Macroeconomics Chapter 1

margin change

describe a small incremental (increasing) adjustment to an existing plan of action

equality

equality= benefits are distributed uniformly among society's members each portion of the pie is equal to each other

two possibilities of market failure

externality and market power

rational people

people who systematically and purposefully do the best they can to achieve their objectives

economics

study of how society manages its scarce resources

property rights

the ability of an individual to own and exercise control over scarce resources

scarcity

society has limited resources and therefore cannot produce all the goods and services people to wish to have

efficiency

society is getting maximum benefits from its scarce resources ------> absence of waste making the pie as big as possible

Suppose Dave works 8 hrs per day and that in 1 hour Dave can either mow 1 lawn or he can trim 5 bushes. 1) What is Dave's opportunity cost of mowing 4 lawns? 2) What is Dave's opportunity cost of trimming 30 bushes?

1) 20 bushes 2) 6 lawns

Which of the following describe some of the trade-offs faced by a family deciding whether to buy a new car? Check all that apply. A- The vehicle is available in several colors. B- An increase in the family's car payment means the family will be unable to afford a vacation. C- Fuel efficient cars are more expensive, but regular cars require spending more on gas. D- A larger vehicle means saving time by not having to make multiple trips somewhere, but a smaller vehicle is cheaper.

B C D

Why Policymakers should think about incentives?

Public policymakers should never forget about incentives: Many policies change the costs or benefits that people face and, as a result, alter their behavior. A tax on gasoline, for instance, encourages people to drive smaller, more fuel-efficient cars. That is one reason people drive smaller cars in Europe, where gasoline taxes are high, than in the United States, where gasoline taxes are low. When policymakers fail to consider how their policies affect incentives, they often end up with unintended consequences

example of opportunity cost

The total cost of a choice includes both the actual monetary amount paid and the opportunity cost of your time incurred by making that choice over another. By turning down the cashier job (and going to college), you forgo earning your annual salary of $27,000, so this is the opportunity cost of your time from attending your first year of college. You also choose to pay $34,000 for tuition, supplies, and additional housing expenses. So your total cost of attending your first year of college is over $61,000 . Nevertheless, you decide to attend college, so the value of the benefits must exceed the cost.

Explain the two main causes of market failure and give an example

externality the impact of one person's actions on the well being of a bystander ex: factories polluting people's home areas market power the ability of a single economic order (or small group of actors) to have a substantial influence on market prices ex: if everyone in town needs water but there is only one well, the owner of the well is not subject to the rigorous competition with which the invisible hand normally keeps self-interest in check; she may take advantage of this opportunity by restricting the output of water so she can charge a higher price

business cycle

fluctuations in economic activity, such as employment and production

incentive

something such as prospect of a punishment or reward that includes a person act

example of marginal benefits and costs

spend more on water or diamonds? The reason is that a person's willingness to pay for a good is based on the marginal benefit that an extra unit of the good would yield. The marginal benefit, in turn, depends on how many units a person already has. Water is essential, but the marginal benefit of an extra cup is small because water is plentiful. By contrast, no one needs diamonds to survive, but because diamonds are so rare, people consider the marginal benefit of an extra diamond to be large.

market power

the ability of a single economic order (or small group of actors) to have a substantial influence on market prices ex:if everyone in town needs water but there is only one well, the owner of the well is not subject to the rigorous competition with which the invisible hand normally keeps self-interest in check; she may take advantage of this opportunity by restricting the output of water so she can charge a higher price.

opportunity cost

the cost of something is what you give up to get it includes not just money but value of time best alternative use of resource

Suppose Jacob is planning to sell his house. He has already spent $10,000 on various house repairs and can sell his house now for $100,000. Jacob has another option of spending an additional $15,000 to improve his kitchen in which he will be able to sell his house for $120,000. Should Jacob make the kitchen improvements before selling his house?

