Economics 212 Introduction to Macroeconomics Professor Cotton 1

Economics 212 Introduction to Macroeconomics Professor Cotton 1

What do economists study? Are NBA referees biased in favor of athletes of their own 2 race? How does going to college affect your lifetime earnings? What do interest groups buy with political contributions? Which government policies effectively decrease smoking or obesity? Why are some countries rich and some countries poor? What’s the best way to increase employment or fight a recession?

What do economists do? Apply rigorous logical and mathematical techniques to formally and carefully analyze problems Economic Theorists develop models A simple model can help us better understand an issue Focusing on only the most important aspects of a problem allows us to develop the greatest intuition Empirical Economists test the models Use statistical techniques to test the models Econometrics 3

Most economics questions fit in 1 of 2 categories: MICROeconomics MACROeconomics Individual behavior (e. g. , Aggregate or average 4 firms, people, households) How many employees will GM lay off? What characteristics determine if Joe goes to college? Joe’s income or GM profit How much of the “pie” do you get? behavior (e. g. , country) Total unemployment in the economy? What policies determine the average level of education? Gross Domestic Product How big is the entire “pie”? How do we make it bigger?

Macroeconomics Deals with the classic issues in economics: Unemployment Inflation National Output & National Income Population Growth Economic Growth Bond Prices Money & Banking 5

Which questions are Macro? Are NBA referees biased in favor of athletes of their own 6 race? How does going to college affect your lifetime earnings? What do interest groups buy with political contributions? Which government policies effectively decrease smoking or obesity? Why are some countries rich and some countries poor? What’s the best way to increase employment or fight a recession?

Consider Econ if you’re interested in: Business including Marketing and Finance Government / Political Science Law International studies Sociology Psychology Statistics / Applied Mathematics Some books to read, if interested: The Logic of Life by Tim Hartford Freakonomics by Steven Levitt and Stephen Dubner Super Crunchers by Ian Ayres 7

About Me Prof. Christopher Cotton My research involves game theory and competitions Interest groups compete for policy reform Individuals compete for raises and promotions I’m a Microeconomist, not a Macroeconomist Why do I want to teach Intro Macroeconomics? The material is essential for understanding current events The first macro class that I took as an undergraduate student… I will focus on the topics that will help you carry on a 8 conversation about the current state of the US economy

Goals of class Understand trade off between inflation and unemployment Assess different fiscal and monetary policies Why does a downturn in one sector hurt the entire economy? Prepare for future economics and finance classes Be able to read economic policy articles in the Wall Street Journal or The Economist 9

What you need Textbook: Parkin’s “Macroeconomics” ninth edition Another book: Wheelan’s “Naked Economics” Subscription to My. Econ. Lab. com (comes with new Parkin) You must be willing to keep up on the material. It is challenging, and the lectures will help but only if you understand the material from the previous lecture. Good skills in Algebra, and the ability to draw and interpret graphs given data. 10

Topic 1: Basic Economic Principals Law of Diminishing Returns Production Possibilities Frontier Opportunity Costs Absolute & Comparative Advantage Supply and Demand 11

Factors of Production Factors of production are the inputs used to create outputs (goods and services) for consumption Land 2. Labor 3. Capital (“produced means of production”) 4. Entrepreneurship 1. 12

What if we increase all of the factors of production by the same amount? + = 13 +

What if we increase all of the factors of production by the same amount? + + = 14 ? ? ? +

What if we increase all of the factors of production by the same amount? + + = 15 +

What if we increase all of the factors of production by the same amount? Question: Suppose 1 farmers working 10 acres of land with 1 tractor and 1 bag of seeds can produce 1 ton of corn. Then how many tons of corn can be produced by 2 equally competent farmers working 20 equally productive acres of land with 2 tractors and 2 bags of seeds? Answer: At least 2 tons. (Maybe more, if the farmers benefit from working as a team. i. e. , Economies of Scale) 16

What if we increase only of of the factors of production? + + 17 + = ? ?

What if we increase only of of the factors of production? + + 18 = +

What if we increase only one of the factors of production? Example 1 Question: Suppose 1 farmers working 10 acres of land with 1 tractor and 1 bag of seeds can produce 1 ton of corn. Then how many tons of corn can be produced by 2 equally competent farmers working the same amount of land with the same number of tractors and seeds? Answer: Maybe 2 tons or more, if there are benefits of working together (Economies of Scale). But not necessarily. Maybe there is only so much work to do, and the new farmer adds nothing 19

What if we increase only of of the factors of production? + + 20 + = ? ?

