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AP MACROECONOMICS
Mr. Messick
THE STUDY OF ECONOMICS

Economics: The study of scarcity and choice.
Market Economy: Market decisions are decentralized
and made by firms and individuals. i.e., United
States, United Kingdom, Germany
 Command Economy: Market decisions are
centralized and made by bureauocratic institutions.
i.e., Cuba, North Korea, Saudi Arabia, Iran, & Libya
 Political boundaries do NOT define
markets…markets are truly global and w/o borders.


Resources Are Scarce!
Can’t Always Get What You Want…
 Resource: Anything that can be used to produce
something else.

ECONOMIC WAY OF THINKING

Economic Thinking is Marginal Thinking

Rational Thinking…studying the “gray” areas

Margin meands “edge” so just changing a small
incremental part.
What happens if I study just one more hour?
 Should I go to sleep 1 hour earlier?


What are the benefits of making small changes?
What are the costs of making small changes
Why are diamonds so expensive?
 Why is water so cheap?

RESOURCES ARE SCARCE
Land
 Labor
 Capital
 Entrepreneurship

…because resources are scarce it leads to
Opportunity Costs (“Opportunity Lost”) & tradeoffs



What you have to give up to choose something else.
It is always the NEXT BEST ALTERNATIVE!
Doesn’t have to be monetary, but it has to have
meaning or utility such as TIME, HAPPINESS
USE OF MODELS IN ECONOMICS

Why Use Models



To Answer Questions!
To Evaluate Policy
Characteristics of Models


A Question
Simplification and Abstraction


Assumptions about Economic Behavior


Think “wind tunnel” for aerospace engineers
Ceteris Paribus (all relevant factors stay the same)
Ways to Express Models
1.
2.
3.
Graphs
Words
Equations
ANALYZING IS NOT JUDGING

Positive Economics





Not “good” or “bad” economics…just analysis
Does a cut in taxes lead to an increase in employment?
What would be the effect of a carbon emissions tax?
Does not judge whether or not a policy is effective.
Normative Economics


Assessments or Judgment of what we should do
Not just one answer for normative economics


Depends on your point of view, i.e. business vs environmentalists
Goals must be clearly stated ahead of time






Productive Efficiency (produce at a minimal cost)
Allocative Efficiency (are we producing what people want)
Equity (is it fair?)
Economic Growth (enhance standard of living across generations
Stabilizing or De-Stabilizing (employment increase or decrease)
Goals are in conflict…growth vs stability, efficiency vs equity.
PRODUCTION POSSIBILITIES CURVE (FRONTIER)

PPC is a simple economic model showing the
trade-offs an individual, firm, government faces
in how to allocate scarce resources between to
competing goods or services.
PPC models scarcity
 PPC models opportunity cost



What must be given up to order to have additional units of
other goods.
PPC models efficiency

A point on the line represents efficient use of resources.
 All resources are efficiently and fully used.
 All technologies are efficiently used.
PRODUCTION POSSIBILITIES CURVE (FRONTIER)
Quantity Of
Fish
18
16
14
12
10
8
6
4
2
D
A
C
B
4 8 12 16 20 24 28 32 36
Quantity of Coconuts
PRODUCTION POSSIBILITIES CURVE (FRONTIER)
Quantity Of
Capital
Goods
Captial Goods:
Machinery, Tools, &
Equipment Used To
Make Consumer Goods
Why is this curve bowed outward?
(1) Because of the Law of Increasing
Costs. The more of a good that is
produced, the greater its opportunity
cost.
(2) Because resources are not perfectly
adaptable to alternative uses, our PPC
is unlikely to be linear.
(3) Mathematically, this can be seen by
the slopes of the lines closer to the
endpoints are more horizontal and
vertical showing an greater increase
of opportunity costs.
Quantity Of
Consumer
Goods
Consumer Goods:
Goods consumers buy
directly from the firms
that make them.
22
20
PRODUCTION POSSIBILITIES CURVE (FRONTIER)
18
16
Quantity
of Timber
14
12
10
y
8
6
4
2
5
10
15
Quantity of Salmon
20
25
PRODUCTION POSSIBILITIES CURVE (FRONTIER)

