Intro to Macro 01 27 2014 Starting Assumption Humans are social creatures With exception of humans social creatures have hard wired social structures their social relationships don t really change drastically Human societies are dynamic and change through out time and space Humans invent their social structures Robert Heilbroner 1919 2005 Wrote Worldly Philosophers 1953 Organizing against Calamity o Custom Tradition Go with what worked in the past familiar Ex Hunter gatherer feudalism o Command Force power rules Forced coercion Dictatorship monarchy o Self interest Markets Determines who does what Adam Smith 1723 1790 Philosopher political economist Author of The Wealth of Nations The o o o invisible hand self interest behavior competitive markets Market buyers sellers money exchange for goods services o Competitive choice o Socially optimal o Markets are best equipped to provide for society s interests o Role for gov t laissez faire The Fallacy of Composition The whole is more than the sum of the parts o Ex Standing up at a sporting event individually it was a good idea to stand up but when everyone does it it doesn t have an average positive effect o Ex Cells are invisible to the naked eye but when put together are able to be seen o need different tools and theories to work with the big picture Opportunity Cost Scarcity requires choices opportunity cost is the next best option Model o Two regions two activities o Production Probability Frontier PPF Products on the axis one graph for each region o Socially optimal efficiency o Pig principle more is better o calculate opportunity cost o slope gives opportunity cost of x axis Perspectives Mercantilist Thought o Transition between feudalism and capitalism industrial revolution o gold is wealth finite resources o trade is zero sum game can have a winner without a loser Adam Smith o Wealth of Nations not about gold o trade can be mutually beneficial not zero sum o specialized based on absolute advantage David Ricardo o Built upon Smith s perspective o Opportunity cost o Specialize using comparative advantage lowest opportunity cost o Provides a more general rule than Smith Modeling comparative advantage Autarky no trade Missed notes Market Failure Invisible hand produces disappointing or embarrassing results for society Market power o one small number of firms have disproportionate power o invisible hand works best when markets are competitive Public goods o Free riders o Non exclusive consumption o Remedies Non market allocation Collect taxes to fund them Private membership Youtube mjmfoodie Externalities o Transaction impacts third parties o When social costs differ from private costs from the transactions the discrepancy is invisible to the specific producer o External costs do matter but they don t get included in production decisions o Remedies Command and control regulation Pigouvian taxes Marketable permits ex Air rights Equity o market blind to fairness o can the customer pay o Remedies Non market allocation Rationing first come first served Price controls ceilings and floors GDP 01 27 2014 Gross Domestic Product GDP is the total dollar value of final output produced within a nation s borders in a given time period focused geographically outsourced things don t count even if it s a US company wheat flour bread sandwich example final means focus only on the additional value or deduct the pieces counted more than once Why do we need it o Measure of macroeconomic output o Quantity scale for macro graphs o Comparisons across space geographic comparisons o Comparisons across time historical comparisons Macro Measures Nominal GDP o prices quantities o value of final output produced in a given period measured in the prices of that period current dollars Real GDP o quantities only o value of final output produced in a given period adjusted for changing prices constant dollars o minimize the effect of changing prices GDP deflator o prices only Examples o Measuring with different units lessens integrity o Cost nominal GDP to fill the tank increases quantity remains the same because we know the tank has not gotten bigger because it s the same car Real GDP so then we know it was the price of gas that increased GDP deflator o look at numbers on slides nominal GDP says the economy is growing while Real GDP says there was a recession quantity decreases but prices increase so much that it over compensates for the decrease in quantity inflation o FRED II graph great source of macro data Default unit is nominal GDP Gray shading to signify recession The Business Cycle Ups and downs of US economy Looking at Real GDP Peaks plateaus economy stops growing Trough when the economy bottoms out Recession point between peaks and troughs Expansions tend to be longer than recessions Recovery can take a long time www nber org track recessions Conventional Wisdom o Recession is a decline in real GDP that continuous for at least two or more consecutive quarters o Wrong identify by months not quarters Reality o NBER business cycle dating committee makes the decision o Cambridge MA The Relationship o nominal GDP Real GDP 100 GDP deflator o table on slides use year 1 prices o inflation is the percentage change in the price index new deflator old deflator old deflator percentage change in GDP deflator keep changing old deflator Inflation 01 27 2014 Inflation an increase in the general average price level of goods and services not a change in any one specific price Deflation a decrease in the general average price level of goods and services not a change in any one specific price both are not universally good Disinflation making the rate of inflation slow down Measuring Inflation GDP Deflator Producer Price Index o Focuses on things most relative to businesses Consumer Price Index o Focuses on things most relative to consumers o Things that affect cost of living Sources of Inflation Aggregate Demand Aggregate Supply Average Price Level y axis and Real GDP x axis Not just the supply and demand of one market but the whole economy Demand Pull Inflation o o o o o Cost o o o too many dollars chasing too few goods excess spending too much injection into the circular flow corresponds with high GDP demand curve shifted to the right Push Inflation Supply curve shifts to the left Supply shock something has impacted costs of production lower GDP Inflation tends to go up during the boom or expansion periods Typically caused by demand pull The two worst inflations during 74