1) should only make the kitchen improvements be4 selling house if the marginal benefit exceeds the marginal cost 2) marginal benefit= 120,000 (improve)- 100,000 (don;t improve= 20,000 3)marginal cost= 15,000 (amount to pay for improvements 4) 20,000 (mb) > 15,000 (mc) 5) Yes, he should make the kitchen improvements be4 selling house

Ten Principles of Economics

1. People face trade-offs 2. The Cost of something is what you give up to get it 3. Rational people think at margin 4. People respond to incentive 5. Trade can make everyone better off 6. Markets are usually a good way to organize economic activity 7. Governments can sometimes improve market outcomes 8. A country's standard of living depend on its ability to produce goods & services 9. Price rise when the government prints too much money 10. Society faces a short-run trade off between inflation and unemployment

You were planning to spend Saturday working at your part-time job, but a friend asks you to go skiing. You were planning to spend Saturday studying at the library, but a friend asks you to go skiing. What are included in the true cost of going skiing?

Any monetary costs from going skiing, as well as anything you lose by going skiing, wages/time studying

hw example of opportunity cost

Caroline is training for a triathlon, a timed race that combines swimming, biking, and running. Consider the following sentence: Each hour she spends swimming is an hour that she can't spend biking or running. Which basic principle of individual choice does this sentence best illustrate? Answer: All choices have opportunity costs. If Caroline decides to swim, she forgoes the time that she could have spent biking or running. So the opportunity cost of an hour of swimming is an hour of biking or an hour of running, whichever is the highest-valued alternative Kyoko must sacrifice in order to spend an additional hour swimming. There is no information on the effectiveness of an extra hour of swimming as compared to that of an extra hour of biking or running. Therefore, you don't know whether Caroline has an incentive to spend more time on swimming. Similarly, you don't know whether it is most efficient for Caroline to spend the same amount of time on each of the three activities.

You are trying to decide whether to take a vacation. Most of the costs of the vacation (airfare, hotel, and foregone wages) are measured in dollars, but the benefits of the vacation are psychological. How can you compare the benefits to the costs? A- Compare the airfare and hotel costs of the vacation against the foregone wages. B- Determine the benefits of what you give up by going on the vacation, and compare them to the benefits of going on vacation. C- Get a degree in psychology.

Determine the benefits of what you give up by going on the vacation, and compare them to the benefits of going on vacation

What causes inflation?

In almost all cases of large or persistent inflation, the culprit is growth in the quantity of money. When a government creates large quantities of the nation's money, the value of the money falls. In Germany in the early 1920s, when prices were on average tripling every month, the quantity of money was also tripling every month. Although less dramatic, the economic history of the United States points to a similar conclusion: The high inflation of the 1970s was associated with rapid growth in the quantity of money, and the low inflation of more recent experience was associated with slow growth in the quantity of money.

an example of scarce resources

Larry is training for a triathlon, a timed race that combines swimming, biking, and running. Consider the following sentence: Larry has only 20 hours per week that he can devote to training for his race. Which basic principle of individual choice does this sentence best illustrate? Larry faces limited choices due to time constraints. If he had an unlimited amount of time, he would spend many more hours training for the triathlon. However, time, the key resource for his training, is scarce, and Larry has only 20 hours to spend.

example of trade can make everyone better off

People in the U.S. state of Iowa eat both corn and potatoes. It is technically possible for farmers to grow both corn and potatoes in Iowa, yet almost no farmers grow potatoes. Instead, every year, Iowa exports corn and imports potatoes from the U.S. state of Idaho, where farmers specialize in potatoes. Which of the following principles of economic interaction best describes this scenario? There are gains from trade when producers specialize. Idaho specializes in potatoes, and Iowa specializes in corn. Specialization allows the two states to produce more potatoes and corn as a whole than if both states attempted to produce everything. Trade ensures that people in both states have enough corn and potatoes to eat.

indivisible hand

Smith assumed that individuals try to maximize their own good (and become wealthier), and by doing so, through trade and entrepreneurship, society as a whole is better off. The invisible hand is essentially a natural phenomenon that guides free markets and capitalism through competition for scarce resources.

productivity

The amount of goods and services per each unit of labor input. In nations where workers can produce a larger quantity of goods and services per hour, most people enjoy a high standard of living; in nations where workers produce less quantity of goods and services per hour experience lower standard of living.

