Download Keynesian Economics

Economics Notes
Mrs. Willis
Fundamental Economic Concepts
Defining Scarcity in Context pg 3
-Scarcity exists when wants are greater than the resources available to satisfy those want…forces people to
make choices.
-Resources are limited and wants are unlimited.
-TANSTAAFL- There ain't no such thing as a free lunch.
-Opportunity cost: the value of the next best thing…real costs that are measurable in terms of the real
value that is forgone when a choice is made.
--Production possibilities: many diff. Combos of
goods and services can be produced w/ the same
resources. Producing 1 good will reduce the
possibility of prod. Another good…represented by
the production possibility curve.
-All resources are not good substitutes for all others
with the same efficiency.
Factors of production pg 4
-Factors of production: All production of goods and
services requires the use of resources: land, capital, entrepreneurial resources
-Land resources: natural resources that come from nature
-Labor resources- human capital, skills and knowledge of humans.
-Capital resources- real capital, goods that are produced to be used later to prod. Final goods and services
for consumption.
-Entrepreneurial resources: decision making involved in using resources to produce goods and services.
The Role of Incentives in a Market Economy pg 4
-Incentive: a reason for people to take risks.
-Competition: seller’s efforts to attract buyers. Will happen when markets are few of barriers to entry or
exit..signal of profits is strong.
-Effects of competition:
1. Lower prices of product
2. Better quality of product
-Ceteris Paribus-Latin phrase meaning "all other things being equal." Economists assume cetris paribus
when analyzing economic trends.
The Science of Economic Decision-Making pg 5
-Economics: the science of personal and group decision-making.
-The greater the difference b/t the benefits and the cost of a decision, the easier it is to make a choice. Often
difficult when benefits and costs are similar.
Marginal Analysis pf 5
-Marginal Decision Making: the choices that are a matter of degree. The margin is the diff. B/t the costs
of 2 alternatives or the diff. B/t 2 benefits.
-Positive Economics-what is-analyzes facts or data to establish scientific generalizations about economic
behavior.
-Normative economics-what ought to be-involves value judgments about what the economy should be
like, and includes goals.
Microeconomics: study of the indiv. Parts of the economy and the actions of the individs and firms.
Macroeconomics: study of economy as a whole: focus on aggregate behaviors of prodcers and consumers.
Economic Systems pg 6
-a group of people in regions to organize their economic activities. Systems are developed around:
1. traditional practices
2. planning or command dominated systems
3. market principles dominated
-Develop what to produce, how to produce, and who will receive the benefits of the production
Market Systems pg 7-Free enterprise, aka capitalism, private enterprise, free market.
-The rights of the individ. and private ownership is highly valued. Have laws of supply and demand.
Individ profit is encouraged.
Planned or Command Systems: a group makes economic decision as a whole, or the economic decisions
are made by the government n the name of society. Hinges on how decision makers hold their power. Close
relationship b/t political structure and economic structure. Ex: Soviet Union
Traditional Systems: Rare, found in lesser-developed regions. Economic decision-making is powered by
tradition, usually resulting from moral, religious, or cultural forces.
**Pure market systems do not exist. Most are Mixed market Systems.
Mercantilism pg 7: economic practice characterized by central planning, strong government control, and
heavy reliance on exports to build wealth in gold and silver. Found in Europe through the 26t-18th century.
Socialism: systems in which a group voluntarily shares their resources for the good of the group.
-Laissez-faire: policy by which government leaves things alone.
Microeconomics:
-Market: any situation in which resources, goods, or services are exchanged. Found in many forms when
an exchange takes place.
-Price: a signal to a producer that resources can be used to create a product that will result in profit.
Common point of reference for value.
Supply and Demand Theory
-motivates producers to use resources to create goods and services, and these signals motivate consumers to
use the goods and services to satisfy their wants.
-Markets are fluid and ever changing.
Law of Supply of 10
-the quantity supplied is directly related to the price, ceteris
paribus. As price increase, the willingness of producers to increase
the quantity supplied will increase.
-At higher prices, producers will offer more. However, resources
will be limits at 1 point.
-Willingness to supply goods and services is determined by
resource costs relative to market price.
-Higher the profit, the greater incentive to produce.
-Factors determining the costs of production are: resource costs,
transaction costs, and an expected normal profit.
Law of Demand pg 11
-the quantity demanded is inversely related to the price, ceteris paribus. As the price increases, there is less
willingness to purchase a good or service.
-Demand curve slopes downward.
-Demand begins w/ tastes and preferences and a utility for the
object.
-Budget constraint: a low income may not allow a person to
demand goods or services w/o giving up other important wants.