What if we increase only of of the factors of production? + + 21 + <

What if we increase only one of the factors of production? Example 2 Question: Suppose 1 farmers working 10 acres of land with 1 tractor and 1 bag of seeds can produce 1 ton of corn. Then how many tons of corn can be produced by 200 equally competent farmers working 10 acres of land with 1 tractor and 1 bag of seeds? Answer: Definitely not 200 tons of corn. (Maybe not ever 1 ton if the additional 199 workers are just getting in the way. ) 22

Law of Diminishing Returns If one factor of production is increased, while the other factors of production remain unchanged, then eventually, the marginal increase in output from an additional unit of input will be lower than the marginal increase in production from the previous unit of input. e. g. , the benefit of adding the 101 st worker is less than the benefit of adding the 100 th worker. (Assuming the other factors of production are fixed. ) 23

Law of Diminishing Returns Graph: 24

A scary interpretation Thomas Malthus (1798): food production and population growth 25

Malthusian Theory of Pop Growth The world cannot support a population above a certain level Therefore, world population will be kept in line through “positive” and “preventative” checks. Positive checks – Increase the death rate War Famine & Disease Preventative checks – Decrease the birth rate Increased use of contraception Increased age of marriage 26

World Population – graph it Year 10, 000 BC 1 million 950 AD 250 million 1600 500 million 1804 1 billion 1927 2 billion 1961 3 billion 1974 4 billion 1987 5 billion 2000 6 billion 2011 27 Population 7 billion Note that data and graph are from Wikipedia’s entry on World Population. Just because I use Wikipedia for lecture data, does not mean you should use it as a main source for your papers. However, you should always give credit to your sources, even if it is Wikipedia.

World Population – graph it 28

So, what happened? What didn’t Malthus account for? Changes in technology What happened around the major kink in the graph? Mid-1700 s = Industrial Revolution Better access to food, medicine, shelter Better water supply, sewage 29

Another example – US Output Year Population (millions) 1935 73 127 1950 295 152 1965 719 194 1980 2, 784 227 1995 30 Total Output ($ billions) 7, 265 263 Total output is US Gross Domestic Product, as provided by the BEA. Population figures come from the US Census

Increase in population also… + + 31 +

came with increases in technology + + 32 +

came with increases in technology + + 33 +

came with increases in technology + + 34 + +

came with increases in technology + + 35 + + +

Important Questions: What are the four factors of production? What is the law of diminishing returns? Why is technology important? Why was Thomas Malthus wrong? Might he still be proven correct? Next concept: Opportunity Costs & Productions Possibilities Frontier 36

Opportunity costs Definition: The (value of the) next-best alternative we forgo, or give up, when choosing an action. What’s the opportunity cost of studying for your test on a Saturday night? Is it higher or lower than the opportunity cost of studying for your test on a Tuesday night? We can refer to opportunity costs in terms of items forgone, or in terms of the monetary value of the items forgone. 37

Production Possibilities Frontier (PPF) Definition: the maximum level of production in an economy, given its factors of production Graph an example for an economy that can only produce 2 goods (e. g. , guns & butter) If the economy is producing along its PPF, it cannot produce more of one good without giving up some production of another good. If the economy is inside its PPF, it can do better Can’t be outside of the PPF 38

Opportunity Cost of Illustrated by movement along the PPF. What’s the opportunity cost of producing 1000 tubs of butter? What’s the opportunity cost of making one more tub of butter? 39

French Colony of Louisiana, 1750 You’re the “economic” advisor. Suppose you have 1000 workers with equal sized farms spread across the colony. Your workers can either farm rice or corn. If you put all of your inputs into corn production, then you produce 10, 000 bushels of corn If you put all of your inputs into rice production, then you produce 3, 000 bushels of rice What happens if you devote 900 workers to corn production, and the rest to rice production? Which workers should produce corn? What about a 50 -50 split? 40

Rainfall in Louisiana 41

Opportunity costs What is the opportunity cost of producing 100 bushels of corn? What is the opportunity cost of producing 100 additional bushels of corn? 42

What happens to the PPF when… A fleet of ships land on the shore with 500 new farmers 43 looking to settle in Louisiana? Someone invents a more efficient plow? Rice production technology improves? Disease kills off 500 farmers? A hurricane increases flooding throughout the colony? The royal governor outlaws corn production? Coastal farmers go on strike, refusing to work?

