Ranjit Dighe
Jan. 24-28, 2000

Mon., Jan. 24, 2000


I. Introduction
II. What is (macro)economics?
III. Outline of course


[This was a typical first day of class. Syllabi were distributed, roll was called, and students filled out informational questionnaires and, in many cases, signed up for subscriptions to the Wall Street Journal. I gave brief definitions of economics, distinguished between macro- and microeconomics, and went over the syllabus.]

How to pronounce my name:
RUN jet dig GAY

Why I make my notes available to you: so that in class, you can focus on trying to comprehend or ponder over what I'm saying, instead of frantically trying to jot down everything I say and feeling like you're on a treadmill. If there's something you don't understand, the time to ask me is anytime. Go ahead and interrupt me. The only stupid question is the one you don't ask.


* What is economics?
-- The study of the allocation of scarce resources, both by individuals and societies.
---- Does that definition seem a bit vague?
------ A resource is scarce is there is less of it than we (or some of us) would like. Time is scarce, food is scarce, land is scarce (--> wars), goods are scarce. Good liberal arts colleges in warm climates are scarce. Even government spending is scarce.
-- How do we allocate society's resources? The political debate is largely an argument over the allocation of scarce resources: government vs. private sector, current vs. future, military vs. social spending ("guns vs. butter").
---- But it's not always a zero-sum game. Society's resources are not always used efficiently. Great Depression an obvious example: ten million unemployed, thousands of shut-down factories --> How do we reallocate those resources from "idle" to "in use"?

* Two "flavors" of economics:
MICRO (individual firms, households, markets, industries)
MACRO aggregates (GDP, unemployment, inflation)

We'll spend most of the next week learning a little micro, since macro grew out of micro, and it's hard to understand any part of economics without understanding basic micro concepts like supply and demand, equilibrium, and opportunity cost.


[This was basically a quick review of the syllabus, which contains a lot of vital information and would bear re-reading.]


Wed., Jan. 26, 2000


I. Introduction to economics, continued
II. Intro to economic theory

* Still not too late to sign up for a Wall Street Journal subscription. It's highly recommended that you do.

* On the textbook: buying the new edition might be your best bet, because the multiple-choice questions in the Study Guide (which comes shrink-wrapped with the new edition) ought to be good practice for the test. If you already bought a used one, you could return it and buy the new one, or you could buy the study guide separately.

* Teaching assistant for this class: Rem Dragovoy
-- E-mail:
-- phone: x4175

* A question many of you might have: Will this course help me make a lot of money? Well, I've got two things to say to you:
(1) If you "make a lot of money," you'll go to jail. Only the Bureau of Engraving and Printing -- and the banks, thru the magic of deposit creation -- are empowered to make money.
(2) Now that we've got the terminology down, will this course help you get rich? Make a killing on the stock market, or run a business? Well, not exactly. We'll be learning about economic aggregates like GDP, inflation, unemployment, and interest rates -- it's extremely useful stuff to know, but it probably won't make you any richer. At some point I may work in a lecture on the stock market -- to how it relates to the macroeconomy as a whole -- but no, economics probably won't teach you much more about how to get rich than, say, history or philosophy or psychology. --> PARADOX (?) -- lots of people do major in econ because they want to go to business school later on, and business schools seem to like econ majors --> an econ major serves as a SIGNALING DEVICE.


Why I decided to study economics, back when I was a college freshman: I was very interested in politics, and economics seemed more concrete than political science, maybe would provide a means to back up my rash assertions. I quickly learned there was a bit more to economics than that, but it does have a lot of relevance to politics and current events.

Politics and economics: A lot of people thinking taking economics makes you more conservative. There may be a little something to that, but it's a very little. I prefer to think of the political continuum as having two dimensions, not just liberal-vs.-conservative but also (and here's where the economics comes in) castor-oil-vs.-snake-oil (or, no-free-lunch vs. there-IS-a-free-lunch).

                                           free lunch (politicians)
                                            no free lunch (economists)

IN-CLASS EXERCISE / OUR FIRST POP QUIZ: The question: What is the economy?
-- [Students were given five minutes to give their best answers to that question. People constantly refer to "the economy" without necessarily being clear on what they mean, so it's a useful exercise.]

