Summary Macroeconomics chapters 1 - 10, 12, 13 and 19
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Course
Economics
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Universiteit Leiden (UL)
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Macroeconomics
Summary study book Macroeconomics of Paul Krugman & Robin Wells (Chapter 1 - 10, 12, 13, 19) - ISBN: 9781429283434, Edition: 3, Year of publication: 2012
2024 Exam Domination with [Macroeconomics,Krugman,3e] Study Guide
Macroeconomics, Krugman - Solutions, summaries, and outlines. 2022 updated
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Chapter 1 – The principles.
The principles of individual choice:
1. Choices are necessary because resources are scarce. People have limited income and
time, so they have to make decisions.
2. The true cost of something is its opportunity cost – that what you must give up in order
to get something you want.
3. “How much” is a decision at the Margin. These decisions require making trade-offs:
comparing the costs and benefits of doing a little bit more or less of an activity. The studies
of such decisions is known as marginal analysis.
4. People usually respond to incentives exploiting opportunities to make themselves better
off. This principle is the basis of all predictions about human behavior.
Principles of interaction of individual choices:
5. There are gains from trade. These gains arise from division of tasks (=specialization).
Because of specialization, the economy can produce more.
6. Because people respond to incentives, markets move towards equilibrium – a situation
when no individual would be better off doing something different.
7. Resources should be used efficiently to achieve society‟s goals, so that it has fully
exploited all opportunities to make everyone better off. Mostly there is a trade-off between
equity (fairness) and efficiency.
8. Markets usually lead to efficiency because people usually exploit gains from trade.
Efficiency: all opportunities to make some people better without making other people
worse off have been exploited.
9 When markets don‟t achieve efficiency, government intervention can improve society‟s
welfare. Markets fail because:
- Individual actions have side effects that are not properly taken into account by the market.
- One party prevents mutually beneficial trades from occurring in an attempt to capture a
greater share of resources for itself.
- Some goods are unsuited for efficient management by markets.
Principles of economy-wide interactions:
10. One person‟s spending is another person‟s income. This can cause a chain reaction of
changes in spending behavior that tends to have repercussions that spread through the
economy.
11. Overall spending sometimes gets out of line with the economy‟s productive capacity. Low
spending can cause recessions, and too much spending can cause inflation – a rise in prices.
12. Government policies can change spending, through taxes (influences how much people
have left), its control of the quantity of money and its own spending on e.g. education.
These are called „tools of macroeconomic policy‟.
Chapter 2 – Economics models: Trade-off and trade.
A model is a simplified representation of reality that is used to better understand real-life
situations. How?
1. To find or create a real but simplified economy, or
2. Simulate the workings of the economy on a computer. These are called thought
experiments.
Models allow economist to focus on the effects of only one change at the time. This
assumption is the other things equal assumption, meaning that all other relevant factors
remain unchanged.
,Trade-offs: The Production Possibility Frontier (PPF)
This model improves our understanding of trade-offs by considering a simplified economy
that produces only two goods. There are three points in a PPF graph, inside (feasible but not
efficient), on (feasible and efficient in production) and outside (not feasible) the frontier line.
The PPF is a good way to illustrate the general economic concept of efficiency. A key
element is that there are no missed opportunities in production. If the production is on the
frontier line, we say the economy is efficient in production. However, it is important to
understand that efficiency in production is only part of an efficient economy as a whole.
Efficiency also requires the economy to allocate its resources so that consumers are as well
off as possible – this is called efficient in allocation. To be efficient, an economy must
produce as much of each good as it can, given the production of other goods, and it must
also produce the mix of goods that people want to consume.
The PPF is also useful as a reminder of that fundamental point that the true cost of any good
isn‟t the money it costs to buy, but what must be given in order to get that good - the
opportunity cost. As more of a good is produced, its opportunity cost typically rises
because well-suited inputs are used up and less adaptable inputs must be used instead.
