Economics Exam 1

HOW to Produce

The second basic economic question concerns HOW we produce output. Should this class be taught in an auditorium or in small discussion sections? Should it meet twice a week or only once? The HOW question isn't just an issue of getting more output from available inputs. It also encompasses our use of the environment. Should the waste from pig farms be allowed to contaminate the air, groundwater, or local waterways? Or do we want to keep the water clean for other uses? Humanitarian concerns may also come into play. Should live pigs be processed without any concern for their welfare? Or should the processing be designed to minimize trauma? The HOW question encompasses all such issues. Although people may hold different views on these questions, everyone shares a common goal: to find an optimal method of producing goods and services. Page 13The best possible answer to the HOW question will entail both efficiency in the use of factors of production and adequate safeguards for the environment and other social concerns. Our goal is to find that answer.

macroeconomics

The study of aggregate economic behavior, of the economy as a whole

FOR WHOM to Produce

The third basic economic question every society must confront is FOR WHOM? The answers to the WHAT and HOW questions determine how large an economic pie we'll bake and how we'll bake it. Then we have to slice it up. Should everyone get an equal slice of the pie? Or can some people have big pieces of the pie while others get only crumbs? In other words, the FOR WHOM question focuses on how an economy's output is distributed across members of society.

Personal Distribution of Income

The way total personal income is divided up among households or income classes

Incentives

There is a risk entailed in distributing slices of the pie based on need rather than work effort. People who work hard to bake the pie may feel cheated if nonworkers get just as large a slice. Worse still, people may decide to exert less effort if they see no tangible reward to working. If that happens, the size of the pie may shrink, and everyone will be worse off. This is the kind of problem income transfer programs create. Government-paid income transfers (e.g., welfare, unemployment benefits, Social Security) are intended to provide a slice of the pie to people who don't have enough income to satisfy basic needs. As benefits rise, however, the incentive to work diminishes. If people choose welfare checks over paychecks, total output will decline. The same problem emerges in the tax system. If Paul is heavily taxed to provide welfare benefits to Peter, Paul may decide that hard work and entrepreneurship don't pay. To the extent that taxes discourage work, production, or investment, they shrink the size of the pie that feeds all of us.

Determinants of Demand (Economic Explanation)

They want money in exchange for their goods. Hence prices and income are just as relevant to consumption decisions as are more basic desires and preferences. In explaining consumer behavior, then, economists focus on the demand for goods and services. To say that someone demands a particular good means that he or she is able and willing to buy it at some price(s). In the marketplace, money talks: The willingness and ability to pay are critical. Many people with a strong desire for a Maserati (see photo) have neither the ability nor the willingness to actually buy it; they do not demand Maseratis. Similarly, there are many rich people who are willing and able to buy goods they only remotely desire; they demand all kinds of goods and services.

(Chapter 3) (pg 48) When selling services in the market, this person is regarded as a "business"; when away from the office, he or she is regarded as a "consumer".

This distinction is helpful in emphasizing that THE CONSUMER IS THE FINAL RECIPIENT OF ALL GOODS AND SERVICES PRODUCED.

(Chapter 2)(pg 42) A Progressive tax does this by imposing higher tax rates on people with larger incomes. Under such a system a rich person pays not only more taxes but also a larger portion of his or her income.

Thus A PROGRESSIVE TAX MAKES AFTER-TAX INCOMES MORE EQUAL THAN BEFORE-TAX INCOMES. -the federal income tax is designed to be progressive

The Best Possible Mix

Ultimately the designation of any particular mix of output as "best" rests on the value judgments of a society. A militaristic society would prefer a mix of output closer to point B in Figure 1.1. By contrast, Iceland has no military and so produces at point A. In general, one specific mix of output is optimal for a country—that is, a mix that represents the best possible allocation of resources across competing uses. Locating and producing that optimal mix of output is the essence of the WHAT challenge.

