Introduction to Macroeconomics  What is Economics Economics is concerned with the way resources are allocated among alternative uses to satisfy human wants.

Economics An economy face many decisions:  Who will work?  What goods and how many of them should be produced?  What resources should be used in production?  At what price should the goods be sold?

Economics  What caused the financial crisis in 2008?  Why did the market fail in the financial market and health care market?  Why does the recession last so stubbornly long?  Is the economy recovering from recession?

Learn economic reasoning  Should the government be required to balance budget each year?  Supporters’ argument: Just like an individual household, when the government income falls in recession, they should also cut spending to balance the budget.

Economic reasoning is often against conventional wisdom  What is true for a household may not be true for the entire economy  If the government cuts in spending in recession, it makes bad situation worse.  Lesson in the Great Depression  “Paradox of Thrift”

Economics is useful  Required by many disciplines, including Business Administration, Pharmacy, Industrial Engineering, etc.  Makes you intelligent and think economically  Help planning your career

What does economics do?  Economics is concerned with the way resources are allocated among alternative uses to satisfy human wants. Human wants are unlimited But the productive sources, such as land, labor and capital, at any moment, are limited. Hence, we need economics to help to efficiently allocate resources to satisfy human wants.

 “There is no such thing as a free lunch!” Scarcity and choice

What does Economics study?  What (and how much) are to be produced? Issue of Consumption  How to produce? Issue of Production  For whom to be produced? Issue of Distribution.

What (and how much) are to be produced  Issue of Consumption  In a market system, we use dollars to vote. Then the firms, motivated by making profits, respond to produce goods that can bring them more dollars.  Consumers want more computers, they will spend more money on computers, and firms observing more demand for computers, they produce more.

What (and how much) are to be produced  Issue of Consumption  In a planning system, the central planers makes the decision.  They never can follow the consumers preferences closely. Hence, there are often shortages and surpluses in the markets  That is why the Soviet system collapsed.

How to produce  In a market system where the private ownership prevails, the production decision is made by private firms.  They are motivated by making profits.  Incentive compatible.

How to produce  In the centrally planning system, like the former Soviet Union, Cuba, the planners issue orders to firms to produce  The plan is a comprehensive table that requires firms to produce the quantities, assortments, etc.  But the planners never know if the firms can produce the right amount of each product and at right cost.  That is why the planning system, the communism, fails.

For whom to produce  Issue of distribution  After the goods produced, who can receive how much?  Bill Gates? Carty Finkbeiner or Michael Bell? Plumber Joe Smith?

For whom to produce  In a market system, it depends how many dollars you have. Income and wealth.  This raised the equity issue.  This may also cause the economy unproductive If the income gap causes the society unstable.

For whom to produce  A large income gap may also lower the aggregate utility of the society If the a luxury mansion is just behind a slum in the same block. It makes the rich residents in the mansion also uncomfortable

Urban slum

Do you like to live in this mansion?

For whom to produce  The market system can efficiently solve the problems of consumption and production but not the distribution problem  The government is needed to make transfer payment to reduce the inequality in income distribution

Transfer payment  Transfer payment include progressive tax for rich, and subsidy, welfare payment for the very poor.  This will raise the aggregate utility (welfare) of the entire community.  This is justified by the marginal utility theory.

Income distribution and transfer payment  It will bring the issue of the: Efficiency v. Equity Efficiency means society gets the most that it can from its scarce resources. Equity means the benefits of those resources are distributed fairly among the members of society.

Income distribution  Two extremes: perfect egalitarian and absolute inequality  In a perfect egalitarian society, every one receives the same income, regardless what his contribution is  This will hurt the incentive system, and people won’t work hard.

Income distribution  In an extreme inequality, where is the overwhelm wealth of the society goes to a very small fraction of the population, the society is in a danger of social unrest.

Income distribution  So, a society should choose something between. While the government should keep the incentive system and award those who contribute more to the economy, the government should also help the poor and disadvantaged, to improve their living conditions.

Conclusion: Markets Are Usually a Good Way to Organize Economic Activity.  A market economy is an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services. Households decide what to buy and who to work for. Firms decide who to hire and what to produce.

Conclusion: Markets Are Usually a Good Way to Organize Economic Activity.  Adam Smith made the observation that households and firms interacting in markets act as if guided by an “invisible hand.” Because households and firms look at prices when deciding what to buy and sell, they unknowingly take into account the social costs of their actions. As a result, prices guide decision makers to reach outcomes that tend to maximize the welfare of society as a whole.

Governments Can Sometimes Improve Market Outcomes.  Markets work only if property rights are enforced. Property rights are the ability of an individual to own and exercise control over a scarce resource  Market failure occurs when the market fails to allocate resources efficiently.  When the market fails (breaks down) government can intervene to promote efficiency and equity.