CHAPTER 1 INTRODUCTION Dr Widad Soufi What is economics Economics is the study of choices that economic agents households firms governments must ID: 489397
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Slide1
PRINCIPLES OF MACROECONOMICS
CHAPTER 1: INTRODUCTION
Dr.
Widad
SoufiSlide2
What
is
economics?
Economics
is
the
study
of
choices
that
economic
agents (
households
,
firms
,
governments
) must
make
as
they
use
scarce
resources
under
the influence of
incentives
.
Large and
complex
subject
to
be
understood
through
ten
principlesSlide3
TEN PRINCIPLES: Trade-off
1.
Every
choice
that
people face
involves
a
trade
-off.
Definition
:
Whenever
we
choose
to
get
more of
something
or do more of
some
activity
,
we
have to
forgo
something
else
.
Examples
:
-
Consumption
vs.
Saving
- Production vs.
Research
-
Work
vs. Education
-
Efficiency
vs.
EquitySlide4
TEN PRINCIPLES: Trade-off
Efficiency
:
Noone
in society
can
be
made
better
off
without
making
someone
else
worse
off.
Equity
:
Everyone
in society
receives
an
equal
share
of
what
the society
producesSlide5
TEN PRINCIPLES:
Opportunity
cost
2.
Every
trade
-off
implies
an
opportunity
cost
.
Definition
:
The
opportunity
cost
is
whatever
needs
to
be
forgone
when
one
gets
more of
something
or
does
more of
some
activity
.
Examples
:
What
is
the
opportunity
cost
of a trip to NYC?
What
is
the
opportunity
cost
of a
cup
of coffee?
What
is
the
opportunity
cost
of
studying
?Slide6
TEN PRINCIPLES: Marginal
analysis
3.
When
making
choices
, people
think
at
the
margin
.
Definition
:
People
evaluate
the
effect
of an
incremental
increase
of
something
or
some
activity
before
making
a
decision
.
The
benefit
from
getting
more of
something
or
doing
more of an
activity
is
called
the
marginal
benefit
.
The
opportunity
cost
of
getting
more of
something
or
doing
more of an
activity
is
the
marginal
cost
.
Examples
:
-
Studying
vs.
Playing
sports
-
Producing
cheese
vs.
Producing
yogurt
Slide7
TEN PRINCIPLES:
Incentives
4. People
respond
to
incentives
.
Definition
:
When
the marginal
benefit
is
higher
(
lower
)
than
the marginal
cost
of an
additional
unit of
some
item,
then
we
have an
incentive
to
get
more (
less
) of the item.
Examples
:
-
Studying
vs.
Playing
sports
-
Producing
cheese
vs.
Producing
yogurt
Slide8
TEN PRINCIPLES: Trade
5. Trade
increases
welfare
.
Definition
:
International
trade
of
goods
and services
allows
countries to
specialize
, exchange, and
buy
more
at
lower
prices
. So, countries are
better
off
from
engaging
in
trade
.
Example
:
Household
/
plumberSlide9
TEN PRINCIPLES: Markets
6.
Economic
activity
is
better
organized
through
the
decentralized
decisions
of
many
households
and
firms
that
interact
in
markets
.
Adam Smith: « invisible hand »
How
does
the « invisible hand »
work
?
Rational
interest
Utility
maximization
Profit
maximization
Conditions:
Voluntary
exchange
Protection of
property
rights
The invisible hand
produces
efficiency
(
although
not
always
), but
it
does
nothing
about
equity
.Slide10
TEN PRINCIPLES: Markets
When
does
the invisible hand not
work
?
When
the
government
intervenes
in the
market
(
e.g
. to
improve
equity
),
it
prevents
the
price
from
adjusting
in
response
to a
shortage
or surplus.
Examples
:
-
C
ommunist
system
where
prices
are set
-
Government
policies
distording
the
market
price
:
- Taxes and subsidies
- Quotas
-
P
rice
floor
or
ceilingSlide11
TEN PRINCIPLES: Market
failures
7.
Governments
can
improve
market
efficiency
.
There are situations
where
resources
are not
allocated
in the best possible
way
,
so
the invisible hand
does
not
work
and the
market
fails
to
achieve
an efficient
outcome
.
Such
situations are as
follows
:
-
imperfect
information
-
externalities
-
imperfect
competition
- public
goods
-
commons
In
these
cases the
government
may
intervene
to
improve
efficiency
.
The
government
may
also
intervene
to
improve
equity
(
see
above
)
because
the invisible hand
does
nothing
about
welfare
distribution. It
is
only
concerned
with
efficiency
.Slide12
TEN PRINCIPLES:
Productivity
8. A
country’s
living standard
depends
on
its
workers
’
productivity
.
Definition
:
The
productivity
is
the
amount
of
goods
and services
produced
by
each
unit of
labor
.
Productivity
depends
on:
Education
Capital
Technology
.Slide13
TEN PRINCIPLES: Inflation
9.
Prices
rise
when
the
government
supplies more money.
Definition
:
Inflation
is
the
sustained
increase
in the
average
price
level
.
Inflation
is
often
caused
by a
rapid
money
growth
. Inflation
is
usually
feared
by
governments
as
it
imposes
costs
on society and
hence
reduces
efficiency
. Slide14
TEN PRINCIPLES: Phillips
curve
10. There
exists
a short
run
trade
-off
between
inflation and
unemployment
.
Definition
:
The Phillips
curve
describes
the
negative
relationship
between
inflation and
unemployment
.
There
is
a large agreement
among
economists
that
this
relationship
only
exists
in the short-
run
.
Why
?Slide15
TEN PRINCIPLES: Phillips curve
The main
reason
for the short-
run
trade
-off
between
unemployment
and inflation
is
the
fact
that
in the short-
run
prices
are
sticky
(
prices
adjust
slowly
to changes in
government
policies
).
Thus
,
when
money
growth
increases
(
so
inflation
rises
) and
prices
are
sticky
low
, people
spend
more,
so
firms
sell
more,
so
they
hire
more
labor
and
unemployment
falls
.
In the long-
run
,
prices
are flexible,
so
the long-
run
effects
of
government
policies
are
likely
different
from
their
short-
run
effects
. Slide16
Quiz (Mankiw
, P. 16)
What
is
the
opportunity
cost
of
seeing
a
movie
Why
should
policy
makers
think
about
incentives
?
What
does
the invisible hand of the
market
place do?
Why
is
productivity
important?
Slide17
HOMEWORK (
Mankiw
, P. 16-17)
Solve
the
following
problems
: 3, 6, 9, 11, 15Slide18
REFERENCES
Mankiw
, Gregory.
Principles
of
Macroeconomics
.
Third
edition
.