My best definition: The ECONOMY is the vast network of production and distribution of all the different goods, services, and assets that we purchase. Note that it is a decentralized network -- it's both everywhere and nowhere.
-- Since the main organizing mechanism in the U.S. economic system is the market (the forces of supply and demand), the U.S. economy is, to some extent:
    the tens of thousands of product and asset markets in this country, taken both individually and collectively.
+  government production of goods and services, which often occurs independently of the market. (Add those in, and you're pretty close to the total picture. In a country like the old Soviet Union, government production of goods and services was nearly all of the economy.)

The "big three" variables in macroeconomics are gross domestic product, unemployment, and inflation.
* Gross domestic product (GDP) (or "national output" or "aggregate output")-- The total quantity of "final" goods and services produced in an economy in a given period.
* Unemployment rate-- The percentage of the labor force that is not working and is actively looking for work.
* Inflation-- The rate of increase in the overall price level

Two types of economic questions: POSITIVE and NORMATIVE:

Def. Positive-- "what is" & how does it work.
-- Ex.: "Since Bill Clinton took office, the U.S. unemployment rate has fallen by more than a third (from 7.3% to 4.1%)."

Def. Normative-- "what should be"(more touchy-feely); evaluates outcomes as good or bad, & possibly prescribes solutions or different policies
-- Ex.: "The unemployment rates of certain segments of the population (blacks, teenagers) are still way too high, and the government should take corrective action-- say, federal jobs programs or expanding the money supply."

Both micro and macro have elements of the positive and the normative.
The distinction between positive & normative is not always a clear one.
-- Ex.: "The sharp drop in the unemployment rate is evidence that Bill Clinton's economic program has worked." (Some would disagree; regardless, it's a loaded statement w/ policy implications. As Clinton himself might say, it depends on what your definition of "worked" is...)

Macroeconomics is typically in a state of flux. Micro is relatively more stable; microeconomists tend to agree with each other about a lot more than macroeconomists do. When people say economists always disagree (the playwright George Bernard Shaw: "If all the world's economists were laid end to end, they still wouldn't reach a conclusion"), they typically mean macroeconomists.

Why is macro so controversial?
1) It's a relatively new field, dating back to 1930s (the Great Depression and the publication of John Maynard Keynes's The General Theory). Micro, by contrast (just "economics" before 1930s/40s) has been around since 1776 (Adam Smith's The Wealth of Nations). Before Keynes, everyone was basically a microeconomist and the government rarely intervened directly in the economy.
2) The issues tend to be more socially and politically charged than in micro. Exs.: taxes, interest rates, inflation-- these are issues that affect people directly, and virtually any policy will benefit some people and hurt others.


Fri., Jan. 28, 2000

I. Introduction to economic theory
II. Introduction to macroeconomics


Next week we'll be learning some basic microeconomic theory. Now, what exactly is theory?

* Economic theory: a statement, or set of related statements, about cause and effect or action and reaction in economic life

* Model: a formal statement of a theory, often mathematically

* Empirical testing: the use of real-life observation to test economic theory

Now, why do we need all this theory? What does it have to do with the real world? The answer is that it offers a way of explaining the real world. Without it, someone once said, we could only stare stupidly at the world, the way cows look up at the sky. Theory is (ideally) based on observation of the real world. Naturally, any theory is going to have to leave a few things out. The goal is to "simplify, simplify" in order to expose and analyze certain aspects of how things operate.
--> A key assumption: "ALL OTHER THINGS EQUAL" (in Latin, ceteris paribus). For a theory or model to identify some key relation between two variables - say, the tendency for people to buy more of a good when its price is reduced - we need to hold other things constant.
---- For example, a reduction in the price of Porsche sports cars should increase the demand for Porsches, but you might not notice that effect if you don't take into account changes in the prices of other cars, changes in the general price level, or changes in people's income or tastes.

Economics without theory is kinda like rock music without guitars. It can be done, but what's the point?


