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Milton Friedman was the economist and Co-Writer of Power of the Market.
Immigrants travelled to U.S they first arrived at New York Manhattan, They found no
restrictions to enter a market and they were able to get jobs at the factories and after
some time when they learned the language (English) they were able to give a better life
to themselves.
They take opportunities that they can get in U.S
Founders of the country built and inherit us the climate that gave full scope to the poor
from other lands who came here
Hong Kong has no natural resources but has experienced rapid economic growth
because there’s no tariffs on imports or exports and no duties
Hong Kong’s rapid economic growth is owed to the free market
Hong Kong is one of the free markets in the world and it enables people to get into any
businesses they want, to trade with whomever they want, to buy in the cheapest
market around the world but if they fail, they bear the cost and if they succeed, they get
the benefit
The market tells businessowners what to produce but how best to produce it through
another set of prices (the cost of material, wages)
The concept of the free market that Hong Kong practice today came from Adam Smith
in Scotland
The free market is important not only for productive efficiency but even more to foster
harmony and peace of the people around the world
Human and political freedom has never existed and cannot exist without free market
If a new competitor arises, the company can submit a request a tariff or quota from the
government (very difficult to obtain), or they will have to adapt and overcome o If they
decide to not adapt, the competitor will eventually put them out of business.
In the impersonal forces of a free market, the prices are the key (prices for materials,
wages) because they decide the price of the product
Self-same prices, the wages of labor, the interest on capital determines how much a
person must spend on the market
If what people get is not the determinate of what they produce, how they produce, and
how successfully they work, there’s no incentive for people to act in accordance with
the info transmitted
The fundamental of the free society is voluntary cooperation (ex: buying and selling)
Business is a wonderful institution provided it must face competition in the marketplace
and can’t get away with something except by producing a better product at a lower cos
The economic market includes a buying and seller
Individuals are deeply interested in their own interests that they work together;
cooperating to pursue their own interests with the byproduct of creating a great society
No regulations, no permits, no red tape can be seen as a “golden age” - 19th century o
Government constantly intervened. Law always sided with the business’ vs the workers
Some saw this era as beneficial as small businesses had the opportunity to thrive if they
chose, however this was an era where the workers were taken advantage of put at great
risk
•
In Friedman’s perspective: The main beneficiaries of a free-market system are
those that are economically disadvantage. No tariffs, free trade, no restrictions on
exports, no restrictions on monetary transactions, little to no intrusion by the
government. The market is a subtle mechanism that moves and pushes the industry and
creation for new business, wants individual rule, want them to have control over their
own lives. Government intervention is grown
Chapter 1
Macroeconomics: The study of the economy a whole address, many topical issues such as
What causes recessions? What is “government stimulus” and why might it help?
- How can problem in the housing market spread to the rest of the economy?
- What is the government budget deficit?
- How does it affect worker, consumers, businesses, and taxpayers?
- Why does the cost of living keep rising?
- Why are so many countries poor? What policies might help them grow out of poverty?
- What is the trade deficit? How does it affect the country’s well-being?
The three most important indicators of the macroeconomy are:
1. Real GDP. – measure of quantity of goods & services in an economy in the given
year.
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2. U.S Inflation Rate- measure of how prices are changing on average.
Usually positive or low inflation rates in the US.
Expectations where there were relatively low inflation rates are: WWI (high inflation
rate) and between two world wars.
3. Unemployment Rate: measures the fraction of individuals that are seeking work but
are not employed.
Usually below 10% but never below 0%
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Usually there is a dramatic response when there is a shock, for example oil shocks.
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You can get the current unemployment data from bls.