(Chapter 3) (pg 53) We know a consumer's tastes, income, other goods, and expectations all affect the decision to buy web design services. But

WE FOCUS ON THE RELATIONSHIP BETWEEN QUANTITY DEMANDED AND PRICE

Specifically, every nation must resolve three critical questions about the use of its scarce resources:

WHAT to produce. HOW to produce. FOR WHOM to produce.

To understand how an economy works, we have to ask and answer a lot of questions. Among the most important are these:

What are the basic goals of an economic system? How does a market economy address these goals? What role should government play in shaping economic outcomes?

Four separate groups of market participants

-Consumers -Business firms -Governments -Foreigners

Gross Domestic Product (GDP)

-refers to the total value of all final goods and services produced in a country during a given time period. -a summary measure of a nation's output

These investment goods are used

1. To replace worn-out equipment and factories, thus maintaining our production possibilities 2. To increase and improve our stock of capital, thereby expanding our production possibilities.

(Chapter 3) (pg 50) In a market-based economy, you must also be willing to pay for the things you want. Specifically,

A DEMAND EXISTS ONLY IF SOMEONE IS WILLING AND ABLE TO PAY FOR THE GOOD>

(Chapter 3) (pg 49) Whatever it looks like

A MARKET EXISTS WHEREVER AND WHENEVER AN EXCHANGE TAKES PLACE.

Shifts in Demand

A change in the quantity demanded at any (every) price

Demand Curve

A curve describing the quantities of a good consumer is willing and able to buy at alternative prices in a given time period, ceteris paribus

Patterns of Consumption

A good way to start a study of consumer demand is to observe how consumers spend their incomes. Figure 4.1 provides a quick summary. Note that close to half of all consumer spending is for food and shelter. Out of the typical consumer dollar, 34 cents is devoted to housing—everything from rent and repairs to utility bills and grass seed. A closer examination of consumer patterns reveals that we do in fact change our habits on occasion. In the last 10 years, our annual consumption of red meat has declined from 125 pounds per person to 115 pounds. In the same time, our consumption of chicken has increased from 47 pounds to 70 pounds. We now consume less coffee, whiskey, beer, and eggs but more wine, asparagus, and ice cream compared to 10 years ago. Smartphones and computer tablets are regarded as essentials today, even though no one had these products 15 years ago. What prompted these changes in consumption patterns?

Demand Schedule

A table showing the quantities of a good consumer is willing and able to buy at alternative prices in a given time period, ceteris paribus

(Chapter 3)(pg 59) Like the market demand, the market supply curve is the sum of all the individual supplier decisions about how much output to produce at any given price. The market supply curves slopes upward to the right, indicating that

LARGER QUANTITIES WILL BE OFFERED AT HIGHER PRICES -MARKET SUPPLY IS AN EXPRESSION OF SELLER'S INTENTIONS, OF THE ABILITY AND WILLINGNESS TO SELL, NOT A STATEMENT OF ACTUAL SALES

(Chapter 3) (pg 56) Our combined willingness to buy- our collective market demand- is nothing more than the sum of our individual demands. The same kind of aggregation can be performed for all the consumers in a particular market. The resulting

MARKET DEMAND IS DETERMINED BY THE NUMBER OF POTENTIAL BUYERS AND THEIR RESPECTIVE TASTES, INCOMES, OTHER GOODS, AND EXPECTATIONS.

(Chapter 3) (pg 55) It's important to distinguish shifts of the demand curve.

MOVEMENTS ALONG A DEMAND CURVE ARE A RESPONSE TO PRICE CHANGES FOR THAT GOOD. Such movements assume that determinants of demand are unchanged. By contrast, SHIFTS OF THE DEMAND CURVE OCCUR WHEN THE DETERMINANTS OF DEMAND CHANGE -CHANGES IN QUANTITY DEMANDED: movements along a given demand curve in response to price changes of that good (such as from d1 to d2 in Figure 3.3) -CHANGES IN DEMAND: shifts of the demand curve due to changes in tastes, income, other goods, or expectations (such as from D1 to D2 in Figure 3.3)

Government Failure

When market failure occurs, there is usually a call for the government to "fix" the failure. This may or may not be a good response. Government intervention doesn't always Page 16work out so well. Indeed, economists warn that government intervention can fail as well. Government failure government failure Government intervention that fails to improve economic outcomes. occurs when intervention fails to improve—or actually worsens—economic outcomes. The possibility of government failure is sufficient warning that there is no guarantee that the visible hand of government will be any better than the invisible hand of the marketplace.

