Day 35 Principles of macroeconomics Summary chapter 1-6

Principles of macroeconomics

Summary chapter 1-6

Chapter 1

Economic is the study of how people take decisions under the scarcity principle, and macro economics focuses on the large scale such as nations and worldwide economy. The basic components in macroeconomics do not vary than microeconomics. It states that as a rational person, we must act only if the extra benefit generates from that activity exceeds the extra cost. Generally, this cost is associated with the next-best alternative that has to be forgone by taking the activity. In people’s daily lives, there are four major pitfalls which prevent them to make rational economic decisions:they tend to use proportions rather than absolute dollar to measure costs and benefits; they take account of the sunk cost which can not be recovered, instead of take account of opportunity costs. And they make mistakes on distinguishing average and marginal costs. Similar to microeconomics, the macroeconomics uses the demand and supply curve to analysis the market. If the price is lower than the equilibrium price, there is excess in demand. In contrast, if the price is higher than the equilibrium price, there is excess in supply.The price change in complements and substitutes will change the demand, along with the customer’s expectations which affect their reservation price. On the other hand, any factors that influence the production will shift the supply curve. When a perfectly competitive market is at its equilibrium level, it normally produces at the socially optimal quantity as well. Then the society reaches its efficiency level, where there are no cash on table.

Chapter 2

When an individual is simply more efficient at producing all goods and services than others, he/she has an absolute advantage. If an individual has the lower opportunity cost on producing a specific product, he/she holds a comparative advantage. A country(individual) will achieve maximum production when concentrates on the project with comparative advantage, and that affects the goods and services a nation chooses to produce. We use the production possibilities curve to describe the production specification relationships. The slope of the curve is the opportunity cost represent on the quantities of other products need to be forgone for producing an additional unit. However, in an open economy, the consumption possibilities for a country's citizen can be larger than the production possibility. The country will reach its maximum consumption possibilities when producing at the point where the slope is equal to the international market opportunity cost.There are many sources of comparative advantages, for example: the inborn talent, education and natural resources could affect the opportunity costs. Although production specialization can promote productivity, it also leads to disadvantage for non-diversity products, which might cause the country losing trading opportunities. In addition, the psychological toll on workers performing the single, tedious producing process is heavy, and may carry out problems.

Chapter 3

There are six important criteria that economists aim to achieve. First of all, it is to raise living standards, this can be measured by the growth in gross domestic output. Secondly, economists tend to avoid extreme figures in the short-run business cycle in economy. An economic expansion is usually followed by a contraction, so they do not want to see a drastic change that extensively slow done the GDP growth. The third aim is to maintain a relative low inflation rate, which is evaluated by calculating the change in the consumer price index every year. The CPI is the price of the standard basket of goods and services in the current year divided by the same basket price in the base year. Inflation is the overall increase in general price. Therefore, the change in relative price corresponding to demand/supply change is not inflation. It determines the purchasing power of currencies plus the real return on investment. The real interest is the nominal interest rate deflated( minus inflation rate), it measures the percentage increase in real purchasing power of a financial asset. The CPI and inflation rate may fail to explain the living condition of people, due to the quality bias and substitution bias. The fourth objective for economists is to maintain sustainable public and national debts. Which public debt is owned to private sectors by the government and national debts is owned to other nations. The last two aims are to adjust saving ratio and provide the employment opportunities for people. The saving is important for the long-run since it determines the future economic growth, and the employment rate is also related to the GDP. Speaking of which, the GDP is the market value of final goods and services produced in a country’s borders during a given period. We can use the value-added method to determine GDP indirectly. The aggregate value of all firm's market value of its product or services minus the cost of inputs purchased from other firms. Otherwise, we use the expenditure approach to assess GDP. We assume the national GDP is equaled to the total aggregate expenditures by consumers expenditure, government expenditure, investment spending and net exports. In order to adjust for inflation, we use real GDP to measure the economic well-being. Which the quantities produced are valued at the price in the base year. It defines the goods and services that are available, but may fail to account among other welfare factors such as environmental quality, leisure time or economic inequality.

