Download aggregate price level

EC 102.01
Lecture 1
Syllabus
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Instructors: Asst. Prof. Burçay ERUS and Dr. Burcu
YAKUT-ÇAKAR
How to reach the instructor:
 By e-mail: burcay.erus@boun.edu.tr,
burcu.yakut@boun.edu.tr
 By phone from the office: 359 7638 or 359 7652
 After the class or by appointment
 Office Hours: Tuesday 15:00-17:00 and by
appointment
Textbook: : Macroeconomics in Context, Goodwin, et al.,
M.E. Sharpe, 2009,
Powerpoints will be posted on the website
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Course requirements:
 Midterms (2*30%)
 Final (40%)
Cheating will be severely punished!
See the syllabus at the course website for more info.
What is economics
Study of how society decides what, how
and for whom to produce
 Study of the way people organize
themselves to sustain life and enhance its
quality
 resource maintenance, production,
distribution and consumption of goods and
services.

Macroeconomics vs.
Microeconomics
Microeconomics focuses on how decisions are made by
individuals and firms and the consequences of those decisions.

Ex.:
How much it would cost for a university or college to
offer a new course? (including the cost of the instructor’s
salary, the classroom facilities, the class materials, and so on).
Having determined the cost, the school can then decide
whether to offer the course.
Macroeconomics vs.
Microeconomics
Macroeconomics examines the aggregate behavior of the
economy ─ how the actions of all the individuals and firms in the
economy interact to produce a particular level of economic
performance as a whole.
Ex.:
Overall level of prices in the economy (how high or how
low they are relative to prices last year) rather than the price
of a particular good or service.
Microeconomic vs
Macroeconomic Questions
Microeconomic
Macroeconomic
Should I go to summer school or take
a job?
How many people are employed this
summer?
What determines salary offered by
Garanti Bank to Huseyin Kum, a
recent Bogazici grad?
What determines overall salary level in
the economy?
What determines the price of
chocolate produced by Eti and Ulker?
What determines the level of prices in
the overall economy?
What government policies are needed
to make it easier for Roma students to
enroll in schools?
What government policies should be
adopted to promote employment and
growth in overall economy?
What determines whether Akbank
opens a branch in Berlin?
What determines overall trade in
goods, services, and financial assets
between Turkey and the rest of the
world?
Digression: Development of
Macroeconomics
Classical Period: 18th century – industrial revolution
Stressing the issues of growth and development based
on an image of smoothly-functioning markets.
Specialization/division of labour + laissez faire
Great Depression, Keynes and Monetarism
Aggregate demand is important, need to use fiscal
policy to keep demand and employment at high
levels – Keynes
Governments should only aim for steadiness in the
money supply via monetary policies - Monetarism
How Individuals Make Choices:
Basic
principles behind the individual choices:
1. Resources are scarce.
2.
The real cost of something is what you
must give up to get it
 Opportunity cost
It is all about what you have to forgo to obtain
your choice.
How Individuals Make Choices:
3. “How much?” is a decision at the
margin.
 Trade-offs
 Marginal decisions and marginal
analysis