Linear PPC Graph: Constant opportunity cost


Why? Because slope is constant for any two points on the
PPC. Since opportunity cost = slope, therefore
opportunity costs are constant!
Curved PPC Graph: Increasing Opportunity Costs
Why? Because the slope
is not constant! If you
keep increasing the
quantity of salmon at a
constant rate, the
quantity of lumber
(opportunity cost)
decreases at an ever
faster rate!
PRODUCTION POSSIBILITIES CURVE (FRONTIER)
Resource Increase
Resource Decrease
Land
Land
Labor
Labor
Capital
Capital
Entrepreneurship
Entrepreneurship
PRODUCTION POSSIBILITIES CURVE (FRONTIER)
Resource Increase
Resource Decrease
Causes
• Recession
• Depression
Land
• Increase in quantity of land
• Increase in quality of land
• Discovery of new resources
Land
• Decrease in quantity of land
• Decrease in quality of land
• Exhaustion of current resources
Labor
• Increase in Labor Force
• Increase in Education (Skills)
Labor
• Decrease in Labor Force
• Decrease in Education (Skills)
Capital
• Increase in quality of machinery
• Increase in quantity of machinery
• Increase in Capital technology
Capital
• Decrease in quality of machinery
• Decrease in quantity of machinery
Entrepreneurship
• Increase in technology helps physical
capital to improve.
• Development of new markets & products
Entrepreneurship
• Decrease in use of new technology.
• No development of new markets & products
PRODUCTION POSSIBILITIES CURVE (FRONTIER)
Determinants of Long Term Economic Growth
@ 25% is attributable to growth in human capital (Labor)
1.

2.
@ 25% is attributable to physical capital

3.
More education as well as more experience
More machinery as well as more places producing goods
@ 50% is attributable to New Technology (Entrepreneurship)
Source: The Instant Economist, Timothy Taylor, p.128
PRODUCTION POSSIBILITIES CURVE
(FRONTIER)

Some example PPC graphs with explanations…
PRODUCTION POSSIBILITIES CURVE
& COMPARATIVE ADVANTAGE





Trade: Using specialization, individuals provide goods
and services to others and receive goods and services
in return.
By trading, economies gain more goods and services
than trying to be self-sufficient.
Comparative Advantage shows us how this economic
gain is made.
Comparative Advantage: Determines specialization
for trade between nations; based on the nation with
the lower relative or comparative cost of production.
Absolute Advantage: An economy that produces
absolutely more of a certain good than another
economy.
PRODUCTION POSSIBILITIES CURVE
& COMPARATIVE ADVANTAGE
Military
Equipment
(000’s)
United States
Ukraine
Military
Equipment
(000’s)
Butter (000’s)
Equipment
Butter
Butter (000’s)
Equipment
Butter
1,000,000
0
80,000
0
700,000
30,000
40,000
40,000
0
100,000
0
80,000
PRODUCTION POSSIBILITIES CURVE
& COMPARATIVE ADVANTAGE
• Even though the United States enjoys ABSOLUTE ADVANTAGE-that
does not alone tells us what to produce….
• …rather it is COMPARATIVE ADVANTAGE that should dictate what
the Ukraine or United States produces.
• How do you calculate comparative advantage?
• Know the definition of comparative advantage!
Comparative Advantage means one entity can produce something at a
lower marginal opportunity production cost than another entity.
1. What is the opportunity cost of military equipment? To
produce guns what do you have to give up? (answer: butter
production)
2. What is the opportunity cost of butter? To produce butter
what do you have to give up? (answer: military equipment)
3. Find the marginal opportunity costs for guns and butter for
each country…
PRODUCTION POSSIBILITIES CURVE &
COMPARATIVE ADVANTAGE
Since marginal means additional, we must find out
the marginal opportunity cost for one gun and one
butter of both countries. Just set up a table…
Ukraine
United States
1 butter = ____ guns
1 butter = ____ guns
1 gun
1 gun
= ____ butter
= ____ butter
Remember marginal opportunity cost is just slope …so
start with butter on the x-axis for both countries. But
use the two most extreme points which are the x and y
intercepts to find slope.
Then determine which country can produce that good at
a LOWER marginal opportunity cost-that country has
the comparative advantage in producing that good!
PRODUCTION POSSIBILITIES CURVE
& COMPARATIVE ADVANTAGE
How much should each country produce & trade in
order to maximize their benefit? What about point B?
Produces
1,000,000
Trades
-140,000
Consumes after
Specialization &
Trade
860,000
Butter
0
35,000
35,000
30,000
5,000
Guns
0
140,000
140,000
40,000
100,000
Butter
80,000
-35,000
45,000
40,000
5,000
United States Guns
Ukraine
Consumes
Before Trade
(Point B)
700,000
Gain
From
Trade
160,000
On your graph, plot the new points for each country under “Consumes
after Specialization & Trade”. What do you notice?
PRODUCTION POSSIBILITIES CURVE
& COMPARATIVE ADVANTAGE
Military
Equipment
(000’s)
United States
Military
Equipment
(000’s)
Butter (000’s)
Ukraine
Butter (000’s)
SECTION 2
MODULE 5: INTRO TO DEMAND
Competitive Market: A market with many buyers
and sellers of the same service.
 Supply & Demand Model: A pictorial model to
describe behaviors in a competitive market.


