Unit 1 (Macro)

ECO 2013 / MACRO
PROF. H.J. VAN BOVEN

Chapter 1: Limits, Alternatives, and Choices (11 pages)
I.
II.
Economics is a social science

A.
Examines how individuals, institutions, and society make optimal (best) choices under conditions
of scarcity.
B.
Examines the efficient use of limited resources to achieve the maximum satisfaction of our wants.
C.
Human action is conscious or purposeful behavior meaning that people make decisions facing
constraints with some desired outcome in mind.
Economic way of thinking
A.
Scarcity
Purposeful behavior
Benefit cost analysis
Efficiency
Visual representation of scarcity

Unlimited wants
>
Limited output produced using factors of production

Output is limited because ______________________
Big circle
>
Small circle
Efficiency is shown as ____________________

B.
Scarcity forces people to make constrained optimization decisions.

1.
Cant have it all. According to Mick Jagger, You cant always get what you want.
2.
There is no such thing as a free lunch
3.
All decisions involve tradeoffs: To obtain more of one thing, society or individuals must
forego the opportunity of getting the next best thing
4.
Opportunity cost of an activity refers to ____________________
2
C.
III.
Decision making uses marginal analysis, comparing the marginal benefit to its marginal cost
1.
Marginal benefit (MB) refers to the additional benefit of a specific activity.
2.
Marginal cost (MC) refers to the additional cost, opportunity cost, of a specific activity.
3.
If the MB (activity X) exceeds the MC (activity X),
then ___________________
If the MB (activity X) is less than the MC (activity X),
then ___________________
If the MB (activity X) equals the MC (activity X),
then the optimal has been

achieved
Theories, principles, and models

A.
Economics uses the scientific method

1.
Discover systematic patterns in reality in order to establish cause-and-effect

relationships, a.k.a. principles, models, or laws
2.
Facts (data)
3.
Decisions and economic policies should be based on economic principles to resolve

specific economic problems.
Hypothesis (to be tested)
Principle, model, law
B.
Abstractions ---- principles, models, laws, theories, (maps) ---- are simplifications of reality.
C.
Ceteris paribus means variables other than those being considered are assumed to not change.
Purpose of the ceteris paribus assumption is that it allows us to examine a functional
relationship between a dependent variable (effect) and an independent variable (cause)
without the intrusion of other relevant variables.
D.
IV.
Problems in applying the scientific method in economics

1.
Economic conditions and institutions are constantly changing.
2.
Controlled laboratory experiments are difficult to do or impossible.
3.
Ceteris paribus is only an assumption.
The beach versus the sand, rocks, and shells

A.
Macroeconomics examines the performance or behavior of the entire economy or its major
aggregates.
B.
Microeconomics examines the behavior of individual buyers, workers, and business firms in
specific product and resource markets.
3
C.
All fields of study have two categories of statements

1.
2.
V.
Positive statements or positive economics

a.
Objective. Fact. What is.
b.
Functional cause-and-effect relationships.
c.
Is not necessarily true, but can be proven to be either true or false.
Normative statements or normative economics

a.
Subjective. Opinion. What ought to be.
b.
Value judgments.
c.
Cannot be proven to be true or false by reference to the facts.
Societys economizing problem or problem of scarcity

A.
Economic wants exceed the productive capacity of an economys limited resources
B.
Scarcity is a problem faced by all economic systems (e.g., capitalism, socialism, communism)
C.
Scarcity can never be eliminated
D.
Four general categories of economic resources, factors of production, or inputs

1.
Land (N) refers to gifts of nature (natural resources) used in the production process
2.
Capital (K) refers to:
a.
Investment means:
b.
Financial capital ---- money, stocks, and bonds ---- are not capital because:
3.
Labor (L) refers to the physical actions and mental activities that people contribute to the
production of goods and services.
4.
Entrepreneurial ability (E) refers to the entrepreneur or innovator
4
VI.
The production possibilities model (page 13 textbook)

A.
Visual representation of scarcity, different levels of production, opportunity cost, unsatisfied wants
Given existing technology and the
current supply of inputs, it is
impossible for an economy to produce
outside its PPF
Unattainable today
Possible to produce a combination
of output inside the PPF
Attainable, but inefficient
________________________________________________________________________________
The ceteris paribus assumptions for a given PPF:

1.
The available supplies and quality of the factors of production are currently fixed.
Land (N), labor (L), capital (K), entrepreneurial ability (E)
2.
Technology and thus productivity are currently fixed.
B.
Production possibilities frontier shows the ___________________ combinations of output that

can be produced when the economy uses its limited resources efficiently.
C.
To achieve efficiency or doing the best with what we have requires ____________________
of available resources.
5
D.
Tradeoffs, opportunity costs, no free lunch

A fully employed economy must sacrifice one good to get more of another good
E.
The production possibilities curve is bowed out from (concave to) the origin because of the
law of increasing opportunity cost.
The economic rationale for the law of increasing cost is:
F.
Using marginal analysis to achieve the optimal (best) level of output or the best point on the PPF.
1.
Resources are allocated efficiently or allocative efficiency is achieved when:

a. (using an equation)
b. (verbally)
2.
Visual representation allocative efficiency
6
VII.
The production possibilities model as it relates to some key macroeconomic issues

A.
B.
Unemployment
1.
If the economys level of output is on the PPF, then resources are fully employed
2.
If the economys level of output is inside the PPF, then resources are unemployed
or underutilized
Economic growth
1.
Refers to the ability of an economy to bake a larger economic pie or produce a

larger potential output
2.
Illustrated by the economys PPF shifting outward.
3.
Sources of economic growth

a.
Increase in the quantity and quality of inputs (N, L, K, E).
b.
Advances in technology and thus increases in labor productivity.
C.
Economic decline
D.
Present choices and future possibilities