Monopoly

a firm that produces the entire market supply of a particular good or service

Price Elasticity

a measure of the sensitivity of demand to changes in price

Progressive Tax

a tax system in which tax rates rise as incomes rise

Microeconomics

concerned with the details of this big picture. In microeconomics we focus on the individuals, firms, and government agencies that actually make up the larger economy. Our interest here is in the behavior of individual economic actors. What are their goals? How can they best achieve these goals with their limited resources? How will they respond to various incentives and opportunities?

Law of Diminishing Marginal Utility

each successive unit of a good consumed yields less additional utility

Government failure

government intervention that fails to improve economic outcomes

Price Floor

lower limit imposed on the price of a good or service

Quintile

one fifth (of total population)

Productivity

output per unit of input- for example, output per labor-hour

Capital Intensive

production processes that use a high ratio of capital to labor inputs

Utility

refer to the expected pleasure, or satisfaction, obtained from goods and services.

Total Utility

refers to the amount of satisfaction obtained from your entire consumption of a product.

Marginal Utility

refers to the amount of satisfaction you get from consuming the last (i.e., marginal) unit of a product.

Factors of Production

resource inputs used to produce goods and services, such as land, labor, capital, and entrepreneurship

Demand

the ability and willingness to buy specific quantities of a good at alternative prices in a given time period, ceteris paribus

Supply

the ability and willingness to sell (produce) specific quantities of a good at alternative prices in a given time period, ceteris paribus

Ceteris Paribus

the assumption that nothing else changes

Real GDP

the inflation-adjusted value of GDP; the value of output measured in constant prices

Human Capital

the knowledge and skills possessed by the workforce

As the economy has grown,

the mix of output has changed dramatically.

Opportunity Cost

the most desired goods and services that are forgone in order to obtain something else

Law of Demand

the quantity of a good demanded in a given time period increases as its price falls, ceteris paribus

Law of Supply

the quantity of a good supplied in a given time period increases as its price increases, ceteris paribus

Market Demand

the total quantities of a good or service people are willing and able to buy at alternative prices in a given time period; the sum of individual demands

Market Supply

the total quantities of a good that sellers are willing and able to sell at alternative prices in a given time period, ceteris paribus

Nominal GDP

the total value of goods and services produced within a nation's borders, measured in current prices.

Market Mechanism

the use of market prices and sales to signal desired outputs (or resource allocations)

Per Capita GDP

total GDP divided by total population; average GDP -Per Capita GDP is an indicator of how much output each person would get if all output were evenly divided among the population

Price ceiling

upper limit imposed on the price of a good or service

(Chapter 2) (pg 34) The relative decline in manufacturing is due primarily to the rapid expansion of the service sector

AMERICA HAS BECOME LARGELY A SERVICE ECONOMY.

(Chapter 2) (pg 34) The relative decline in manufacturing doesn't mean that the manufacturing sector has actually shrunk.

AS IN FARMING, TECHNOLOGICAL ADVANCES HAVE MADE IT POSSIBLE TO INCREASE MANUFACTURING OUTPUT TREMENDOUSLY, EVEN THOUGH EMPLOYMENT IN THIS SECTOR HAS GROWN ONLY MODESTLY

Factor Market

Any place where factors of production (land, labor, capital and entrepreneurship) are bought and sold

Product Market

Any place where finished goods and services (products) are bought and sold

Market

Any place where goods are bought and sold

(Chapter 2) (pg 39) Without legally protected ownership rights, few individuals would buy or build factories. Even the incentive to write textbooks would disappear if government copyright laws didn't forbid unauthorized downloading or photocopying.