4. People usually take advantage of
opportunities to make themselves better
off.
 Incentives

Economic Activity in Context
Macroeconomic Goals
positive vs. normative questions
Concept of “well-being”
(i) Living standards – “keep living standards of
the individuals high enough to maintain
long, healthy and enjoyable lives”
economic growth + political freedom +
social inclusion
- economic development
Growth but: What is produced? How ? For
whom?
Economic Activity in Context
(ii) Stability – temporal dimension
fluctuations - boom vs. recession
business/trade cycles – alternating periods of
B/R
(iii) Sustainability
financially? – “debt crises”
socially? – “disparities in living standards”
ecologically? – “catastrophic effects”
Need for a rethinking of economic growth
Economic Activity in Context
Share in national income
1987
1994
2002
2003
2004
2005
2006
Total Household Income
100
100
100
100
100
100
100
Lowest 20 %
5,2
4,9
5,29
6
6,04
5,1
5,8
Second 20 %
9,6
8,6
9,81
10,28
10,69
9,9
10,6
Third 20 %
14,1
12,6
14,02
14,47
15,22
14,8
15,2
Fourth 20 %
21,2
19
20,83
20,93
21,88
21,9
21,5
Highest 20 %
49,9
54,9
50,05
48,32
46,17
48,4
46,9
Gini coefficient
0,43
0,49
0,44
0,42
0,40
0,43
0,41
What Economies Do?
Goals (were): good stds of living, stability and
sustainability – need to understand building
blocks
Need to combine micro and macro perpectives to
understand the functionings
Four essential economic activities:
resource maintenance, production, distribution and
consumption of goods and services.
Essential Economic Activities
Resource maintenance: tending to preserving
or improving the stocks of resources for
preservation and quality of life
Capital stock – valuable for economic
contribution!
Types: natural (physical assets provided by
nature), manufactured (human productive
activities added to natural), human (individual’s
capacity fo labour – skills and knowledge),
social (stock of trust, mutual understanding).
Essential Economic Activities
Production: conversion of resources into useble
products – tangible/intangible, manufactured
Inputs -> outputs + waste products
Need to consider capital stocks
Distribution: sharing of products and resources
among people
Markets facilitate exchange relations
Transfers - payments given without return
expectation (monetary/non-monetary – in kind)
Essential Economic Activities
Consumption: final use of goods and services by
individuals to satisfy needs.
May choose to save for consumption in the following
periods.
Flow of savings (either from individuals, business
and government) add to the stock of available
financial assets.
Use of financial intermediaries help facilitate the
savers to loan out to those who want to borrow
Some borrowed funds could be used for creation of
new investment goods – aim to maintain
resources
Spheres of Economic Activity
Core Sphere – household, family, community that organize
resource management, production and consumption.
work is rewarded directly by what it produces
eg. Childcare, elderly care, decisions on labour supply, decision
on skills and education, allocation of consumption (and
savings/investment)
Public-Purpose Sphere – governments, NGOs, international
organizations
Exist for a specific purpose related to the “public good”, i.e.
beyond individual and family interest.
eg. Regulation, direct provision
Spheres of Economic Activity
Business Sphere – firms, looking for opportunities to
buy and manage resources.
Responds to demands for goods and services (as
opposed to core: direct needs; public-purpose: its
constitutents)
Propriatorships, partnerships, cooperatives, corporations
One clear goal : making profit! (most valuable outputs to
produce, produce at the least possible cost,
innovation)
Less Developed Country Context – Informal Sphere
Outside government oversight and regulation – could be
illegal, illicit but not necessarily.
Models in Economics:
A
model is a simplified representation of a
real situation that is used to better understand
real-life situations.
The
production possibility frontier (PPF)
illustrates the trade-offs facing an economy
that produces only two goods. It shows the
maximum quantity of one good that can be
produced for any given production of the other.
Tom’s Trade-offs: The Production
Possibility Frontier
Increasing Opportunity Cost
Economic Growth
Economic growth results in
an outward shift of the PPF
because production
possibilities are expanded.
Transactions: The Circular-Flow Diagram
The circular-flow diagram is a model that represents
the transactions in an economy by flows around a circle.
Circular-Flow of Economic
Activities
Economic Agents:
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Households: do consumption decision and are the owners of
factors of production
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Aim: maximize utility
Firms: rent or employ the factors of production and do the
production decision
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Aim maximize profits
Where they interact:
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Markets for goods and services
Markets for factors of production
Market
not a place but a mechanism bringing seller and buyer
together
Price mechanism allocates the resources
Graphs: Pay attention to scale and
size of increments
Graphs:
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Pay attention to the variable of interest
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Be wary of causality
The Great Depression
The Great Depression precipitated a thorough rethinking of
macroeconomics, which gave rise to modern macroeconomics.
The Business Cycle
The business cycle is the short-run alternation between
economic downturns and economic upturns.