1.
What is the benefit of shifting resources from the production of consumer goods to
the production of capital goods?
2.
What is the opportunity cost of shifting resources from the production of consumer
goods to the production of capital goods?
3.
Visual representation
7
VIII.
Critical thinking applied learning exercises

A.
Given the change in economic circumstance, ceteris paribus, indicate whether the PPF
shifts outward, shifts inward, or does not shift. Be able to explain why.
1.
__________
Advances in computer technology increase labor productivity
2.
__________
Increase in the number of women in the labor force
3.
__________
Elimination of discrimination
4.
__________
Emigration of workers from a nation
5.
__________
Hurricane destroys production facilities and infrastructure
6.
__________
Utilizing previously unemployed labor resources (VIII.B.2 is similar)
7.
__________
Government establishes and enforces well-defined property rights
8.
__________
Government builds an interstate highway system
9.
__________
Government tax incentives encourage firms to increase investment
10.
__________
Government policies discourage entrepreneurial efforts
11.
__________
Increase in international specialization and trade
12.
__________
Increase in stock market prices
13.
__________
Federal Reserve increases the money supply
14.
__________
Prices of consumer goods and services increase substantially
15.
__________
Substantial increase in consumer wants
8
IX.

Draw a production possibilities graph to indicate how each of the following changes in economic
circumstance will affect a nation. Label the axes. Explain your answer.
1.
The federal government decides to allocate more resources to national defense.

This example illustrates tradeoffs and opportunity cost.
2.
The unemployment rate declines from 10% to 5%.

Labor force (L) = Unemployed + Employed (chapter 9)
This example illustrates the business cycle (chapter 9)
3.
Technological advance in the production of books, but not in the production of beer.
This example illustrates that technological advance leading to economic growth
does not necessarily mean proportionate increases in a nations capacity to produce
all its products.
4.
Standardized examination scores (e.g., SAT scores) decline and grade inflation.
This example may illustrate economic decline, ceteris paribus
9
X.
Pitfalls to objective economic reasoning (Last Word section)

A.
Biases, preconceptions, or prejudices.
B.
Loaded terminology frequently used by the news media
C.
Errors in reasoning or logic

1.
2.
XI.
Fallacy of composition
a.
Assumes what is true for the individual must necessarily be true for the group.
b.
Examples:
False-cause fallacy (post hoc, ergo propter hoc fallacy)

a.
Assumes that because one event (B) follows another (A) it must be the result of the
first (A). Do not confuse correlation with causation.
b.
Examples:
Chapter 1 Appendix: Graphs and their meaning

A.
Three types of relationships between two variables

1.
Direct (positive) relationship occurs when the two variables move in the ____________
direction.
2.
Inverse (negative) relationship occurs when the two variable move in the ____________
direction.
3.
No relationship, variables are unrelated or independent of one another.
B.
If a variable that was assumed constant (ceteris paribus) changes, then the curve shifts
or changes location.
C.
Slope of a line measures the amount by which one variable changes as the other changes.
10
XII.
Self-Assessment Diagnostic (chapter 1)

1.
T F
Economics is primarily concerned with determining the most equitable distribution

of societys income.
2.
T F
An economic model is unrealistic and therefore of no practical significance.
3.
T F
Economic models are limited to variables that are directly related to one another.
4.
T F
Scarcity arises when people find themselves living in poverty.
5.
T F
Scarcity arises when there is never enough of anything.
6.
T F
Costs exist because resources are limited and have alternative uses.
7.
T F
No free lunch means that we must pay money for everything we get.
8.
When the government chooses to build more roads these resources are no longer available
for public education. This dilemma illustrates the concept of _______________________.
9.
An economic explanation for why most college-aged movies stars do not attend college is
________________________________________________________________________.
10.
T F
From an economic perspective, when a student decides to attend another year of

college the student has concluded that the marginal benefits of attending college
has increased that year.
11.
T F
According to marginal analysis a decision maker takes an action if the marginal

benefit of the action is positive.
12.
T F
The process of accumulating common stocks and bonds is known as investment.
13.
T F
An unemployed worker is a factor of production.
14.
T F
The production possibilities frontier (PPF) is downward sloping because of scarcity.
15.
T F
The PPF bows outward from the origin because opportunity costs increase as the
production of a good increases.
16.
T F
Economic efficiency means that an economy is producing the maximum output

from its available resources.
17.
T F
If an economy is operating efficiently, it is not possible to increase production of

any good.
18.
T F
For an economy to reach its maximum output, an economy must eliminate scarcity.
19.
T F
To realize an efficient allocation of resources an economy must achieve an

equitable distribution of income.
S.A.D (chapter 1)
11
20.
T F
Allocative efficiency arises when the optimal amount of those goods and services
most highly valued by society are produced.
21.
T F
Resources are being efficiently allocated to a product when the marginal benefit
(MB) of the product equals its marginal cost (MC).
22.
T F
If the marginal benefit (MB) of an activity exceeds its marginal cost (MC),
then society is under-allocating resources to this activity or producing too little.
23.
When the marginal cost (MC) of an activity exceeds its marginal benefit (MB), then
society is _________________________ resources to this activity or producing too much,
there is too much of a good thing.
24.
T F
If an economy is experiencing high unemployment its level of output is inside its