BY ESTABLISHING OWNERSHIP RIGHTS, CONTRACT RIGHTS, AND OTHER RULES OF THE GAME, THE GOVERNMENT LAYS THE FOUNDATION FOR MARKET TRANSACTIONS

(Chapter 2)(pg 28) In a market economy, every product commands a specific price. Hence, the value of each product can be observed easily.

By multiplying the physical outcome of each good by its price, we can determine the total value of each good produced. (Picture 2.1) - the seperate values for the output of oranges, razors, and video games can be added up. The resultant sum ($4.2 billion, in this case) is a measure of the value of total output.

Central Planning

Central planning is still the principal mechanism of choice in some countries. In North Korea and Cuba, for example, the central planners decide how many cars and how much bread to produce. They then assign workers and other resources to those industries to implement their decisions. They also decide who will get the bread and the cars that are produced. Individuals cannot own factors of production or even employ other workers for wages. The WHAT, HOW, and FOR WHOM outcomes are all directed by the central government.

Determinants of Demand (Sociopathic Explanation)

Consider first the explanations of consumer behavior offered by other fields of study. Psychiatrists and psychologists have had a virtual field day formulating such explanations. The Austrian psychiatrist Sigmund Freud (1856-1939) was among the first to describe us as bundles of subconscious (and unconscious) fears, complexes, and anxieties. From a Freudian perspective, we strive for ever-higher levels of consumption to satisfy basic drives for security, sex, and ego gratification. Sociologists offer additional explanations for our consumption behavior. They emphasize our yearning to stand above the crowd, to receive recognition from the masses. For people with exceptional talents, such recognition may come easily. But for the ordinary person, recognition may depend on conspicuous consumption. Owning a larger car, wearing the newest fashion, and taking an exotic vacation become expressions of identity that provoke recognition, even social envy. Thus we strive for higher levels of consumption—so as to surpass the Joneses, rather than just keep up with them.

Externalities

Costs (or benefits) of a market activity borne by a third party; the difference between the social and private costs (or benefits) of a market activity.

(Chapter 3) (pg 58) How much income must be offered to induce web designers to do a job depends on a variety of things. The

DETERMINANTS OF MARKET SUPPLY INCLUDE -TECHNOLOGY -FACTOR COSTS -OTHER GOODS -TAXES AND SUBSIDIES -EXPECTATIONS -NUMBER OF SELLERS

Modest Expectations

In view of all these debates and uncertainties, you should not expect to learn everything there is to know about the economy in this text or course. Our goals are more modest. We want you to develop some perspective on economic behavior and an understanding of basic principles. With this foundation, you should acquire a better view of how the economy works. Daily news reports on economic events should make more sense. Political debates on tax and budget policies should take on more meaning. You may even develop some insights that you can apply toward running a business or planning a career.

(Chapter 3) (pg 51) How much services he purchases will depend on the actual price of the web services in the market. Hence,

DEMAND IS AN EXPRESSION OF CONSUMER BUYING INTENTIONS, OF A WILLINGNESS TO BUY RATHER THAN A STATEMENT OF ACTUAL PRICES.

(Chapter 3) (pg 53) A consumer's willingnuss to buy a product at various prices depend on a variety of forces. We call those forces

DETERMINANTS OF DEMAND. THE DETERMINANTS OF MARKET INCLUDE -TASTES -INCOME -OTHER GOODS -EXPECTATIONS -NUMBERS OF BUYERS

(Chapter 4) (pg 78)

Do not confuse diminishing marginal utility with dislike. Figure 4.3 doesn't imply that the second box of popcorn isn't desirable. It only says that the second box isn't as satisfying as the first. It still tastes good, however. How do we know? Because its marginal utility is positive (right graph), and therefore total utility (left graph) rises when the second box is consumed. "So long as marginal utility is positive, total utility must be increasing." Not all goods approach zero (much less negative) marginal utility. Yet the more general principle of diminishing marginal utility is experienced daily. That is to say, "additional quantities of a good eventually yield increasingly smaller increments of satisfaction". Total utility continues to rise, but at an ever slower rate as more of a good is consumed.

