because

you're gonna go from

four to five thousand and it's gonna

actually be negative because you started

at five and you go to four sorry about that

that

now you're also going to go from

0 to 100 so that is actually a positive 100

100

so your slope in this particular case is

negative 10.

your opportunity cost is 10 tons of weight

how do you remember this well one of the

things i always try to remember

when i'm doing this is rise over run is

basically what

it is literally like a treadmill so any

of you who've ever used a treadmill

the rise is what the adjustment that you

make up and down

on your treadmill in this case 10 inches

the run

is the distance that the treadmill is

giving you to run on in this particular

case is 48 inches

so rise over run at this particular

slope treadmill

is 5 over 24 that is the what

there is a nice little recording here

by the federal reserve sorry

and i'm going to pull this up for us now

so we can watch it

and this is going to give us a little

idea of how

basis

in the previous segment we learned that

scarcity forces people to make a choice

and when people choose there is an

opportunity cost

opportunity cost is the value of the

next best alternative

when a decision is made is what is given

up the opportunity cost of producing one

more widget

is the lost opportunity to produce two gadgets

gadgets

so the ppf can be used to illustrate two

very important economic concepts

scarcity and opportunity cost now let's

move beyond the basics and see how the

ppf graph illustrates some bigger

economic ideas

the space right here on the inside of

the frontier

helps illustrate our next lesson lesson three

three

a point inside the frontier represents underemployment

underemployment

movement back toward the frontier

reflects economic expansion

the frontier represents maximum

production with the available resources

but it isn't just the points along the

line that are production possibilities

econ isle could alternately produce at

any point inside the frontier

so while it could produce four gadgets

and four widgets

it might produce only two gadgets and

two widgets

in this case econ isle would not be

fully employed

or put differently resources in econ

isle would be

underemployed in fact any point inside

the frontier represents underemployment

which is a failure to reach full employment

employment

why would an economy produce below its potential

potential

well it could be in a recession which is

a significant decline in general

economic activity

extending over a period of time during a

recession econ isles production will

likely decline resulting in workers

losing jobs

and leaving other resources machines and

factories underutilized as well

when economic activity picks up again

production levels would likely move back

towards the frontier

that is the economy would move back

toward full employment

the shift from recession toward the

frontier is sometimes called economic expansion

expansion

so far we've talked about econ iowa's

possibilities up to its frontier

but the frontier line itself can shift

two primary changes can cause the

frontier to shift

a change of productive resources and

technological change

remember that the frontier reflects the

available resources

the frontier will shift as the economy

acquires or loses productive resources

for example if the labor force grows and

other resource levels stay the same

the frontier will shift outward or

if an economy diverts resources to

produce more capital goods

which means they are using economic

resources to make

other resources the frontier will shift outward

outward

technological change is an advance in

overall knowledge

in a specific area the gains achieved

through technological change

tend to be gains through increased

productivity or

an increase in economic output per input

in fact productivity is measured as the

ratio of output

per worker per unit of time take fred

for example

imagine fred can produce two widgets per hour

hour

but then his productivity improves and

he can produce three widgets per hour

notice that there is still only one fred

and we are still measuring his

production per hour

but his output has increased two factors

can increase worker productivity over time

time

investment in physical capital things

such as computer software and tools

and human capital human capital is the

knowledge and skills that people obtain

through education experience and training

training

imagine fred's hand tools were replaced

with new power tools

all of a sudden fred would be able to

produce more output

in the same amount of time his increase

in productivity would be due to

investment in physical capital

and then when fred learns to use the new

power tools more effectively

he'll likely increase his productivity

even more

this increase on productivity would be

due to investment in human capital

increasing the productivity of workers

allows for more production

without an increase in resources and

improvements in productivity will shift

the frontier outward

which illustrates our fourth lesson

lesson four

an outward shift of the frontier

reflects economic growth

fred increased his productivity by

learning how to use new tools

increasing the productivity of workers

allows for more production

without an increase in resources and

improvements of productivity will shift

the frontier outward

which reflects economic growth for econ

aisle an

outward shift can mean that it can

produce both more gadgets

and more widgets those that i said the

economy can produce

more of both goods remember that when

the ppf

is static producing more gadgets means

producing fewer widgets

there is an opportunity cost but when

the frontier shifts

outward it is possible to produce more

of both goods

economists call this economic growth a

sustained rise over time in a nation's

production of goods and services

economic growth is important because it

allows more people

to have more of what they want over time

be sure to watch part three of this

series to learn our final lesson and

so as you can see there's a lot that

goes into the production possibilities

curve and it

is a direct reflection of the economy

now granted

um econ island is only has widgets and

uh gadgets but

the point being is is that it's still an

economy as a whole

so now we start to take that beyond

just one we start to look at how we can

compare different opportunity costs and

different economies

for instance here's england and france

england and france both can produce wine

and cloth

and given their particular availability

of resources

they have two different production

possibilities curve

which one has an opportunity cost

the answer is england because

