Principles of Macroeconomics - Notes Chapter 1

1. What Economics Is and Why It's Important:

- Economics is the study of how humans make decisions under conditions of scarcity. Scarcity means that
human wants for goods, services, and resources exceed what is available.

- Specialization and the division of labor allow individuals and firms to produce more by focusing on their
areas of advantage. This increases economic productivity.

- Studying economics helps you understand major problems facing the world, prepares you for informed
citizenship, and develops your critical thinking skills.

2. Microeconomics and Macroeconomics:

- Microeconomics focuses on the actions of individual agents like households, workers, and firms.

- Macroeconomics looks at the economy as a whole, focusing on goals like economic growth,
unemployment, and inflation.

- Macroeconomic policies include monetary policy (conducted by the central bank) and fiscal policy
(government spending and taxes).

3. How Economists Use Theories and Models:

- Economists use theories and models to simplify complex real-world issues and derive insights.

- The circular flow diagram is a basic model that illustrates how households and firms interact in the
goods/services market and the labor market.

- Economists start with theories and models to help them understand and analyze economic problems,
rather than figuring out the answer first.

4. Economic Systems:

- There are three main ways economies can be organized: traditional, command, and market economies.

- Most modern economies are mixed, combining elements of command and market systems.

- Globalization refers to the increasing economic connections and integration across national borders,
driven by factors like improved transportation and communication.

The key themes are that economics is about making decisions under scarcity, and economists use
theories and models to simplify and analyze complex economic issues, taking both microeconomic and
macroeconomic perspectives. The chapter also provides an overview of different economic systems and
the rise of globalization.

]1. What is scarcity? (p. 7)

Answer: Scarcity means that human wants for goods, services and resources exceed what is available.

2. What are two causes of scarcity? (p. 7)

Answer: The ultimate scarce resource is time, and there is only a finite amount of other resources
available like labor, tools, land, and raw materials.

3. What is the maximum amount of ham the residents of Smithfield can consume in a month if the town
has 100 people and each ham requires 10 people to produce it and takes a month? (p. 11)

Answer: The maximum amount of ham the residents of Smithfield can consume in a month is 10 hams,
since there are 100 people and each ham requires 10 people to produce it.

4. Why does it make more economic sense for the consultant to spend her time at the consulting job and
shop for her vegetables? (p. 11)

Answer: Because the consultant can earn $200 per hour from her consulting job, which is more than she
would likely earn from growing her own vegetables, so it makes sense for her to focus on her consulting
work and purchase vegetables.

5. Why does it make more sense for the computer systems engineer to hire a painter to paint his house
rather than doing it himself? (p. 11)

Answer: Because the computer systems engineer can earn more by focusing on his high-skilled job
rather than taking the time to paint the house himself.

6. What would be another example of a "system" in the real world that could serve as a metaphor for
micro and macroeconomics? (p. 12)

Answer: The chapter uses the example of a lake ecosystem to illustrate the difference between
microeconomics and macroeconomics.

7. If we extend the circular flow model to add imports and exports, how would you draw the flows of
imports, exports, and the payments for each on the diagram? (p. 14)
Answer: You would add a foreign country as a third agent to the circular flow diagram, and draw flows
representing imports, exports, and the payments for each between the domestic economy and the
foreign country.

8. What is an example of a problem in the world today, not mentioned in the chapter, that has an
economic dimension? (p. 15)

Answer: The chapter does not provide a specific additional example, but it notes that "virtually every
major problem facing the world today, from global warming, to world poverty, to the conflicts in Syria,
Afghanistan, and Somalia, has an economic dimension."

9. What is public enterprise, and how is it a characteristic of command economies? (p. 15)

Answer: Public enterprise refers to resources and businesses being owned by the government, which is a
characteristic of command economies in contrast to market-oriented economies with private enterprise.

