Arkansas State University Department of Economics and Finance Economics 2313:Principles of MacroeconomicsWhat is Economics?Why do economists disagree?What is macroeconomics?Most Macroeconomists are focused on answering two questions:RESOURCESSlide 7Slide 8Slide 9Reproducible inputsThe Three QuestionsThe Economic SystemClassifying Economic SystemsTraditional EconomySlide 15Slide 16Command economyCommandSlide 19Slide 20Slide 21Slide 22Slide 23Market Economy (free enterprise, capitalism)Market Economy: ResourcesMarket System: Resource AllocationMarket SystemPolitical Economy and EconomicsMixed SystemsEconomic System in the USModels and AbstractionCeteris paribusFallacy of compositionSchools of Macro ThoughtNeoclassicalNeoclassicalArkansas State University Department of Economics and FinanceEconomics 2313:Principles of MacroeconomicsWhat is Economics?Definition 1:–Economics “studies human behavior as a relationship between ends and scarce means which have alternative uses" (Robbins, 1932).In other words:–Economics is the study of how society chooses to allocate its scarce resources to the production of goods and services in order to satisfy unlimited wants (Tucker, p. 5). Definition 2:–Economics studies how societies organize themselves to provide for their material well-being.Why do economists disagree?What is macroeconomics?•Macroeconomics focuses on the behavior of the economy as a whole•How does it differ from Microeconomics? •What determines: –The total level of output: GDP? –The aggregate level of prices: CPI or PPI?–The level of employment? –Interest rates? Wages? Foreign exchange rates?Most Macroeconomists are focused on answering two questions:•Why do we have business cycles? •What should policy makers do to dampen this cycle?RESOURCES•Natural resources (“Land”)–Exhaustible resources –Renewable resources•Human resources (“Labor”)• Reproducible inputs (“capital??”)–Produced means of productionRESOURCES•Natural resources (“Land”)–Exhaustible resources (coal, oil)–Renewable resources (solar, wind)RESOURCES•Human resources (“Labor”)–Mental and physical expenditures of human energy–All labor is some combination of brain work and manual workRESOURCES•Reproducible inputs–Produced means of production–Tools, machinesReproducible inputs•Outputs of production process that are used as inputs in other production processes•Not necessarily “capital”•Capital can refer to financial or “money capital” (not an input, but can be used to purchase any inputs) or to industrial capital or “capital goods”•Reproducible input only becomes a capital good when it is used to produce “commodities”•Commodity: anything produced for sale in a marketThe Three Questions1. What to produce?–not just production of whatever2. How to produce it?–alternative methods of production3. How to distribute what is produced?–to guarantee the reproduction of the communityThe Economic System–Definition: the organization methods used to determine what goods and services are produced, how they are produced, and for whom they are produced–Society’s answer to the three questions:•Traditional Economy•Command Economy•Market EconomyClassifying Economic Systems•Who owns the resources?•What decision-making process is used to allocate resources and products?•What types of incentives guide economic decision makers?•These are standards used to distinguish economic systems.Traditional EconomyIn traditional societies–goods and services are produced by the family for their personal consumption– often some combination of age, gender, and kinship relations determine•Who does what? (division of labor)•Who gets what? (distribution of the social product)–There is little surplus (something extra) so there is only a limited need for markets (places to buy and sell goods and services)Traditional Economy• In a traditional economy, resources are allocated according to long-lived practices from the past. Rautes,Southern NepalMaasai, East AfricaTraditional Economy•What works well?–little friction among members because relatively little is disputed •What doesn’t?–Restricts individual initiative –Lack of advanced goods, new technology, and growthCommand economy•In tradition society, religious or cultural institutions determine production and distribution.•In a command system, political institutions determine production and distribution. •Some central political authority—a Chief, Lord, King, Central Planning Board—decides ‘who does what’ and ‘who gets what’.Command•European feudalism is a prime example of a command system.•Lords and Serfs.Command•Slavery is another form of command. (The Enslavement of Africans to perform plantation labor in the ‘new world’ may be a special case of “capitalist slavery”).CommandCommand can be a very effective way of efficiently marshalling resources. Many of the great ‘public works’ projects of the ancient world were the result of a command type system. But, it can be brutal, especially when referring to slavery.Command•But command can also be very brutal.Command–Recent example:• Socialist Political Systems–Central Authority–Production cost vs. priceCommand•What works well?–An equitable distribution of income–Rapid growth is possible–No unemployment•What doesn’t?–Decision makers have the power to be absolutely wrong–Quality and variety of goods can sufferMarket Economy (free enterprise, capitalism) •The third historical system of organizing production and distribution is the market.•no central organization.•millions and billions of independent decisions concerning buying and selling.Market Economy: Resources•In a free-market country, people can own their own businesses and property. People can also buy services for private use, such as healthcare. (But most capitalist governments also provide their own education, health and welfare services. )Market System: Resource Allocation•What are the institutions that govern a market’s systematic operation•Competition…supply and demand forces…price mechanism… ‘higgling and haggling.’Market System•What works well?–provides a wide variety of goods and services that buyers and sellers exchange at the lowest prices–advance technology–economic growth–Individual initiatives•What doesn’t (argument against)?–Lack of