Professor Cotton

1
Economics 212Introduction to Macroeconomics

• Professor Cotton

2
What do economists study?

• Are NBA referees biased in favor of athletes of
  their own 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?
• Whats the best way to increase employment or
  fight a recession?

3
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

4
Most economics questions fit in 1 of 2 categories

• MICROeconomics

• MACROeconomics

• Individual behavior (e.g., firms, people,
  households)
• How many employees will GM lay off?
• What characteristics determine if Joe goes to
  college?
• Joes income or GM profit
• How much of the pie do you get?

• Aggregate or average 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?

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Macroeconomics

• Deals with the classic issues in economics
• Unemployment
• Inflation
• National Output National Income
• Population Growth
• Economic Growth
• Bond Prices
• Money Banking

6
Which questions are Macro?

• Are NBA referees biased in favor of athletes of
  their own 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?
• Whats the best way to increase employment or
  fight a recession?

7
Consider Econ if youre 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

8
About Me

• Prof. Christopher Cotton
• My research involves game theory and competitions
• Interest groups compete for policy reform
• Individuals compete for raises and promotions
• Im 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 conversation about the current state
  of the US economy

9
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

10
What you need

• Textbook Parkins Macroeconomics ninth edition
• Another book Wheelans Naked Economics
• Subscription to MyEconLab.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.

11
Topic 1 Basic Economic Principals

• Law of Diminishing Returns
• Production Possibilities Frontier
• Opportunity Costs
• Absolute Comparative Advantage
• Supply and Demand

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Factors of Production

• Factors of production are the inputs used to
  create outputs (goods and services) for
  consumption
• Land
• Labor
• Capital (produced means of production)
• Entrepreneurship

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

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

• ???

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

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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)

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

• ????

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

19
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

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

• ????

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

• lt

22
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.)

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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 101st worker is
  less than the benefit of adding the 100th worker.
  (Assuming the other factors of production are
  fixed.)

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Law of Diminishing Returns

• Graph

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A scary interpretation

• Thomas Malthus (1798) food production and
  population growth

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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

27
World Population graph it
Year Population
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 7 billion
Note that data and graph are from Wikipedias
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.
28
World Population graph it
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So, what happened?

• What didnt Malthus account for?
• Changes in technology
• What happened around the major kink in the graph?
• Mid-1700s Industrial Revolution
• Better access to food, medicine, shelter
• Better water supply, sewage

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



32
came with increases in technology



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came with increases in technology



34
came with increases in technology




35
came with increases in technology





36
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

37
Opportunity costs

• Definition The (value of the) next-best
  alternative we forgo, or give up, when choosing
  an action.
• Whats 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.

38
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
• Cant be outside of the PPF

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Opportunity Cost of

• Illustrated by movement along the PPF.
• Whats the opportunity cost of producing 1000
  tubs of butter?
• Whats the opportunity cost of making one more
  tub of butter?

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French Colony of Louisiana, 1750

• Youre 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?

41
Rainfall in Louisiana
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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?

43
What happens to the PPF when

• A fleet of ships land on the shore with 500 new
  farmers 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?

44
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)

45
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.

46
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.

47
Who has the absolute advantage?

• Jokes
• Bikes
• Physics
• Economics

• Lance Armstrong
• Jerry Seinfeld
• Albert Einstein
• Prof. Cotton

?
48
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.

49
Who has the comparative advantage?

• Jokes
• Bikes
• Physics
• Economics

• Lance Armstrong
• Jerry Seinfeld
• Albert Einstein
• Prof. Cotton

50
Examples Individuals

• Scotty and Iris can make both sweaters and beer
• 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?

Sweaters Beer
Scotty 1000 900
Iris 1300 1000
51
Examples Individuals

• Scotty and Iris can make both sweaters and beer
• 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

Sweaters Beer
Scotty 1000 900
Iris 1300 1000
52
Examples Individuals

• Scotty and Iris can make both sweaters and beer
• Graph the PPF for an economy made up of Scotty
  and Iris.

Sweaters Beer
Scotty 1000 900
Iris 1300 1000
53
Examples Countries

• The French and Irish can make both wine and beer
• 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?

Beer Wine
France 500 1000
Ireland 1000 100
54
Examples Countries

• The French and Irish can make both wine and beer
• 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

Beer Wine
France 500 1000
Ireland 1000 100
55
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 Aidans PPF
• Draw Sallys PPF

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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

57
Examples

• Abby, Bruce and Carlos can make cheese and bread
• 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

Cheese Bread
Abby 500 600
Bruce 200 700
Carlos 600 300
58
Examples

• Abby, Bruce and Carlos can make cheese and bread
• Who has the comparative advantage in Cheese?
• Abby v. Bruce? ? Abby
• Abby v. Carlos? ? Carlos
• Bruce v. Carlos? ? Carlos
• Carlos gt Abby gt Bruce

Cheese Bread
Abby 500 600
Bruce 200 700
Carlos 600 300
59
Examples

• Abby, Bruce and Carlos can make cheese and bread
• Graph the PPF for the economy with trade.

Cheese Bread
Abby 500 600
Bruce 200 700
Carlos 600 300
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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?

61
Next Concept Supply Demand
62
Auction for a Coke

• At 0.25, _____ people would like to buy 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
• At 3.75, _____ people would like to buy a Coke

63
Demand for Coke

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

64
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.

65
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.

66
Imagine if.
Each person on this side of the classroom has
been given one set of coasters each.
Each person on this side of the classroom hasnt.

67
Imagine if.
Each person on this side of the classroom has
been given one set of coasters each.
Each person on this side of the classroom hasnt.
(I like the other side better)
68
How much would you require to give up your
coasters?
69
How much would you be willing to spend to buy
some coasters?
70
Price Total of sellers 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 20 0
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Graph it.
72
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?

73
US Market for Bourbon

• What happens to the market for bourbon when
• the Jack Daniels 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

74
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?
• This is a price floor, resulting in a surplus

75
Details

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

76
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)

77
Substitutes and Complements

• What are some substitutes and complements of
• Pickup truck?
• Pen?
• Movie ticket?
• Orange?
• Bourbon?
• Cigarette?
• Gasoline?

78
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

79
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

80
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

81
Shifts in supply and demand

• Market for Coke
• Price of Pepsi increases (substitute)
• Price of pizza decreases (complement)
• New health reports show its 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

82
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

83
Labor Market

• Supply is made up of many individual workers
• Demand is from firms and organizations(counterint
  uitive?)
• Minimum wage laws