ECON 102 Lesson #1

Key Concepts from Introduction to Macroeconomics - Winter 2025

• The lecture covers concepts like scarcity trade-offs, Pareto efficiency, equity, and what marginal cost and benefit mean
• It also covers differences between comparative and absolute advantage and why they are important in economics
• Macro models and their use by economists got examined
• The lecture also aims to make students aware of the differences between procyclical, countercyclical, leading, and lagging variables

What is Economics?

• Economics is the study of how people make choices confronting scarcity and the societal results of those choices.
• Scarcity forces choices because resources such as land, labour, and time are limited while individuals' wants are unlimited.
• Scarcity implies societal choices involve trade-offs, with each decision carrying an opportunity cost.

Opportunity Costs

• Trade-offs are faced by individuals, firms, and governments when deciding how much of a good to consume versus another.
• Limited budgets/resources in face of unlimited needs and wants force optimal allocation.
• There's no such thing as a free lunch - to get goods or services comes at a cost.

Understanding Trade offs

• Trade-offs are necessary when resources are scarce, affecting choices by individuals, firms, governments, and societies.
• Individuals and firms allocate resources by balancing leisure, work, and study or choosing between full-time (no job) vs. part-time (job) study.
• Societies and governments make trade-offs between economic growth (more pollution) vs. environmental protection (less growth) or low inflation (higher unemployment) vs. high unemployment (lower inflation) in the short run.

Equity vs Efficiency

– Societies face trade-offs because of natural resource scarcity and additional trade-offs created by societies. – Equity versus efficiency forms one kind of such trade-off.

• Resources are efficiently allocated when society maximizes the use of scarce resources.
• Equity is fairness in how resources are distributed across society

Pareto Efficiency

• Pareto efficiency, also known as Pareto optimality, is a term often used when economists discuss efficiency.
• Pareto efficiency happens when it's impossible to improve one person's situation without worsening someone else's.
• Redistribution means that the society was not at Pareto optimal level originally

Single Payer or Private Health Care?

• The U.S. healthcare system is driven by market forces, encouraging competition and innovation.
• The U.S. system includes high-quality medical research and cutting-edge technologies, but there is inequity in access, with millions uninsured or underinsured (26 million).
• The U.S. has higher healthcare spending per capita but mixed health outcomes.
• The Canadian healthcare system is publicly funded and regulated with virtually no competition.
• The Canadian system may see slower the adoption of innovations.
• Canadian healthcare has universal coverage for essential care, but potential long wait times for elective procedures.

Progressive (and High) Income Taxes

• Scandinavian tax systems use highly progressive taxes to fund extensive welfare programs like parental leave (up to 480 days) and free education for residents.
• Scandinavian systems reduce income inequality but can lead to work disincentives.
• U.S. tax systems have higher income inequality and reduced social safety nets.
• The U.S. tax system encourages entrepreneurship and investment, but are less progressive than Scandinavian systems.

Economic growth and pollution

• Economic expansion driven by industrial activity and increased transportation can boost the standard of living while shrinking natural spaces.
• More economic activity increases pollution that damages well-being and health.
• Society has a trade-off between growth and pollution.

Rationality

• Trade-offs, require individuals make choices weighing the costs and benefits.
• Economics assumes individuals (or agents) are rational.
• Rational individuals, facing trade-offs, take the best possible decision to maximize personal gain.

Cost-Benefit Analysis

• Cost-benefit analysis is how rational individuals make choices.
• Marginal cost refers to expenses from buying or making one extra item.
• Marginal benefit refers to the extra revenue/benefit from consuming/producing one additional item.
• Rational people maximize satisfaction where marginal cost = marginal benefit, ensuring a positive economic surplus.

Cost-Benefit Example

• The cost of buying cup of coffee is $1 and the benefit of producing an extra cake is $2.
• The rational individual should buy the cup of coffee as the marginal benefit exceeds the marginal cost.
• The economic surplus refers to the difference between the benefit of consuming the extra cup of coffee ($2 benefit) and its cost ($1).

Cost-benefit analysis for multiple items example

• The cost of each cup of coffee is $1.
• First cup of coffee boosts energy to produce 1 extra cake above the standard 5.
• Having a second cup boosts energy but only allows to make 1/2 cake. -In this case, the cost of buying coffee ($1) = benefit ($1 each).
• The second cup of coffee has equal cost and benefit of producing ($1 each), making the individual indifferent between buying and not buying the second cup of coffee.