Where on the PPF? To be on the PPF, need “full employment” of factors of production. Macroeconomic policy making is often aimed at moving production as close to the PPF as possible. At which point on the PPF does production take place? Depends on what people want or need Command Economy (government decides, central planner) Market Economy (individuals decide own actions) 44

Next Concept: Comparative Advantage Absolute Advantage Comparative Advantage Who should produce what in an efficient economy? Unless told otherwise, assume that there are constant opportunity costs of production (linear individual PPFs) for questions of comparative advantage. 45

Absolute Advantage Someone has an absolute advantage in producing something when they can do so more efficiently (using fewer factors of production, e. g. , less labor) than someone else. The person or group that is “better” at producing a good has the absolute advantage in doing so.

Who has the absolute advantage? Jokes Lance Armstrong Bikes Jerry Seinfeld Physics Albert Einstein Economics 47 ? Prof. Cotton

Comparative Advantage Someone has comparative advantage in producing something when their opportunity costs of doing so are lower than someone else. Compared to someone else, everyone has a comparative advantage in the production of something. Comparative advantage does not imply absolute advantage.

Who has the comparative advantage? Jokes Bikes Jerry Seinfeld Physics Albert Einstein Economics 49 Lance Armstrong Prof. Cotton

Examples – Individuals Scotty and Iris can make both sweaters and beer Sweaters Beer Scotty 1000 900 Iris 1300 1000 Who has the absolute advantage in each product? For each person, What is the opportunity cost of making a beer? What is the opportunity cost of making a sweater?

Examples – Individuals Scotty and Iris can make both sweaters and beer Sweaters Beer Scotty 1000 900 Iris 1300 1000 Scotty has the lower opportunity cost of beer So, Scotty has the comparative advantage in beer Iris has the lower opportunity cost of sweater So, Iris has the comparative advantage in sweaters

Examples – Individuals Scotty and Iris can make both sweaters and beer Sweaters Beer Scotty 1000 900 Iris 1300 1000 Graph the PPF for an economy made up of Scotty and Iris.

Examples – Countries The French and Irish can make both wine and beer Beer Wine France 500 1000 Ireland 1000 100 Who has the absolute advantage in each product? For each country, What is the opportunity cost of making beer? What is the opportunity cost of making wine?

Examples – Countries The French and Irish can make both wine and beer Beer Wine France 500 1000 Ireland 1000 100 France has the lower opportunity cost of wine So, France has the comparative advantage in wine Ireland has the lower opportunity cost of beer So, Ireland has the comparative advantage in beer

Examples If Aidan specializes, every week he can brew 12 gallons of beer, or he can bake 6 pizzas If Sally specializes, every week she can brew 6 gallons of beer, or she can bake 12 pizzas Pizza and beer go together, so people must consume 1 gallon of beer for every 1 pizza they eat. Assume constant opportunity costs Draw Aidan’s PPF Draw Sally’s PPF

Example If they produce alone, how many pizzas and how much beer do they each consume? 4 pizzas and 4 gallons of beer Draw the joint PPF when they work together Working together, how many pizzas and how much beer do they each consume? 6 pizzas and 6 gallons of beer GAINS FROM TRADE 56

Examples Abby, Bruce and Carlos can make cheese and bread Cheese Bread Abby 500 600 Bruce 200 700 Carlos 600 300 As always with comparative advantage problems in this class, assume linear PPFs for each producer. Who has the absolute advantage in each product Carlos has it in Cheese Bruce has it in Bread

Examples Abby, Bruce and Carlos can make cheese and bread Cheese Bread Abby 500 600 Bruce 200 700 Carlos 600 300 Who has the comparative advantage in Cheese? Abby v. Bruce? Abby v. Carlos? Carlos Bruce v. Carlos? Carlos > Abby > Bruce

Examples Abby, Bruce and Carlos can make cheese and bread Cheese Bread Abby 500 600 Bruce 200 700 Carlos 600 300 Graph the PPF for the economy with trade.

Comparative Advantage Summary Use the concept of comparative advantage to argue in favor of companies moving production from US to China or India. Who gains? On average, US citizens are better off. Are all US citizens better off? Consider the exchange of goods and services. Which does the US have comparative advantage in compared to most other countries?

