Principles of Macroeconomics
ECON203, (EA)
Lecture 1: Introduction
Instructor: Turki Abalala
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Class Outline
 Key tools and Terms of Economics:
• Economics, microeconomics and macroeconomics.
• Economic Problem: Scarcity and Choice.
• Two Big Economic Questions.
• Goods and Services.
 Circular-Flow Model
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Key Tools & Terms of Economics
 Economics?
• A social science that studies how people use their scarce
resources to satisfy their unlimited wants.
• It has tow major branches: Microeconomics and
Macroeconomics.
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Key Tools & Terms of Economics
1. Microeconomics:
The study of choices that individuals and business make and the
way they choices interact in markets and are influenced by
governments.
2. Macroeconomics:
The study of the aggregate effects on the national economy and
the global economy of the choices that individuals , business and
governments make.
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Key Tools & Terms of Economics
• Economic Problem:
– Basic economic problem is wants are virtually unlimited
while the resources available to satisfy these wants are
scarce.
• Scarcity:
– Our inability to satisfy all our wants.
– Human and property resources are scarce, hence the
goods and services we produce must be limited.
• Choices:
– The poor and rich alike face scarcity, so they must MAKE
CHOICES.
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Key Tools & Terms of Economics
Two Big Economic Questions
Q1. How choices determine what, how, and for
whom goods and services get produced?
Q2. When do choices made in self-interest also
promote the social interest ?
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Key Tools & Terms of Economics
 What Do We Produce?
We divide the vast array of goods and services produced into:
• Consumption goods and services
• Capital goods
• Government goods and services
• Export goods and services
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Key Tools & Terms of Economics
• Consumption goods and services
Goods and services that are bought by individuals and used to
provide personal enjoyment and contribute to a person’s
standard of living.
• Capital goods
Goods that are bought by businesses to increase their
productive resources.
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Key Tools & Terms of Economics
• Government goods and services
Goods and services that are bought by governments.
Examples are missiles, bridges, and police protection.
• Export goods and services
Goods and services produced in one country and sold in other
countries. Examples are airplanes produced by Boeing and
Citicorp banking services sold to China.
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Key Tools & Terms of Economics
 How Do We Produce?
Factors of productions are the productive resources used to
produce goods and services. Factors of production are
grouped into four categories:
• Land
• Labor
• Capital
• Entrepreneurship
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Key Tools & Terms of Economics
• Land
It does not refer only a plots of ground but also includes all
other natural resources such as crude oil, water, air, and
minerals etc.
• Labor
It is not simply the number of human bodies but it refers to
the work time and work effort that people devote to
producing goods and services. It categorized into two parts–
physical and mental.
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Key Tools & Terms of Economics
• Capital
In economics the term capital refers to final goods produced
for use in further production. It also categorized into two
parts. These are:
Physical capital: factories, machines, tools, buildings,
airports, highways and other manufactured items
employed to produce goods and services.
Human capital: consists of the knowledge and skill
people acquire to enhance their labor productivity.
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Key Tools & Terms of Economics
• Entrepreneurial Ability:
• Special kind of human skill
• Talent required to dream up a new product or find a better
way to produce an existing one.
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Key Tools & Terms of Economics
 For Whom Do We Produce?
Factors of production are paid incomes:
• Rent Income paid for the use of land.
• Wages Income paid for the services of labor.
• Interest Income paid for the use of capital.
• Profit (or loss) Income earned by an entrepreneur for
running a business.
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Key Tools & Terms of Economics
 Choices made in self-interest also promote the social
interest?
• Choices that are the best for the individuals who makes
them are choices made in the pursuit of self-interest
• Choices that are the best for society as a whole are said to
be in the social interest
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Key Tools & Terms of Economics
Goods and Services:
 Goods are:
• Tangible items
• Require scarce resources
• Satisfy human wants
 Services are:
• Intangible items
• Require scarce resources
• Satisfy human wants
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Circular-Flow Model
Circular-Flow Model is a model of the economy that shows the
circular flow of expenditure and income that result from decision
makers’ choices and the way those choices interact to determine
what, how and for whom goods and services are produced.
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Circular-Flow Model
 Households: Individuals and group of people living together.
They own the factors of production.
• As owners, they supply labor, capital, land, and
entrepreneurship to firms.
• As consumers, households demand the goods and services
produced.
 Firms: Institutions that organize the production of goods and
services.
• Demand the factors of production.
• Supply the goods and services.
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Circular-Flow Model
 Markets: Any arrangement that bring buyers and sellers
together and enable them to get information and do business
with each other.
• Goods markets: Markets in which goods and services are
exchanged (bought and sold).
• Factors Markets: Markets in which the services of factors
of production are exchanged (bought and sold). Labor, or
job, market is the most important of the resource markets.
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Circular-Flow Model
Goods and
services bought
supplied
Rent, wages, interest,
and profit
Households supply resources in the
factor markets and demand goods
and services in the goods market.
Firms supply goods and services in
goods market and demand resources
in the factor market
Expenditure on
goods and
services
Money flows in factor market
determines wages (labor), interest
(capital), rents (land), and profits
(entrepreneurship) which flow as
income to households
Labor, land, capital,
entrepreneurship
hired
Goods and
services supplied
Factor markets determine the prices
for goods and services which flow as
revenue to firms
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Circular-Flow Model
 Real Flows:
• The services of factors of production that go from
households through factor markets to firms.
• The goods and services that go from firms through
goods markets to households.
 Money Flows:
• The income earned by the factors of production.
• The expenditure on goods and services.
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Circular-Flow Model
 Governments
Governments are divided into two broad levels:
• Federal Government
• State and local government
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Circular-Flow Model
 Federal Government
The federal government’s major expenditures are to provide
1. Goods and services (including legal system and national
defense).
2. Social Security and welfare benefits (including income for
retired people and transfers to households)
3. Transfers to state and local governments
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Circular-Flow Model
 The federal government finances its expenditures by
collecting taxes. The main taxes are
• 1. Personal income taxes
• 2. Corporate (business) taxes
• 3. Social Security taxes
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Circular-Flow Model
 State and Local Governments
State and local governments expenditures provide
1. Goods and services (including police, schools, roads…etc)
2. Welfare benefits (including unemployment benefits)
State and local governments finance these expenditures by
collecting taxes. The main taxes levied are
1. Sales taxes
2. Property taxes
3. State income taxes
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Circular-Flow Model
 Governments In the Circular Flow
• Households and firms pay
taxes and receive transfers.
• Governments buy goods
and services from firms.
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Reference
• Chapter 1-3 “Foundations of Macroeconomics”:
for circular-flow model see pages.48-51
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Now it’s over for today.
Any question?
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