PPF (production possibilities frontier).
25.
T F
The effect of reducing high unemployment will be to shift the economys PPF outward.
26.
T F
Economic growth is represented by a movement from a point inside the PPF to a

point on the curve.
27.
The opportunity cost of economic growth is the current ___________________________

that must be forgone.
28.
T F
Given a substantial expansion of societys wants the economy can produce

at a point outside its production possibilities frontier.
29.
T F
If we say that two variables are directly related, this means that an increase
in one variable is associated with an increase in the other variable.
30.
Macroeconomics rocks!
1. F
2. F
3. F
4. F
5. F
6. T
7. F
8. tradeoffs, opportunity cost
9. MB(college) < MC(college), opportunity cost too high
10. F
11. F
12. F
13. T
14. T
15. T
16. T
17. F
18. F
19. F
20. T
21. T
22. T
23. over-allocating
24. T
25. F
26. F
27. consumption
28. F
29. T
30. :)
ECO.2013 / MACRO

Chapter 2: The Market System and the Circular Flow (6 pages)
I.
Economic system
A.
A set of institutional arrangements and a coordinating mechanism used to respond to

the condition of scarcity or the economizing problem
B.
Examples of an economic system include capitalism, socialism, and communism
C.
Economic System (ism)
Rules of the Game
Fundamental Questions
Why do rules (laws) exist?
Scarcity forces people to

answer these questions in order
to survive
1.
Institutional arrangements
a.
b.
2.
1.
Output question
2.
Input question
3.
Distribution question
4.
Change question
5.
Progress question
Ownership of resources
Legal structure
Methods for coordinating economic activity

a.
b.
c.
Social process (dont rock the boat)

Political process (force)
i.
Collective-voting method
ii.
Command method
Market process (voluntary)
All economic systems face

scarcity and must address these
five questions
2
II.
III.
Capitalism or the market system

A.
An economic system that gives private individuals and institutions the right to own the
resources (land, labor, capital, E) used in production.
B.
Decision-making process used to respond to the Fundamental Questions is primarily the

market process.
Characteristics of capitalism
A.
Private property rights
B.
Economic freedom; a few legal limitations to economic freedom may exist
C.
1.
Freedom of enterprise
2.
Freedom of choice
Self-interest is the motivating force

1.
Self-love (Adam Smith)

Concerned with status which involves vanity, veneration, and virtue
2.
D.
E.
Gives direction, order, and consistency to what might otherwise be chaos
Competition or competitive markets (not monopolistic markets)

1.
Basic regulatory or controlling mechanism of capitalism
2.
Independently acting economic agents pursuing their self-interest
3.
Freedom of buyers and sellers to enter or leave a market
4.
Diffusion of economic power; no economic unit has any market power
Markets and prices

1.
The organizing or coordinating mechanism
2.
Market price is discovered through the voluntary interaction of buyers and sellers
in the product and resource markets.
3.
Market system is a gigantic communications system where price is a signal that

serves as the coordinating or rationing mechanism
3
F.
Limited government
1.
Providing the legal structure

Establish and enforce the legal rules of the game to protect private property
rights and provide the services needed for a market economy to operate effectively.
2.
Maintain competition
Restrict anticompetitive market activity because competition promotes efficiency
3.
Reallocate resources
Correct market failures (chapter 4)
4.
IV.
a.
Public goods
b.
Externalities
Government failure (chapter 5)
Some characteristics common to all economic systems

A.
Use of technology and capital goods
B.
Specialization
C.
1.
Self-sufficiency breeds inefficiency
2.
Human specialization or division of labor
3.
Geographic specialization
4.
The economic benefit of specialization

a.
Promotes the efficient use of societys or the worlds limited resources
b.
Increases regional or world total output
M-o-n-e-y
4
V.
The market system or capitalism answering the Fundamental Questions

A.
Output question.
1.
What goods and services will be produced?
Guiding function of prices and profits

From societys point of view, the function of economic profits and losses
is to signal that resources should be reallocated from less desired uses to
more desired uses.
B.
C.
D.
2.
Consumer sovereignty
3.
Market system promotes allocative efficiency (chapter 1)
Input question.
How will the goods and services be produced?
1.
Profit maximization implies cost minimization
2.
Productive efficiency occurs when firms use the best technology and right mix of
productive resources to achieve minimum production costs (least-costly method).
3.
Market system promotes productive efficiency
Distribution question.
Who will get the goods and services?
1.
Depends on ones income.
2.
Money income depends on:

a.
The quantities of human and property resources supplied
b.
The prices of those resources in the resource market
3.
Market justice: To each according to what he/she creates.
4.
Is the market system efficient?
Change Question.
Is the market system fair?
How will the system accommodate change?
1.
Consumer preferences, technology, supplies of resources change over time; prices and
profits are signals that convey this information. Guiding function of prices and profits
2.
Market system is a highly effective communications system
5
E.
VI.
Progress question.
How will the system promote progress?
1.
Higher standard of living as measured by increasing income (output) per person
2.
Technological advance promotes capital accumulation, economics growth, and

creative destruction
Competition and the Invisible Hand

A.
Adam Smith, The Wealth of Nations, 1776
B.
Invisible hand metaphor:
Resource suppliers and firms, seeking to further their own

self-interest within a competitive market system, will
automatically promote the public interest (as if guided by an
invisible hand)
Self-interest or private interest means maximizing utility, income, and profits.