You win $100 in a basketball pool. You have a choice between spending the money now or putting it away for a year in a bank account that pays 5% interest. Which of the following is included in the opportunity cost of spending $100 now? A- There isn't an opportunity cost because you won the money B- The $105 you would have a year from now if you put it in the bank C- The cost of entering the basketball pool

The opportunity cost is The $105 you would have a year from now if you put it in the bank The opportunity cost of an item is what you give up to get that item. In this case, by spending the $100 now, you give up the money you would have a year from now if you put it in the bank account that pays 5% interest.

Suppose Americans decide to save more of their incomes. If banks lend this extra saving to businesses, which use the funds to build new factories, how might this lead to faster growth in productivity? Who do you suppose benefits from the higher productivity? Is society getting a free lunch?

The savings made by people are mobilized by the banks. Banks in turn provide loans to the business firms which use the funds to expand their production by establishing new factories. This leads to faster growth in productivity because when production capacities are increased so is the per capita production. The benefit from the increased productivity is enjoyed by workers, entrepreneurs and all households. Society is not getting a free handout because when people are saving their money there is a trade-off. The people postponing their present needs and saving for the future helps the economy improve productivity.

market failure

a situation in which a market left on its own fails to allocate resources efficiently

Economics is best defined as the study of

a) how society manages its scarce resources. b) how to run a business most profitably. c) how to predict inflation, unemployment, and stock prices. d) how the government can stop the harm from unchecked self-interest. Answer is A.

A marginal change is one that

a) is not important for public policy. b) incrementally alters an existing plan. c) makes an outcome inefficient. d) does not influence incentives.

Governments may intervene in a market economy in order to

a) protect property rights. b) correct a market failure due to externalities. c) achieve a more equal distribution of income. d) All of the above. Answer is D.

Explain whether each of the following government activities is motivated by a concern about equality or a concern about efficiency. In the case of efficiency, discuss the type of market failure involved. a. regulating cable TV prices b. providing some poor people with vouchers that can be used to buy food c. prohibiting smoking in public places d. breaking up Standard Oil (which once owned 90 percent of all oil refineries) into several smaller companies e. imposing higher personal income tax rates on people with higher incomes f. instituting laws against driving while intoxicated

a. This shows the government's concern about efficiency. The market failure involved is due to market power where small group of persons or a single person influences market prices. b. This shows the government's concern about equality. c. This shows the government's concern about efficiency. The market failure involved is known as an externality. It shows the negative impact of the smoker's actions on the well-being of others. d. This shows the government's concern about efficiency. The market failure involved is due to market power, where Standard Oil would unduly influence the market prices of oil and exploit people. e. This shows the government's concern about equality. f. This shows the government's concern about efficiency. The market failure involved is known as an externality. It shows the negative impact of the intoxicated driver's actions on the well-being of others.

inflation

an increase in the overall prices in the economy

Why isn't trade among countries like a game with some winner and some losers?

because both sides can gain something

How do rational people make decisions?

by comparing the marginal benefits and marginal costs and seeing if the marginal benefits exceed the marginal costs

3 Subcategories for the Ten Principles

how people make decisions, how people interact, and how the economy as a whole works how people make decisions 1. People face trade-offs 2. The Cost of something is what you give up to get it 3. Rational people think at margin 4. People respond to incentive how people interact 5. Trade can make everyone better off 6. Markets are usually a good way to organize economic activity 7. Governments can sometimes improve market outcomes how the economy as a whole works 8. A country's standard of living depend on its ability to produce goods & services 9. Price rise when the government prints too much money 10. Society faces a short-run trade off between inflation and unemployment -

externality

the impact of one person's actions on the well being of a bystander ex: factories polluting

example of tradeoff

there is no such thing as a free lunch, guns and butter, society deciding between efficiency or equality

During the Revolutionary War, the American colonies could not raise enough tax revenue to fully fund the war effort; to make up the difference, the colonies decided to print more money. Printing money to cover expenditures is sometimes referred to as an inflation tax. Who is being taxed when more money is printed? A- Banks only B- Families of soldiers in active duty C- Anyone who is holding money

Answer is C. When the government prints money, it imposes a tax on anyone who is holding money. This is because printing money decreases the value of money by causing inflation, or an increase in the overall level of prices in the economy. See Section: Principle 9: Prices Rise When the Government Prints Too Much Money.

