Principles of Macroeconomic Literacy Principles of Macroeconomic Literacy John Scott University of North Georgia Copyright © 2015 John Scott All rights reserved. No part of this book may be reproduced in whole or in part without written permission from the publishers, except by reviewers who may quote breif excerpts in connection with a review in newspaper, magazine, or electronic publications; nor may any part of this book be reproduced, stored in a retrieval system, or transmitted in any form or by any means electronic, mechanical, photocopying, recording, or other, without written permission from the publisher. Published by: University of North Georgia Press Dahlonega, Georgia Printing Support by: Booklogix Publishing Services, Inc Alpharetta, Georgia Cover design by Corey Parson ISBN: 978-1-940771-18-2 Printed in the United States of America, 2015 For more information, please visit ung.edu/press Or email [email protected] If you need this document in another format, please email the University of North Georgia Press at [email protected] or call 706-864-1556. Contents Chapter 1 Economic Decisions-------------------------------------- 9 Chapter 2 Government Decision Making: Public Choice - - - - - - - - - - 27 Chapter 3 Value Creation Through Production -------------------------- 45 Chapter 4 Value Creation Through Trade------------------------------ 55 Chapter 5 Socialism and Capitalism --------------------------------- 69 Chapter 6 Money and Prices -------------------------------------- 79 Chapter 7 Causes and Effects of Inflation ------------------------------ 91 Chapter 8 Credit Markets ----------------------------------------101 Chapter 9 Output, Income, and Economic Growth - - - - - - - - - - - -115 Chapter 10 Labor Markets-----------------------------------------127 Chapter 11 Macroeconomic Adjustment - - - - - - - - - - - - - - - -139 Chapter 12 The Federal Budget -------------------------------------153 Summary of the Entire Text 7 SUMMARY OF THE ENTIRE TEXT People try to make themselves better off by interacting with each other in the economy. By engaging in production and trade, individuals create value for themselves and for society at large. Problems often arise, which people solve as best they can. People are best able to solve their own problems because they know their abilities and their preferences for goods and services better than others know them. If people are forced by others, who do not know them as well, to take actions that are against their own judgment, production and trade will become less efficient, so value is destroyed and they will end up with fewer goods and services—food, medical care, shelter, clothing, transportation, information, and entertainment—than they would have had if they had been free to choose for themselves. They will live shorter, more miserable lives. As you read you will find links to stories, documents, and sound and video files on the web. Some of them are for references only and will be marked as [reference]. Others are [essential]. Essential links may contain test material. References to Bastiat’s work are always essential. The following story introduces some concepts that are necessary to understand the logic of the course. Story: The Best Thing After Ramona asked Greg to have a seat across the desk, he said, “I’m not working hard enough to suit you because I’m not going to work at your pizza place for the rest of my life.” She pursed her lips to keep from smiling. “So what better thing are you going to do with the rest of your life?” Trays banged in the kitchen. Jen was mad that they left her with cleanup. “I’m waiting,” Ramona said. “Well,” he said. “Nobody asked me before, but I’ve thought about it a lot. Here’s what I want to do—the most valuable thing I can possibly do.” Ramona tapped a nail on her desk. “How do you know this isn’t the most valuable thing you can do?” “Because I can get another job—maybe better. And after I graduate, I’ll be able to do even better.” “Is it just money? Is that all value is to you?” “No,” Greg said. “It’s not just money.” She threw up her hands. “Then what?” He sat back in the chair. “Let me ask you a question. Why don’t you double my pay?” She laughed. “Because there are lots of guys out there that will do your job for what I pay you—maybe some would do it better and maybe some would do it for less money. And, besides, if I doubled your pay, I’d have to charge more for pizza, then Papa John’s would end up selling all the pizza in town, and you wouldn’t have your high-paid job for very long. You know they’d be glad to put me out of business.” Jen yelled from the kitchen, “I could use some help in here.” He crossed his ankle over his knee and knitted his fingers behind his head. “So you’re saying that how much I make is based on how much people are willing to pay for pizza—and, heck, Papa John’s doesn’t pay any better than you. Sounds like your value for me is all about how much pizza I can make and how much you sell it for—just money.” 