when england chooses to produce more cloth

cloth

its cost constant wine is fair look look

at how

flat that curve is rise over run when

france decides

to produce a little more wine i mean

sorry a little more cloth

look at how much wine it has to give up

so if you look with

difference between 100 and 200

you can see that we went from four you

know maybe about 400 wines

to 200 that's 201

whereas for instance if when england

goes from 100

to 200 it's less than a hundred

lower

so additional resources are definitively needed

needed

to improve your economic

situation resources or improvement

technology will

move your entire production

possibilities curve outward

you can produce more wheat and more

computers or

any combination in between in this

particular case the production

possibility curve moved out

and everyone will be better off because

their additional resources or

improvement in technology which we just

now it's not always true

that everything works equally for instance

instance

in this particular example you have the

production of cube

computers and the production of cars we

have a nice

blue production possibilities curve and

you can all draw where the base here

for um cars is a thousand and if you

were to produce only computers you'd be at

three thousand now what happens there's

a technological advance in the computer industry

industry

which enables the economy to produce

for any given car in other words it's a

one-sided technology advance

so all of a sudden if they didn't

produce any cars

they could produce 4 000 computers

but if they produce only cars there's

still a thousand so the curve

is still going to fall down to the

thousand but it's going to go all the

way up to four so what are we doing

we've moved the production possibility

curve outward but only for one

particular case so if you were to look

at point a

and you guys can draw this one and that

means that we are producing

600 cars and we're producing 2200 computers

computers

and then all of a sudden you go to 650 cars

what happens with the computers you only

you went to 23 000 computers

the production of both cars and

computers increases at some points

because we've gotten so much more

efficient with computers

but as we get to the point in which we

only produce cars obviously the

efficiency goes away

so it allows you to be better off even

if it's a one-sided

improvement everybody's better off but

it's just weighted to one side or the other

so why is this boat outward what is it

about the production possibilities curve

that when i started to look at the ones

that were more

traditional i have now a curve that has

a little bit of a bow

versus that nice linear line well what

really ends up happening

the opportunity cost increase as you

move from one to another so if we start

off with beer and we're moving towards

mountain bikes

when you're in the middle it seems as

though the curve is kind of nice and

relative but when you start to get towards

towards

only producing mountain bikes you see

that you start losing more and more beer

and this is partially because the

opportunity cost starts to increase

as you produce and get closer to only

so if we look at this at point a

most of the workers are producing beer

and even those are probably better

suited to buying

building bikes why is that see if point a

this is mostly a beer economy which

means that there are probably people

in the labor force who are so much

better mechanically at doing something

like a bicycle

than they are at producing beer so what

ends up happening right there is is that

you've got a

opportunity cost on mountain bikes is

you don't have to give up much beer to

get more mountain bikes

because what's happening is that you're

moving your resources

at that point in time from a to probably

whatever that

most call it be you're moving the

resources over and the resources you're

probably moving are those people who are

so good at bikes

they're probably really not very very

good brewers so

as you move all the way to this newbie

you've got a lot more workers that are

producing bikes and a few left producing

beer now you got the best brewers so now

as you start to shift towards more and

more bikes now you've got your best

brewers moving away from

beer production and you're starting to

cause a drop in beer

so either side of the production

possibility curve when you're more at

these these these

ends you're giving up a lot of one for

another another

lot of another for one for instance when

you got too

high into beer if you went from the

point that's not labeled to a

you didn't give up too much beer but you

gave a lot of mountain bikes

when you're down here at the closer to

the mountain bikes

as you move towards more and more

mountain bikes you give up a ton of beer

so as you get to those steep ends you're

causing people who are probably

much more suited to one

to move to another and if we think about yourself

yourself

and your majors and what you're thinking

about doing in life you realize that

everybody is suited to things differently

differently

and although you could probably do

something else

for instance i probably could put

together a mountain bike i'm probably

much better off

growing beer because i like chemistry

because i

i like to cook i'm probably much better

so the economic reason behind the boeing outward

outward

is because different workers have

different skills

and there's different opportunity costs

and so some resources or a mix of

resources will cause

varying opportunity costs and one of the examples

examples

some land is well suited to farming

some plant does not have a ton of rocks

some land is growl is simply flat

it makes sense some land is not suited

to farming

if all lands in the united states was

dedicated to farming

we wouldn't necessarily produce that

much more

then we produce when the optimal land

for the united states is used for funding

funding

and this is where you have to allocate

your resources according to what really

this gets us at the end of chapter two

we've gone through and we've discussed

what we've discussed if there's macro

micro issues

we've discussed that economists are

policy advisors and they

make different types of statements

normative and positive we've discussed

economists as scientists in terms of

two different models the circular flow

diagram and the production possibilities frontier

frontier

and these will come back and we will

discuss these over and over again

but these are kind of the concepts that

start to

have the foundation of where we are

moving to macro issues for the rest of

the semester

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Mankin Principles of Macroeconmics Chapter 2