Economic models
- Simplified version of reality
- Irrelevant details not included
- Show relationships of variables
- Devise policies to improve economy
Ex: Demand for cars
Shows various events affect price and quantity of cars. Assumes the market is competitive
Variables:
Qd = quantity of cars demanded
Qs = Quantity supplied
P = Price of cars
Y = Income
Ps = Price of steel (input)
Demand equation: Qd = D(P,Y)
 Law of demand – when the price of a product increases the quantity demanded may go
down, there is a negative relationship
 With a normal good there is a positive relationship, when income rises the demand for the
should product increase
 Demand curve shows the relationship between quantity demanded and price – other things
being equal
 Supply curve shows the relationship between quantity supplied and price –other things
equal
 Supply equation: Qs = S(P, Ps) o P = Price o Ps = Price supply o Qs = Quantity supply
 Law of supply – positive relation between price and quantity supplied
 Equilibrium price and quantity – when the demand and supply curves cross
 An increase in income increases the quantity of products consumers demand at each price
when increases the equilibrium price and quantity. This shifts the demand curve to the up
along the supply curve to the right o There will be a new equilibrium (higher) price and
quantity
The Use of Multiple Models
- No one model can address all the issues we care about - Ex: our supply-demand
model of the car market:
• Can tell us how a fall in aggregate income affects price & quantity of cars
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• Cannot tell us why aggregate income falls
So we learn different models for studying different issues (ex: unemployment, inflation,
long-run growth)
For each new models, you should keep track of:
• Its assumptions
• Which variables are endogenous, which are exogenous
• The questions it can help us understand, those it cannot
Prices: Flexible vs. Sticky
- Market clearing = An assumption that prices are flexible adjust to equate supply and
demand
- In the short run, prices are sticky and doesn’t change right away in response to supply or
demand
• Ex: Many labor contracts fix the nominal wage for a year or longer, many magazine
publishers change prices only once every 3-4 years
- The economy’s behavior depends party. On whether prices are sticky or flexible:
• If price is sticky (short run) = demand may not equal supply, and it explains why
unemployment is happening or why companies can’t sell their products
• If price is flexible (long run), market’s clear and economy behaves very differently
Chapter 2 notes
Gross Domestic Product: Expenditure and Income 1. Total expenditure on domestically – produced final goods/services
- Total expenditure in this case means income because every $ spent by a buyer becomes
seller’s income
2. Total income earned by domestically – located factors of production
- Factors of production = Land, labor, capital, human capital entrepreneurship
The Circular Flow
-Households’ expenditure eventually becomes income for them
Value added
- Value added = Value of output – value of the intermediate goods used to produce that
output
Ex: Compute value added and GDP
Farmer sells $1
Value added: $1
Miller sells $3
3-1=$2
Baker sells $6
6-3=$3
Engineer eats
GDP: 1+2+3=$6
• GDP = value of final goods produced, sum of all the value added
• Since the value of the final goods already includes the value of the intermediate
goods, including intermediate AND final goods in GDP would be double-counting
The Expenditure Components of GDP
- C = consumption
- I = Investment
- G = Gov. spending
- NX = Net exports
- Y =C+I+G+NX
Value of total output (GDP) , Aggregate expenditure
Consumption (C)
- The value of all goods (services bought by household)
• Durable goods = lasts long time (Ex: cars, appliances)
• Nondurable goods = lasts short time (Ex: food, clothes)
• Services = work done for consumers or intangible (Ex: traveling, housing)
US Consumption 2018
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Roughly 2/3 of the US GDP comes from consumption
Services category is the biggest
Investment (I)
- Spending on capital goods (ex: physical assets) used in future production
• Ex: Spent $1000 on used computer to use for business
In this case, it’s not considered investment because the investment only counts as new
capital as investment
• Business fixed investment = Spending on plant/equipment
• Residential fixed investment = Spending by consumers/landlords on housing units
• Inventory investment = The charge in the value of all firm’s inventories
US Investment, 2018
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Business fixed is the highest among the investment
Government Spending (G)
- Gov spending on goods/services
- Excludes transfer payments (e.g. unemployment insurance payment)
US Government Spending, 2018
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Two types of government spending: Federal and state & local
Net Exports (NX)
- NX = Exports – Imports
• NX equals net spending from abroad on our goods and services
US Net Exports, 2018
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Net exports of g & s are negative, therefore imports > exports
There’s a trade deficit
But we export a lot of services, so we have a deficit in goods
We need 3.1% more of goods that are needed to be produced in the country
Ex: Produced $10 and only sold $9. Does this violate expenditure = output identity?