Public interest or social interest means promoting the efficient allocation of resources.
C.
Virtues of the market system

1.
Promotes the efficient allocation of limited resources

Getting the maximum output from societys limited resources
VII.
VIII.
2.
Incentive structure (self-interest) promotes skill acquisition, hard work, investment,

risk taking, and innovation
3.
Emphasizes and promotes economic freedom
The demise of the command systems (Soviet Union, eastern European nations, China)
A.
The coordination problem of central planning
B.
The incentive problem of central planning
The circular-flow model

A.
Visual representation of the flows (real flow and money flow) between the sectors
B.
Households and businesses (sole proprietorships, partnerships, corporations)
C.
Resource market and product market
6
IX.
Think about it
The basic economic problems of life are what to produce, how to produce it, and how the fruits of
production are distributed among the members of society. The survival of all life forms depends on the
ability, as member of a collective (ants, fish, elephants, humans, etc.), to solve these problems or answer
these Fundamental Questions. Except for some advanced human societies, no other life forms interact via
contracts, money, and markets, to solve the basic economic problems of survival.
Only in relatively recent times (the 18th and 19th centuries) and only in some highly developed economic
systems have humans created and utilized the market system as the primary tool for organizing production
and exchange transactions. The standard of living of humans that have not developed market institutions
are, like lower life forms, closely tied to their natural environment by Malthusian principles. When
Nature is bountiful and generous, they thrive. When the conditions of supply provided by Mother Nature
turns frugal and the environment turns bleak, they die. This is not necessarily true for humans living in an
entrepreneurial market system. The residents of market economies gained the means to thrive with everrising standards of living even during periods of harsh natural supply conditions.
Two cheers for the market system, but not three. Why not three cheers?
X.

1.
T F
A characteristic of capitalism is central planning.
2.
T F
A characteristic of capitalism is the private ownership of the means of production.
3.
T F
Consumers express self-interest when they seek the lowest price for a product.
4.
T F
Workers typically express their self-interest by seeking jobs with the best combination of
wages and benefits.
5.
T F
Producers are kings in a market economy because they determine what is produced.
6.
T F
The maximization of profit or the minimization of losses is the primary factor affecting the
economic decisions of entrepreneurs.
7.
T F
If a particular industry is earning economic profits we would expect firms to enter

the industry.
8.
T F
The invisible hand refers to the unseen exploitation of consumers and workers by
powerful multinational corporations.
9.
T F
The invisible hand refers to the federal government taxing the rich and making
transfer payments to the poor to ensure a more equitable distribution of income.
10.
T F
A virtue of the market system is that it promotes an equal distribution of income.
11.
T F
A virtue of the market system is that it eliminates pollution.
1. F
2. T
3. T
4. T
5. F
6. T
7. T
8. F
9. F
10. F
11. F
ECO 2013 / MACRO

Chapter 3: Demand, Supply, and Market Equilibrium (10 pages)
I.
Alfred Marshall in his Principles of Economics (1890) was the first economist to bring the two opposing
forces of supply (sellers) and demand (buyers) together into a formal model.
A.
Market:
B.
Demand:
Supply:
Relationship between product price and

the quantity buyers are _____________
to buy at each price which might exist
during a given time period.
Relationship between product price and

the quantity sellers are willing and able
to sell at each price which might exist
during a given period of time.
Law of demand:
Law of supply:
Price and the _____________________

are inversely (or negatively) related,
assuming all other influences on buyers
planned purchases remain the same.
Price and the quantity supplied

are directly (or positively) related,
ceteris paribus.
Interpreting the demand curve
Interpreting the supply curve
For a given quantity, the demand curve

shows the maximum price buyers are
willing and able to pay for that quantity.
For a given quantity, the supply curve

shows the minimum price that sellers are
willing to accept for that quantity.
For a given price, the demand curve

shows the quantity buyers are willing
and able to buy at that price.
For a given price, the supply curve

shows the quantity sellers are willing
and able to sell at that price.
Why is the demand curve downward

sloping?
Why is the supply curve upward sloping?
A higher price will reduce the quantity

demanded because of the:
A higher price will increase the quantity

supplied because of:
1.
Substitution effect
1.
2.
Income effect
C.
D.
E.
Diminishing returns to labor causing

increasing marginal cost.
2
II.
Factors that affect supply and demand

A.
[Mechanics of the supply and demand model ]
Determinants of demand
Determinants of supply
Factors that change demand;

demand shifters
Factors that change supply;

supply shifters
1. Income of buyers
1. Costs of production
a.
b.
Normal good:
a.
Prices of the factors of production
Income and demand are

directly related, ceteris paribus.
b.
Business taxes (statutory incidence

falls on the seller)
c.
Business subsidies received
Inferior good:
Income and demand are
inversely related, ceteris paribus.
2. Prices of other goods purchased

by the buyer
a.
b.
c.
Substitute goods:
2. Prices of other goods produced

by the seller
a.
Substitutes in production:
Goods used in place of each other.
Goods produced in place of each other
The price of good W and the demand

for good X are directly related,
ceteris paribus.
The price of good R and the supply

of good S are inversely related,
ceteris paribus.
Complementary goods:
b.
Complements in production:
Goods used together.
Goods produced together.
The price of good Y and the demand

for good Z are inversely related,
ceteris paribus.
The price of good T and the supply

of good U are directly related,
ceteris paribus.
Independent goods:
Goods that are not related
3. Preferences of buyers
3. New technologies and productivity
4. Expectations of buyers
4. Expectations of sellers
5. Number of buyers
5. Number of sellers
3
III.
IV.
Markets and prices are the organizing mechanism that coordinates the decisions of buyers and sellers.
A.
The most important variable that influences a buyers decision to buy is ______________.
B.
The most important variable that influences a sellers decision to sell is _______________.
C.
In a competitive market the rationing mechanism that brings the opposing forces of
supply and demand into balance is ____________________.
D.
The market for a product is in equilibrium when there is no tendency for _____________
to change.
E.
In a system of impersonal commercial interaction price serves as a signal in a market economy to

coordinate the diverse wants and abilities of the economys participants. Coordinating and
guiding functions (chapter 2) and rationing functions of price (chapter 3)
Market equilibrium
A.
Situation in which the opposing forces of supply and demand balance each other
B.
Equilibrium
Visual representation of equilibrium
1.
2.
3.
4.
5.
C.
T F
A market is in equilibrium when a fair price is established and the quantity