(Chapter 3) (pg 50) Recall that

EVERY MARKET TRANSACTION INVOLVES AN EXCHANGE AND THUS SOME ELEMENT OF BOTH SUPPLY AND DEMAND

The Demand Curve (Utility Theory)

Economists simply note the existence of certain tastes (desires) and then look to see how those tastes affect consumption decisions. We assume that the more pleasure a product gives us, the higher the price we would be willing to pay for it. If gobbling buttered popcorn at the movies really pleases you, you're likely to be willing to pay dearly for it. If you have no great taste or desire for popcorn, the theater might have to give it away before you'd eat it.

Investment

Expenditures on (production of) new plant and equipment (capital) in a given time period, plus changes in business inventories.

Demand Schedule

Indicates the quantities of a good a consumer is able and willing to buy at alternative prices (ceteris paribus).

Mixed Economies

Few countries still depend so fully on central planners (government) to make basic economic decisions. China, Russia, and other formerly communist nations have turned over many decisions to the market mechanism. Likewise, no nation relies exclusively on markets to fashion economic outcomes. In the United States, for example, we let the market decide how much ice cream will be produced and how many cars. We use the political process, however, to decide how many highways to construct, how many schools to build, and how much military output to produce. Because most nations use a combination of government directives and market mechanisms to determine economic outcomes, they are called mixed economies. There is huge variation in that mix, however. The government-dominated economic systems in North Korea, Cuba, Laos, and Libya are starkly different from the freewheeling economies of Singapore, Bahrain, New Zealand, and the United States.

Production Possibilities

Figure 1.1 illustrates the basic dilemma. Suppose there are only two kinds of goods, "consumer goods" and "military goods". In this case, the question to WHAT boils down to finding the most desirable combination of these two goods.

Exports

Goods and Services sold to other countries/foreign buyers

Imports

Goods and services purchased from foreign sources

Demand Curve

Graphical illustration of a demand schedule. Each point on the curve refers to a specific quantity that will be demanded at a given price.

(Chapter 3) (pg 52) Instead we enter markets with a set of desires and a limited amount of money to spend.

HOW MUCH WE ACTUALLY BUY ANY GOOD WILL DEPEND ON ITS PRICE.

(Chapter 2) (pg 40) Were the slices of the pie carved by the market mechanism, the slices surely would not be equal. Markets reward individuals on the basis of their contribution to output.

IN A MARKET ECONOMY, AN INDIVIDUAL'S INCOME DEPENDS ON -THE QUANTITY AND QUALITY OF RESOURCES OWNED -THE PRICE THAT THOSE RESOURCES COMMAND IN THE MARKET

Market Failure

In studying these questions, economists recognize that neither markets nor governments always have the right answers. On the contrary, we know that a completely private market economy can give us the wrong answers to the WHAT, HOW, and FOR WHOM questions on occasion. A completely free market economy might produce too many luxury cars and too few hospitals. Unregulated producers might destroy the environment. A freewheeling market economy might neglect the needs of the poor. When the market mechanism gives us these kinds of suboptimal answers, we say the market has failed. Market failure occurs when the market mechanism does not generate the best possible (optimal) answers to the WHAT, HOW, and FOR WHOM questions.

The Political Process

Many of these basic economic decisions are made through the political process. Consider again the decision to increase the military share of output after 9/11. Who made that decision? Not me. Not you. Not the mass of consumers who were streaming through real and virtual malls. No, the decisions on military buildups and builddowns are made in the political arena: the U.S. Congress makes those decisions. Congress also makes decisions about how many interstate highways to build, how many Head Start classes to offer, and how much space exploration to pursue. Should all decisions about WHAT to produce be made in the political arena? Should Congress also decide how much ice cream will be produced and how many DVRs? What about essentials like food and shelter? Should decisions about the production of those goods be made in Washington, DC, or should the mix of output be selected some other way? The central actor in this reshuffling of resources and outputs is the market mechanism. Market sales and prices send a signal to producers about what mix of output consumers want. If you want something and have sufficient income, you buy it. If enough people do the same thing, total sales of that product will rise, and perhaps its price will as well. Producers, seeing sales and prices rise, will want to increase production. To do so, they will acquire more resources and use them to change the mix of output. No direct communication between us and the producer is required; we don't need Twitter or Facebook to get our message transmitted. Instead, market sales and prices convey the message and direct the market, much like an "invisible hand." It was this ability of "the market" to select a desirable mix of output that so impressed the eighteenth-century economist Adam Smith. He argued that nations would prosper with less government interference and more reliance on the invisible hand of the marketplace. As he saw it, markets were efficient mechanisms for deciding what goods to produce, how to produce them, and even what wages to pay. Smith's writings (The Wealth of Nations, 1776) urged government to pursue a policy of laissez faire—leaving the market alone to make basic economic decisions.