-Demand of a product will be affected by substitutes.
-Complementary goods: 2 goods for which the demand for one
affects the demand for the other. Ex: French fries and ketchup.
-Marginal Utility: additional utility of consumption of an
addn’l unit of a good/service. The utility may decrease as more
of a good is consumed: diminishing marginal utility. Ex: 1
candy bar vs 20 candy bars.
-Individ’s demands for goods/services drive the market demand.
Equilibrium pg 11
-The interxn of supply and demand determines equilibrium price and qntity.
-Equilibrium price: price at which the quantity supplied and quantity
demanded are the same….sometimes called the “market clearing" price.
Elasticity pg 12
-Demand and supply curves are curved in reality.
-Inelastic demand: change in price may not change the quantity demanded.
-Elastic: refers to the relationship b/t a change in price to the change in
quantity demanded. If a small change creates a great change in quantity
demanded, the price is said to be elastic.
-Price elasticity of demand: % of change in the quantity demanded divided by the % change in price. If
number is greater than 1, the price is elastic.
Ex: Change in quantity = 33%
Change in price = 25%
.33 /.25 = 1.32
1.32 > 1 Elastic demand
-Cross-price elasticity: the relationship b/t the demand for 1 product and the price of another. Sub good
will have a + cross price elasticity. A zero says the 2 products are unrelated.
Shifts in Demand and Supply pg 13
-A change in any factor that influences demand or supply may cause a shift-a movement of the demand or
supply curve to the left or right.
-Movement along the curve: consumer may change the quantity demanded due to a change in the price
Behaviors of Producers
-Producers seek profit maximization. Profits are the difference b/t revenue and costs.
-Producers have fixed costs- major capital expenditures, do not change with level or production. Also have
variable costs-costs that change with the level of production.
-Producer will continue to produce as long as the marginal revenue (increase in total revenue from the sale
of the next unit of prod.) is greater than or equal to the marginal cost (the cost of the next unit of prod).
Markets and Competition pg 13
-Competition results in lower prices and an improvement in the quality of goods and services.
-Perfect Competition: a market with many buyers and sellers, with unrestrained entry or exit, identical
goods and services, and equal access to market info for all competitors.
-real world markets that are close are those for commodities, such as wheat.
Monopoly pg 14
-market types that are non-competitive markets, in which production or price is controlled by a single
producer. Incentives do not exist in this market.
-this control may be acquired through:
1. patent: government grant of the exclusive right to make, use, and/or sell an invention for a
specified period of time.
2. copyright: legal right of the creator to exclusive control of an original literary or artistic product.
-Results when 1 firm has such size(economy of scale) that no other prod. can use the resources as efficient.
-May result when there are significant barriers of entry to the market.
-Regulated monopolies: operate w/ strict price controls and universal service requirements. They recover
costs and price.
-monopolistic competition: market in which there are a sig # of sellers that produce differentiated products
and few barriers to entry. None of the companies have a advantage that is so significant that is limits
competition. Ex: Microsoft
Oligopoly: A market that is controlled by a few firms. Products may be identical. Ex: auto industry.
Price Floors and Ceilings pg 15
-Price ceiling: maximum legal price for an item. Government interferes when the free market doesn’t
achieve the social or political goals of society.
-Shortage: a situation where the demand exceeds the supply at the market price. Results in upward
pressure on price, which causes the producers to increase supply.
-Price floor may result in a surplus: when the supply exceeds the demand. Price would fall, and a new
equilibrium would be set on the curves.
Production Decisions pg 16
-based on the costs of the resources relative to the price of the output
Explicit costs: expenditures for resources used in production
Implicit costs: opportunity costs of time and capital resources forgone when a decision is made to produce.
Total product: # of units produced
Avg. product: # of units produced per unit of input
Marginal Product: additional output from the addition of a unit of input.
Productivity: measure of output per unit of input and is used as a measure of economic efficiency.
Labor productivity: measure of labor resource efficiency.
-Using improved inputs, such as better skilled labor or better technology, can increase productivity.
Macroeconomics pg 17
-analysis focuses on aggregate behavior of peeps, businesses, & govs. Also, output, prices & employment.
Circular Flow Model pg 17
-represents the constant flow of resources from owners to producers
and flow of goods and services from producers to consumers.
-All resources are owned by the Household Sector. All production
takes place in the Business sector.
-households provide land, labor, capital, to businesses/firms.
Say’s Law
-demand creates profit signals to which producers respond 
consumer sovereignty: consumers are the driving force of the market.
