SUMMARY OF KRUGMAN’S MACROECON FOR AP
,CHAPTER 1
, 1.1 - The Study of Economics
Individual Choices: The Core of Economics
- Economics: the study of scarcity and choice
- Individual Choices: decisions made by individuals about what to do, which necessarily
involve decisions about what not to do
- Economy: a system for coordinating a society’s productive and consumptive activities
- Market Economy: economic system in which decisions of individual producers and
consumers largely determine what, how, and for whom to produce, with little
government involvement in the decisions
o No central authority tells people what to make or whom to ship it
o Each make what one thinks will be most profitable and consumers choose what
to buy
- Command Economy: economic system where the industry is publicly owned and a
central authority makes production and consumption decisions
o USSR tried between 1917-1991 but didn’t work
o Producers unable to make because they lacked raw material or succeeded but
nobody wanted the products
o Famous for long lines at shops
o Problem with CE: lack of incentives
o Incentive: reward or punishment that motivate particular choices
o In ME producers free to charge high prices when there is shortage of something
High prices/profits provide incentives for producers and eliminate
shortages
Economists are skeptical of changing people’s behavior that doesn’t
change incentives
E.g.: telling manufacturers to reduce pollution won’t be effective, but
giving them a financial incentive will succeed
Property rights: establish ownership and grant individuals the right to
trade goods and services with each other
PR create incentives in ME
E.g.: with PR to own something comes the incentive to make
something, so if you own a lake, it gives you the incentive to not
pollute it
In econ, decisions of what to do with ton of pollution, next hour of
free time, etc. are marginal decisions
Marginal benefit: gain from doing something one more time
Marginal benefit: cost of doing something one more time
If the marginal benefit > marginal cost does it again, otherwise,
don’t
Marginal analysis: study of the costs and benefits of doing a little
bit more of an activity versus doing a little less
,Resources are Scarce
- People make choices because resources are scarce
- Resource: anything that can be used to produce something else AKA factors of
production
o Land: refers to all resource that come from nature like minerals, timber,
petroleum
o Labor: effort of workers
o Capital: refers to manufactured goods used to make other goods and services
(machinery, buildings, tools, etc.)
o Entrepreneurship: efforts of entrepreneurs in organizing resources for
production taking risks to create new enterprises, and innovation to make new
products and production processes
- Scarcity: if a resource is not available in sufficient quantities to satisfy all the various
ways a society wants to use it
- Just as individuals make choices a society makes them too, society’s choices are the sum
of those individual’s decisions
- There are decisions that a society decides are best left to them, not the individual
o For example: area that was previously farmland is now being built up, the
residents feel land should be left undeveloped, no individual has an incentive to
keep land rather than send it for a profit; there is a trend in which local govs are
buying them and preserving it
- In most cases decisions about how to use scarce resources are often best left to
individuals but sometimes should be left to a community or group
Opportunity Cost: The real cost of something is what you must give up to get it
- Opportunity Cost: what you must give up in order to get something else, include
monetary costs and non-monetary costs
o You either want to go to a liberal art college (LAC) or community college (CC)
that is hours away, if you attend the former LAC the OC is the forgone chance of
going to the CC
- OC’s are crucial to individual decisions for all costs are OC’s because the alternatives are
given up
o So if both colleges are worth the same the cost has nothing to do with payments
but everything with forgone opportunities
o Suppose tuition at CC are 5K less than LAC, in that case what you give up to
attend the LAC is is ability to attend CC plus what you could do with $5K
, Micro vs. Macro
- Micro: study of how people make decisions and how decisions interact
o choices of individuals, houses, small firms, smaller part of economy
o school uses it to determine how much it would cost to offer a new course
(salary, book costs); by measuring costs and benefits school can decide to offer
the course of not
- Macro: study of overall ups and downs in the economy
o Focuses on economic aggregates: economic measures that summarize data
across many different markers (unemployment, inflation, GDP)
Concerned with general level of prices in econ and how high or low they are
relative to last year, rather than price of a particular good or service
Positive vs. Normative Economics
- Economic analysis draws on basic econ principles but how are they applied, depends on
the purpose of the analysis
o Positive Economics: branch of econ that describes the way the economy actually
works
o Normative Economics: branch that makes prescriptions about the way the econ
should work
- HOW MUCH REVENUE WILL THE TOLLS YIELD NEXT YEAR?
- HOW MUCH WOULD THAT INCREASE IF TH TOLL WRE RAISED BY 5 CENTS?
- SHOLD TOLL BE RAISED BEARING THAT TOLL INCREASE WOULD REDUCE TRAFFIC AND
POLLUTION NEAR ROAD BUT IMPOSE HARSHIPS ON COMMUTERS?
- The first questions are about facts, meaning there is 1 right answer
- Q 3 is whether or not tolls should be raised, it may not have a right answer, for two
people can agree on effect of a higher toll could disagree about whether raising toll is
good idea
o E.g.: one lives near turnpike but doesn’t commute will care about the noise and
pollution but not about the price, a commuter who doesn’t live near has
opposite priorities
- Question 2 is a “what if”, economic models provide representations of reality suck as
graphs or equations that are good for answering these kind of questions
- The answers serve as guide to policy but are still predictions, that is tells you what will
happen now it its good
o So let’s say that the model says an increase in tolls will raise property values in
communities near the read but will bother people who use the turnpike, so is it
good or not, depends on whom you ask
One concerned with communities near the road will support it, but
someone concerned with welfare of drivers will not
- Still economists engage in normative econ even if there is no right answer, so why?
