MACROECONOMICS CHAPTER ONE FOUNDATIONS AND MODELS Scarcity unlimited wants exceed limited resources Economics the study of the choices people make to attain their goals given their scarce resources Must assume that people are rational people respond to incentives and optimal decisions are made at the margin o People are rational economists assume consumers and firms use all available information as they act to achieve their goals individuals weigh the benefits and costs of each action and choose an action only if the benefits exceed the costs o People respond to incentives refers to economic incentives o Optimal decisions are made at the margin optimal decision is to continue any activity up to the point Determined by choices that consumers firms and the government make where marginal benefit equals marginal cost MB MC Asks the following questions o What goods and services will be produced o How will the goods and services be produced o Who will receive the goods and services produced Depends largely on how income is distributed Considered a social science Cannot be controlled but can be influenced Economic Models simplified versions of reality used to analyze real world economic situations Based on making assumptions because models must be simplified in order to be useful Models are used if they lead to a hypothesis confirmed by statistical analysis Economic Variable something measurable that can have different values i e the incomes of doctors Market a group of buyers and sellers of a good or service and the institution arrangement by which they come together to trade Marginal Analysis analysis that involves comparing marginal benefits and marginal costs Economic Problem a limited amount of economic resources i e workers machines and raw materials is available Trade Off producing more of one good or service means producing less of another good or service due to scarcity Opportunity Cost the highest valued alternative that must be given up to engage in an activity Centrally Planned Economy the government decides how to allocate economic resources i e the Soviet Union Market Economy decisions of households and firms interacting in markets allocate economic resources i e all high income democracies such as the United States Canada Japan and western European countries Tend to be more efficient than centrally planned economies because they promote competition and facilitate voluntary exchange Mixed Economy most economic decisions result from interaction of buyers and sellers in markets but government also plays a role in the allocation of resources hybrid of centrally planned and market economies Productive Efficiency a good or service is produced at the lowest possible cost Possible due to competition Allocative Efficiency production is in accordance with consumer preferences every good and service is produced up to the point where the last unit provides marginal benefit to society equal to the marginal cost of producing it Voluntary Exchange both the buyer and seller of a product are made better off by a transaction Equity fair distribution of economic benefits Often a trade off between efficiency and equity Positive Analysis concerned with what is Primary focus of economics because positive analysis measures the costs and benefits or different courses of action Normative Analysis concerned with what ought to be Microeconomics the study of how households and firms make choices how they interact in markets and how the government attempts to influence their choices Explains how consumers react to changes in product prices and how firms decide what prices to charge for the products they sell also involves policy issues Macroeconomics the study of the economy as a whole including topics such as inflation unemployment and economic growth Explains why economies experience periods of recessions and increasing unemployment and why over the long run some economies have grown faster than others also involves government related policies Interpreting Graphs A change in the price of a product results in movement along a stationary demand curve but a change in any other variable results in a shift along the demand curve Demand curves are actually curved but they are represented with a straight line for simplicity Disposable Personal Income all expenses with the exception of taxes taxes are required Positive Relationship positive slope Total Revenue Price x Quantity Demanded Percentage Change Value in the Second Period Value in the First Period Value in the First Period x 100