exchanged is equitable.
1 4 are ___________________ statements and 5 is a ___________________ statement.
4
V.
VI.
Disequilibrium
A.
When a market is not in equilibrium it is always possible to identify mutually beneficial

trades between buyers and sellers.
B.
Shortage or excess demand occurs

when the QD > QS
Surplus or excess supply occurs

when the QS > QD
C.
Visual representation of a shortage
Visual representation of a surplus
D.
What causes a shortage?
What causes a surplus?
E.
How does the market automatically

eliminate a shortage?
How does the market automatically

eliminate a surplus?
Efficiency
A.
The rationing function of price refers to the ability of the competitive forces of supply
and demand to establish a price at which selling and buying decisions are consistent.,
i.e., where QD = QS.
B.
Given certain conditions, the market system promotes an efficient allocation of resources.
C.
1.
Productive efficiency means producing goods using the latest technology and the leastcostly production methods.
2.
Allocative efficiency means producing the particular mix of goods most highly valued by
society.
Visual representation of efficiency using demand (MB) and supply (MC)
5
VII.
Changes in supply, demand, and equilibrium

A.
B.
[Mechanics of the model ]
When demand or supply changes follow the three-step process to predict what happens to
equilibrium P and Q
Step 1:
Draw the original market and label the price axis (P), the quantity axis (Q),
the supply curve (S), and the demand curve (D).
Step 2:
Based on the definitions and concepts on page 2 determine which curve

shifts. Draw the new demand or supply curve.
Step 3:
Draw the dashed reference lines then read the graph to see what happens to
equilibrium P and Q
Change in demand, holding supply constant

For the graphs, see Figure 3.7 (a) and (b) [textbook, p.66]
Increase in demand (shift right)
C.
Decrease in demand (shift left)
Change in supply, holding demand constant

For the graphs, see Figure 3.7 (c) and (d) [textbook, p.66]
Increase in supply (shift right)
D.
Decrease in supply (shift left)
Complex cases: Change in demand and a change in supply

When only one curve shifts both the new equilibrium P and Q will be predictable.
When both curves shift simultaneously either the new equilibrium P or new equilibrium Q will
be indeterminate. This indeterminateness disappears if one knows the relative size of the changes
in supply and demand.
See Table 3.3 [textbook, p.67]
6
VIII.
Critical thinking and scientific reasoning applied learning exercises

A.
In a competitive market, the forces of supply and demand (rationing function of price)
automatically move the market towards equilibrium price and quantity as if guided by an
invisible hand [Adam Smith, 1776, in chapter 2]
For the following exercises draw a visual representation of the supply and demand model to predict how a
change in economic circumstance, ceteris paribus, affects equilibrium P and Q. Follow the three-step
process!!!
B.
Event: An increase in the cost of building materials.

Predict what happens in the market for new homes.
P: _______________
Q: _______________
C.
Event: The price of new homes in Southwest Florida increase.

New homes and used (existing) homes are substitute goods.
Predict what happens in the used home market.
P: _______________
Q: _______________
D.
Event: A decrease in mortgage rates increase the demand for new homes and favorable
weather conditions increase the supply of new homes.
If both changes in economic circumstance occur simultaneously and independently, predict
how competitive market forces will affect the equilibrium price and quantity of new
homes.
P: _______________
Q: _______________
7
IX.
Government-set prices or price controls
A.
B.
C.
Price controls (non-market clearing prices):

1.
Interfere with the rationing function of competitive prices
2.
Are an obstacle to achieving an efficient allocation of resources
3.
Cause undesirable side effects
Price floor
1.
The minimum legal price a seller may charge for a good
2.
Must be set above the equilibrium price to be an effective price floor
3.
Creates a permanent surplus
4.
Visual representation of government imposed price floor
Price ceiling
1.
The maximum legal price a seller may charge for a good
2.
Must be set below the equilibrium price to be an effective price ceiling
3.
Creates a permanent shortage
4.
Visual representation of government imposed price ceiling
8
X.
Does a human kidney have value?

A
The National Organ Transplantation Act (1984) is example of the undesirable side effects
or inefficiencies that arise in a government price-controlled market.
B.
Visual representation of a government price ceiling in the market for human kidneys
C.
As a result of this government policy a(n) ____________________ of kidneys will arise causing
a(n) ____________________ in the number of people that will die.
D.
The market forces of supply and demand are so powerful in promoting an efficient
allocation of resources that black markets will naturally appear, thereby causing an increase in
criminal activity, if the government imposes an effective price ceiling.
E.
Is a black market an illegal market?

Is a black market an unethical market?
XI.
Non-price rationing mechanisms that arise to circumvent the imbalance in a market

due to the shortage created by a government-imposed price ceiling.
A.
B.
C.
XII.
Additional examples of government price controls

A.
Rent controls (an example of a price ceiling)
B.
Price ceiling on gasoline
C.
Price supports on agricultural products (an example of a price floor)
D.
Minimum wage (an example of a wage floor
9
XIII.

