Principles of Macroeconomics
Like a household, a society faces many decisions. A society must decide what jobs will be done and who will do them. It needs some people to grow food, other people to make clothing, and still others to design computer software
The opportunity cost of an item is what you give up to get that item.
Economists use the term marginal changes to describe small incremental adjustments to an existing plan of action. Keep in mind that “margin” means “edge,” so marginal changes are adjustments around the edges of what you are doing.
A rational decisionmaker takes an action if and only if the marginal benefit of the action exceeds the marginal cost.
You will learn that, in this case, regulating the price that the monopolist charges can potentially enhance economic efficiency.
A market economy rewards people according to their ability to produce things that other people are willing to pay for.
The tradeoff between inflation and unemployment is only temporary, but it can last for several years. The Phillips curve is, therefore, crucial for understanding many developments in the economy.
#1: People Face Tradeoffs #2: The Cost of Something Is What You Give Up to Get It #3: Rational People Think at the Margin #4: People Respond to Incentives #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 Depends on Its Ability to Produce Goods and Services #9: Prices Rise When the Government Prints Too Much Money #10: Society Faces a Short-Run Tradeoff between Inflation and Unemployment
We consider many historical episodes. These episodes are valuable to study because they give us insight into the economy of the past and, more important, because they allow us to illustrate and evaluate economic theories of the present.
The production possibilities frontier shows one tradeoff that society faces. Once we have reached the efficient points on the frontier, the only way of getting more of one good is to get less of the other. When the economy moves from point A to point C, for instance, society produces more computers but at the expense of producing fewer cars.
The production possibilities frontier shows the opportunity cost of one good as measured in terms of the other good. When society reallocates some of the factors of production from the car industry to the computer industry, moving the economy from point A to point C, it gives up 100 cars to get 200 additional computers.
The field of economics is traditionally divided into two broad subfields. Microeconomics is the study of how households and firms make decisions and how they interact in specific markets. Macroeconomics is the study of economy wide phenomena. A microeconomist might study the effects of rent control on housing in New York City, the impact of foreign competition on the U.S. auto industry, or the effects of compulsory school attendance on workers’ earnings.
President Harry Truman once said that he wanted to find a one-armed economist. When he asked his economists for advice, they always answered, “On the one hand, … . On the other hand, …
An economist who says that all policy decisions are easy is an economist not to be trusted.
Practical men, who believe themselves to be quite exempt from intellectual influences, are usually the slaves of some defunct economist.
A minimum wage increases unemployment among young and unskilled workers.
Economists try to address their subject with a scientist’s objectivity. Like all scientists, they make appropriate assumptions and build simplified models in order to understand the world around them. Two simple economic models are the circular-flow diagram and the production possibilities frontier.
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is.A normative statement is an assertion about how the world ought to be.When economists make normative statements, they are acting more as policy advisers than scientists.
Economists use the term absolute advantagewhen comparing the productivity of one person, firm, or nation to that of another. The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good.
Comparative advantage reflects the relative opportunity cost.
A market is a group of buyers and sellers of a particular good or service. The buyers as a group determine the demand for the product, and the sellers as a group determine the supply of the product.
Some markets fall between the extremes of perfect competition and monopoly. One such market, called an oligopoly,has a few sellers that do not always compete aggressively.
In most free markets, however, surpluses and shortages are only temporary because prices eventually move toward their equilibrium levels. Indeed, this phenomenon is so pervasive that it is sometimes called the law of supply and demand:The price of any good adjusts to bring the supply and demand for that good into balance.
The increase in demand raises the equilibrium price from 2.50 and the equilibrium quantity from 7 to 10 cones. In other words, the hot weather increases the price of ice cream and the quantity of ice cream sold.
In any economic system, scarce resources have to be allocated among competing uses.
Supply and demand together determine the prices of the economy’s many different goods and services; prices in turn are the signals that guide the allocation of resources.
The price elasticity of demand measures how much the quantity demanded responds to changes in the price.
Minimumwage laws dictate the lowest wage that firms may pay workers.
