Unit 1: What is Macroeconomics?
Microeconomics studies exchanges among individual consumers and firms in the market to purchase goods and services. In contrast, macroeconomics focuses on exchanges across all of the markets within a country. We consider the interrelated actions of consumers, businesses, government agencies, financial intermediaries, and global trading partners as they exchange resources, goods, and services and facilitate currency and quantity flows. Microeconomics examines how to achieve profit maximization. Macroeconomics explores how to achieve overall economic stability and growth nationally.
Completing this unit should take you approximately 5 hours.
Upon successful completion of this unit, you will be able to:
- define economics and explain its importance;
- compare microeconomics and macroeconomics;
- describe how theories, models, and tools are used to perform economic analysis;
- analyze resource allocation based on scarcity, opportunity cost, and making decisions at the margin;
- apply the production possibilities curve to identify production combinations that are efficient, inefficient, and unattainable;
- define demand, supply, and market equilibrium;
- explain how changes in demand and supply affect the demand and supply curves and alter the equilibrium prices and quantities;
- describe the circular flow model, identifying linkages between the markets for goods and resources and exchanges between businesses and households; and
- analyze price controls and how they create product shortages or market surpluses.
1.1: The Economic Way of Thinking
First, we must recognize that resources, such as our time and money, are limited while our wants are unlimited. Economics explores how to satisfy our unlimited wants in light of these limited resources. Economics is the study of choice. An example is the president of a county who must choose how to spend limited funds on domestic issues versus giving foreign aid. Another example is a college student who must choose how to allocate their limited time for studying, working, and socializing. Opportunity cost is the value of the next best alternative action someone could have taken if they had not chosen a particular action. For example, a college student with an 8:00 am class may prefer to sleep in, but wouldn't we all choose to sleep in rather than attend class if we disregard the value of getting an education? We should be thinking at the margin – on exam day, one hour of class is far more important than one additional hour of sleep, especially if you have already slept for eight hours.
Read this text on why we should study economics. Pay attention to the relationship between production and division of labor. In many ways, economics is the study of choice. Scarcity refers to our demand for goods, services, and resources that exceeds what is available. What is the economic significance of scarcity?
Read this text comparing the micro and macroeconomics perspectives. What are the key factors and components of monetary policy and fiscal policy? Monetary policy is concerned with managing interest rates and the total supply of money in circulation. Central banks, such as the U.S. Federal Reserve, manage monetary policy. Fiscal policy is a collective term for the government's taxing and spending actions that directly impact the federal budget – causing a budget surplus, balanced budget, or deficit.
Read this text on interpreting a circular flow diagram. It explains the basis of important economic theories and models we will explore in more detail. It is important to understand that a theory simply states how two variables are interlinked. For example, I believe the more you study, the higher your GPA. The majority of data demonstrates a theory. Pay attention to the goods and services market and the labor market.
Read this text, which contrasts traditional, command, and market economies. What is gross domestic product (GDP)? How has the rise of globalization affected our economy? Throughout this course, we will explore the economic importance of these key macroeconomic concepts in further detail.
Watch these videos on the tools macroeconomists use to measure the status and trends in the economy. McGlasson explains how economists test hypotheses, develop economic theories, and use models in their analysis.
1.2: Scarcity and Production Choices
The fundamental economic project all societies and people face is the scarcity of resources. Every economy faces tradeoffs that apply to every individual, household, and economic organization. Remember that one good can only be produced by diverting resources from other goods – by producing less of them. Just as people choose how to allocate leisure versus work hours, countries choose how much to produce of various goods.
Watch these videos on resources, scarcity, and how we make choices when resources are scarce. We know that satisfying unlimited wants is impossible. Finding ways to use scarce resources to optimize society's well-being is one of the most important tasks of the science of economics.
Take some time to review this text, which explains how to calculate and graph budget constraints. Opportunity cost is the value of something you gave up to get what you want – the opportunity lost. In short, opportunity cost is the value of the next best alternative. Be sure you understand the concepts of opportunity sets and opportunity costs. Can you think of an example of a scenario that shows the law of diminishing marginal utility? How do marginal analysis and utility influence our choices? The law of diminishing marginal utility means that the more of an item you use or consume, the less satisfaction you get from each additional unit consumed or used. An example is consuming your favorite food, pizza, for the fifth night in a row.
1.3: The Production Possibilities Curve
The production possibility curve is a graphical representation that shows all of the possible options of output for two goods that can be produced using all factors of production, where the given resources are fully and efficiently used. A production possibilities frontier illustrates several economic concepts – allocative efficiency, economies of scale, opportunity cost, productive efficiency, and scarcity of resources.
Study this text on how to interpret graphs of the production possibilities frontier. What is the difference between a budget constraint and a production possibilities frontier? What is the relationship between a production possibilities frontier and the law of diminishing returns? What is the difference between productive and allocative efficiency? A country has a comparative advantage over another when it can produce a certain good at a lower opportunity cost. Can you think of an example?
Let's take a moment to analyze arguments against economic approaches to decision-making. This text shows how to interpret a tradeoff diagram. What are normative and positive statements?
Watch these videos to learn how a production possibilities curve is constructed. Pay attention to how changes in resources affect the PPC curve. Some combinations of products may be unattainable, given the limited existing resources, whereas other combinations of products may be inefficient as they leave some resources unused. The PPC curve helps find levels of production that use all of the available resources in the economy.
1.4: Opportunity Cost
Opportunity cost measures what we give up or forfeit when we choose one thing over another. Opportunity cost measures the value of the alternative we did not choose. This loss may be monetary, time (productivity), or energy (efficiency). When a company allocates resources to one activity or area, it decides not to pursue a competing activity. Opportunity cost is especially important for smaller businesses with more limited resources and funds. Managers weigh which decision will provide the greatest return on their investments with the least risk. Opportunity cost is a concept that is especially important in microeconomics.