10. Why might Belgium, France, Italy, and Sweden have a higher export to GDP ratio than the United
States? (p. 17)

Answer: Smaller economies like Belgium, France, Italy, and Sweden need to trade more across their
borders with other countries to take full advantage of division of labor, specialization, and economies of
scale, compared to the larger U.S. economy.

11. Explain the three reasons why the division of labor increases an economy's level of production. (p. 9)

Answer: 1) It allows agents to focus on areas of advantage due to natural factors and skill levels. 2) It
encourages agents to learn and invent. 3) It allows agents to take advantage of economies of scale. (p. 9)

12. What are three reasons to study economics? (p. 11)

Answer: 1) Economics is crucial for understanding and solving major problems facing the world. 2) It is
important for good citizenship and understanding policy issues. 3) It makes you a well-rounded thinker.
(p. 11)

13. What is the difference between microeconomics and macroeconomics? (p. 12)

Answer: Microeconomics focuses on the actions of individual agents like households and firms, while
macroeconomics looks at the economy as a whole, focusing on goals like growth, unemployment, and
inflation. (p. 12)
14. What are examples of individual economic agents? (p. 12)

Answer: Examples of individual economic agents include households, workers, and business firms. (p.
12)

15. What are the three main goals of macroeconomics? (p. 13)

Answer: The three main goals of macroeconomics are growth in the standard of living, low
unemployment, and low inflation. (p. 13)

16. How did John Maynard Keynes define economics? (p. 13)

Answer: Keynes defined economics as "a method rather than a doctrine, an apparatus of the mind, a
technique of thinking, which helps its possessor to draw correct conclusions." (p. 13)

Imagine you have a big jar of candy, and you want to figure out how to share it fairly with your friends.
Economics is like a set of tools that helps you think about this problem and come up with a good
solution.

1. Method, Not Doctrine: This means that economics is not a strict set of rules or beliefs, like
saying "you must always share equally." Instead, it's a way of thinking that helps you analyze the
situation and make a fair decision based on the circumstances.
2. Apparatus of the Mind: Think of this as a toolbox in your brain. It's full of ideas and methods you
can use to solve the candy-sharing problem. For example, you might think about dividing the
candy equally based on the number of friends or considering who likes which types of candy
more.
3. Technique of Thinking: This is like a step-by-step approach to solving the problem. You might
start by counting the candies and then thinking about how to divide them in a way that makes
everyone happy.
4. Drawing Correct Conclusions: Ultimately, economics helps you reach the right decision. In this
case, you might decide to divide the candy based on each friend's favorite flavors or share it
equally if everyone likes all the candies the same.

17. Are households primarily buyers or sellers in the goods and services market? In the labor market? (p.
14)

Answer: In the goods and services market, households are primarily buyers. In the labor market,
households are primarily sellers of their labor. (p. 14)

18. Are firms primarily buyers or sellers in the goods and services market? In the labor market? (p. 14)

Answer: In the goods and services market, firms are primarily sellers. In the labor market, firms are
primarily buyers of labor. (p. 14)
19. What are the three ways that societies can organize themselves economically? (p. 15)

Answer: The three ways are traditional economies, command economies, and market economies. (p. 15)

20. What is globalization? How do you think it might have affected the economy over the past decade?
(p. 16)

Answer: Globalization is the expanding cultural, political, and economic connections between people
around the world. It has likely increased international trade and financial capital flows over the past
decade. (p. 16)

21. Why would division of labor without trade not work? (p. 10)

Answer: Division of labor only makes sense if workers can use the pay they receive to purchase the other
goods and services they need, which requires trade. (p. 10)

22. Can you think of any examples of free goods, that is, goods or services that are not scarce? (p. 7)

Answer: The chapter does not provide any examples of free, non-scarce goods and services.