The Demand Curve


The Supply Curve


Set of factors that cause demand curve to shift
Set of factors that cause supply curve to shift
The Market Equilibrium
Equilibrium price
 Equilibrium quantity


The way the market equilibrium changes when
supply or demand curve shifts.
SECTION 2
MODULE 5: INTRO TO DEMAND
Ex. 1: Selling my ebook
Demand Schedule
Price ($)
Quantity
Demanded (units)
A
2.00
60,000
B
4.00
40,000
C
6.00
30,000
D
8.00
25,000
E
10.00
21,000
F
12.00
20,000
Scenarios
What do you notice about the relationship between
price and quantity demanded?
Law of Demand
price
….
Quantity demanded
-Or-
Quantity demanded
….
price
ceteris paribus: all else being equal
SECTION 2
MODULE 5: INTRO TO DEMAND
Price ($)
12
10
8
6
4
F
Demand Curve
E
Plot the points from the demand
schedule to create the:
DEMAND CURVE
We have to be very careful….
D
Movement ALONG the demand curve
just tells us at a given price this is the
“quantity demanded” for ebooks….
C
B
A
2
20 23 25 30 40 50
60
We never, ever say demand at $2.00-we
say “quantity” demanded at $2.00.
Quantity Demanded of
My Ebook (000’s)
DO NOT confuse DEMAND with QTY. DEMANDED
Your Graphs Should Always Have “Qty Demanded” on the x-axis
PRICE always determines Quantity Demanded
SECTION 2
MODULE 5: INTRO TO DEMAND
Increases or Decreases in Demand of a Good Causes Shifts in Demand Curve
12
10
8
6
4
Price ($)
F
F
E
E
F
12
10
D
D
C
8
C
B
6
B
4
A
2
20 23 25 30 40 50
60
Increase in Demand for My Ebook
A
2
E
F
D
E
C
D
B
C
A
B
A
20 23 25 30 40 50
60
Decrease in Demand for My Ebook
SECTION 2
MODULE 5: INTRO TO DEMAND

