NYU ECON-UA 1 - Introduction to Macroeconomics

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1Introduction to Macroeconomics (5/9/13)Wants and Desires:Human wants are unlimited. There is no limit to the desires of man. Other than certain needs, a man willalways desire to get more. For example, if I have a problem in my appendix, I will only need to get it operated once. I can’t do anything more to it. Hence, other than certain needs which can’t be fulfilled more than once, human wants are unlimited.The reason human wants keep increasing and are never-ending is because of two things:1) Advertising: Items are always advertised and made to seem even more desirable which is why we get swayed and are never satisfied.2) Technological Change: As new things are produced which strike our fancy and again, are advertised well, we desire to possess them and hence our wants keep increasing.Scarcity Problem:Hence, “Scarcity problem” is the problem of having limited resources but unlimited wants. In other words, we have only a specific number of goods but an infinite number of desires, which causes the goods to be scarce.The scarcity problem has two major implications in the economy:1) Presence of prices: The “prices” exist because the goods are scarce, as simple as that. Every commodity has a certain value attached to it because of how scarce it is. If all the resources were unlimited, then all the goods would be unlimited and hence the prices wouldn’t exist!2) Movement of prices: “Inflation” exists because of scarcity. Scarcity of the good causes the shift in its price. If a good is scarcer, the price will be higher and if it is abundant, it will be cheaper. For example, water is abundant and hence the price of it is very little, almost negligible. But diamond is very scarce, and hence very expensive to procure. What is fascinating is that this wasseen by Adam Smith in what he called the “Water-Diamond Paradox”. This is because water is essential for life, and yet it is so cheap and diamond is useless and it is so expensive. The paradox was resolved later by him, but this was the basis of it.Opportunity Cost:Opportunity cost is the total of the explicit and implicit cost of procuring something.1) Explicit Cost: It refers to the amount of money you directly pay for a commodity or a service. Forexample, let’s take the cost of being at NYU. Total cost: Tuition $44,000/year = $176,000 R & B $10,000/year = $40,000* Misc. $5,000/year = $20,00022) Implicit Cost: It refers to the amount you lose or give up because of the explicit cost, or to procure the commodity. It may or may not be expressed in monetary terms. Hence, it is the added cost. Continuing with the NYU example:Total cost: Lost Income $18,000/year = $72,000** Lost Leisure and time (immeasurable in monetary terms) Lost Investment Income $20,000/year = $80,000***Footnotes: * Although room and boarding is $20,000/year in NYU, we took $10,000/year because wherever else welived, at home or anywhere else, we would run up some cost of living. We are assuming that cost of living to be $10,000/year. Hence, the cost of room and boarding is taken as the difference between the two.** Lost income is the amount you could have earned if you were working instead of being in college. An average American with high school education can earn approx $24,000 a year making it $96,000 in 4 years. But again, we did not take the full amount because we can do some part time work and work over the summer, and hence make up some of the money.*** Investment income is when instead of spending this money on college, we invested it in a bank and got an interest of approx 5% a year, taken as $20,000/yearHence, the total opportunity cost of going to NYU is approx $388,000. (A lot more than just tuition)Production Possibility Frontier (PPF)The PPF basically refers to a graph of a national economy, like the US Economy.3In the above graph, the X-axis represents the amount of defense goods produced and the Y-axis represents the amount of civilian goods produced. Let us assume that at a time of peace and prosperity, the PPF is working at the Point A, where the civilian goods being produced are Q3 and the defense goods being produced are P1. Now lets assume that there is a war taing place because of which the PPF curve shifts from point A to B to eventually C. What happens and why?1) Fewer civilian goods are produced and greater defense goods are produced2) This will cause a rise in the price of civilian goods because their production has gone from Q3 to Q1. Scarcity will come into play and hence the prices will rise.3) To make the production of defense goods from P1 to P3, the production of civilian goods had to go down from Q3 to Q1 because there are a finite number of resources. Hence, the resources being used for the civilian goods were shifted to the defense goods. The PPF works on two important assumptions:1) The amount of resources at a point are given, i.e. there will be no change in the production of resources2) The technology resource at the point is given, i.e. there will be no change in the technology causing the process to be more efficient or etc.Hence, this is called seeing an economy from a “static” point of view. A static point of view is when all the other resources are assumed to be given, and that they are undergoing no change, or a “time freeze”.The US Economy, or rather any economy is capable of producing at any point in the PPF, it varies according to need.Problem: Calculate the Opportunity Cost of the extra defense goods produced, i.e. from P1 to P3.Answer: The Opportunity Cost will be the total of the explicit of implicit cost of production.Explicit Cost: Amount of money being used to produce the defense goods +Implicit Cost: Losing the cost of civilian


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NYU ECON-UA 1 - Introduction to Macroeconomics

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