23. Why are a balanced federal budget and a balance of trade considered secondary goals of
macroeconomics, while growth in the standard of living is considered a primary goal? (p. 13)

Answer: Growth in the standard of living is considered a primary goal because it directly impacts the
well-being of the population. Balanced budgets and trade balances are more indirect means to that end.
(p. 13)

24. Would it be possible for what happens at the macro level to differ from how economic agents would
react at the micro level? (p. 12)

Answer: Yes, it is possible for macro-level outcomes to differ from micro-level behavior, similar to how
the behavior of a crowd can differ from the behavior of the individuals within it. (p. 12)

25. Why is it unfair or meaningless to criticize a theory as "unrealistic"? (p. 13)

Answer: Theories are meant to be simplified representations of reality in order to provide useful
analytical tools, so criticizing them as "unrealistic" misses the point of their purpose. (p. 13)
26. What should an economist do if asked to analyze an issue they don't have a specific model for? (p.
13)

Answer: Like a carpenter in a similar situation, the economist should use their general toolkit of
economic theories and models to try to analyze the new issue, even if they don't have an exact match.
(p. 13)

27. Why do you think most modern countries' economies are a mix of command and market types? (p.
15)

Answer: The chapter does not provide a specific explanation, but most economies likely mix elements of
both to try to harness the benefits of each system.

28. Can you think of ways that globalization has helped you economically? Can you think of ways that it
has not? (p. 16)

Answer: The chapter does not provide specific examples, but globalization has likely impacted individuals
both positively and negatively through its effects on trade, prices, jobs, and more.

29. What is the circular flow diagram and what does it illustrate? (p. 13)

Answer: The circular flow diagram is a model that pictures the economy as consisting of households and
firms interacting in the goods/services market and the labor market. (p. 13-14)

30. How does a theory differ from a model in economics? (p. 13)

Answer: A theory is a more abstract representation, while a model is a more applied or empirical
representation, but the terms are often used interchangeably. (p. 13)

31. What are the three main ways societies can organize their economies? (p. 15)

Answer: The three ways are traditional economies, command economies, and market economies. (p. 15)

32. What is the difference between monetary policy and fiscal policy? (p. 13)

Answer: Monetary policy involves the central bank altering interest rates and credit availability, while
fiscal policy involves government spending and taxes. (p. 13)

33. How does specialization allow businesses to take advantage of economies of scale? (p. 9-10)
Answer: Specialization allows businesses to operate at larger scales, reducing the average cost per unit
produced. (p. 9-10)

34. Why is the export-to-GDP ratio generally higher for smaller economies than larger ones like the US?
(p. 17)

Answer: Smaller economies need to trade more across borders to take full advantage of division of labor,
specialization, and economies of scale. (p. 17)

35. What are the three reasons the division of labor increases production according to Adam Smith? (p.
9)

Answer: 1) It allows agents to focus on areas of advantage, 2) It encourages learning and invention, and
3) It allows exploiting economies of scale. (p. 9)

36. How does the circular flow diagram show the interaction between households and firms? (p. 14)

Answer: Households provide labor to firms in the labor market, and firms sell goods and services to
households in the goods/services market. (p. 14)

37. What is the difference between microeconomics and macroeconomics in terms of their perspective?
(p. 12)

Answer: Microeconomics focuses on individual parts of the economy like firms and households, while
macroeconomics looks at the economy as a whole. (p. 12)

38. How does economics differ from other disciplines in terms of how problems are analyzed? (p. 13)

Answer: Economists use economic theories and models as tools to understand issues, rather than just
presenting facts or opinions. (p. 13)

39. What are some examples of "underground economies" in command-style economic systems? (p. 15)

Answer: The chapter does not provide specific examples, but underground economies refer to markets
operating outside of government regulation in command economies.