Five Principal Factors That Shift The Demand
Curve for a Good or Service
1.
Changes in the prices of related goods or services
2.
Changes in income
3.
Changes in tastes
4.
Changes in expectations
5.
Changes in the number of consumers
SECTION 2
MODULE 5: INTRO TO DEMAND
1.
Changes in Related Prices Goods or Services
“The Case of Substitute Goods”
Price ($)
Price ($)
D
D
McDonald’s McMuffin
Sausage Sandwich
Qty. Demanded (000s)
Dunkin Donuts
Sausage Croissant
Sandwich
Qty. Demanded (000s)
….but suppose the price of McDonald’s sandwich increases ….
Price ($)
Price ($)
Effect of the price
P2
P1
D’
D McDonald’s McMuffin
Q2
Q1
Sausage Sandwich
Qty. Demanded (000s)
Dunkin Donuts
D Sausage Croissant
Sandwich
Qty. Demanded (000s)
SECTION 2
MODULE 5: INTRO TO DEMAND
….but suppose the price of McDonald’s sandwich decreases ….
Price ($)
Price ($)
Effect of the price
P1
P2
D McDonald’s McMuffin
Q1
Q2
Sausage Sandwich
Qty. Demanded (000s)
D’
Dunkin Donuts
D Sausage Croissant
Sandwich
Qty. Demanded (000s)
SUBSTITUTE GOODS
•
•
If the rise in the price of one good causes consumers to switch to another good.
If the decrease in the price of one good causes consumers to switch to another good.
SECTION 2
MODULE 5: INTRO TO DEMAND
1.
Changes in Prices of Related Goods or Services
“The Case of Complementary Goods”
Price ($)
Price ($)
D
D
Panara Bread’s
Cinnamon Crunch Bagels
Qty. Demanded (000s)
Panara Bread’s
Soft Spread Cream Cheese
Qty. Demanded (000s)
….but suppose the price of the Cinnamon Crunch bagels increases ….
Price ($)
Price ($)
Effect of the price
P2
P1
D Panara Bread’s
Q2
Q1
Cinnamon Crunch Bagels
Qty. Demanded (000s)
D’
D
Panara Bread’s
Soft Spread Cream Cheese
Qty. Demanded (000s)
SECTION 2
MODULE 5: INTRO TO DEMAND
1.
Changes in Prices of Related Goods or Services
“The Case of Complementary Goods”
….but suppose the price of the Cinnamon Crunch bagels decreases ….
Price ($)
Price ($)
Effect of the price
P1
P2
D
Q1
Q2
Panara Bread’s
Cinnamon Crunch Bagels
Qty. Demanded (000s)
D’
D
Panara Bread’s
Soft Spread Cream Cheese
Qty. Demanded (000s)
COMPLEMENTARY GOODS
•
•
The rise in the price of one good causes lower demand for the complimentary good.
The decrease in the price of one good causes higher demand for the complimentary good.
SECTION 2
MODULE 5: INTRO TO DEMAND
2.
Changes in Income
Inferior Good
Luxury Good
Normal Good
…but as income
Price ($)
Price ($)
Price ($)
D
D’
Yugo Qty Demanded (000s)
(Inferior Good)
D
D’
Accord Qty Demanded (000s)
(Normal Good)
D’
D
BMW Qty Demanded (000s)
(Luxury Good)
SECTION 2
MODULE 5: INTRO TO DEMAND
2.
Changes in Income
Inferior Good
Luxury Good
Normal Good
…but as income
Price ($)
Price ($)
Price ($)
D’
D
Yugo Qty Demanded (000s)
(Inferior Good)
D
D’
Accord Qty Demanded (000s)
(Normal Good)
D
D’
BMW Qty Demanded (000s)
(Luxury Good)
SECTION 2
MODULE 5: INTRO TO DEMAND
3.
Changes in Consumer Tastes
Teens are no longer shopping at
Abercrombie & Fitch or American Eagle