Price and Quantity

Marginal utility is essentially a measure of how much we desire particular goods. But which ones will we buy? Clearly, we don't always buy the products we most desire. Price is often a problem. All too often we have to settle for goods that yield less marginal utility simply because they are less expensive. This explains why most people don't drive Porsches. Our desire ("taste") for a Porsche may be great, but its price is even greater. The challenge for most people is to somehow reconcile our tastes with our bank balances. In deciding whether to buy something, our immediate focus is typically on a single variable—namely price. Assume that a person's tastes, income, and expectations are set in stone and that the prices of other goods are fixed as well. This is the ceteris paribus assumption we first encountered in Chapter 1. It doesn't mean that other influences on consumer behavior are unimportant. Rather, the ceteris paribus simply allows us to focus on one variable at a time. In this case, we are focusing on price. What we want to know is how high a price a consumer is willing to pay for another unit of a product. The concepts of marginal utility and ceteris paribus enable us to answer this question. The more marginal utility a good delivers, the more you're willing to pay for it. But marginal utility diminishes as increasing quantities of a product are consumed. Hence you won't be willing to pay so much for additional quantities of the same good. The moviegoer who is willing to pay 50 cents for that first mouthwatering ounce of buttered popcorn may not be willing to pay so much for a second or third ounce. The same is true for the second pizza, the sixth soda, and so forth. With given income, taste, expectations, and prices of Page 79other goods and services, people are willing to buy additional quantities of a good only if its price falls. In other words, as the marginal utility of a good diminishes, so does our willingness to pay. This inverse relationship between the quantity demanded of a good and its price is referred to as the law of demand. Figure 4.4 illustrates this relationship again for the case of popcorn. Notice that the demand curve slopes downward: More popcorn is purchased at lower prices.

(Chapter 3) (pg 50) Because money facilitates exchanges

NEARLY EVERY MARKET TRANSACTION INVOLVES AN EXCHANGE OF DOLLARS FOR GOODS (IN PRODUCT MARKETS) OR RESOURCES (IN FACTOR MARKETS).

(Chapter 1) (pg 8)

Our choices about WHAT to produce are not limited to the extremes of points A and B. We could instead produce a combination of consumer and military goods. Point C represents one such combination. To get to point C, we have to forsake maximum consumer goods output (point A) and use some of our scarce resources to produce military goods. At point C we are producing only OD of consumer goods and OE of military goods. Point C is just one of many combinations we could produce. We could produce any combination of output represented by points along the curve in Figure 1.1. For this reason we call it the production possibilities curve; it represents the alternative combinations of goods and services that could be produced in a given time period with all available resources and technology. It is, in effect, an economic menu from which one specific combination of goods and services must be selected.