Of course, because buyers of any good always want a lower price while sellers want a higher price, the interests of the two groups conflict. If the Ice Cream Eaters are successful in their lobbying, the government imposes a legal maximum on the price at which ice cream can be sold. Because the price is not allowed to rise above this level, the legislated maximum is called a price ceiling.By contrast, if the Ice Cream Makers are successful, the government imposes a legal minimum on the price. Because the price cannot fall below this level, the legislated minimum is called a price floor.Let
government imposes a price ceiling of 3) is below the ceiling, the price ceiling is not binding.Market forces naturally move the economy to the equilibrium, and the price ceiling has no effect.
In this case, the government imposes a price ceiling of 3 is above the price ceiling, the ceiling is a binding constrainton the market.
The forces of supply and demand tend to move the price toward the equilibrium price, but when the market price hits the ceiling, it can rise no further. Thus, the market price equals the price ceiling. At this price, the quantity of ice cream demanded (125 cones in the figure) exceeds the quantity supplied (75 cones).
In developing countries, despite population growth, the percentage of people with access to safe drinking water has increased to 74 percent in 1994 from 44 percent in 1980.
Data from every corner of the world show that when cities raise the price of water by 10 percent, water use goes down by as much as 12 percent. When the price of agricultural water goes up 10 percent, usage goes down by 20 percent.
In free markets, landlords try to keep their buildings clean and safe because desirable apartments command higher prices. By contrast, when rent control creates shortages and waiting lists, landlords lose their incentive to be responsive to tenants’ concerns. Why should a landlord spend his money to maintain and improve his property when people are waiting to get in as it is? In the end, tenants get lower rents, but they also get lower-quality housing.
In addition to altering the quantity of labor demanded, the minimum wage also alters the quantity supplied. Because the minimum wage raises the wage that teenagers can earn, it increases the number of teenagers who choose to look for jobs.
Yet price controls often hurt those they are trying to help. Rent control may keep rents low, but it also discourages landlords from maintaining their buildings and makes housing hard to find. Minimum-wage laws may raise the incomes of some workers, but they also cause other workers to be unemployed.
Lawmakers can decide whether a tax comes from the buyer’s pocket or from the seller’s, but they cannot legislate the true burden of a tax. Rather, tax incidence depends on the forces of supply and demand.
A price ceiling is a legal maximum on the price of a good or service. An example is rent control. If the price ceiling is below the equilibrium price, the quantity demanded exceeds the quantity supplied. Because of the resulting shortage, sellers must in some way ration the good or service among buyers.
A price floor is a legal minimum on the price of a good or service. An example is the minimum wage. If the price floor is above the equilibrium price, the quantity supplied exceeds the quantity demanded. Because of the resulting surplus, buyers’ demands for the good or service must in some way be rationed among sellers.
When the government levies a tax on a good, the equilibrium quantity of the good falls. That is, a tax on a market shrinks the size of the market.
A tax on a good places a wedge between the price paid by buyers and the price received by sellers. When the market moves to the new equilibrium, buyers pay more for the good and sellers receive less for it. In this sense, buyers and sellers share the tax burden. The incidence of a tax does not depend on whether the tax is levied on buyers or sellers.
The incidence of a tax depends on the price elasticities of supply and demand. The burden tends to fall on the side of the market that is less elastic because that side of the market can respond less easily to the tax by changing the quantity bought or sold.
Consumer surplus equals buyers’ willingness to pay for a good minus the amount they actually pay for it, and it measures the benefit buyers get from participating in a market. Consumer surplus can be computed by finding the area below the demand curve and above the price.
Producer surplus equals the amount sellers receive for their goods minus their costs of production, and it measures the benefit sellers get from participating in a market. Producer surplus can be computed by finding the area below the price and above the supply curve.
An allocation of resources that maximizes the sum of consumer and producer surplus is said to be efficient. Policymakers are often concerned with the efficiency, as well as the equity, of economic outcomes.
The equilibrium of supply and demand maximizes the sum of consumer and producer surplus. That is, the invisible hand of the marketplace leads buyers and sellers to allocate resources efficiently.
Markets do not allocate resources efficiently in the presence of market failures such as market power or externalities.
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