8 Principles of Macroeconomic Literacy She pointed as she said, “Of course I love your sparkling personality.” “So pay me more.” She rolled her eyes. “I don’t love it that much.” He looked up at the ceiling. “So I guess it is about money. If I find somebody willing to pay me more, it’s because I’m doing something that people really want—really value.” “You could volunteer to help people at the hospital, couldn’t you? Wouldn’t that be more valuable?” Ramona asked. He smirked. “Hospitals have plenty of money. If they’re not willing to pay someone to help out, they must not care about the work that person is doing.” “I’ll make you a deal. If you don’t make yourself more valuable to me, you can go find somebody that values you more. And if you make yourself way more valuable to me for the next six weeks, you get a raise. Deal?” Jen stood in the doorway, hands on hips. “Any time now.” Greg sighed and trudged after her. ☼☼☼☼☼☼☼☼☼☼☼☼☼☼☼☼☼☼☼☼☼☼☼☼☼☼☼ 1Economic Decisions 10 Principles of Macroeconomic Literacy Economics is all about decision making. Economists have studied how to make decisions about how many kids to have, how criminals should be punished, and whether to vote. They also study decisions you usually think about—like whether to buy a fuel efficient car, which profession someone should choose, and how much of a product a company should produce. Economics is the discipline that studies how efficient decisions are made.Any efficient decisions, in any field, are analyzed through the economic way of thinking.Efficient decisions involve choosing the most valuable alternative. VALUE/BENEFIT Thinking Exercise 1.1: Value Concepts What is the value of each of the following? Five quarts of motor oil Five quarts of blood Five Snickers bars Your answers should be numbers that are useful for all decision making—and not just among the three alternatives above. In formulating your answers, consider the contrast between the following. • What is the value of each? • What is price of each? • What is the cost of each? • What is the most you would pay for each? You might write down the answers for each in the table. Table 1.1 Item Value Price Cost Most You’d Pay For 5 Qts Motor Oil 5 Qts Blood 5 Snickers Bars • You should probably start with the easy ones and work to the harder ones. • As you do so, you might ask, “What does this concept mean?” Come up with a meaning and answer each one consistent with that meaning. • You may also wonder about situations. The situation is the one in which you find yourself at this minute. • Remember, your answer to “Value” must be one that is useful in making all decisions. If given the opportunity to choose one of the three options in Thinking Exercise 1, which would it be? If you would choose the blood, you’d have to figure out what you’d do with it, where you’d keep it, etc. Economic Decisions 11 Most people in the here and now would choose the Snickers bars. Even if they don’t like them they could give them to a friend. And if you would choose the Snickers bars, then the value that you wrote down for the Snickers Bars must be the highest of the three. Our choices reveal our values—this is called the theory of revealed preference. If you did the exercise, you may have discovered some things like the following characteristics of value. • Value depends on the situation. • Value is different for different people. Thinking Exercise 1.2: A Third Characteristic of Value Here is what I mean by the third characteristic. At a party, there is all the pizza that everybody there can possibly eat, and it’s good stuff, and they keep making more, fresh. • What is the value of the first slice to you? • What is the value of the second slice to you? • What is the value of the twentieth slice to you? How does the value change as you eat more slices? Does this work for • Value of the first umbrella, second umbrella, third umbrella you own? • Miles driven this week? • Value of the first car, second car, third car you own? The point of Thinking Exercise 2 is to help you see the third characteristic of value. Here it is, along with the other two. • Value depends on the situation. • Value is different for different people. • Subsequent units of the same good have less value. One reason that this is usually a characteristic of value is that we naturally put each unit to its best use.