Income transfers

Payments to individuals for which no current goods or services are exchanged, such as Social Security, welfare, and unemployment benefits. -Such transfer payments accounts for half of all federal spending- this spending is not part of our output of goods and services -Only that part of federal spending used to acquire resources and produce services is counted in GDP

Politics versus Economics

Politicians cannot afford to be quite so complacent about predictions. Policy decisions must be made every day. And a politician's continued tenure in office may depend on being more than approximately right. Economists contribute to those policy decisions by offering measures of economic impact and predictions of economic behavior. But in the real world, those measures and predictions always contain a substantial margin of error. Even if the future were known, economic policy could not rely completely on economic theory. There are always political choices to be made. The choice of more consumer goods ("butter") or more military hardware ("guns"), for example, is not an economic decision. Rather it is a sociopolitical decision based in part on economic trade-offs (opportunity costs). The "need" for more butter or more guns must be expressed politically—ends versus means again. Political forces are a necessary ingredient in economic policy decisions. That is not to say that all political decisions are right. It does suggest, however, that economic policies may not always conform to economic theory. Both politics and economics are involved in the continuing debate regarding the merits of a laissez faire approach versus government intervention. The pendulum has swung from laissez faire (Adam Smith) to central government control (Karl Marx) and to an ill-defined middle ground where the government assumes major responsibilities for economic stability (John Maynard Keynes) and for answers to the WHAT, HOW, and FOR WHOM questions. In the 1980s the Reagan administration pushed the pendulum a bit closer to laissez faire by cutting taxes, reducing government regulation, and encouraging market incentives. President Clinton thought the government should play a more active role in resolving basic economic issues. His "Vision for America" spelled out a bigger role for government in ensuring health care, providing skills training, protecting the environment, and regulating working conditions. In this vision, well-intentioned government officials could correct market failures. President George W. Bush favored less government intervention and more reliance on the market mechanism. President Obama moved the pendulum back: He made it clear that he believed more government intervention and less market reliance were needed to attain the right WHAT, HOW, and FOR WHOM answers. The debate over market reliance versus government intervention again heated up in the 2016 presidential campaign, especially on issues of health care, job protection, and climate change. The debate over markets versus government persists in part because of gaps in our economic understanding. For over 200 years economists have been arguing about what makes the economy tick. None of the competing theories have performed spectacularly well. Indeed, few economists have successfully predicted major economic events with any consistency. Even annual forecasts of inflation, unemployment, and output are regularly Page 18in error. Worse still, there are never-ending arguments about what caused a major economic event long after it occurred. In fact, economists are still arguing over the causes of not only the Great Recession of 2008-2009 but even the Great Depression of the 1930s! Did government failure or market failure cause and deepen those economic setbacks?

(Chapter 3) (pg 54) The determinants of demand do change, particularly over time. Accordingly,

THE DEMANDS OF SCHEDULE AND CURVE REMAIN UNCHANGED ONLY SO LONG AS THE UNDERLYING DETERMINANTS REMAIN CONSTANT.

(Chapter 2) (pg 36) America's tremendous output is thus explained not only by a wealth of resources but by the quality of these resources as well.

THE HIGH PRODUCTIVITY OF THE US ECONOMY RESULTS FROM USING HIGHLY EDUCATED WORKERS IN CAPITAL-INTENSIVE PRODUCTION PROCESSES

(Chapter 2)(pg 42) Although rich and poor alike get Social Security benefits, low wage workers get more retirement benefits for every dollars of earnings. Hence the benefits of the Social Security program are distributed in a progressive fashion. Income transfers reserved exclusively for the poor people- welfare benefits, food stamps, Medicaid and the like are even more progressive

THE INCOME TRANSFER SYSTEM GIVES LOWER INCOME HOUSEHOLDS MORE OUTPUT THAN THE MARKET ITSELF WOULD PROVIDE.

As we observed in Chapter 3, the market demand for a good is simply the sum of all individual consumer demands. Hence the market demand for a specific product is determined by

Tastes (desire for this and other goods). Income (of consumers). Expectations (for income, prices, tastes). Other goods (their availability and price). The number of consumers in the market. In the remainder of this chapter we shall see how these determinants of demand give the demand curve its downward slope. Our objective is not only to explain consumer behavior but also to see (and predict) how consumption patterns change in response to changes in the price of a good or service or to changes in the underlying determinants of demand.