40. Why is the study of economics important for being an informed citizen? (p. 11)

Answer: Economics is crucial for understanding and evaluating government policies, regulations, and
budgets. (p. 11)
41. How does specialization based on comparative advantage lead to greater overall production? (p. 9-
10)

Answer: Specialization allows workers and firms to focus on what they do best, increasing their
productivity. (p. 9-10)

42. What are some examples of economic problems that have important social and political dimensions?
(p. 11)

Answer: The chapter mentions problems like global warming, poverty, and international conflicts as
having economic dimensions. (p. 11)

43. How can the behavior of a crowd differ from the behavior of the individuals within it, as an analogy
for how macro and micro economics can differ? (p. 12)

Answer: The chapter uses this analogy to illustrate how overall economic outcomes can differ from the
individual decisions of economic agents. (p. 12)

44. Why is it important for an economist to have a toolkit of theories and models, rather than just
memorizing facts? (p. 13)

Answer: Theories and models allow economists to analyze new and complex issues, rather than just
reciting information. (p. 13)

45. How does the circular flow diagram illustrate the interdependence between households and firms?
(p. 14)

Answer: The diagram shows how households provide labor to firms, while firms provide goods/services
to households, in a circular flow of transactions. (p. 14)

46. What are some potential benefits and drawbacks of globalization that individuals may experience?
(p. 16)

Answer: The chapter does not provide specific examples, but globalization can impact individuals
through its effects on trade, prices, jobs, and more. (p. 16)

47. Why are some countries' economies more dependent on exports relative to the size of their GDP
compared to larger economies like the US? (p. 17)
Answer: Smaller economies need to trade more across borders to take advantage of specialization and
economies of scale. (p. 17)

48. How does the division of labor increase productivity according to Adam Smith? (p. 9)

Answer: 1) It allows workers to focus on their areas of comparative advantage, 2) It encourages learning
and innovation, and 3) It enables larger scale production. (p. 9)

49. What is the key difference between a theory and a model in economics? (p. 13)

Answer: Theories are more abstract representations, while models are more applied or empirical, but
the terms are often used interchangeably. (p. 13)

50. How does the circular flow diagram illustrate the concept of markets? (p. 14)

Answer: The diagram shows how households and firms interact in both the goods/services market and
the labor market. (p. 14)

51. Why does the US have a lower export-to-GDP ratio compared to smaller economies? (p. 17)

Answer: The large size of the US economy allows it to contain more of the division of labor and
economies of scale within its own borders. (p. 17)

52. What are the three main types of economic systems discussed in the chapter? (p. 15)

Answer: Traditional economies, command economies, and market economies. (p. 15)

53. How does Keynes' definition of economics emphasize its role as a way of thinking rather than just a
body of knowledge? (p. 13)

Answer: Keynes said economics is "a method rather than a doctrine" and "an apparatus of the mind"
that helps draw conclusions. (p. 13)

54. What is the key function of markets according to the circular flow diagram? (p. 14)

Answer: Markets allow the division of labor and specialization by enabling households to purchase the
goods and services they don't produce themselves. (p. 14)

55. Why is scarcity considered the fundamental economic problem? (p. 7)

Answer: Because human wants for goods, services and resources exceed the available supply, requiring
choices to be made. (p. 7)

56. How does the chapter describe the relationship between microeconomics and macroeconomics? (p.
12)

Answer: They provide complementary perspectives, with microeconomics focusing on individual agents
and macroeconomics looking at the economy as a whole. (p. 12)

57. What is the role of government regulations in market-oriented vs. command economies? (p. 15)

Answer: Market economies have fewer regulations, just enough to maintain a level playing field, while
command economies heavily regulate economic decisions. (p. 15)

58. How does the circular flow model illustrate the interdependence between households and firms? (p.
14)

Answer: Households provide labor to firms in the labor market, and firms sell goods/services to
households in the product market. (p. 14)

59. What are some examples of globalization's impacts, both positive and negative, on individuals? (p.
16)

Answer: The chapter does not provide specific examples, but globalization can affect individuals through
its effects on trade, prices, jobs, etc. (p. 16)

60. Why is the study of economics important for understanding and addressing major global problems?
(p. 11)

Answer: Because many global issues like poverty, conflicts, and environmental challenges have important
economic dimensions. (p. 11)

