MACROECONOMICS REVIEW FOR FINAL Economics Studies how society distributes and utilizes its scarce resources to its members in order to satisfy unlimited wants Resources are anything used to produce goods and services Four resources o Labor Human capital Skills and knowledge of labor o Land Natural resources o Physical capital o Entrepreunerialship Manmade goods and services used to make other goods and services Resources are scarce when demand is higher than supply Three basic questions that every society must answer 1 What to produce 2 How to produce a Deals with how resources are used a Deals with production process 3 For whom to produce a Deals with the distribution of goods and services Economy A Mechanism that allocates the scarce resources o Goods and services Allocates resources through o Markets Price and wage adjustments o Government allocation Central planner o Mixed economy Both forms of allocation Macroeconomics Three steps of Macroeconomics a GDP 1 Understand the primary components of measuring the Aggregate economy 2 Develop models to understand how economy works 3 Macro economic policy Understand what the government can do if anything to reduce fluctuations in the economy short run and Growth long run Economics is a social science Economists use the scientific method to study how society deals with scarcity 1 Assumptions a Economists use assumptions to simplify a very complex reality i Rationality assumption People make choices to maximize self interest 1 Implies that people respond to incentives and disincentives ii Ceteris paribus Assumption Must assume that everything else stays constant 2 Models a Simplified representation of reality i Used to simplify complex realities ii Tested by economists with historical data What do Economists do 1 As scientists economists make positive statements a Objective statements that attempt to describe how the economy is 2 As policy advisors economists Normative statements a Subjective statements that describe how the economy should be When societies are deciding how to best use their scarce resources they must consider the opportunity cost of using that resource Opportunity cost or satisfy a want The next best alternative that must be sacrificed to obtain something Production possibility Curve The Production possibility curve shows the different combinations of goods or services an economy can produce at a given time given the available resources and technology assuming that resources are fixed and totally utilized Technology Society s pool of knowledge concerning how goods and services can be produced Trade off between present and future consumption Goods produced by an economy can be broken down into either Consumer or capital goods 1 Consumer goods goods produced for personal satisfaction 2 Capital goods Goods used to produce other goods Producing more capital goods today results in fewer consumption goods today but more Consumption goods in the future Specialization Comparative advantage occurs when a person or country can produce goods at the lowest opportunity cost If a person or country has comparative advantage in the production of the good then they should specialize in the production of this good and trade for everything else o This will increase total production of goods and services and thus the standard of living of people Another way to increase specialization and production is through Division of labor Measuring the Economy s performance Gross Domestic Product GDP measures the level of economic activity GDP per capita measures the standard of living GDP growth change in GDP measures economic growth Resources are distributed in the U S through markets o Two types of actors Households own and sell resources buy goods and services Firms sell goods and services buy resources o Two markets Resource market Goods and services market Since every dollar a buyer spends is a dollar of income for the seller Total spending by households on Goods and services Total income Earned by households The value of all goods produced is GDP GDP measures o Spending on goods and services o Income earned by resources period of time quarterly or annually GDP is the Market value of all Final goods and services Produced Domestically in a given o Goods are valued at their Market prices so that all goods are measured in the same units Does not include items that have no market value such as Goods and services that are produced at home Goods and services that are sold under the table illegal or unreported activity o Final goods are intended for the last user Intermediate goods are goods used as ingredients in the production of other goods GDP only includes final goods o Production only includes new goods excludes used goods o Domestically within a country domestically produced goods Excludes imports Higher GDP means higher income and higher spending GDP ignores things like o Quality of the environment o Leisure time o Home production o Distribution of income How is GDP measured 1 Expenditure method a GDP is measured by adding up all of the spending by all sectors of the economy i Four Sectors 1 Households people a Consumption C 2 Firms businesses a Investment Spending I 3 Government a Government spending G i Spending by households on goods and services i Spending on the goods and services provided by the government at the federal state and local level 1 Excludes spending by the government on transfer payments such as social security disability unemployment etc because no good or service is being received by Government 4 International sector a Net exports Exports Imports Nx i Exports represents spending on goods produced here ii but bought by foreigners Imports are the portions of C I and G that are spent on Goods and Services produced abroad These add up to GDP denoted as Y Y C I G Nx 2 Measuring GDP using the Income approach a GDP is measures by adding up all of the Income earned by the different resources i Four resources 1 Labor Wages and Salaries 2 Land Rent 3 Capital Interest 4 Entrepreunerialship Profits Gross Domestic Income GDI Wages rent interest profits GDP vs NDP Some of the spending on Goods and Services go to replace old worn out capital NDP GDP Depreciation Nominal vs Real values Nominal values are measurements in terms of the Market prices at which goods are sold expressed in current dollars also called money values Nominal GDP Pc x Qc Pc Current prices Qc Current output Real values are measurements where adjustments have been