Cost-Benefit Continued

• The cost of buying the extra coffee outweighs the benefits if a third cup does not allow to individual to produce an additional cake
• Rational consumers consider marginal costs and benefits when making decisions

Optimizing

• In the coffee example, optimal economic surplus is attained with the purchase of 2 cups
• This is when marginal benefit and marginal cost are equal in the example
• Economic surplus for 1 cup or 2 cups is the same, but worker will consume 2 cups since the marginal benefit and cost are equal

Sunk Costs

• When doing cost and benefit assessments consider only avoidable costs.
• Costs that cannot be avoided (sunk costs) should be ignored in decision-making.
• Fixed costs are incurred regardless of production or resource use; optimal choice depends on marginal cost and benefit

Law of Diminishing Return

• Although each additional cup of coffee allows the worker to produce more cakes, each extra cup contributes less and less to the increase in production.
• This example shows diminishing returns, the Law of Diminishing Returns (LDR).
• The law of diminishing return indicates that using an additional unit of a production factor initially boosts total production, will reach a maximum and eventually decreases

Paradox of Value

• The value is tied to scarcity.
• Water is cheap because it is abundant, diamond are expensive because they are scarce
• High-priced diamonds have limited supply, making each additional unit of diamond valuable.
• The marginal benefit associated with consuming an extra amount of diamond is very high, so we are willing to pay a very high price to acquire diamonds

Opportunity Cost

• Opportunity cost shows cost of the thing you didn't pick.
• If drinking coffee helps you work harder for more money or go for a run, the money you could have earned working is the cost of your run

Aspects of Opportunity Cost

• Opportunity cost spans monetary/financial costs and all the other costs associated with the forgone alternative.
• The cost of university is not only tuition but also forgone wages from a full-time job.
• Economists use imputed value when value is not observed or hard to compute directly

Example: Sunk and opportunity costs

• John spent $40 on a ticket for an exclusive art gallery opening and takes a day off from his $500/day job so he can attend it.
• He's offered $100 for his ticket when he gets there.
• His sunk cost equals $40 paid for the ticket
• John's opportunity cost for the gallery is $500 he could have from working , minus the ticket price offer.

Comparative and Absolute Advantage

• Differing skills lead to specialization in specific tasks/jobs.
• Specialization underlies absolute and comparative advantage.
• Absolute advantage means taking fewer hours to perform task compared to someone else.
• Comparative advantage is what determines the benefit of a choice.

Absolute and Comparative Advantage Example

• Absolute advantage is is defined as when someone takes one hour to mow the lawn and a neighbour needs two.
• If the neighbour earns $10/hour while the first person makes $100/hour, the neighbour has comparative advantage.
• The $20 opportunity cost outweighs the $100 for him/her
• Comparative advantage says the first person should focus on their job even if they are better at mowing.

Applying comparative advantage

• Comparative advantage is defined as if the opportunity cost of performing a task is lower than another agent's opportunity cost.
• Absolute advantage compares production levels and comparative advantage is about opportunity costs

Comparative Advantage: Canada vs Mexico

• Canada is better at making cars and trucks than Mexico.
• In Canada, the opportunity cost to make one truck is 2 cars.
• In Mexico, the opportunity cost to make one truck is 4 cars.
• Canada has a comparative advantage making trucks.
• In Mexico, the opportunity cost to make one car is 1/4 of a truck.
• In Canada, the opportunity cost to make one car is 1/2 of a truck.
• Mexico has a comparative advantage making cars.
• Canada should put effort in trucks where their comparative advantage lies, Mexico should put effort in to focus on what they do better than other countries, making cars.

Reasons for Comparative Advantage

• Arises for individuals with innate talent or acquired skills.
• Arises for countries due to technology, resources, capital, institutions, geography, climate, etc.

Comparative Advantage: China vs. Canada

• China has specialization in electronics with low labor costs, economies of scale, advanced manufacturing, investment in technology/infrastructure, and high-demand goods (smartphones/laptops/microchips).
• Canada has abundant natural resources (oil/gas/timber), low extraction/export opportunity cost, primary industries focused on global energy and raw material demands, and is a key trading partner for countries needing these materials.

PPF (Production Possibility Frontier/Curve)

• PPF is very useful for assessing comparative advantage and which goods to specialize in
• Countries or individuals specialize based on opportunity cost.
• Opportunity cost can be shown using the PPF.

