Notes for Session 1 Econ 201 For our first session, you need to think about the following introductory issues: 1. The difference between microeconomics and macroeconomics: we?ll do an example in our lecture session that illustrates this difference. And, we?ll briefly list some of the important macroeconomic issues (both global and domestic) of the present time. (The relevant readings are in chapter 1 of the textbook on the course website.) Which of the following are primarily macroeconomic issues? Inflation and deflation Price controls on rental units, food, energy, etc. Unemployment Trade deficit Effects of airline deregulation on the number of airline companies and price of airline tickets The federal government budget deficit Economic Growth Speculative bubbles in the financial markets 2. Introducing an overall measure of economic success: how do we measure the success of an economy? i. How is the "productivity of labor" defined and what does this concept have to do with economic success? Productivity of labor is defined as: Productivity = Q/L where Q is the level of aggregate output and L is the number of persons employed in a period. Note that for small changes in the variables defining productivity, the labor productivity relationship can be written as: % change in labor productivity = % change in Q - %change in L ii. An example of the effect of productivity improvement on the standard of living. An example on labor productivity using a simple economic model: One hundred workers Produce only T-shirts Produce T-shirts with labor only One worker produces 1 T-shirt per hour Price of T-shirt = $10 per T-shirt economic profits = 0, Price of a T-shirt = Cost of a T-shirt a. What is the (nominal) wage per hour? b. What is the ?productivity? of labor? c. How many T-shirts can a worker buy with one hour of work? Now suppose workers learn to produce 2 T-shirts per hour. If the nominal wage stays the same, then: a. What would be the cost/price of a T-shirt? b. How many T-shirts can a worker buy with one hour of work? c. How has the standard of living (real wage) for workers changed? 3. Which factors help increase the productivity of labor? 4. What types of expenditures (consumption or investment) do we need to make today in order to improve productivity of labor and increase future production and economic ?welfare?? 5. What is the role of savings in all this? Improved labor productivity requires productive investment in technology and production of new and improved capital goods. Productive investment?which, as we will learn, comes from aggregate savings?takes place in an environment with well functioning legal and financial institutions. Legal institutions help define the rules of the game among transacting parties (e.g., sellers and buyers, lenders and borrowers). These include entities such as Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), the Federal Housing Administration (FHA), the FDIC, etc. The financial institutions include commercial banks, investment banks (mostly gone bankrupt since 2008), credit unions, pension funds, insurance companies, mutual funds, etc. The lax regulatory environment as well as fraudulent practices by some financial operators (private non-bank mortgage originators) are part of the speculative bubble of the mid-2000s that upon bursting in 2007 led to decline in investment and other forms of economic activity. This may all negatively affect the rate of labor productivity improvement in the U.S. for the next few years. The relevant readings on labor productivity are Chapter 1 in the text and the three articles on Productivity on the course website. The first piece, Reading 1, is by Robert Samuelson in Newsweek. The second article, Reading 2, is a weblog from the Wall Street Journal on productivity and the U.S. economy?s performance. The third article, by David Wessel, Reading 3, is from the Capital Section of the WSJ. These articles are on the course webpage under Useful Links. Please make sure, via reading these pieces carefully, that you understand some of the ?short run? associations between higher productivity and higher or lower levels of employment, leading some people to assert that if higher productivity implies lower employment, perhaps productivity growth is not such a good thing after all. In Reading 3, the author, David Wessel, responds to this argument and asserts that while in the short term at times higher productivity of labor may be associated with higher unemployment (an undesirable economic condition), in the long term, improved productivity of labor may account for all good things: higher standard of living, better environment, more leisure, etc! How may the short term productivity improvements be associated with increased misery for workers? Note that labor productivity is measured by dividing total output by the number of workers employed. At the beginning of an economic ?recession? (we will learn more about recessions in chapter 5), output falls but firms are reluctant to layoff their workers at the first signs of recession (can you reason why? We also learn more about this in chapter 5). So output falls while employment stays the same (what is the effect on labor productivity?). Then as the economy moves into the middle of the recession phase, employers start to layoff workers as their demand for workers? services dry up. As the economy improves and output rises (i.e., recession is about to end), firms are similarly slow to hire new workers, waiting to make sure the good news is really going to last before they add new workers to their payrolls. Thus, towards the end of a recession, output rises but employment is stagnant, hence productivity rises while labor employment is not increasing. In other words, good economic news does not immediately translate into increased employment and more paychecks for workers. It is useful --for your understanding of the material of this course-- to know that the study of macroeconomics is filled with ?lags? or ?leads? in (dynamic) movements of various variables in terms of one another! We will define some of these useful dynamic terms in the definitions of ?leading? and ?lagging? variables in chapter 5 and will use them to analyze the art and science of ?fixing? our economic system to return it to the path of prosperity with low inflation and low unemployment. 6. To understand the working of an economy in aggregate and the relationship between production, income, and expenditures, let?s start with the one-person economy of Robinson Crusoe (Chapter 2). To understand the concepts of ?National Product? and ?National Income?, let?s start with a simple example, think of the income of a one person economy, that of Robinson Crusoe (Section 2.1?chapter 2 in the text). We review the concept of the Production Possibility Frontier that you learned in your principles of microeconomics before and use the concept of labor productivity to consider i) what is the opportunity cost of any single activity Crusoe undertakes, ii) what is Crusoe?s national income and product, and iii) how Robinson Crusoe can improve his standard of living on the deserted island. Suppose Robinson Crusoe works 10 hours a day. It takes him: 1 hour to catch a fish 4 hours to sew a fishing net 2 hours to build a yard of fence Which of the following describes his production possibility frontier? a. No. of fish * 1 + No. of Nets * 1/4 + No. of Fences * 1/2 = 10 b. No. of fish * 1 + No. of Nets * 4 +No. of Fences * 2 = 10 What is the opportunity cost of an extra Net in terms of fish forgone? How about the opportunity cost of an extra Net in terms of Fences forgone? According to section 2.1?chapter 2 in the text, what is Robinson Crusoe?s ?national income?? How does it resemble, and, differ from a ?real? economy where a lot of people interact through various institutions? Can Crusoe increase some or all of the categories of goods/services he makes as he wishes? What would help increase Robinson Crusoe?s income (without increasing his hours of work)? PAGE PAGE 1
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