Answer: No because unsold output goes to inventory investment
Why Output = Expenditure
- Unsold output goes into inventory, and is counted as “inventory investment” whether
the inventory buildup was intentional
- In effect, we are assuming that firms purchase their unsold output
GDP: An Important and Versatile Concept GDP measures:
• Total income
• Total output
• Total expenditure
• Sum of value-added at all stages in the production of final goods
Real vs. Nominal GDP
- GDP is the value of all final goods/services
- Real GDP = Measures these values using the prices of a base year
- Nominal GDP = Measures these values using the current prices
Ex: Nominal vs. Real GDP
2016
P
Q
2017
P
Q
2018
P
Q
Good A
Good B
$30
$100
900
192
$31
$102
1000
200
$36
$100
1050
205
2016:
Nominal: (30x900) + (100x192) = 46200
Real: (30x900) + (100x192) = 46200 They are the same because this is the base year 2017:
Nominal: (31x1000) + (102x200) = 51400
Real: (30x1000) + (100x200) = 50000
2018:
Nominal: (36x1050) + (100x105) = 48300
Real: (30x1050) + (100x105) = 42000
Real GDP Controls for Inflation
- Changes in nominal GDP can be due to:
• Changes in prices
• Changes in quantities of output produced
- Changes in real GDP can only be due to changes in quantities, because real GDP is
constructed using constant base-year prices
US Nominal and Real GDP
-
Nominal GDP grows relatively faster than Real GDP because price in general increase
over time
When those two lines cross that’s when they used it as the base year
GDP Deflator
- Inflation rate = % increase in the overall level of prices
• One measure of the price level:
GDP deflator = 100 x (Nominal GDP/real GDP)
• Used to remove the effect pf deflation from GDP
Ex: GDP Deflator and Inflation
rate
Nom. GDP
2016
$46200
2017
$51400
2018
$58300
Real GDP
$46200
$50000
$52000
GDP deflator
100
(51400/50000)
x100
= 102.8
(58300/52000)
x100
= 112.1
Inflation rate
N/A
(102.8100)/100x100 =
2.8%
(112.1102.8)/102.8x100
= 9.1
Two arithmetic tricks for working with percentage changes
1. For any variables X and Y, percentage change in (X × Y ) ≈ percentage change in X +
percentage change in Y
EX: If your hourly wage rises 5% and you work 7% more hours, then your wage income rises
approximately 12%.
Why? Because wage income should equal to wage rate times the amount of time you work
(labor hours). Wage rate should equal to wage rate times work hours. Wage income should
equal to wage rate times work hours. % Change of wage income should be wage rate % change
in wage rate times labor hours.
BE CAREFUL: This concept holds true only for percentage that are small as shown in the
example, if the wage change is something like 70% then this doesn’t work.
2. percentage change in (X/Y) ≈ percentage change in X − percentage change in Y EX:
GDP deflator = 100 × NGDP/RGDP.
If NGDP rises 9% and RGDP rises 4%, then the inflation rate is approximately 5% (9%-4%)
Chain-Weighted Real GDP
- Over time, relative prices change, so the base year should be updated periodically.
