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• Exam 1 will be held this Wednesday during lecture.
• The exam consists of short answer, math questions, and multiple choice.
• Make sure that you arrive early for the exam.
• Bring a pencil, calculator, and your PSU ID.

Defining Economics

• Economics is defined as the study of scarcity.
• Scarcity occurs when there are not enough of people's wants at a zero price.
• This means people never have enough of everything to satisfy each desire.
• Unlimited wants exceed limited resources.
• Scarcity cannot be eliminated by the government, it forces governments and individuals to make choices to satisfy people's wants.

Basic Economic Assumptions

• There are general assumptions about how people make decisions in economics:
• People are rational.
• People respond to economic incentives.
• Optimal decisions are made at the margin.
• Rationality means people gather information about their decisions and never intentionally do something that will leave themselves worse off

Responding to Incentives and Margin

• Governments create economic policies that create incentives for individuals to produce and consume.
• Optimal decision-making is conducted at the margin.
• Marginal benefits exceeding marginal costs will cause one to continue doing an action and vice versa

Opportunity Cost

• Opportunity cost is the highest valued next best alternative that must be sacrificed to obtain or satisfy a want or engage in an activity.
• It is not the collection of alternatives, but just the next best option.
• Opportunity cost occurs within every decision, for every single individual.

Positive vs. Normative

• Statements that are either positive or normative can be analyzed and placed into two categories:
• Positive economics are if A, then B, and are written in a way that allows it to be proven true or false.
• Normative economics are value judgements and opinions, and cannot be proven true or false.

Micro vs. Macro

• Microeconomics focuses on decisions made by individuals and firms and focuses on the smaller prices of the economy.
• Macroeconomics focuses on Inflation, unemployment, etc.
• Concepts of microeconomics aggregate into the concepts which are seen in macroeconomics.

Production

• Production is any activity that results in the conversion of resources into products that can be used in consumption.
• Factors of Production:
• Land
• Labor (L)
• Physical Capital (K)
• Human Capital
• Entrepreneurship (Subdivision of labor)

Economic Systems

• Governments must implement economic systems that answer how people allocate scarce resources because resources and inputs are scarce.
• An economic system is a society's institutional mechanic for discerning the way in which scarce resources are used to satisfy human wants.
• Successful economic systems must answer 3 questions:
• What goods will be produced?
• How will goods be produced?
• Who will receive the goods that were produced?

Communism

• An economic system in which most or all property and resources include collectively that are owned and distributed by the government.
• There is no private ownership of land or economic resources.
• The government provides people with all their necessities, which is determined by the government.
• "From each according to his ability, to each according to his needs"

Problems with Communism

• The level of effort each individual contributed had no effect on income no matter the effort level.
• This resulted in a large free rider problem.
• People were not motivated to innovate and create new technology.
• Everyone is equal, but equally poor.
• There are human right issues.
• Leaders are rich, while the rest of the citizens are poor.

Socialism

• An economic system under which each person, through a democratically elected government, is given an equal share of the basic resources and economic inputs.
• "From each according to his ability, to each according to his contribution."
• The economy Is planned by the central government, but individuals can own personal property.
• Industrial property is communally the government.
• Classes can exist, but large differences are diminished.

Democratic Socialism

• An economic and social ideology that while both society and economy should be run democratically, they should be dedicated to meeting the needs of people as a whole.
• Extensive social welfare programs help provide basic needs to people.
• The government provides goods such as education, public transportation, and health care for free. (Other goods are distributed by free markets)

Capitalism

• Decentralized decision making.
• Free Markets determine prices and the allocation of goods.
• There is private property.
• Factors of production are owned by firms and individuals.

United States Free Market

• Although it employs capitalism, the United States' usage of government-created safety nets and policies are similar to what is used in social democracy.
• Welfare programs are widely criticized and debated in American politics.

Incentives

• When creating programs, governments must design these safety nets to have correct and appropriate benefits and incentives for its users.

Proper Incentives

• Incentives that incentivize productive behavior are:
• Temporary
• Gradually phase out benefits
• Have proper defined times and benefits

Markets

• Markets are a group of buyers and sellers of a good and the arrangements by which they come together to trade.
• Product Market - Market for goods and services (Final goods/services/outputs)
• Factor Market - Markets for the factors of production
• As Individuals, people often purchase goods / services in the product market and sell work their labor / work in the factor market.