o Economists are also citizens with their own opinions
o Econ analysis can be used to show that some policies are better than others
regardless of opinions
,CHAPTER 1
, 1.1 - The Study of Economics
Individual Choices: The Core of Economics
- Economics: the study of scarcity and choice
- Individual Choices: decisions made by individuals about what to do, which necessarily
involve decisions about what not to do
- Economy: a system for coordinating a society’s productive and consumptive activities
- Market Economy: economic system in which decisions of individual producers and
consumers largely determine what, how, and for whom to produce, with little
government involvement in the decisions
o No central authority tells people what to make or whom to ship it
o Each make what one thinks will be most profitable and consumers choose what
to buy
- Command Economy: economic system where the industry is publicly owned and a
central authority makes production and consumption decisions
o USSR tried between 1917-1991 but didn’t work
o Producers unable to make because they lacked raw material or succeeded but
nobody wanted the products
o Famous for long lines at shops
o Problem with CE: lack of incentives
o Incentive: reward or punishment that motivate particular choices
o In ME producers free to charge high prices when there is shortage of something
High prices/profits provide incentives for producers and eliminate
shortages
Economists are skeptical of changing people’s behavior that doesn’t
change incentives
E.g.: telling manufacturers to reduce pollution won’t be effective, but
giving them a financial incentive will succeed
Property rights: establish ownership and grant individuals the right to
trade goods and services with each other
PR create incentives in ME
E.g.: with PR to own something comes the incentive to make
something, so if you own a lake, it gives you the incentive to not
pollute it
In econ, decisions of what to do with ton of pollution, next hour of
free time, etc. are marginal decisions
Marginal benefit: gain from doing something one more time
Marginal benefit: cost of doing something one more time
If the marginal benefit > marginal cost does it again, otherwise,
don’t
Marginal analysis: study of the costs and benefits of doing a little
bit more of an activity versus doing a little less
,Resources are Scarce
- People make choices because resources are scarce
- Resource: anything that can be used to produce something else AKA factors of
production
o Land: refers to all resource that come from nature like minerals, timber,
petroleum
o Labor: effort of workers
o Capital: refers to manufactured goods used to make other goods and services
(machinery, buildings, tools, etc.)
o Entrepreneurship: efforts of entrepreneurs in organizing resources for
production taking risks to create new enterprises, and innovation to make new
products and production processes
- Scarcity: if a resource is not available in sufficient quantities to satisfy all the various
ways a society wants to use it
- Just as individuals make choices a society makes them too, society’s choices are the sum
of those individual’s decisions
- There are decisions that a society decides are best left to them, not the individual
o For example: area that was previously farmland is now being built up, the
residents feel land should be left undeveloped, no individual has an incentive to
keep land rather than send it for a profit; there is a trend in which local govs are
buying them and preserving it
- In most cases decisions about how to use scarce resources are often best left to
individuals but sometimes should be left to a community or group
Opportunity Cost: The real cost of something is what you must give up to get it
- Opportunity Cost: what you must give up in order to get something else, include
monetary costs and non-monetary costs
o You either want to go to a liberal art college (LAC) or community college (CC)
that is hours away, if you attend the former LAC the OC is the forgone chance of
going to the CC
- OC’s are crucial to individual decisions for all costs are OC’s because the alternatives are
given up
o So if both colleges are worth the same the cost has nothing to do with payments
but everything with forgone opportunities
o Suppose tuition at CC are 5K less than LAC, in that case what you give up to
attend the LAC is is ability to attend CC plus what you could do with $5K
, Micro vs. Macro
- Micro: study of how people make decisions and how decisions interact
o choices of individuals, houses, small firms, smaller part of economy
o school uses it to determine how much it would cost to offer a new course
(salary, book costs); by measuring costs and benefits school can decide to offer
the course of not
- Macro: study of overall ups and downs in the economy
o Focuses on economic aggregates: economic measures that summarize data
across many different markers (unemployment, inflation, GDP)
Concerned with general level of prices in econ and how high or low they are
relative to last year, rather than price of a particular good or service
Positive vs. Normative Economics
- Economic analysis draws on basic econ principles but how are they applied, depends on
the purpose of the analysis
o Positive Economics: branch of econ that describes the way the economy actually
works
o Normative Economics: branch that makes prescriptions about the way the econ
should work
- HOW MUCH REVENUE WILL THE TOLLS YIELD NEXT YEAR?
- HOW MUCH WOULD THAT INCREASE IF TH TOLL WRE RAISED BY 5 CENTS?
- SHOLD TOLL BE RAISED BEARING THAT TOLL INCREASE WOULD REDUCE TRAFFIC AND
POLLUTION NEAR ROAD BUT IMPOSE HARSHIPS ON COMMUTERS?
- The first questions are about facts, meaning there is 1 right answer
- Q 3 is whether or not tolls should be raised, it may not have a right answer, for two
people can agree on effect of a higher toll could disagree about whether raising toll is
good idea
o E.g.: one lives near turnpike but doesn’t commute will care about the noise and
pollution but not about the price, a commuter who doesn’t live near has
opposite priorities
- Question 2 is a “what if”, economic models provide representations of reality suck as
graphs or equations that are good for answering these kind of questions
- The answers serve as guide to policy but are still predictions, that is tells you what will
happen now it its good
o So let’s say that the model says an increase in tolls will raise property values in
communities near the read but will bother people who use the turnpike, so is it
good or not, depends on whom you ask
One concerned with communities near the road will support it, but
someone concerned with welfare of drivers will not
- Still economists engage in normative econ even if there is no right answer, so why?
o Economists are also citizens with their own opinions
o Econ analysis can be used to show that some policies are better than others
regardless of opinions