1.
T F
A market refers to a group of buyers who are willing and able to purchase a good.
2.
T F
Demand refers to the desires of individuals.
3.
T F
For demand to exist there must be a supply of the product.
4.
T F
A decrease in the price of Oreo cookies will increase the demand for Oreo cookies.
5.
T F
A normal good is a good for which demand increases when price decreases.
6.
T F
An inferior good is a good made with substandard materials.
7.
T F
The supply curve shows that the larger the quantity suppliers have to sell, the
lower the price they will have to charge in order to sell it.
8.
A market is in equilibrium when the ____________________ equals the quantity supplied
9.
T F
A market is in equilibrium when the number of buyers equals the number of sellers.
10.
T F
At the equilibrium price all buyers who want the product will get it.
11.
T F
An increase in demand will cause the price to rise and the quantity sold to fall.
12.
If the quantity of homes supplied in a community is greater than the quantity of homes demanded,
then a _______________ of homes will arise and we would anticipate that in a competitive market
for homes the _______________ price will _______________.
13.
T F
Allocative efficiency is defined as suppliers of a good using the best technology

and right mix of productive resources to achieve minimum production costs.
Questions #14 through #17 examine the mistakes in the following actual media report.
In Cuba at official prices there is a constant shortage of consumer goods. People explain that in
Cuba scarcity is caused by low prices. Cuban citizens say that the condition of scarcity will be
eliminated if the government will allow markets to respond to the forces of supply and demand.
14.
T F
Scarcity is caused by low prices.
15.
T F
Scarcity creates shortages of goods.
16.
T F
The market system automatically eliminates scarcity.
17.
The market system automatically eliminates ___________________________________.
The T/F questions are all false. Be able to explain why!!

8. quantity demanded
12. surplus / actual or market / fall towards the equilibrium price
17. shortages and surpluses
S.A.D. (chapter 3)
10
For questions #16 through #19 draw a visual representation of the market for the good and predict
how the change in economic circumstance will affect equilibrium P and Q. Use my three-step process!
18.
Event: Income increases over time

Market for long-distance bus tickets (assume bus tickets are an inferior good)
P: _______________
Q: _______________
[See Figure 3.7(b), p.66]
19.
Choose two goods that are complements.
Good A: _________________________
Good B: _________________________
Event: The price of good A decreases

Market for B
P: _______________
Q: _______________
[See Figure 3.7(a), p.66]
20.
Event: Technological advance increases the productivity of construction workers

Market for new homes
P: _______________
Q: _______________
[See Figure 3.7(c), p.66]
21.
Event: Government increases the impact fee (excise tax) on new construction.
Market for new homes
P: _______________
Q: _______________
[See Figure 3.7(d), p.66]
ECO 2013 / MACRO
Chapter 7 (or 25): Measuring Domestic Output and National Income (10 pages)
I.
II.
National income accounting

A.
National Income and Product Accounts (NIPA) compiled by the Bureau of Economic
Analysis (BEA), U.S. Department of Commerce
B.
Developed in the late-1930s and early-1940s.
C.
Set of rules and definitions for measuring actual aggregate economic activity.
D.
Measures the flow of money and physical products and resources in the circular flow.
E.
Measures the economys overall performance over time.
F.
Used to formulate policies that will improve the economys health over time.
Circular flow model of the economy when viewed as a double-entry bookkeeping system shows that there
are two equivalent ways to measure an economys output of goods and services in a given year.
Expenditures Method
Income Method
Total spending
C + I + XN + G
GDP is the market value of all

final goods and services produced
within a nation in a given year
Total output
GDP
Total income
wages + rent + interest + proprietors

income + corporate profits ( + indirect
business taxes + depreciation + net
foreign factor income)
GDP is the income earned producing
final goods and services
within a nation in a given year
2
III.
Gross domestic product (GDP) using the expenditures method

GDP is the market value of all final goods and services produced within a nation in a given year.
A.
Market transaction or market value

1.
Market value (P Q) solves the aggregation problem involving heterogeneous goods
2.
But market value (P Q) creates a measurement problem if the price level changes
over time.
Must differentiate between nominal GDP (market value) and real GDP
3.
B.
A few non-market transactions are included in GDP as imputed (estimated) values.

a.
Imputed rent for owner-occupied homes
b.
Imputed value of food produced and consumed on a farm
Only final goods and services included in GDP

1.
A final good or service is purchased by the ultimate or final user and is not resold
2.
Focus is on final goods because they are the ultimate ingredients for human satisfaction
C.
Production by American-owned and foreign-owned resources within the U.S.
D.
Current production of sold and unsold goods (or inventories).
E.
Compare GDP to GNP.

U.S. gross domestic product consists of the total market value of all final goods and services
produced by American-owned and foreign-owned resources within the borders of the U.S.
U.S. gross national product consists of the total market value of all the final goods and services
produced by American-owned resources anywhere in the world.
3
IV.
Not included in GDP

A.
Most non-market transactions

Productive use of scarce resources, but difficult to measure since activity does not pass through an
organized market to be recorded
Household production for household consumption
B.
Transactions involving intermediate goods and services.

Avoids double counting
An intermediate good or service is purchased for use in producing another good, for further
processing, or for resale; not consumed by the ultimate user.
C.
Transactions where nothing was produced

Just a reallocation or transfer of existing funds
D.
1.
Public transfer payments, e.g., social security payments, veterans benefits,

unemployment benefits, welfare payments.
2.
Private transfer payments, e.g., giving a gift of money to someone.
3.
Stock and bond market transactions
Transactions involving used stuff or secondhand sales.

Nothing was currently produced.
Just a reallocation of existing assets
E.
Transactions in the underground economy.

Productive use of scarce resources, but their market value is difficult to measure.
Includes both legal activities done off the books and illegal market transactions not reported.
F.
Goods and services produced by American-owned resources (and foreign-owned

resources) outside the United States
4
V.
The four components of GDP using the expenditures method C + IG + XN + G.

A.
Personal consumption expenditures (C)

1. Non-durable goods
2. Services (about 60% of C)
3. Durable goods: Products that have expected lives of 3 years or more

B.
Gross PRIVATE domestic investment (IG)

1.
Nonresidential
Capital goods are vital to a nations current and future consumption.
a.
Structures
b.
Producers durable equipment (tools, machinery)
Intellectual property products

Useful ideas that increase the economys ability to produce goods and services
i.
Software (excludes software embedded, or bundled, in computers)
ii.
Research and development (increases stock of technology and know-how)
iii.
Entertainment (music and film), literary, and artistic originals
2.
Residential structures (including manufactured homes and improvements)
3.
Changes in inventories
Unsold output during the accounting period is added to IG (GDP) because it represents
current production. The firm is the end user. When the inventory is sold in the next
accounting period the dollar amount is subtracted from IG (GDP) to avoid counting it twice.
C.
D.
Net exports (XN)
XN = Exports Imports
1.
Exports include current production of final goods and intermediate goods.