A depression is a very deep and prolonged downturn.
Recessions are periods of economic downturns when output
and employment are falling.
Expansions, sometimes called recoveries, are periods of
economic upturns when output and employment are rising.
The Business Cycle
What happens during a business cycle, and what can be done
about it?
the effects of recessions and expansions on unemployment;
the effects on aggregate output; and
the possible role of government policy.
Employment and Unemployment
Employment is the number of people working in the economy.
Unemployment is the number of people who are actively
looking for work but aren’t currently employed.
The labor force is equal to the sum of employment and
unemployment.
Employment and
Unemployment
Discouraged
workers are non-working people who
are capable of working but are not actively looking for a
job.
Underemployment is the number of people who work
during a recession but receive lower wages than they
would during an expansion due to smaller number of
hours worked, lower-paying jobs, or both.
The unemployment rate is the ratio of the number of
people unemployed to the total number of people in the
labor force, either currently working or looking for jobs.
History of the unemployment rate
since 1948
Taming the Business Cycle
Policy efforts undertaken to reduce the severity of recessions are
called stabilization policy.
One type of stabilization policy is monetary policy,
changes in the quantity of money or the interest rate.
The second type of stabilization policy is fiscal policy,
changes in tax policy or government spending, or both.
Long-Run Economic Growth
Secular long-run growth, or long-run growth, is the
sustained upward trend in aggregate output per person over
several decades.
A country can achieve a permanent increase in the standard of
living of its citizens only through long-run growth. So a central
concern of macroeconomics is what determines long-run growth.
U.S. real gross domestic product per person
from 1900 to 2004
Aggregate Price Level
A nominal measure is a measure that has not been adjusted for
changes in prices over time.
A real measure is a measure that has been adjusted for changes
in prices over time.
The change in real wages is a better measure of changes in
workers’ purchasing power than the change in nominal wages.
The aggregate price level is the overall level of prices in the
economy.
Consumer price index from 1913 to 2004
Inflation and Deflation
A
rising aggregate price level is inflation.
A falling aggregate price level is deflation.
The inflation rate is the annual percent change
in the aggregate price level.
The economy has price stability when the
aggregate price level is changing only slowly.
Inflation and deflation since 1929
The Open Economy
A closed economy is an economy that does not trade goods,
services, and assets.
The United States has become increasingly open, so that openeconomy macroeconomics has become increasingly important.
Open-economy macroeconomics is the study of those
aspects of macroeconomics that are affected by movements of
goods, services, and assets across national boundaries.
The Open Economy
One of the main concerns introduced by open-economy
macroeconomics is the exchange rate, the price of one currency
in terms of another.
Exchange rates can affect the aggregate price level.
They can also affect aggregate output through their effect on
the trade balance, the difference between the value of the
goods and services a country sells to other countries and the
value of the goods and services it buys in return.
Economists are also concerned about capital flows,
movements of financial assets across borders.
Movements of the exchange rate
between the U.S. dollar and the euro
Distribution: Who gets what and
how???
Distribution in form of exchange and in form of transfer –
Main Q: who receive the incomes generated by
production and the role of government, if any.
Exchange relations: two agree to trade on the basis of
mutuall agreed terms.
Goods and labour markets – monetary flow (L/K income)
Wages, rents, profits – controversial debate over which
is the productive one!
Distribution: Who gets what and how???
Taxes and transfers: funds flowing to and from gov.
From – dependency needs not met elsewhere (care,
shelter, education, health services)
Two main types of transfer programs – social insurance
and means-tested.
Insurance- pool insurance (contributions) to hedge for
risks
Means-tested - non-contributory but
income/assets/wealth being tested
TR: Social Insurance Institution, Unemployment
Insurance Fund, Social Assistance and Solidarity
Fund
Distribution: Who gets what and how???
Taxes and transfers: funds flowing to and from gov.
To – collection of income and consumption/sales taxes (e.g.VAT)
– direct vs. indirect taxes
Proportional?? Progressive vs. regressive
Tax system in TR relies heavily on indirect taxes: in 2008, 32.7 %
of tax revenues come from income taxes while indirect taxes
comprise of 63 % (OECD average 42 %).
Structure of taxation: share of tax revenues in TR constitutes only
24.5 % of GDP (OECD average: 35.8 %, EU-15: 38.8%)
Share of income taxes in GDP (2007) in TR 5.6%
(OECD: 13.2%; EU 15: 14%)
Distribution: Who gets what and how???
Distribution of Income - share of income received by the
population/households
Quintiles – equal sized groups
Distribution of income in TR
Distribution: Who gets what and how???
Measuring Inequality - need to describe the
pattern of inequality - Lorenz Curve
The more bended the
curve, the greater the
inequality of income
Gini Coefficient: ratio of
area between the
Lorenz Curve and
diagonal
0 (perfect equality) < Gini
< 1 (complete
inequality)