General Notes about Circular Flow

• Households BUY from the PRODUCT market and SELL to the FACTOR market.
• Firms BUY from the FACTOR market and SELL to the PRODUCT market.
• Financial systems for lending are not represented in the diagram
• International trades are not represented in the diagram

GDP

• Gross Domestic Product is the market value of all final goods and services produced in a country during a period of time, typically one year.
• Goods are included in GDP in the year they are produced.
• Make sure to look at the year goods were produced in when answering GDP related Questions.
• GDP can represent the production or total income, as production constitutes income for another individual
• GDP can be broken up into four major categories:
  • Personal Consumption (c)
  • Gross Private Investment (I)
  • Government Purchases (G)
  • Net Exports (NX)
• The formula for GDP is Y = C + I + G + NX

Consumption

• Spending by households on goods and services, not including spending on a new house.
• Examples of Services: House cleaning, Landscaping, childcare
• Nondurable goods: Food, drink, clothing
• Durable Goods: Appliances, furniture, cars, tools

Investment

• Spending by firms on new factories, buildings, and spending by households on new houses
• Broken down into:
  • Business fixed investment (New equipment and buildings)
  • Residential Investment (New house)
  • Change in inventory

Government Purchases

• Spending by federal, state, local government on goods and services
• Transfer payments are not included in government purchases.

Net Exports

• Net exports are calculated with the formula: Exports – Imports.
• This value can be positive or negative.
• Imports are subtracted because we want to only consider the domestic production, and the imports were not produced in the country.

Household Production in GDP

• Household production is NOT included in the calculation of GDP.
• Examples: Childcare, cleaning, and cooking not typically paid for with money

Underground Economy in GDP

• The underground economy is NOT included in the calculation of GDP.
• Trades that are hidden to avoid taxes or illegal goods / services are not counted.
• Simple cash transactions are not reported and not counted in GDP
• Developing countries have a large informal sector which is being unreported for calculations.

GDP Practice Problem

• Consumption Expenditures: 1000
• Investment Expenditures: 400
• Government Purchases: 200
• Transfer Payments: 75
• Imports: 100
• Exports: 200
• Wages: 750
• Solving for GDP: 1000 + 400 + 200 + (200-100) = 1700

Examples of What Would Be Considered Apart of the 2025 GDP for the United States

• Purchasing dinner at a restaurant for Valentine's Day (Consumption)
• Spending on a real estate agent to purchase a house (Consumption)
• Purchasing a brand new home (Investment)
• A company sells 500 products to someone who lives in Mexico (Net Exports)
• Social security payments for grandma are not inlcluded, because they are transfer payments
• Purchasing a car that was built in 2011 is not included, because it was not built in the current year.

GDP and Well-Being Limitations

• While gross domestic product measures production, it excludes things like:
• The value of leisure
• Pollution or other negative effects of production
• Crime, other social problems
• The distribution of income
• High production does not mean the people are necessarily doing better.
• WW2 represents the highest GDP, despite the fact that people were in a war.

GDP and Population

• GDP is divided by the population to make comparisons of GDP between countries with different populations and calculate the GDP per capita.

Nominal vs Real GDP

• Nominal GDP values the goods depending on the price of the current year.
• Real GDP values the goods depending on the price of some base year.

GDP Deflator

• GDP Deflator Formula: GDP Deflator = (Nominal GDP / Real GDP) * 100

Estimating Inflation

• By taking the percentage change of the GDP Deflators, we can estimate inflation
• Inflation Rate = ((new Deflator - old Deflator) / old Deflator) x 100

Practice Problems

• 2017 (Base Year)
• Tacos = $3 x 5000
• Burgers = $25 x 500
• Fries = $45 x 310
• Nominal GDP = 41450
• 2025
• Tacos = $5 x 6500
• Burgers = $31 x 710
• Fries = $52 x 400
• Nominal GDP = 75310
• 2026
• Tacos = $7 x 7050
• Burgers = $40 x 800
• Fries = $50 x 415
• Nominal GDP = 102100

Real GDP with 2017 as the base year

• Same as nominal
• 2025
• Tacos = $3 x 6500
• Burgers = $25 x 710
• Fries = $45 x 400
• Real GDP = 55250
• 2026
• Tacos = $3 x 7050
• Burgers = $25 x 800
• Fries = $45 x 415
• Real GDP = 59825

GDP Deflator

• 2017 GDP deflator = 100

• 2025 GDP deflator = (75310/55250) x 100 = 136.31

• 2026 GDP deflator = (102100/59825) x 100 = 170.66

• Inflation rate between 2025 and 2026 = ((170.66 – 136.31)/ 136.31) x 100 = 25.21%

Chapter 9

• 5 min break

Labor Force

• Sum of employed and unemployed workers in the economy
• Must be in the workforce to be considered unemployed.