Properties of the PPF

– PPF shows various combinations of cars and trucks an economy can produce with existing technology and resources – Point C means only cars are made

• Point T shows production when only making trucks.
• Points X and Y represent when economy can produce some amount of cars and trucks.
• PPF shape comes from the assumption of diminishing returns
• When the same transfer is very productive initially, then the next one is less productive and so on.
• Increases in car production requires an increasing amount of forgoing truck production
• Opportunity costs of producing more trucks (in terms of cars) is increasing

More Properties of the PPF

• W, X, Y and Z show efficient allocation

• The points show Pareto efficient because of maximal output

• Moving to Point V within PPF from Point W means output is down

• Point R outside PPF is unattainable in the current economy

Other useful properties of PPF

• Opportunity costs can be assessed at points along PPF when making cars.

• Moving from point Z to Y implies that production increases for cars from OC3 to OC2.

• Production in trucks falls from OT3 to OT2.

• This can be shown as the opportunity cost as.

• Opportunity cost increases when producing cars. OT3-OT2 OC2-OC3

Returns to Scale

• Diminishing returns: to increase car production by 1 unit requires more and more trucks to be given up.
• Constant returns to scale (CRS): implies that same amount of trucks must be sacrificed to increase car production by same amount every time.
• Increasing returns implies that you have to give up less and less trucks to produce another unit of cars.

PPF Movements

• Assuming unchanging technology and population, movements along the PPF efficiently reallocate resources.

PPF shifts

• Outward shifts will happen through, state of technology, worker training, changes in population goods and available and capital-labour ratio

What is Macroeconomics?

• Macroeconomics looks at whole economy rather than focus on specific individuals/firms.
• The entire economy is the aggregate economy.
• Macroeconomics deals with aggregate outcomes
• Individual actions still significantly affect aggregate economy.
• Various issues of interest from Macroeconomic perspectives include economy and economic growth.
• Economy goes up and down over short and medium timeframes, otherwise known as business cycles. – The behavior of economy in short and long-run are studied, issues like unemployment, productivity, and the role of central banks/governments.

Macro Models

• Macroeconomists utilize theoretical and empirical economic models to explain the behaviour of economic agents and understand the macroeconomy and these models are used as tools to carry policy simulations.
• Models can range from being simple with limited equations to being complex with hundreds of equations.
• Models explain economic occurrences, do counterfactual analysis, and perform policy experiments

Concepts of Macro Models

• Macro models are often built from microfoundations i.e. from the bottom and aggregating all the information up
• Macro models assume agents are rational when making decisions
• Macro models make calculations on various economic data to assess the correlation of the data to other areas
• In building macro models, we assume a representative agent that stands in for all other economics agents in the economy
• Because of issues with these types of models, economists make other models where all agents a heterogeneous

Endogenous and exogenous variables

• Endogenous variables are determined within the model.
• The exogenous variables are determined outside of it and do not affect the models
• For instance, price and quantity would both be an Endogenous variable while severe weather or war would be exogenous

Macro Indicators

• Economists pay specific to three criteria: GDP, Unemployment rate, and Inflation rates
• As of July 2024, the unemployment rate was 6.4%, Real GDP grew by 1.7%, and inflation rates were around 2.7%.

Positive Correlation:

• Positive variable correlation between X and Y means X increase and Y increase (or X decreases and Y decreases)
• A good example is the meat consumption and GDP per capita.

Negative correlation

• Negative variable X and Y correlation means as one moves, the other goes in opposite direction
• An example would be maternal mortality and GDP

Deviations

• Macro variables have long trends on time-scales
• Economists study deviations to evaluate long-run trends and growth potentials
• Long-run deviations denoted with recessions and expansions

Procyclical, Countercyclical, and Acyclical

• A variable is noted as procyclical if the trends positively match against the trend of the GDP
• A countercyclical variable is negatively correlated with the deviations of GDP
• A variable is acyclical if it does not correlate

Lagging/Leading indicators

• A Leading indicator happens when economic activity has that changes BEFORE GDP i.e volume of new orders
• A Lagging indicator happens when economic activity changes AFTER GDP i.e unemployment rates

General principles of economics

• Tradeoffs exist for all economics due to scarcity
• Efficiency of economic agents is paramount in usage of existing resources
• Focus on minimizing advantages where economic resources are abundant