How are inflation and unemployment is related short run?

Increasing the amount of money in the economy stimulates the overall level of spending and thus the demand for goods and services. Higher demand may over time cause firms to raise their prices, but in the meantime, it also encourages them to hire more workers and produce a larger quantity of goods and services. More hiring means lower unemployment.

marginal benefit vs marginal cost

Marginal benefit refers to what people are willing to give up in order to obtain one more unit of a good, while marginal cost refers to the value of what is given up in order to produce that additional unit.

Are Labor unions are the primary reason the standard of living in the United States has changed over time ?

No, The increase in average income and thus the standard of living is mainly the result of increased productivity. In other words, an hour of work produces more goods and services than it used to in your grandparents' era

example of incentive

Suppose that in the hypothetical country of Trashland, garbage cans are distributed to whoever is willing to pay the most. This distribution rule gives the residents of Trashland an incentive to spend time Economists study the choices that people make as they seek to obtain the greatest benefits at the least possible costs. If owning a good will maximize people's benefits in this sense, they will choose to do things to help them obtain that good. As a result, the way that goods are distributed influences how people act. If the distribution of goods is to those willing to pay the most, people have an incentive to spend time earning money to pay for goods. When goods are distributed by price, economists refer to it as a market economy. Different rules for distributing goods will change individuals' incentives. For example, if the next person in line will be awarded a good, people have an incentive to hold their place in the line. Similarly, if a government policy assigns goods to individuals, then people have an incentive to lobby government officials to try to influence the way the goods are given out.

The Social Security system provides income for people over age 65. If a recipient of Social Security decides to work and earn some income, the amount he receives in Social Security benefits is typically reduced.

The provision of Social Security benefits lowers an individual's incentive to save for retirement because it provides income to retired individuals once they've reached age 65. This means that even if an individual hasn't been saving for retirement while working, he can still count on Social Security benefits to support himself through the retirement years. Moreover, because a person gets fewer after-tax Social Security benefits the greater his earnings are, there is also an incentive not to work (or not work as much) once he has hit the retirement age of 65.

When monetary policy increases and decreases what happens?

When the government uses monetary policy to decrease the quantity of money, then the demand for goods and services decreases. This change in the demand will lead to lower prices, causing firms to produce fewer goods and services—which requires fewer workers. Therefore, lower prices lead to higher unemployment levels in the short run. When the government uses monetary policy to increase the quantity of money, then the demand for goods and services increases. This change in the demand will lead to higher prices, causing firms to produce more goods and services—which requires more workers. Therefore, higher prices lead to lower unemployment levels in the short run. In the long run, however, an increase in the quantity of money will lead only to an increase in the price levels but will have no effect on the unemployment level. The economy faces a trade-off between inflation—an increase in the overall price levels—and unemployment in the short run. In particular, higher inflation rates usually correspond to lower unemployment levels, while lower inflation rates correspond to higher levels of unemployment.

If a nation has high and persistent inflation, the most likely explanation is

a) the central bank creating excessive amounts of money. b) unions bargaining for excessively high wages. c) the government imposing excessive levels of taxation. d) using their monopoly power to enforce excessive price hikes. Answer is A.

Your opportunity cost of going to a movie is

a) the price of the ticket. b)the price of the ticket plus the cost of any soda and popcorn you buy at the theater. c) the total cash expenditure needed to go to the movie plus the value of your time. d) zero, as long as you enjoy the movie and consider it a worthwhile use of time and money. Answer is C.

Adam Smith's "invisible hand" refers to

a) the subtle and often hidden methods that businesses use to profit at consumers' expense. b) the ability of free markets to reach desirable outcomes, despite the self-interest of market participants. c) the ability of government regulation to benefit consumers, even if the consumers are unaware of the regulations. d) the way in which producers or consumers in unregulated markets impose costs on innocent bystanders. Answer is B.

what are the broad reasons for a government to intervene in the economy and change the allocation of resources that people would choose on their own?

to promote both efficiency and equality efficiency: think of market failure --> externality+ market power when there is market failure, the government can implement policies to reduce externality. With the example of the factories creating pollution and health problems, the government can make rules to restrict factories polluting. The market power example of a person owning the only water well reminds me of a monopoly and government can have rules to restrict monopolies and trusts. the invisible hand promote efficiency, but not equality. Government can promote both efficiency and equality. For example, making lower income people pay lower taxes than higher income people. Welfare programs. EOP programs.