Chapter 4

Saving and wealth are two essential measures of macroeconomic performance. They are separate factors yet hold mutual impact. Wealth is the value of assets minus total liabilities, and saving is the disposable income less current spending. Wealth is the stock figure which represents a value at a point of time, and saving is the flow represents the rate of change in wealth. In some extent, wealth will affect consumer’s saving pattern, on the other hand, change in wealth equals to saving plus net capital gain.The main motivation of savings are: life-cycle, precautionary and bequest saving. However, other outside factors like real interest rate, self-control and demonstration effects also have a substantial impact over saving behavior. The national saving level is the key determinant for the economy’s future growth, it is considered with two sectors, private and public saving.The private sector, is the combined savings of households plus business. It equals to the after-tax income minus consumption expenditures. The public saving is the amount remains after the government covers its spending by the net tax collected( tax-transfer payments to the public). A negative public saving can be interpreted to government budget deficit, and a positive public saving means the government is experiencing the budget surplus. Even though though some countries like Australia may have a low household saving level, it may not cause a problem due to the business saving, and public saving is large enough to cover it. As stated before, the saving defines the national ability to supply funds that used for investment on new capital goods. This relationship is directed by the real interest rate. It is straight-forward, since the high interest rate will increase the supply of saving and decrease the firm’s willingness to borrow for investment, vice versa. Moreover, the requirement of new technology will stimulate the demand of investment, therefore, raise the real interest rate. A government budget deficit will dramatically reduce the national saving supply, hence push the real interest rate as well. This is the crowding out effect which harm the economy’s propensity to invest on new capital goods, which will benefit the economy in the future.

Chapter 5

Introduced in the microeconomics before, a firm will keep hiring workers as long as the value of marginal production is at least great as the wage. However, the real wage which related to the real purchase power from the income should be used to define the demand/supply relation of employment. Same as other demand curves, the firm will hire more workers at lower costs, in other words, less wages, so the cure is downward sloping. The change in VMP will shift the demand curve, which can be based on change in the relative price on the product or the change in the productivity of workers. On the other hand, the supply of labor is the number of people who are willing to work at each real wage level, thereby the size of the working-age population has the effect on the labor supply. Modern industrial countries like Australia have lots of regulations and control over wages, so the firm use the real unit labor costs to match the cost variation with the productivity. If the real unit labor cost is increasing over a period, then it is likely the real average labor cost has increased with a larger scale than the average labor productivity. Then the firm will lay off the labor hired. On the contrary, the firm will keep hiring new labors. The globalization has become the trend of development in the past decade. When the economy opens to the world for trade, it is very common to see that importing industry to be hurt by the foreign imported products. Because the imported goods will generally have lower price or higher quality. As a consequence, the demand of labor in the importing industry will decline, due to the value of marginal product has dropped. The reduced real wage and employment quantities will drive workers mobilized to the exporting industry market, which benefited by the globalization. This market will offer more place and higher wages, since the firms are earning more than before. During this worker mobility process, government may provide transition aid such as training to workers. As we know, the technology change will boost the productivity of workers, but it may vary the real wage differently on different workers. For instance, the skill-biased technological effects the marginal products of higher-skilled workers differently from lower-skilled workers. Thus the firm will seek more higher-skilled workers and fewer lower-skilled workers. In addition, an accountant may lose his job, due to the fast development of accounting software such as MYOB, Quicken simply reduce the quantity needed for perform the task. By studying the labor market, we observe the quantity of labor demanded can be less than the labor supplied. Therefore, there are people experiencing unemployment. The unemployment is considered to be a cost for the society, due to the workforce is not fully utilized. It also creates physiological and social costs that make the society unstable. The unemployment has been divided into for types: firstly, there are always a natural unemployment rate, which is independent of the economy’s performance. In addition, the frictional unemployment is less concerned because is the short-term situation caused by the workers searching for the right job. Besides the last two types of unemployment, the structural unemployment is the true burden over the government. People are unemployed due to the lack of skills of aspirations leads this long-term and chronic unemployment. Furthermore, the cyclical unemployment occurs when the economy is experiencing contraction. As an economist, the aim to fully utilize the workforce to product the maximum output, but there are other impediments to full employment. To illustrate, the minimum wage laws, labor unions, and other employee beneficiary regulations that increase the unit labor cost will prevent to an employer to hire the social optimal level of labors.

Chapter 6

As we discussed before, the short-term business cycle of the economy shows the tend of experiencing expansion and contraction repeatedly. We called the beginning of the contraction as the peak, it is the high pint of economic activity prior to the downturn. The low point of economic activity prior to a recovery is the through. The economic fluctuation is the most important indicator for macroeconomics, since it related to the unemployment and output produced. However, it is extremely hard to predict, so normally we use unemployment rate as the key indicator for short-term economy fluctuations. The economy's potential output is an estimated output which assumes the resources such as labor and capital are utilized at the normal rate. This can be different to the actual economy output, depends on the economy is overusing or using insufficiently with its resources.When the actual output is larger than the potential output, there is an expansionary gap, in contrast, there is a contractionary gap. Both expansionary and contractionary gap require the government’s attention, because the contrationary gap indicates the economy is not fully utilizing its resources to reach potential output. And under expansionary gap, firm faces the demand for their products that significantly excess their normal capacity, which will raise the price and cause inflation. As explained prior, the cyclical unemployment occurs when there is contrationary gap, it is calculated with the total unemployment less the natural rate of unemployment. Using OKUN’s law, we can define the relation ship between the cyclical unemployment rate and the economic fluctuation. Which the change in the output gap can be measured by a percentage of change in cyclical unemployment. Shows in the following function .