voluntary exchange
Ex: money for object; objects for objects
Trade helps both sides
Trade creates value
Trade is a positive-sum game (interaction)
Trade encourages diverse interactions
Thomas Sowell: A Conflict of Visions
Resources are limited and can’t meet all wants and desires (constrained vision)
Land: Natural resources
Labor: Workers and their skills
Capital: Tools
the highest valued forgone alternative
study of individual units that make up the economy
Ex: What food will I buy for dinner; Type of car
the study of the economy as a whole
Ex: Forests vs Houses; Steak vs Soy
What will be produced?
How will it be produced?
For whom will it be produced?
Who decides in socialism?
Price
Buyers’ Income
Tastes and Preferences
Taxes
Price Expectations
Influences quantity demanded
Leads to demand curve having a downward slope
Does not shift curve like other factors, change in quantity demanded instead (move along curve)
Buyers’ Income (+)
If buyers expect lower prices in the future, demand decreases today (shifts left)
If buyers expect higher prices in the future demand increases today (shifts right)
Price
Costs of inputs/resources (-)
Technology (+)
Taxes (-)
Price expectations (+)
Influences quantity supplied
Leads to supply curve having an upward slope
If sellers expect higher prices in future, supply decreases today (shifts left)
If sellers expect lower prices in future, supply increases today (shifts right)
where opposing forces are in balance (where supply meets demand)
If suppliers raise prices, less demand for good leads to a surplus and suppliers are forced to return to equilibrium
If suppliers lower prices, more demand for good leads to a shortage and suppliers are forced to return to equilibrium
An economy based on voluntary exchange via markets for goods and services
Prices are signals
the market value of final goods and services produced in a country in a year
National Income Accounting
GDP = output = income
Produce more output
Produce a more valuable output
Produced in a year
Inventory counts
Used goods not counted
Financial assets not counted
Consumption
Investment
Government Spending
Net Exports
%∆X
= Change in X / Starting X
= (X1 - X0) / X0
Raw GDP data, adjusted for price changes. GDP in “current dollars”
GDP adjusted for price changes across time. GDP in “constant dollars”
Begin with (raw) nominal GDP data, divide to filter out old prices, multiply to put in new
Nom GDPt / Pt x Pbase year = Real GDPt
Non-market production is omitted
Underground activity is omitted
Leisure time is omitted
Environmental impacts are omitted
Income increases happiness but only up to a point
Paradox goes away when we interpret percentages
Retirees
Stay-at-Home Workers
Full-Time Students
Marginally Attached Workers
Cyclical unemployment
Structural unemployment
Frictional unemployment
Unemployment caused by changes in the industrial makeup (structure) of the economy
Government policies to alleviate painful transitions: subsidies/programs to retrain or relocate workers
Unemployment caused by delays in matching available jobs and workers
Decreases when search time decreases
Increases when search time increases, hiring and firing regulations, and unemployment regulations
typical rate of unemployment when the economy is growing normally
No cyclical but structural and frictional are present
Estimate price level (P)
Calculate price level
Consumer Price Index (CPI): based on consumption patterns of a typical consumer
GDP Deflator: based on the prices of all final goods and services in GDP
Price confusion
Future price uncertainty
Money illusion
Wealth redistribution
Tax distortions
Menu costs
Shoe-leather costs
market participants uncertain about future price levels
when future price level is uncertain, people are reluctant to sign long-term contracts
Causes of Inflation
Equation of Exchange: MV = PY
P = Inflation, Y = Nominal GDP
M = Money supply
V = Velocity of money: average number of times a unit of money changes hands in a given year
Equation of Exchange in growth rates: %∆M + %∆V ~ %∆P + %∆Y
Milton Friedman - “Inflation is always and everywhere a monetary phenomenon.”; “When the supply of money grows relative to the quantity of goods and services, it takes more money to buy a particular service
P = Inflation, Y = Nominal GDP
M = Money supply
V = Velocity of money: average number of times a unit of money changes hands in a given year
goods used to produce other goods and services
spending on capital goods is investment
Supplies = Savers
Demanders = Borrowers
Good/Service = Savings/Loans
Price = Interest rate
Savings on x axis, R (interest rate) on y axis
Interest rate
Income and Wealth
Time preferences
Consumption smoothing: people prefer smooth consumption patterns
the reward for saving (+)
as interest rate increases, more money is saved (incentives affect behavior)
wealthier people can save more (+)
Increase in income/wealth -> increases savings
People prefer goods and services sooner rather than later (-)
Now is preferred to later
Increase in time preferences -> decreases in savings
Interest Rate
Capital Productivity
Investor (firm) Confidence
How productive are the tools? (+)
Increase in K productivity, more investment
Business firms’ expectations about future economic activity (+)
Increase in investor confidence -> increase in investment
Savings = Investment
S = Savings, D = Investment
Indirect Finance: middleman; Banks = Financial Intermediary
Direct Finance: Bonds and Stocks
Borrower
Date of maturity
Value at maturity = face value or par value
Will the borrower default?
Greater default risk leads to lower dollar price and higher interest rate
Two special debt instruments
U.S. Treasury bonds
Home Mortgages
U.S. Treasury bonds
Home Mortgages
loan contract for homebuyers
Like a bond; Typically mature in 30 years; Difficult to rate
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