A 1996 bill reforming the federal government's antipoverty programs limited many welfare recipients to only 2 years of benefits. This change gives people the incentive to find a job ____ quickly than if welfare benefits lasted forever. The loss of benefits after 2 years will result in the distribution of income becoming ____ equal. In addition, the economy will be ____ efficient because of the change in working incentives.

This change gives people the incentive to find a job more quickly than if welfare benefits lasted forever. The loss of benefits after 2 years will result in the distribution of income becoming less equal. In addition, the economy will be more efficient because of the change in working incentives. This change in the government's antipoverty program reduces equality in the distribution of income, since those who cannot find a job will get no income at all; however, the economy is more efficient given the increased incentive for the unemployed to find work and contribute to the nation's output.

The company that you manage has invested in developing a new product, but the development is not quite finished. At a recent meeting, your salespeople report that the introduction of competing products has reduced the expected sales of your new product to . If it would cost to finish development and make the product, should you go ahead and do so? What is the most that you should pay to complete development?

ou should finish development. The most you should pay to complete development is $3 million. Because the $5 million your company invested in a new product has already been spent, it should not be considered in the decision of whether to finish development, according to the principle of thinking at the margin. In this case, the additional cost to finish development is $1 million, whereas the expected additional benefit of the new product is $3 million in profit (assuming that the company receives zero profit if the product remains unfinished). Therefore, your company should go ahead and finish the product. In fact, your company should be willing to pay up to $3 million to finish development since that is the marginal benefit from doing so.

example of how government can improve market outcomes

Because a type of fish is on the verge of extinction, the government imposes rules that prohibit fishing in the publicly owned spawning grounds. At first, owners of fishing boats complain about this restriction on where they can fish, but soon they notice that the number of adult fish swimming outside the protected area is much higher than it was before. With the restriction, each fishing boat ends up catching more fish than it did before the restriction was in place. Which of the following principles of economic interaction best describes this scenario? When a market outcome is inefficient, government intervention can improve overall welfare. In this case, since the young fish can be caught by any boat owner, the individual pursuit of self-interest leads to a bad outcome—extinction of this type of fish—which makes everyone in the fishing industry worse off. If the government prohibits fishing in the spawning grounds where young fish are born and mature, this motivates boat owners to consider alternatives until the fish mature and reproduce. With this restriction, everyone is better off in the end.

example of markets are a good way to organize economic activity

Immediately after an ice storm brought down power lines throughout the region, hardware stores were sold out of batteries and flashlights. However, within a couple of days, special deliveries brought in extra batteries and flashlights, and everyone who wanted to buy a flashlight or batteries was able to do so. Which of the following principles of economic interaction best describes this scenario? Markets allocate goods effectively. After the ice storm, people rushing to the store to purchase batteries and flashlights created a shortage of these items. However, to accommodate this shortage, hardware stores requested special deliveries to restock their inventories, bringing back equilibrium in the market.

example of marginal analysis

Neha is training for a triathlon, a timed race that combines swimming, biking, and running. Consider the following sentence: Because her pool sessions are helping her swim more quickly, Neha plans to reduce by 1 hour per week the time she spends training on the bike and increase by 1 hour the time she spends in the swimming pool; however, her husband says that she should stop doing any biking and running and spend all 20 hours per week in the pool. Which basic principle of individual choice does Neha's plan illustrate that her husband's advice does not? Many decisions are made on the margin. explanation: Neha's decision about pool time versus bike time is a how-much decision. Both bike time and pool time can help reduce her race time. Because pool time seems to be having a greater effect at the moment, it makes sense for her to spend a bit more time in the pool and a bit less time on the bike. However, this does not mean that it makes sense for her to spend all her time in the pool and no time on the bike. If she cut out all training on the bike, the value of a little bit of bike training might be higher than the value of the last hour of pool training. Neha does not treat biking versus swimming as an all-or-nothing decision. She makes small changes at the margin in the number of hours spent training for each activity.