because teens do not want these names
plastered on the front of their shirts; or,
simply put, these retailers are no longer “in”.
Apple’s Iphone 6 is here. Teens want it!!
C’mon Dad & Mom …splurge for me!
Price ($)
D
D’
American Eagle Qty Demanded (000s)
Price ($)
D
D’
Apple Iphone Qty Demanded (000s)
(Inferior Good)
SECTION 2
MODULE 5: INTRO TO DEMAND
4.
Changes in Expectations
Market coffee prices are expected to
substantially increase in the next three
months.
Price ($)
D
D’
Dunkin Donuts 2 lb Coffee Beans
Qty Demanded (000s)
The Platinum X-Box debuts
in November 2014
Price ($)
D
D’
Standard X Box
Qty Demanded (000s)
SECTION 2
MODULE 5: INTRO TO DEMAND
2.
Changes in Expectations
Inferior Good
Luxury Good
Normal Good
…income is expected to increase in the near future
Price ($)
Price ($)
Price ($)
D’
D
Yugo Qty Demanded (000s)
(Inferior Good)
D
D’
Accord Qty Demanded (000s)
(Normal Good)
D
D’
BMW Qty Demanded (000s)
(Luxury Good)
SECTION 2
MODULE 5: INTRO TO DEMAND
2.
Changes in Expectations
Inferior Good
Luxury Good
Normal Good
…income is expected to decrease in the near future
Price ($)
Price ($)
Price ($)
D
D’
Yugo Qty Demanded (000s)
(Inferior Good)
D
D’
Accord Qty Demanded (000s)
(Normal Good)
D’
D
BMW Qty Demanded (000s)
(Luxury Good)
SECTION 2
MODULE 5: INTRO TO DEMAND
5.
Changes in Number of Consumers
Communist Cuba now opens up trade
with the United States.
Price ($)
D
D’
US Automotive Market
Qty Demanded (000s)
China announces huge import tax on
Orange Juice.
Price ($)
D
D’
Orange Juice Market
Qty Demanded (000s)
SECTION 2
MODULE 5: INTRO TO DEMAND
~Demand Summary~
Variable
Price of the good itself
A Change in that Variable
Represents a movement
along the Demand curve
Income
Shifts the Demand Curve
Prices of Related goods
Shifts the Demand Curve
Consumer Tastes
Shifts the Demand Curve
Expectations
Shifts the Demand Curve
Number of Buyers
Shifts the Demand Curve
SECTION 2
MODULE 6: INTRO TO SUPPLY
Ex. 1: Producing Calaphon® Spatulas
What do you notice about the relationship between
price and quantity supplied?
Supply Schedule
Price ($)
Quantity
Demanded (units)
A
1.00
95,000
B
2.00
100,000
C
3.00
115,000
D
4.00
125,000
E
5.00
150,000
F
6.00
200,000
Scenarios
Law of Supply
price
….
Quantity Supplied
-Or-
Quantity Supplied
….
price
ceteris paribus: all else being equal
SECTION 2
MODULE 6: INTRO TO SUPPLY
Price ($)
E
5
We have to be very careful….
D
4
C
3
Supply Curve
B
2
1
Plot the points from the supply
schedule to create the:
SUPPLY CURVE
F
6
A
95 100 115 125 150 200
Movement ALONG the supply curve just
tells us at a given price this is the
“quantity supplied” for spatulas….
We never, ever say supply at $2.00-we
say “quantity” supplied at $2.00.
Quantity Supplied of
My Ebook (000’s)
DO NOT confuse SUPPLY with QTY. SUPPLIED
Your Graphs Should Always Have “Qty Supplied” on the x-axis
PRICE always determines Quantity Supplied
SECTION 2
MODULE 6: INTRO TO SUPPLY