61. How does the division of labor increase productivity according to Adam Smith? (p. 9)

Answer: 1) It allows workers to focus on comparative advantages, 2) It encourages learning and

innovation, and 3) It enables economies of scale. (p. 9)

62. What is the key difference between the microeconomic and macroeconomic perspectives? (p. 12)
Answer: Microeconomics focuses on individual agents like households and firms, while macroeconomics
looks at the economy as a whole. (p. 12)

63. Why are a balanced budget and trade balance considered secondary goals of macroeconomics? (p.
13)

Answer: Because growth in living standards is seen as a more direct and important measure of economic
well-being. (p. 13)

64. How does the circular flow model illustrate the concept of markets? (p. 14)

Answer: It shows how households and firms interact as buyers and sellers in both the goods/services
market and the labor market. (p. 14)

65. What are some potential economic benefits and costs of globalization for individuals? (p. 16)

Answer: The chapter does not provide specific examples, but globalization can impact individuals
through trade, prices, jobs, etc. (p. 16)

66. Why is scarcity considered the fundamental economic problem facing society? (p. 7)

Answer: Because human wants exceed the available supply of resources, requiring choices and tradeoffs
to be made. (p. 7)

67. How does the division of labor lead to greater overall productivity according to Adam Smith? (p. 9)

Answer: 1) It allows workers to focus on their comparative advantages, 2) It encourages learning and
innovation, and 3) It enables economies of scale. (p. 9)

68. What is the key difference between monetary policy and fiscal policy as tools of macroeconomic
management? (p. 13)

Answer: Monetary policy involves the central bank adjusting interest rates and credit, while fiscal policy
refers to government spending and taxation. (p. 13)

69. Why do smaller economies like Belgium, France, and Sweden tend to have higher export-to-GDP
ratios than the larger US economy? (p. 17)

Answer: Smaller economies need to rely more on trade across borders to take advantage of
specialization and economies of scale. (p. 17)
70. How does the circular flow model illustrate the interdependence between households and firms in
an economy? (p. 14)

Answer: Households provide labor to firms in the labor market, while firms sell goods and services to
households in the product market. (p. 14)

71. What are some potential economic benefits and costs of globalization that a country might
experience? (p. 16)

Answer: The chapter does not provide specific examples, but globalization can affect a country through
trade, investment, and labor market impacts. (p. 16)

72. Why is the study of economics important for making informed decisions as a citizen? (p. 11)

Answer: Because economics is crucial for understanding and evaluating government policies, regulations,
and budgets. (p. 11)

73. How does the division of labor increase productivity according to Adam Smith's analysis? (p. 9)

Answer: 1) It allows workers to focus on comparative advantages, 2) It encourages learning and

innovation, and 3) It enables economies of scale. (p. 9)

74. What is the key difference between the microeconomic and macroeconomic perspectives in
economics? (p. 12)

Answer: Microeconomics focuses on individual agents like households and firms, while macroeconomics
examines the economy as a whole. (p. 12)

75. Why are balanced budgets and trade balances considered secondary goals of macroeconomic policy
compared to growth in living standards? (p. 13)

Answer: Because improvements in living standards are seen as a more direct measure of economic well-
being. (p. 13)

76. How does the circular flow model illustrate the concept of markets in an economy? (p. 14)

Answer: It shows the interactions between households and firms in both the goods/services market and
the labor market. (p. 14)
77. What are some potential economic upsides and downsides of globalization that individuals may
experience? (p. 16)

Answer: The chapter does not provide specific examples, but globalization can impact individuals
through effects on trade, prices, jobs, etc. (p. 16)

78. Why is the problem of scarcity considered fundamental to economics? (p. 7)

Answer: Because human wants exceed the available supply of resources, requiring choices and tradeoffs
to be made. (p. 7)

