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2 Microeconomics looks closely at the behavior of individual participants in the economy. While it does aggregate the observations it makes and draws general conclusions, more often than not it is focused on the trees rather than on the whole forest. The forest is the focus of Macroeconomics. 2

3 Here s another look Micro is focused on individual agents and their interactions. Macro is focused on the overall economic environment. 3

4 This view, which looks at the Micro/Macro divide, shows how difficult it is to completely separate the two disciplines. After all, every economic agent the micro economist focuses on exists in a macro world. 4

5 You ve seen this chart or one very much like it before. It s the circular flow model but this time, it includes the influence of the government, foreign economies, and the banking sector. The underlying principles are the same however. Households and firms interact, buying/selling products/services/labor, etc. in the overall economy which is impacted by the actions of government, banks, and foreign banks/firms/governments. 5

6 We think about the overall level of activity in the circular flow as GDP or gross domestic product. What goes into GDP? Well, the estimates above, in trillions of dollars, represent the total value of all final goods and services bought by the final user during a given time period. Note the value of intermediate products (components) is already factored into the estimate you see here. 6

7 Changes in GDP both up and down over a period of years is called a business cycle. The trend shown here is upward consistent with the previous GDP chart but it doesn t have to be upward. There are 4 stages or parts. The first part is the expansion part. Starting at point A, label the blue line in the two places where expansion is occurring. 7

8 The second stage is peak This is where expansion ends and recession/contraction starts. Label the two peaks. 8

9 The third stage is contraction/recession. Label that phase 9

10 Finally, the trough stage is where contraction/recession ends and growth resumes. 10

11 Here are all four on a similar chart. This one also shows the overall trend heading up. Again, The first is stage on the chart is expansion. (GDP goes up) Second stage is peak. (GDP growth ends, recession starts) Third stage is contraction/recession. (GDP decreases at least 2 consecutive quarters) Fourth stage is trough. (Recession ends, expansion starts) 11

12 After a lengthy post war (WWII) debate about unemployment, macro economic theorists began to focus on the longer term issue of economic growth. Classical theorists assumed that technology is predetermined exogenous and excluded it from their models of the economy. But let s take a big step back in time and consider a British political economist and demographer approach. He focused on changes in the quantity of labor, and theorized that population tended to grow geometrically, while supply of land (which provided food) was limited and could not grow at all. Given those assumptions, and the assumption of a relatively fixed level of technology, what would have happened if his theory had been right? (Population outstrips the ability of the economy to supply it with food. People starve, start wars, etc. and population growth slows, or reverses.) N.B. 12

13 Having said that Malthus wasn t exactly right, it s only fair to point out that he wasn t exactly wrong either. Some of the elements of his theory are still useful in trying to understand the interaction of population and limited food or water supplies and the resulting problem of famine particularly in countries that are less developed than ours. 13

14 If Malthus was a pessimist, a late 1700s/early 1800s contemporary of his named David Ricardo was more of an optimist. His work focused on the clash between the newly emerged industrialists and landowners. One flash point in that clash was over the Corn Laws rising population contributed to rising demand for grains (corn was the term for all grains, not just corn) which also led to higher prices. The landowners liked that trend because it allowed them to make more profits. The industrialists complained because they had to pay higher wages so that people could afford food so they began to import cheaper foreign grain. You can guess what happened next the landowners, who dominated parliament, passed the Corn Laws which imposed tariffs on that imported grain. Industrialists complained. People starved. Ricardo s analysis suggested that unless the landowners control of the price of grain could be weakened, they would capture most of the benefits of higher grain prices so he advocated the repeal of the laws using the principle of comparative advantage as the foundation of his argument. 14

15 DEFINITION OF 'COMPARATIVE ADVANTAGE' The ability of a firm or individual to produce goods and/or services at a lower opportunity cost than other firms or individuals. A comparative advantage gives a company the ability to sell goods and services at a lower price than its competitors and realize stronger sales margins. The principle of comparative advantage argues for specialization. 15

16 We re going to do a little comparative advantage exercise to help us get our heads around this concept. I ll do the first one. You figure out the rest. Use salads as the cost of producing a pizza. Use pizza as the cost of producing a salad. You ll need two answers for each of 4 scenarios. Here s the first scenario: Opportunity cost of producing 9 pizzas (for Nino) is salads? For one pizza salads. What are the 2 nd, 3 rd, and 4 th scenarios? Nino pizza 36/4 (salads) Tony pizza 12/2 (salads) Nino salad 9/ ¼ (pizzas) Tony salad 6/ ½ (pizzas) Who has the lower opportunity costs for making pizzas? (Tony) Who has the lower opportunity costs for making salads? (Nino) Who has the comparative advantage for producing pizza? Tony Salad? Nino 16

17 So who should do what? Pizza Tony Salad Nino. 16

18 These goals often conflict with each other. 17

19 Fiscal and Monetary policies interact. Those interactions may or may not be beneficial to the economy as a whole. 18

20 DEFINITION of 'Phillips Curve' An economic concept developed by A. W. Phillips stating that inflation and unemployment have a stable and inverse relationship. According to the Phillips curve, the lower an economy's rate of unemployment, the more rapidly wages paid to labor increase in that economy. 19

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