Intro and Micro Review Big Idea 1 Incentives Matter Incentives rewards and penalties that motivate behavior Incentives are everywhere We take for granted that we can buy kiwi fruit from New Zealand The things we buy require the coordinated efforts of millions Why do so many people work for our benefit Big Idea 2 Aligning Self and Social Interest When self interest aligns with the broader public interest we get good outcomes Markets channel self interest of millions of people Adam Smith described this coordination as the invisible hand Big Idea 2 Aligning Self and Social Interest Markets do not always align self interest with the social interest Sometimes market incentives are too strong External costs e g pollution Overutilization of commonly held resources the tragedy of the commons Sometimes market incentives are too weak External benefits Example Flu shots Big Idea 3 Trade offs Opportunity cost The value of what you give up when you make a choice Example College Opportunity cost is important for two reasons 1 Helps us evaluate trade offs 2 Helps us understand behavior Big Idea 3 Trade offs Big Idea 4 Marginal Thinking Making choices by comparing the extra benefit to the extra cost of an action We engage in marginal thinking all the time Example Adjusting our speed while driving Trade offs usually involve choices about a little bit more or a little bit less Big Idea 5 Power of Trade All involved in voluntary exchange are better off The power to increase production through specialization Specialization is important for countries as well as individuals Does Martha Stewart Iron her own clothes Allows us to take advantage of economies of scale Big Idea 6 Wealth and Growth 2007 more than half a billion people contracted malaria About a million mostly children died Malaria was once common in the U S Wealth ended it Lesson Wealthier countries have Greatest access to sanitation facilities antibiotics education fulfilling jobs and careers In short Wealth matters Understanding economic growth is crucial Big Idea 7 Institutions Matter What makes a country rich Most proximate causes large amounts of physical and human capital Use of the latest technological knowledge Why do some countries have more physical and human capital Answer Differences in incentives Big Idea 7 Institutions Matter Macroeconomists are especially interested in the incentives to produce new ideas New ideas are the lifeblood of economic growth Ideas have peculiar properties Ideas can be shared without limit Ideas are not used up Big Idea 8 Booms and Busts No economy grows at a constant pace Booms and busts are part of the normal response to changing economic conditions Not all booms and busts are normal The Great Depression was not normal National output fell by 30 percent Unemployment exceeded 20 percent Stock market fell to less than a third of its original value Big Idea 9 Inflation and Money Supply Inflation an increase in the general level of prices One of the most common problems of macroeconomics Inflation is caused by a sustained increase in the money supply A Billionaire in Zimbabwe Big Idea 9 Inflation and Money Supply In the U S the money supply is controlled by the Federal reserve Low inflation since the early 1980s is a testament to successful Fed policy In Zimbabwe the government was printing money so rapidly that in 2009 prices were rising by billions of percent per month Big Idea 10 Central Banking The Federal Reserve Bank the Fed is often called on to combat inflation A challenge because there is a lag between when the Fed makes a decision and when the effects of the decision on the economy are known It is difficult to make the right guess about where the economy is going If the Fed gets it wrong it can make things worse It is wise to think of the Fed as a highly fallible institution that faces a very difficult job Micro Review Comparative Advantage Comparative advantage the ability of a country to produce a good at lower opportunity cost than another country Absolute advantage the ability of a country to produce a good using fewer inputs than another country A country need not have an absolute advantage in anything to benefit from trade To understand why we need to understand the principle of comparative advantage Comparative Advantage The Production Possibility Frontier PPF PPF shows all the combinations of goods that a country can produce given Productivity Supply of inputs A convenient tool to understand opportunity cost and comparative advantage Comparative Advantage Both countries have 24 units of labor each w o trade they both allocate 12 units of labor each to shirts and computers Units of Labor Needed to Produce Computers and Shirts Country Computers Shirts Mexico United States 12 1 2 1 PPFs w o Trade Mexico USA 14 30 12 25 10 20 Computers Shirts 8 6 15 4 10 2 5 0 0 0 5 1 1 5 Computers 2 2 5 0 0 5 10 15 Shirts 20 25 30 PPFs w o Trade Mexico USA 14 30 12 25 10 20 Computers Shirts 8 6 15 10 4 2 Slope 6 5 Slope 1 0 0 0 5 1 1 5 Computers 2 2 5 0 0 5 10 15 Shirts 20 25 30 Opportunity Cost Opportunity Costs Country Opportunity cost Opportunity of 1 computer cost of 1 Shirt Mexico 6 shirts 1 6 of a computer United States 1 shirt 1 computer Opportunity Costs Production Consumption no trade Country Computers Shirts Mexico 1 6 United States 12 12 Total Production 13 18 Opportunity Costs and Comparative Advantage Theory of comparative advantage A country can increase its wealth by Specializing in producing goods for which it has a comparative advantage Trading for the goods for which it does not have a comparative advantage Opportunity Costs Production in Mexico and U S Specialization Country Computers Shirts Mexico 0 12 United States 14 10 Total Production 14 22 Opportunity Costs Consumption in Mexico and U S Specialization and Trade Country Mexico United States Total Production Computers Shirts 1 13 12 1 14 9 6 3 13 10 3 22 With trade the price of both goods will be equal assume 1 computer 3 shirts Assume Mexico now consumes 9 shirts and trades the remaining 3 for 1 computer Assume the U S consumes 13 computers and trades the remaining computers for 3 shirts Trade Mexico USA 14 30 12 25 10 20 Consumption w trade Computers Shirts 8 6 15 4 10 2 5 Consumption w trade 0 0 0 5 1 1 5 Computers 2 2 5 0 0 5 10 15 Shirts 20 25 30 Comparative Advantage and Wages Wages are included in the model Example Wage rate Consumption number of workers Suppose Pshirt 100 and Pcomputer 300 Comparative Advantages and Wages
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