The PPF also helps us understand economic growth – expansion of the economy‟s
production abilities, the economy can produce more of everything. There are two sources of
economic growth: 1) increase in the economy‟s factors of production, the resources used
to produce goods and services (land, labor, physical capital and human capital) and 2)
progress in technology, the technical means for the production of goods and services.
Comparative Advantage and Gains from Trade
A country has a comparative advantage in producing something if the opportunity cost of
that production is lower for that country than for other counties. The model provides two
things: 1) a clear illustration of the gains of trade – through specialization and trade, both
countries produce more and consume more than if they were self-sufficient, and 2) it
demonstrates that each county has a comparative advantage in producing something, and
everyone has a comparative disadvantage in something. The US for example has an
absolute advantage, the country can produce more output per worker than other
countries. But it can still benefit from trading because comparative advantage is the basis for
mutual gain.
Transitions: The Circular-Flow Diagram
The Circular-Flow diagram represents the transactions that take place in an economy by
two kinds of flows around a circle: flows of physical things such as goods, services, labor, or
raw materials in one direction, and flows of money that pay for these physical things in the
opposite direction. The simplest diagram illustrates an economy that contains only two kinds
of inhabitants: households and firms. There are also two kinds of markets: markets for
goods and services (in which households buy goods they want from firms) and factor
markets (firms buy resources they need to produce). Factor markets ultimately determine
an economy‟s income distribution, how the income created in an economy is allocated
between less skilled workers, highly skilled workers, and the owners of capital and land. A
few complications of this diagram include: a missing government, no space for family
businesses, and missing firms selling to other firms.
, Positive vs. Normative Economics
Analysis that tries to answer questions about the way the world works, which have definite
right and wrong answers, is known as positive economics (about description). Analysis
that involves saying how the world should work, is known as normative economics (about
prescription).
When and Why economists disagree
Media exaggerates the fact that they disagree, when they agree, they just don‟t cover it in
the news because it is not worth covering. Another thing is that economics is closely tied up
in politics. An important source of differences lies in values. A second arises from economic
modeling, which can lead to different conclusions.
Chapter 3 – Supply and demand.
A competitive market is a market in which there are many buyers and sellers of the same
good or service. No individual‟s actions have a noticeable effect on the price at which the
goods or service is sold. The markets behavior is described by the supply and demand
model. There are five key elements in this model:
1. The demand curve.
2. The supply curve.
3. The set of factors that cause the demand curve to shift and the set of factors that cause
the supply curve to shift.
4. The market equilibrium, which includes the equilibrium price and equilibrium quantity.
5. The way the market equilibrium changes when the supply curve or demand curve shifts.
1. The demand curve
A demand schedule shows how much of a good or service consumers will want to buy at
different prices. This can be used to draw a demand curve – a graphical representation of
the demand schedule, showing the relationship between quantity demanded and price. The
quantity demanded is the actual amount of a good or service consumers are willing to buy
at some specific price. Generally, the proposition that a higher price for a good, other things
equal, leads people to demand a smaller quantity of that good is so reliable that economists
call it the law of demand. A shift of the demand curve is a change in the quantity
demanded at any given price, represented by the change of the original demand curve to a
new position, denoted by a new demand curve. This is different than a movement along
the demand curve, which is a change in the quantity demanded of a good arising from a
change in the good‟s price. There are five factors that shift the demand curve for a good or
service:
- changes in the prices of related goods or services. Two goods are substitutes if a rise in
the price of one of the goods leads to an increase in the demand for the other good. Two
goods are complements if a rise in the price of one good leads to a decrease in the
demand of another good.
- Changes in income. When a rise in income increases the demand for a good –the normal
case- it is a normal good. When a rise decreases the demand of a good, it is an inferior
good.
- Changes in tastes.
- Changes in expectations.
- Changes in the number of consumers. An individual demand curve illustrates the
relationship between quantity demanded and price for an individual consumer.
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