The Cost of War

The 9/11 terrorist attacks on New York City and Washington, DC, moved the mix of output in the opposite direction. Military spending increased by 50 percent in the three years after 9/11. The wars in Iraq and Afghanistan absorbed even Page 10more resources. The economic cost of those efforts is measured in lost consumer output. The money spent by the government on war might otherwise have been spent on schools, highways, or other nondefense projects. The National Guard personnel called up for the war would otherwise have stayed home and produced consumer goods (including disaster relief). These costs of war are illustrated in Figure 1.3. Notice how consumer goods output declines (from C1 to C2) when military output increases (from M1 to M2).

WHAT to Produce

The WHAT question is quite simple. We've already noted that there isn't enough time in the day to do everything you want to. You must decide what to do with your time. The economy confronts a similar question: There aren't enough resources in the economy to produce all the goods and services society desires. Because wants exceed resources, we have to decide WHAT goods and services we want most, sacrificing less desired products.

Market Shortage

The amount by which the quantity demanded exceeds the quantity supplied at a given price; excess demand.

Market Surplus

The amount by which the quantity supplied exceeds the quantity demanded at a given price; excess supply

dimishing marginal utility

The concepts of total and marginal utility explain not only why we buy popcorn at the movies but also why we stop eating it at some point. Even people who love popcorn (i.e., derive great total utility from it), and can afford it, don't eat endless quantities of popcorn. Why not? Presumably because the thrill diminishes with each mouthful. The first box of popcorn may bring gratification, but the second or third box is likely to bring a stomachache. We express this change in perception by noting that the marginal utility of the first box of popcorn is higher than the additional or marginal utility derived from the second box. The behavior of popcorn connoisseurs is not that unusual. Generally speaking, the amount of additional utility we obtain from a product declines as we continue to consume larger quantities of it. The third slice of pizza is not as desirable as the first, the sixth soda not so satisfying as the fifth, and so forth. Indeed, this phenomenon of diminishing marginal utility is so commonplace that economists have fashioned a law around it. This law of diminishing marginal utility states that each successive unit of a good consumed yields less additional utility.

(Chapter 2) (pg 33) The GDP accounts subtract imports from exports.

The difference represents net exports. In 2015 the value of exports was less than the value of imports. When imports exceed exports, we are using more goods and services than we are producing. -Hence we have to subtract net imports from consumption, investment, and government services to figure out how much we actually produced. That is why net exports appear as a negative item in Figure 2.2.

Barter

The direct exchange of one good for another, without the use of money

Theory versus Reality

The distinction between macroeconomics and microeconomics is one of many simplifications we make in studying economic behavior. The economy is much too vast and complex to describe and explain in one course (or one lifetime). Accordingly, we focus on basic relationships, ignoring unnecessary detail. What this means is that we formulate theories, or models, of economic behavior and then use those theories to evaluate and design economic policy. The economic models that economists use to explain market behavior are like maps. To get from New York to Los Angeles, you don't need to know all the details of topography that lie between those two cities. Knowing where the interstate highways are is probably enough. An interstate route map therefore provides enough information to get you to your destination. Page 17The same kind of simplification is used in economic models of consumer behavior. Such models assert that when the price of a good increases, consumers will buy less of it. In reality, however, people may buy more of a good at increased prices, especially if those high prices create a certain snob appeal or if prices are expected to increase still further. In predicting consumer responses to price increases, we typically ignore such possibilities by assuming that the price of the good in question is the only thing that changes. This assumption of "other things remaining equal (unchanged)" (in Latin, ceteris paribus) allows us to make straightforward predictions. If instead we described consumer responses to increased prices in any and all circumstances (allowing everything to change at once), every prediction would be accompanied by a book full of exceptions and qualifications. We would look more like lawyers than economists. Although the assumption of ceteris paribus makes it easier to formulate economic theory and policy, it also increases the risk of error. Obviously, if other things do change in significant ways, our predictions (and policies) may fail. But like weather forecasters, we continue to make predictions, knowing that occasional failure is inevitable. In so doing, we are motivated by the conviction that it is better to be approximately right than to be dead wrong.

Laissex fiare

The doctrine of "leave it alone", of nonintervention by government in the market mechanism