Five Principal Factors That SHIFT The Supply
Curve for a Good or Service
1.
Changes in the input prices
2.
Changes in prices of related goods or services
3.
Changes in technology
4.
Changes in expectations
5.
Changes in the number of producers
SECTION 2
MODULE 6: INTRO TO SUPPLY
Increases or Decreases in SUPPLY of a Good Causes Shifts in SUPPLY CURVE
Price ($)
6
F’
E
5
E’
D
4
2
A
5
2
B’
1
A’
95 100 115 125 150 200 Qty. Supplied of
Spatulas (000’s)
Increase in Supply Curve
F
E’
E
D’
D
C’
3
C’
B
F’
6
4
D’
C
3
1
Price ($)
F
C
B’
A’
B
A
95 100 115 125 150 200
Qty. Supplied of
Spatulas (000’s)
Decrease in Supply Curve
SECTION 2
MODULE 6: INTRO TO SUPPLY
1.
Changes in Input Prices
To make my spatulas I need plastic pellets, black dye, and stainless steel.
These ingredients are called “inputs” in the business world.
As you could imagine pricing changes in my inputs change my ability to
produce and will affect the overall supply of spatulas.
Plastic Pellets Price
Price ($)
S’
S
Spatulas
Qty. Supplied (000s)
Plastic Pellets Price
Price ($)
S
S’
Spatulas
Qty. Supplied (000s)
SECTION 2
MODULE 6: INTRO TO SUPPLY
2(a)
Changes in the Prices of Related Goods or Services
“The Case of Substitute Goods”
As a manufacturer, I supply more than just spatulas to the market. I also
produce spoon strainers using the same exact inputs. Let us see how the
market for spoon strainers affects my supply of spatulas.
Price of Spoon Strainers
Price of Spoon Strainers
Price ($)
S’
S
Spatulas
Qty. Supplied (000s)
Price ($)
S
S’
Spatulas
Qty. Supplied (000s)
SECTION 2
MODULE 6: INTRO TO SUPPLY
2(b)
Changes in the Prices of Related Goods or Services
“The Case of Complementary Goods”
As a manufacturer, I also supply the complementary good of sheets of molded
resin as a byproduct of my manufacturing process. Let us see how the market
for sheets of molded resin affect my supply of spatulas.
Price of Sheets of Molded Resin
Price ($)
S
Price of Sheets of Molded Resin
Price ($)
S’
Spatulas
Qty. Supplied (000s)
S’
S
Spatulas
Qty. Supplied (000s)
SECTION 2
MODULE 6: INTRO TO SUPPLY
3.
Changes in Technology
Any changes in technology, help me to reduce my inputs yet still let me to
produce at the same level of output. Threfore, I can increase my production
capacity without additional cost. This causes my supply of spatulas to
increase and results in the supply curve shifting to the right. I am more
willing to supply spatulas at any given price.
Technology
Technology
Price ($)
S
S’
Spatulas
Qty. Supplied (000s)
Price ($)
S’
S
Spatulas
Qty. Supplied (000s)
SECTION 2
MODULE 6: INTRO TO SUPPLY
4.
Changes in Expectations
If I anticipate a price increase of spatulas in the near future, I will idle some
manufacturing capacity now in anticipation of the future downturn.
Likewise, if I anticipate a price decrease of spatulas in the near future, I will
re-start idle manufacturing capacity now in anticipation of the future upturn.
Anticipated Increase in Price
of spatulas in the near future
Price ($)
S’
S
Spatulas
Qty. Supplied (000s)
Anticipated Reduction in Price
of spatulas in the near future
Price ($)
S
S’
Spatulas
Qty. Supplied (000s)
SECTION 2
MODULE 6: INTRO TO SUPPLY
5.
Changes in Number of Producers
If I anticipate a price increase of spatulas in the near future, I will idle some
manufacturing capacity now in anticipation of the future downturn.
Likewise, if I anticipate a price decrease of spatulas in the near future, I will
re-start idle manufacturing capacity now in anticipation of the future upturn.
Anticipated Increase in Price
of spatulas in the near future
Price ($)
S’
S
Spatulas
Qty. Supplied (000s)
Anticipated Reduction in Price
of spatulas in the near future
Price ($)
S
S’
Spatulas
Qty. Supplied (000s)
SECTION 2
MODULE 6: INTRO TO SUPPLY
~Supply Summary~
Variable
Price of the good itself
A Change in that Variable
Represents a movement
along the supply curve
Input Prices
….
Shifts the Supply Curve
Technology
….
Shifts the Supply Curve
Expectations
…..
Shifts the Supply Curve
Number of Sellers ….
Shifts the Supply Curve