Unemployment

• Individuals can be classified into 3 groups:
• Employed:
  • Worked 1+ hours in reference week
  • Or were temporarily away from job
• Unemployed:
  • Not currently at work, but available to work
  • Actively looked for work during the previous month
• Discouraged workers are people who are available for work, but haven't looked for a job within the previous four weeks.
• They are not considered unemployed

Unemployment Rate Formula

• Unemployment Rate = (Unemployed People / Labor Force) * 100

Labor Force Participation Rate

• Labor Force Participation Rate = ( Labor Force / Working Age Population )
• Employment Population Ratio: (# employed) / (# working-age population)

Practice Problem

• Total Population: 20000
• Working Age Population: 17500
• Employed People: 13000
• Unemployed People: 1200
• Labor Force Participation Rate : ((13000 + 1200)/17500) x 100 = 81.14%
• Unemployment rate: 1200/(13000+1200) x 100 = 8.45%
• LFPR for adult men has declined greatly
• The LFPR for adult women has increased greatly.
• Traditional Gender roles have reduced and become obsolete
• Education more women in college today (Earning professional jobs after education)
• It has become more difficult for a household to live off of a single income
• There is Increased access to childcare (one parent doesn't need to always stay home)
• Divorce Rates have increased
• Median age of Marriage has increased (For both men and women)
• The LFPR for adult men has decreased partly from:
• The decline in manufacturing and manual labor jobs
• Men staying in school longer
• Criminal Records
• Drug use, Injury, Disability
• Marrying later
• Video Games

Types of unemployment

• Frictional Unemployment: Short-term unemployment that arises from the process of matching workers with jobs
• Occurs mostly because of job search, and Includes seasonal unemployment
• Enters/reenters labor force or is between jobs
• Is not considered bad
• Structural unemployment:
• Arises from persistent mismatch between skills and attributes of workers and requirements of jobs - Longer length of being unemployed
  • ex: VCR repairman
• May need more training to earn a more "modern" job
• Is considered bad
• Cyclical Unemployment: Unemployment caused by a business cycle Recession
• Considered bad
• In normal recoveries after a recession, unemployment due to cyclical factors will fall

Inflation

• Inflation Rate: The percentage increase in the price level from one year to the next
• Price Level: A measure of the average prices of goods and services in an economy
• Two commonly used are:
• Consumer Price Index
• Producer Price Index
• Calculating CPI
  • Use quantity of goods from a base year (this is kept constant)
  • Calculate the cost to purchase the same basket in each year
  • Remember: Expenditures = Price x Quantity
  • Take the cost to purchase in current year and divide by cost in the base year (Multiply by 100) to calculate the CPI

Consumer Price Index

• CPI = (Cost of market basket in given year) / (Cost of market basket in base year) X 100
• The formula for Inflation Rate: inflation rate =(CPI(2)-CPI(1))/CPI(1) x 100
• Price Index for Inflation Adjustments
• People can use CPI to estimate the purchasing power of money in current year dollar evaluations.
• Value in Today's dollars = value in year-born dollars x (CPI TODAY/CPI OLD)

Practice CPI Problems

• Problem statement: Using 2012 as a base year, calculate the CPI for 2025; expenditures in current year are 4020; Expenditures in Base year are 2730

• CPI: (4020/2730) x 100 = 147.25

• Problem statement: Using 2012 a base year: where Expenditures in Current Year: 5550 and Expenditures in Base year: 2730, calculate the CPI for 2026

• CPI: (5550/2730) x 100 = 203.30

• Inflation Rate Rate: (203.30 - 147.25)/147.25 x 100 = 38.06%

• Suppose in 1999 your parents were paid $40,000

• What is the value of those dollars today? What you're given: 1999 CPI: 166.6 and 2025 CPI: 315.6

• Solving it = 40000 x (315.6/166.6) = 75774.31

Interest Rates

• When people lend money to someone, there is an interest agreement
  • $1000 with 6% interest would be paid back in 1 year as $1060
• Nominal interest rates don't change over time, however prices continue to rise
  • People can adjust for inflation by calculation the real interest rate
  • REAL INTEREST RATE = NOMINAL RATE – INFLATION RATE
  • While this is, it tends to be the most accurate for low interest and inflation rates