According to national income accounting the ultimate user is the foreign nation.
2.
Imports are subtracted from exports because imports do not entail production in
the U.S.
Government consumption and investment expenditures (G)

1.
Includes spending at all levels of government -- federal, state, local. G includes spending
on all public services, e.g., tax collection, public education, military-police-court services,
R & D, new equipment and government structures. The final user is society.
Since many government purchases do not pass through an organized market
(e.g., does a market for aircraft carriers exist?), they are valued at the cost of production,
mostly labor costs.
2.
Excludes public transfer payments because they do not represent payments for
current production
5
VI.
Value-added method of determining GDP

A.
Examine the stages of production to avoid double counting
B.
Value added is the market value of a firms output minus the market value of inputs
purchased from other firms
C.
Critical thinking applied learning exercise

A consumer pays $6.00 for a gallon of gasoline. The owner of the oil well receives $3.60
per gallon from an oil refiner, the oil refiner receives $5.40 per gallon from a gasoline
wholesaler, the gasoline wholesaler receives $5.60 per gallon from a gas station owner.
VII.
1.
Value added by the oil well owner
$__________
2.
Value added by the oil refiner
$__________
3.
Value added by the gasoline wholesaler
$__________
4.
Value added by gas station owner
$__________
5.
These market transactions contribute
$__________ to GDP
Gross private domestic investment versus net private domestic investment.

A.
B.
Two components of gross investment.

1.
Net investment (net additions to the economys stock of capital).
2.
Replacement investment (consumption of fixed capital or depreciation).
3.
IG = IN + Depreciation
IN (stock) = IG (inflow) Depreciation (outflow)

1.
If
IN > 0
then ____________________________________________.
2.
If
IN = 0
then ____________________________________________.
3.
If
IN < 0
then ____________________________________________.
6
VIII.
Measuring GDP using the income approach

A.
Compensation of employees
Wages, salaries, and employer paid benefits.
B.
Rent
Income received by households and businesses that own property resources.
C.
Interest
Money paid by businesses to the suppliers of financial capital.
D.
Proprietors income
Net income of sole proprietorships, partnerships, unincorporated firm
E.
Corporate profits
Earning of the owners of corporations
1.
2.
3.
F.
National income (NI) is the income earned by American-owned resources anywhere.
G.
To get from NI or GNP (American resources anywhere) to GDP:

1.
IX.
Corporate income taxes

Dividends
Retained earnings
Adjust NI for net foreign factor income

a.
If U.S-owned resources earned more overseas than foreign-owned resources

earned in the U.S., then net foreign factor income is positive and GDP > GNP
b.
If U.S.-owned resources earned less overseas than foreign-owned resources

earned in the U.S., then net foreign factor income is negative and GDP < GNP
2.
Add indirect business taxes (which are included in consumption expenditures)
3.
Add consumption of fixed capital (which is not earned by anyone)
Other national accounts

A.
Net domestic product (NDP) equals GDP minus consumption of fixed capital
Measures the total output that the economy can consume in a given year without hurting its
capacity to produce in future years
B.
National income (NI) is the income earned by American-owned resources anywhere.
C.
Personal income (PI) is the income received whether earned or unearned.
D.
Disposable income (DI) is income after taxes
7
X.
Nominal GDP and real GDP

A.
Nominal GDP year t = Price year t Quantity year t

Nominal means money values or current prices that existed in a particular year
Money or nominal values are the common denominator to sum a heterogeneous output
B.
Ruler or measurement problem arises when using money values or current prices over
time
1.
Inflation: Reduces the real value or purchasing power of a dollar
2.
Deflation: Increases the real value or purchasing power of a dollar
3.
To make a meaningful comparison between dollar or nominal values from

different years must convert the nominal number to a real number.
There are two methods to convert a nominal value to a real value.
C.
Method 1 [use a price index]

1.
Price index measures the price level in a given year relative to a base year
GDP Price index year t
Price of market basket year t

Price of market basket base year
Steps to follow to calculate real GDP

a.
Calculate nominal GDP for each year.
b.
Calculate the price index for each year.
c.
Calculate real GDP for each year.

Real GDP year t
D.
Nominal GDP year t

Price index year t
Method 2 [use constant prices]

1.
Steps to follow to calculate real GDP

a.
Use constant base-year prices to calculate real GDP for each year.
b.
Real GDP year t
Price base year
Quantity year t
8
XI.