-Says’ law: French economist Jean Baptiste Say said that supply creates it own demand. Total demand
must equal total value of production. Underlying principle of supply-side economics. If barriers to
increasing output and employment are removed, the economy will grow since people will have greater
capacity to demand the goods that are produced.
Aggregate Supply and Demand pg 18
Aggregate demand: total demand in an economy. A function of
all wants and income level equaling Gross Domestic Product.
Vert axis = price level Hor Axis = total output.
-Downward slope to the right.
Aggregate Supply: relationship b/t total quantity of output and the price level. Slopes upward.
-Equilibrium Price level: point at which the aggregate demand and
aggregate supply curves intersect.
Measuring Economic Activity pg 19
-Leading economic indicators: things that indicate the direction the
economy will take in the future. Ex: new car purchases, etc.
-Concurrent economic indicators: provide a sense of current
economic activity. Ex: employment rates
Lagging economic indicators: confirm past levels of economic
activity. Ex: length of unemployment.
Index of Leading Economic Indicators: weighted index of 12
measurements that indicate the direction of economy over a year.
National Economic Goals
Employment Act of 1946 and Humphrey-Hawkins Act of 1978: under these mandates, congress and the
executive branch must design and implement public policies that purse the goals of growth of output, full
employment, and price stability.
-HH Act established no more than 4 % unemployment rate. They also require an annual report from the
Prez and the Prez’s council on Economic Advisors to the Congress.
Interest Rates: tools used to stimulate or slow growth. Also manipulating money supply does this too.
Measuring Output pg 19
Gross Domestic Product: the total value of all final goods and services produced w/in a given time period
using factors of production w/in an economy (nation).
GDP = C + I + G + X
C = total spending on consumption I = investment G = government purchases X = net exports
Gross national Product pg 20
-involves the value of the production of a nation’s permanent residents, or nationals, regardless where they
work. Domestic residents are primarily in the US.
Problems:
-neither GDP nor GNP says anything about the quality of life of the nation, nor on externalities: external
benefits or costs of an economic activity that are not born by the producer or consumer. Ex: air pollution.
-Doesn’t include goods & services that were produced outside trad. markets, & non-market transactions.
-GDP expressed in terms of current dollar value is called the nominal GDP.
-Dividing the GDP by the size of the population: per capita gross domestic product.
-Real GDP growth: measure of economic growth after adjusting for inflation.
Measuring the Price Level pg 21
-overall level of prices is measure by using the CPI
Consumer Price Index: measurement of change in the cost of a fixed basket of products and services. US
Bureau of Labor Statistics puts it out monthly. Also called “cost of living” index or “measure of inflation.”
GDP price inflator: measures changes in price level relative to the growth of the GDP from yr to yr.
Cost push inflation: caused by a rise in the costs of actors of production, increase in costs of labor, natural
resources, capital goods, that can push prices up.
Demand pull inflation: caused by consumer demand bidding up the prices of goods and service.
Deflation: a decrease in the general price level of the economy.
-Those who owe money benefit by repaying debts with inflated dollars.
-Those that owed money will receive payments that have reduced purchasing power.
Labor force: # of people who are employed plus the # of people who are seeking employment.
Unemployment rate: # of unemployed people divided by the labor force.
Business Cycle pg 21
-model of the predictable increases and decreases in
economic activity
Recession: when the GDP does not grow and declines
over a period of time
Depression: severe and long-term downturn in business
activity, severe unemployment.
Expansion: sustained period of growth.
Rational expectations
-theory where people’s expectations about the future can
actually guide economic decisions.
Index of Consumer Confidence: tracks the optimism and pessimism of consumers regarding the
performance of the economy.
Money pg 22
-tool that facilitates trade
-Money has 3 basic functions:
1. is a Medium of exchange
2. serves as a unit of account or measure of value
3. is a mechanisms to store value.
-Currency must be durable, transportable, distinguishable, difficult to counterfeit.
-Most money is available in demand deposits for checking accounts. Only 25% is in money.
Interest rates: cost of using money or credit to purchase something in the present and pay for it later. Great
demand for available funds causes interest rates to increase. Less demand for funds causes a decrease.
Gresham’s Law pg 23
-16th century: Thomas Gresham proposed that bad money replaces good money in the market. Bad money
= form of money that people prefer to spend. Good money = any form of money that people prefer to keep.
Monetary Policy:
-consists of actions that influence the money supply and interest rates.
-Increasing supply of $ in the economy will cause interest rates to fall  increasing prod. and consumption.
- Decreasing supply of $ in the economy will cause interest rates to rise slowing prod. and consumption.
-Federal Reserve System (Fed) implements monetary policies. Established in 1913 by the US Central
Bank. Has the Board of Governors and 12 regional federal banks. Governors are appointed by the Prez.