The major players in our economy are: households, firms, the government, and the "rest of the world" (i.e., other countries with which we trade goods and services). A good way to identify those major players in our economy and how they relate to each other is through something called THE CIRCULAR-FLOW DIAGRAM of production and income.
-- [We saw an overhead of Figure 6.1 of the textbook (Case & Fair, p. 121), "The Circular Flow of Payments."]
-- The circular-flow diagram shows how households supply labor and savings to firms, who use that labor and invest those savings so as to produce goods and services, which they in turn sell back to those households. In other words, resources flow from households to firms in the form of labor services and savings, and they flow back from firms to households in the form of goods and services. Or we could think of income flowing from firms to households in the form of wages, interest, and dividends, and then flowing back to firms in the form of revenues for the goods they produce and sell.

Recall from last time: the "big three" variables in macro are GDP (national output), unemployment, and inflation. "Economic growth," which all politicians claim to be for, relates to the first of those, GDP.

Defn. Economic growth: An increase in real (inflation-adjusted) output (or real per capita output, which means real output per person).
-- We need to adjust key measures like GDP for changes in prices, so that we can be sure that an increase in GDP actually represents more output being produced, not just higher prices (inflation).

The economy, as measured by real GDP, typically grows from year to year, and the U.S. economy has shown very impressive growth over long periods of time. It does not always grow at the same constant rate, however. Sometimes it grows very rapidly, sometimes less rapidly, and sometimes it actually falls. A key theme of macroeconomics is this one:

We must distinguish between trend economic growth and business cycle fluctuations.

Defn. Business cycle: the more or less regular fluctuations of GDP around its long-run trend, along with associated changes in levels of employment, unemployment, and prices
-- [We saw an overhead of Case & Fair's Figure 6.4 (p. 127), "A Typical Business Cycle."]

The best, most precise ways to describe the ups and downs of economic activity:

Defn. Contraction: a period over which real GDP steadily falls. (Also sometimes called a RECESSION.)

Defn. Expansion: a period over which real GDP steadily rises. (Also sometimes called a RECOVERY.)

Two less precise, but very common, ways to describe the ups and downs of economic activity:

Defn. Recession: (no universally accepted definition, but)
(1) conventionally, a period in which real output declines for two consecutive quarters.
(2) Alternatively, a period in which actual GDP falls well short of the trend level of GDP (this trend level is roughly the same thing as "potential GDP," a concept that will be introduced later).

Defn. Boom: a prolonged period when actual GDP exceeds the trend level of GDP.

[We then took a graphical tour of the U.S. economy over time, especially since 1970. We saw overheads of the following graphs from Case & Fair's book:

-- Figure 6.5, "Percentage Deviation of Real GDP Around Its Trend, 1900-1997
---- This figure illustrates the actual business cycles that the U.S. experienced in the 20th century. Real GDP fell way below trend in the Great Depression, falling a whopping 45% relative to trend by 1933, and rose sharply above its trend (economic booms) in all of the major wars the U.S. fought in the 20th century. In the most recent recessions, in the early 1980s and 1990s, real GDP fell below trend.

-- Figure 6.6, "Real GDP, 1970 to 1997"
---- Note how U.S. GDP has more than doubled since 1970 and has had a fairly steady upward trend. There were three recessions in this span but real GDP quickly resumed its upward trend.

-- Figure 6.7, "Unemployment Rate, 1970 to 1997"
---- The U.S. unemployment has shown quite a lot of volatility since 1970. It was at the same low level, near 4%, in both early 1970 and late 1997, but in between it jumped around a lot. Unemployment reached especially high levels in the 1974-75 and 1980-82 recessions. In some cases unemployment has increased even while real GDP was growing, like in 1992. The unemployment rate has steadily fallen since 1992 and was at 4.1% in December 1999.

-- Figure 6.8, "Percentage Change in the GDP Price Index, 1970 to 1997" (this number is one measure of the INFLATION RATE).]
---- By its own historical standards, the U.S. experienced relatively high inflation rates during the 1970s and early 1980s. Strangely, the two "high inflation periods" on the graph coincided with economic recessions; more typically, inflation is high when the economy is booming and inflation falls when the economy enters a recession. That phenomenon of high inflation and stagnant or negative economic growth at the same time is called stagflation and had never really happened before in this country.
---- Also notable is that the inflation rate has fallen steadily during the 1990s, even as the economy has been expanding. That pattern of inflation and unemployment falling at the same time is also unusual, and a blessing that economists can only hope will continue.