Next Concept: Supply & Demand 61

Auction for a Coke At $0. 50, _____ people would like to buy a Coke At $0. 75, _____ people would like to buy a Coke At $1. 00, _____ people would like to buy a Coke At $1. 25, _____ people would like to buy a Coke At $1. 50, _____ people would like to buy a Coke At $1. 75, _____ people would like to buy a Coke At $2. 00, _____ people would like to buy a Coke At $2. 25, _____ people would like to buy a Coke At $2. 50, _____ people would like to buy a Coke At $2. 75, _____ people would like to buy a Coke At $3. 00, _____ people would like to buy a Coke At $3. 25, _____ people would like to buy a Coke At $3. 50, _____ people would like to buy a Coke 62 At $0. 25, _____ people would like to buy a Coke At $3. 75, _____ people would like to buy a Coke

Demand for Coke The numbers on the previous slide represent the DEMAND for Coke at each price Graph it 63

Supply of Coke How much Coke is available (i. e. , supplied) at each price Usually supply is increasing price. Producers are willing to sell more of something when the price is high. What about in our class? The vending machine down the hall means that supply is a vertical line at $1. 25. 64

Supply & Demand Key model for analyzing the market economy Supply– How much of a good or service firms are willing to supply at different prices Demand– How much of a good or service individuals want to buy at different prices Equilibrium (“market-clearing”) Price– The price at which the number of goods supplied equals the number of goods demanded. 65

Imagine if…. Each person on this side of the classroom has been given one set of coasters each. 66 Each person on this side of the classroom hasn’t.

Imagine if…. Each person on this side of the classroom has been given one set of coasters each. 67 Each person on this side of the classroom hasn’t. (I like the other side better)

How much $$$ would you require to give up your coasters? 68

How much would you be willing to spend to buy some coasters? 69

Price Total # of buyers $0. 00 0 20 $1. 00 2 18 $2. 00 4 16 $3. 00 6 14 $4. 00 8 12 $5. 00 10 10 $6. 00 12 8 $8. 00 14 6 $9. 00 16 4 $10. 00 18 2 $11. 00 70 Total # of sellers 20 0

Graph it. 71

US Market for Bourbon What is the equilibrium price and quantity? What happens when the price of bourbon is too high? What happens when the price of bourbon is too low? 72

US Market for Bourbon What happens to the market for bourbon when… …the Jack Daniel’s distillery burns to the ground? Decreases supply …someone invents a more cost-effective way to make bourbon? Increases supply …a highly publicized study shows that people who drink bourbon live longer happier lives? Increases demand …Scotch becomes trendy? Decreases demand 73

US Market for Bourbon Assume that the equilibrium price of bourbon is $20 per bottle What happens when… …the US government passes a law saying that the price of bourbon cannot exceed $10 per bottle? This is a price ceiling, resulting in a shortage …the US government passes a law saying that the price of bourbon cannot fall below $30 per bottle? 74 This is a price floor, resulting in a surplus

Details Substitutes and complements What determines the shape of supply and demand? The invisible hand of the market place Price ceilings and floors 75

Substitutes and Complements Substitutes – A good that can be used in place of another good Complements – A good that is used in conjunction with another good Complements can be in either consumption (i. e. , pizza & beer) or production (i. e. , dough and cheese) Substitutes can also be in either consumption (i. e. , pizza or tacos) or production (i. e. , sugar or corn syrup) 76

Substitutes and Complements What are some substitutes and complements of… …Pickup truck? …Pen? …Movie ticket? …Orange? …Bourbon? …Cigarette? …Gasoline? 77

Shape of Supply & Demand The availability of substitutes determines the shape (steepness) of the supply and demand curves Demand for cigarettes Demand for ham Demand for gasoline Demand for apple juice Supply for apples 78

The Invisible Hand The “invisible hand” If the price is above the equilibrium price, there is a surplus. More people want to sell than buy at that price. In an effort to sell their goods, suppliers will decrease prices in an effort to undercut other suppliers so they are not left with a surplus. This tends to drive the price towards equilibrium If the price is below the equilibrium price, there is a shortage. More people want to buy than sell at that price. Buyers will increase their price offers in an effort to entice sellers to sell to them. This tends to drive the price towards equilibrium 79

Price Ceilings and Floors Price ceilings keep the market price from going above a fixed level Price floors keep the market price from falling below a fixed level Keep the market from achieving equilibrium Examples Rent ceilings in NYC Price gouging laws during a gasoline panic Farm price supports 80

Shifts in supply and demand Market for Coke 81 Price of Pepsi increases (substitute) Price of pizza decreases (complement) New health reports show it’s bad for you Sugar increases in price Trade reform make it easier to import soda from Mexico Government sends stimulus check to all citizens Hot dog market when bun price increases Miller Beer market when Bud price increases Sport coat market when UM requires them in class Milk market when price of hay increases

Shifts in supply and demand Shifts in demand Complement or substitute price change Shifts in taste Shifts in income Shifts in supply Input price change Change in technology 82

Labor Market Supply is made up of many individual workers Demand is from firms and organizations (counterintuitive? ) Minimum wage laws 83