Watch this video for a graphical representation of opportunity cost on the production possibilities curve. As the video shows, a point inside the curve shows that resources are not being used efficiently. These are points of inefficiency. Any point outside the curve represents a point beyond our grasp but could be attained with more resources and technology.
Any point on the production possibilities curve is a point of efficiency; any movement up or down the curve represents changes in production. As you obtain more of one good, you have to give more of the other good, which is why opportunity cost is represented by moving along the curve itself.
1.5: Demand, Supply, and Market Equilibrium
The laws of supply and demand are basic to economics. How these forces interact determines the prices of goods when we shop, the profits a company makes, and how one person becomes rich while another remains poor. We see the interplay of supply and demand everywhere. The market brings buyers and sellers together to trade physically and virtually. Demand, supply, and price are the bedrock of market economics.
Demand predicts how many goods or services we buy from a vendor at a particular price. The higher the price, the less we want to buy. Supply is how many goods or services a seller will part with for a certain price. The lower the price, the fewer goods the vendor wants to sell because making them does cost time and money. Prices signal whether the supply or demand for a product is rising or falling.
Read this text on the basics of demand and supply. You should be able to list the factors that shift the demand curve and those that shift the supply curve. Be sure to study the difference between demand and quantity demanded (and between supply and quantity supplied).
Watch these videos for additional perspectives on demand, the Law of Demand, and the variables that shift the demand curve. Be sure you understand the difference between demand and quantity demanded. Knowing this difference will help you determine if a change in a specific variable causes a movement along the demand curve or a shift of the curve.
Watch these videos to learn about supply, the Law of Supply, and the variables that shift the supply curve. Like our discussion on the difference between demand and quantity demanded, we must distinguish between supply and quantity supplied. As you will see, a change in quantity supplied causes a movement along the supply curve, whereas a change in supply is a shift of the entire curve.
Watch this video to put demand and supply on the same graph and determine equilibrium quantity and price. Learn how changes on the demand and supply side of the market affect the equilibrium outcome.
Read this text, which explains that prices are rarely at equilibrium. For example, the price of gas rises and falls throughout the year depending on whether their production supplies are limited. The price for roses before Valentine's Day leaps due to the rising demand to buy flowers for the holiday. The price plummets on February 15th when the demand has decreased. The main idea of this text is that something is perfectly priced when supply equals demand. But this rarely occurs because relevant factors are constantly changing.
1.6: Market Equilibrium
Equilibrium describes the situation where the quantity demanded equals the quantity supplied. The equilibrium price is the price or dollar amount (if you are trading in U.S. dollars) where these two lines intersect. The buyer is willing to pay the price, and the seller is willing to sell. The equilibrium quantity is the quantity of goods or services where these two lines intersect. The seller is willing to provide the number of goods. At equilibrium, there is no economic pressure from surpluses or shortages that would cause price or quantity to change.
Read this section to see how demand can increase by shifting to the right when income rises, when the price of complementary goods falls, when tastes or preferences change to favor a particular good or service, and when the number of people or population rises. Conversely, demand can fall or shift to the left when income falls, when the price of complementary goods rises, when tastes or preferences change away from a particular good or service, and when the number of people or population falls.
Watch this lecture on the circular flow of income and expenditures in a closed economy. Note that goods and services are exchanged in product markets, and factors of production are exchanged in factor markets.
1.7: Price Ceilings and Price Floors
Government price controls (price floors and ceilings) alter the market outcome if price controls are set at levels that make them effective. Simply put, price controls limit the most you can pay or charge for something. Price ceilings set a maximum cost, keeping prices from rising above a certain level. A price floor establishes a minimum cost – a bottom-line benchmark that keeps prices from falling below a certain level.
Read this text on price controls, price ceilings, and price floors.
The video presents real-world examples of price floors and ceilings.
Read this text to learn about consumer, producer, and social surplus. Why are price floors and ceilings inefficient in terms of the market economy? How do politicians use them as a social adjustment mechanism?
1.8: Labor and Financial Markets
The theories of demand and supply apply to labor markets, including job seekers or employees who supply their labor and firms, corporations, and other employers that hire job candidates to run their businesses. Like the market for goods, the labor market refers to the supply and demand for labor – employees provide the supply, and employers provide the demand. The law of demand applies in labor markets in the following way: a higher salary or wage represents a higher price in the labor market and leads to a decrease in the quantity of labor demanded by employers. In comparison, a lower salary or wage leads to an increase in the quantity of labor demanded.
For example, let's say a grocery store promises to pay cashiers $100 an hour if they apply during the next 24 hours. Workers from around the city will line up to get a job there. The store will easily be able to fill all of its position openings, and its demand for labor will decrease (a decrease in the quantity of labor demanded by the employer).
Another common example of demand and supply is the price fluctuation of securities. Stock market analysts study the demand and supply of stocks to predict future price trends. Market prices depend on the interaction of demand and supply. An equilibrium price represents a balance of demand and supply factors. Prices tend to return to this equilibrium unless some characteristics of demand or supply change.
Read this text, which applies what we have learned about demand and supply to the labor market, including a discussion of the price of labor (wages or salaries), shifts in labor demand and supply, and price floors in the labor market (living and minimum wages).
Read this text on how demand and supply work in financial markets. How does the interest rate affect supply and demand? The United States borrows money from foreign investors from other countries to finance its activities. How does the U.S. national debt affect domestic financial markets? What is the role of price ceilings and usury laws in the United States?
This text demonstrates the efficiency of the market system in disseminating information about relative scarcities of goods, services, labor, and financial capital.
Unit 1 Assessment
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Take this assessment to see how well you understood this unit.
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