Quantity Theory of Money
-Goal of monetary policy is to control of supply of money to achieve an optimal level of output and
employment w/out inflation.
-Expressed by Quantity theory of money, MV = PQ, which is called the equation of exchange.
M= money
V= velocity of money
P = price
Q= quantity of output
-Types of money supply: M1 and M2:
M1 = cash in the hands of the non bank public
M2 = broader, included M1 as well as savings accounts.
-Tools of monetary policy are open market ops, changes in discount rate, and member bank reserve
rqrments.
-Federal Open Market Committee- determines targets for key interest rates, mainly the Fed Funds Ratethe rate from which banks borrow overnight from other banks.
-If expansionary policy is desired to combat recession, the Fed will buy government securities, which
causes banks reserves to increase. With more reserves, the banks can offer more loans.
-Banks are rq’rd to put a reserve in Fed Bank. If Fed changes reserve requirement, this will cause change
in the money multiplier- is the reciprocal of reserve requirement: 1/reserve ratio = money multiplier.
-Fed does not set interest rates, it sets the discount rate: rate at which Fed reserve Banks loan funds to
member banks.
-Wealth effect: when people feel wealthier, they tend to increase their demand for goods and services.
Real interest rate: rate charged over and above the anticipated inflation rate.
Fiscal Policy pg 25
-involves the use of government spending and taxation to influence the level of economic activity. The gov
can give businesses or people more or less income to spend.
-Tax revenues are intended to provide public goods.
Budget deficits: when the government takes in less tax revenues than what it spends
Budget surplus: when the government takes in more tax revenues than what it spends
National debt: Net of gov. deficits and surpluses over the years. Called public debt. 1999 = US had a debt
of 5.7 trillion dollars
Keynesian Economics
John Maynard Keynes pub. a book , The General Theory of Employment, Interest, and Money in 1936.
Said in periods of decreased demand and output, govt policies could be used to replace private spending.
In the Model, national output is divided into 4 sectors:
1. Consumption
2. Gov. spending
3. Private investment
4. Net exports
When slow down occurs in 1 and 3, 2 can step in to relief the depression.
-Keynes theory was used in the Great Depression by Franklin D Roosevelt to rebuild after the depression.
Government Spending
US office of Management and Budget classifies federal spending into 3 broad categories:
1. discretionary outlays (national defense, domestic programs, international progs)
2. mandatory outlays (social security, deposit insurance)
3. Net interest.
-Largest budget item: $403 billion for Social Security. $251 billion for income security programs, $203 bil.
for Medicare, and $291 bil. for national defense.
International Trade and Global Economic Development
-Growth of US except during Depression of 1929. World War I helped with growth out of the Depression.
Phillips curve: trade-off between inflation and unemployment. As price increase, unemployment
decreases. Stagflation: high unemployment and high inflation.
-Extreme poverty persists in some area that lack natural resources, access to capital, or underlying legal and
political structures that have hindered economic growth.
-Economic development must have:
1. natural resources
2. human resources
3. access to capital resources
4. Investment
-Countries do not have to have all 4.
-Countries are classified into 3 categories based on per capita GDP:
1. developed countries: US, large industrial base, use of tech, and skilled workforce
2. developing countries: Mexico, dependent on agriculture, not lots of tech
3. less-developed countries: Africa, have natural resources, but depend on external capital
investment for development. Per capita GDP of $3000 or less. Have higher birth rates, infant
mortality rates, and low literacy rates, and low life expectancies
Theory of Trade pg 29
Comparative advantage: used when he/she chooses to produce 1 or more goods for which the opportunity
cost is low.
Absolute advantage: Advantage in 1 market
Exchange rates: price of 1 nation’s currency in terms of another country’s currency
Tariffs: used to prevent unfair trades such as dumping and to discourage dependency on other nations. A
tax on imports
Quotas: a limit on the quantity or value of a good that can be imported/exported.
General Agreement on Tariffs and Trade (GATT): Many nation committee that’s goal is to reduce
tariffs and promote free trade. Have ongoing discussions, called rounds.
World Trade Organization: 140 nations are in WTO. Was created in 1995 to administer the goals and
agreements of GATT. Headquarters are in Geneva, Switzerland.
North America Free Trade Agreement: Effective Jan 1, 1994: supports the gradual removal of barriers to
free trade in North America and effectively aims to establish a free trade zone which includes US, Mexico,
and Canada.
-In Europe, the Maastricht Treaty of 1991, brought an end to border controls and tariffs and began
monetary coordination. Renamed European Union, and its currency is the euro. Composed of 15 nations.