A.
Using the price index method to determine real GDP

Between 2009 and 2014 in the nation of Floridastan nominal GDP increased from $360 billion to
$450 billion and the GDP price index increased from 120 to 125 (2008 = 100).
The nations nominal GDP increased by $________ billion.
The nations real GDP ______________________________
Using the constant-price method to determine real GDP

The nation of Erewhon produces two goods, hot dogs (HD) and hamburgers (H). The data for the
economy is given below. The base year is 2001. Calculate nominal GDP and use method 2 to
calculate real GDP.
Year
Price of HD
Quantity of HD
Price of H
Quantity of H
2001
$1
100
$2
50
2002
$2
150
$3
100
2003
$3
200
$4
150
1.
2001 nominal GDP is
$____________
2.
2002 nominal GDP is
$____________
3.
2003 nominal GDP is
$____________
4.
2001 real GDP is
$____________
5.
2002 real GDP is
$____________
6.
2003 real GDP is
$____________
If you have nominal GDP and real GDP, then you can indirectly calculate the price index without
having to use the more direct market basket approach
If Real GDP year t = Nominal GDP year t ,
Price index year t
then Price index year t = Nominal GDP year t

Real GDP year t
7.
2001 GDP price index is
____________
8.
____________
9.
____________
9
XII.
Final thoughts about real GDP

A.
Assuming inflation exists, then after the base year nominal GDP will exceed real GDP
B.
The meaning of real GDP

1.
Real GDP is nominal GDP corrected for changes in the price level
or real GDP measures the _______________________________ of production
2.
XIII.
Does size matter?

a.
If real GDP increases, then the size of the economic pie increased.
b.
If real GDP decreases, then the size of the economic pie decreased.
c.
If real GDP is larger in year 2 than in year 1, has the nations standard of living or
overall measure of welfare increased?
Shortcomings of GDP in measuring overall welfare or well-being

The purpose of the GDP statistic is to measure the performance of the economy, the size of the economic
pie. Even though there is a high correlation between economic performance and standard of living, the
GDP statistic was never meant to measure overall well-being.
A.
Non-market activities not included, e.g., household production for household consumption.
B.
Value of leisure time not included, e.g., watching the sun set.
C.
Improved product quality understated.
D.
Underground economy or legal and illegal production not reported.
E.
Production of economic bads included in GDP, e.g. pollution cleanup, jails.
F.
Composition of output, e.g., $200 for an economics textbook vs. $200 for a gun.
G.
Distribution of output, e.g., income skewed towards the rich vs. equally divided.
H.
Noneconomic sources of well-being, e.g., aesthetics, beauty, love, and civility.

10
XIV.
Self-Assessment Diagnostic (chapter 7 or 25)

1.
T F
Gross domestic product is the market value of all goods and services produced by
domestic- and foreign-owned resources within a nation in a given year.
2.
T F
A household purchasing a new home is included in personal consumption expenditures (C)
3.
T F In calculating the net exports (XN) component of GDP, the value of imports is subtracted
from exports because imports must be bought with foreign currency.
4.
T F
Public transfer payments are included in GDP because they increase the income and
spending of recipients.
5.
T F
The total value added to a product and the market value of the final product are equal.
6.
T F
GDP understates the economic well-being of a nation because it excludes the value of
leisure.
7.
The largest expenditures component of U.S. GDP is _____________________________.
8.
The largest component of U.S. national income is _______________________________.
9.
If the GDP price index is 175 then prices, on average, are ____________________ higher
than in the base year.
10.
The GDP price index equals real GDP divided by nominal GDP (multiplied by 100).
11.
If nominal GDP increased from $500 billion to $600 billion and the GDP price index
increased from 125 to 150, then real GDP ______________________________________.
12.
If prices in 2015 are higher on average than in the base year, then 2015 real GDP is ____________
2015 nominal GDP
13.
T F
Real GDP is GDP valued at constant base-year prices.
14.
T F
Real GDP is nominal GDP corrected for changes in the price level.
1. F
11. did not change
2. F
12. less than
3. F
13. T
4. F
14. T
5. T
6. T
7. personal consumption expenditures (C)
8. compensation of employees or wages and benefits
9. 75 percent
10. F

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ECO 2013 / MACRO

PROF. H.J. VAN BOVEN

Economics is a social science

Economic way of thinking

Visual representation of scarcity

Limited output produced using factors of production

Efficiency is shown as ____________________

Scarcity forces people to make constrained optimization decisions.

There is no such thing as a free lunch

Opportunity cost of an activity refers to ____________________

Marginal benefit (MB) refers to the additional benefit of a specific activity.

If the MB (activity X) exceeds the MC (activity X),

If the MB (activity X) is less than the MC (activity X),

If the MB (activity X) equals the MC (activity X),

then the optimal has been

Theories, principles, and models

Economics uses the scientific method

Discover systematic patterns in reality in order to establish cause-and-effect

Decisions and economic policies should be based on economic principles to resolve

Hypothesis (to be tested)

Principle, model, law

Problems in applying the scientific method in economics

Economic conditions and institutions are constantly changing.

Controlled laboratory experiments are difficult to do or impossible.

Ceteris paribus is only an assumption.

The beach versus the sand, rocks, and shells

All fields of study have two categories of statements

Positive statements or positive economics

Objective. Fact. What is.

Functional cause-and-effect relationships.

Is not necessarily true, but can be proven to be either true or false.

Normative statements or normative economics

Subjective. Opinion. What ought to be.

Cannot be proven to be true or false by reference to the facts.

Societys economizing problem or problem of scarcity

Economic wants exceed the productive capacity of an economys limited resources

Scarcity can never be eliminated

Four general categories of economic resources, factors of production, or inputs

Capital (K) refers to:

Entrepreneurial ability (E) refers to the entrepreneur or innovator

The production possibilities model (page 13 textbook)

Given existing technology and the

current supply of inputs, it is

impossible for an economy to produce

outside its PPF

Possible to produce a combination

of output inside the PPF

Attainable, but inefficient

The ceteris paribus assumptions for a given PPF:

Technology and thus productivity are currently fixed.

Production possibilities frontier shows the ___________________ combinations of output that

Tradeoffs, opportunity costs, no free lunch

Resources are allocated efficiently or allocative efficiency is achieved when:

Visual representation allocative efficiency

The production possibilities model as it relates to some key macroeconomic issues

Refers to the ability of an economy to bake a larger economic pie or produce a

Illustrated by the economys PPF shifting outward.

Sources of economic growth

Increase in the quantity and quality of inputs (N, L, K, E).