- In essence, chain-weighted real GDP updates the base year every year, so it is more
accurate than constant-price GDP. • Takes the average of the years
- Your textbook usually uses constant-price real GDP because:
• the two measures are highly correlated
• constant-price real GDP is easier to compute
Consumer Price Index (CPI)
- A measure of the overall level of prices
- Published by the Bureau of Labor Statistics (BLS) - Uses:
• Tracks changes in the typical household’s cost of living
• Adjusts many contracts for inflation (“COLAs”)
• Allows comparisons of dollar amounts over time
How the BLS Constructs the CPI
1. Survey consumers to determine composition of the typical consumer’s “basket” of
goods
2. Every month, collect data on prices of all items in the basket; compute cost of basket
3. CPI in any month equals
100 x (Cost of basket in that month/cost of basket in base period)
Ex: Compute the CPI
Basket: 20 pizzas, 10 CDs
Prices:
Pizza
CDs
$15
2019
$10
11
12
2020
13
15
2017
2018
16
Compute:
- The cost of the basket
Price of pizza x 20 pizzas + Price of CDs x 10 CDs
2017: (10x20) + (15x10) = 350
2018: (11x20) + (15x10) = 370
2019: (12x20) + (16x10) = 400
2020: (13x20) + (15x10) = 410
- The CPI (use 2017 as base)
2017: 100 x (350/350) = 100
2018: 100 x (370/350) = 105.7
2019: 100 x (400/350) = 114.3
2020: 100 x (410/350) = 117.1
- The inflation rate from the preceding year (Use CPI not real and nominal GDP)
2017: N/A
2018: (105.7-100)/100 x 100 = 5.7%
2019: (114.3-105.7)/105.7 x 100 = 8.1%
2020: (117.1-114.3)/114.3 x 100 = 2.5%
The Composition of the CPI’s “basket”
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Main ones included are Food/beverage, housing, apparel, transportation, medical care,
recreation, education, communication, and other goods/services
However, when looking at students, the bracket for education might be bigger than that
of elderlies. On the other hand, medical care bracket for elderlies might be bigger than
that of students. So, this is very much dependent on who you ask
Why the CPI May Overstate Inflation
- Substitution bias = The CPI uses fixed weights, so it cannot reflect consumers’ ability to
substitute toward goods whose relative prices have fallen. • As a result the true cost of
living may increase rapidly
- Introduction of new goods = The introduction of new goods makes consumers better off
and, in effect, increases the real value of the dollar. But it does not reduce the CPI,
because the CPI uses fixed weights.
- Unmeasured changes in quality = Quality improvements increase the value of the dollar
but are often not fully measured.
• Ex: Computers 10 years ago is not the same as the ones you have now
The Size of the CPI’s bias
- In 1995, a Senate-appointed panel of experts estimated that the CPI overstates inflation
by about 1.1% per year.
- So, the BLS adjusted reduce the bias.
• Updated the market basket every two years rather than every 10 years, which
reduces the substitution and new biases, and reduced the size biases -Now, the CPI’s
bias is probably under 1% per year.
CPI vs. GDP Deflator
- Prices of capital goods:
• included in GDP deflator (if produced domestically)
• excluded from CPI
Because CPI only includes consumption Prices of imported consumer goods:
• included in CPI
• excluded from GDP deflator - The basket of goods:
• CPI: fixed
Uses the base year bundle
• GDP deflator: changes every year
Two Measures of Inflation in the US
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In 80s the CPI skyrocketed because it reflects the change in the price of oil
They overall move up and down together
Categories of the Population
- Employed (E) = working at a paid job
- Unemployed (U) = not employed but looking for a job
- Labor force (L) = the amount of labor available for producing goods and services; all
employed plus unemployed persons. L = E + U
- Not in the labor force = not employed, not looking for work. Population – All the labor
force (people who are 16 and older)
Two Important Labor Force Concepts
- Unemployment rate = percentage of the labor force that is unemployed
• Unemployment rate = Unemployed/Labor force x 100
- Labor force participation rate = the fraction of the adult population that
“participates” in the labor force (that is, working or looking for work) •
Labor force participation rate = Labor force/All the population x 100
Ex: Computing Labor Stats
-
US adult population by group Jan 2019
# employed = 156.7 million
# unemployed = 6.5 M
Adult population = 258.2 M
Calculate:
Labor force: # employed + # unemployed 156.7 + 6.5 = 163.2 M
The # of people not in the labor force: Adult population – Labor force 258.2 – 163.2 = 95 M
The labor force participation rate: Labor force/ adult pop x 100 163.2/258.2 x 100 = 63.2%
The unemployment rate # of unemployed/labor force x 100 6.5/163.2 x 100 = 3.89%
The Establishment Survey
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The BLS obtains a second measure of employment by surveying businesses, asking how
many workers are on their payrolls.
Neither measure is perfect, and they occasionally diverge due to:
• treatment of self-employed persons
• new firms not counted in establishment survey
• technical issues involving population inferences from sample data
Two Measures of Employment Growth- They generally move closely together