79. How does the division of labor increase overall productivity according to Adam Smith's analysis? (p.
9)

Answer: 1) It allows workers to focus on comparative advantages, 2) It encourages learning and

innovation, and 3) It enables economies of scale. (p. 9)

80. What are the key differences between monetary policy and fiscal policy as macroeconomic tools? (p.
13)

Answer: Monetary policy involves the central bank, while fiscal policy refers to government spending and
taxation. (p. 13)

81. Why do smaller open economies tend to have higher export-to-GDP ratios than larger, more self-
sufficient economies like the US? (p. 17)

Answer: Smaller economies need to rely more on trade and specialization across borders to take
advantage of economies of scale. (p. 17)

82. How does the circular flow model illustrate the interdependence between households and firms in
the economy? (p. 14)

Answer: Households provide labor to firms in the labor market, while firms sell goods/services to
households in the product market. (p. 14)

83. What are some potential economic benefits and costs of globalization that a country might
experience? (p. 16)

Answer: The chapter does not provide specific examples, but globalization can impact a country through
trade, investment, and labor market changes. (p. 16)
84. Why is an understanding of economics important for making informed decisions as a citizen? (p. 11)

Answer: Because economics is crucial for understanding and evaluating government policies, regulations,
and budgets. (p. 11)

85. According to Adam Smith, how does the division of labor increase overall productivity? (p. 9)

Answer: 1) It allows workers to focus on comparative advantages, 2) It encourages learning and

innovation, and 3) It enables economies of scale. (p. 9)

86. What is the key distinction between the microeconomic and macroeconomic perspectives in
economics? (p. 12)

Answer: Microeconomics focuses on individual agents, while macroeconomics examines the economy as
a whole. (p. 12)

87. Why are stable prices and full employment considered secondary goals of macroeconomic policy
compared to growth in living standards? (p. 13)

Answer: Because improvements in living standards are seen as a more direct measure of economic well-
being. (p. 13)

88. How does the circular flow model illustrate the role of markets in the economy? (p. 14)

Answer: It shows how households and firms interact as buyers and sellers in both product and labor
markets. (p. 14)

89. What are some potential economic upsides and downsides of globalization that a country might
experience? (p. 16)

Answer: The chapter does not provide specific examples, but globalization can impact a country through
trade, investment, and labor market changes. (p. 16)

90. Why is scarcity considered the fundamental problem that economics seeks to address? (p. 7)

Answer: Because human wants exceed the available supply of resources, requiring choices and tradeoffs
to be made. (p. 7)
91. According to Adam Smith, how does the division of labor lead to increased productivity? (p. 9)

Answer: 1) It allows workers to focus on comparative advantages, 2) It encourages learning and

innovation, and 3) It enables economies of scale. (p. 9)

92. What are the key differences between monetary policy and fiscal policy as macroeconomic tools? (p.
13)

Answer: Monetary policy involves central bank actions, while fiscal policy refers to government spending
and taxation. (p. 13)

93. Why do smaller open economies tend to have higher export-to-GDP ratios than larger, more self-
sufficient economies? (p. 17)

Answer: Smaller economies need to rely more on trade and specialization across borders to take
advantage of economies of scale. (p. 17)

94. How does the circular flow model illustrate the interconnectedness of households and firms in the
economy? (p. 14)

Answer: Households provide labor to firms in the labor market, while firms sell goods/services to
households in the product market. (p. 14)

95. What are some potential economic benefits and costs of globalization that a nation might
experience? (p. 16)

Answer: The chapter does not provide specific examples, but globalization can impact a country through
trade, investment, and labor market changes. (p. 16)

96. Why is an understanding of economics important for making informed decisions as a citizen and
voter? (p. 11)

Answer: Because economics is crucial for understanding and evaluating government policies, regulations,
and budgets. (p. 11)

97. How does the circular flow model illustrate the role of markets in coordinating economic activity? (p.
14)

Answer: The circular flow diagram shows how households and firms interact as buyers and sellers in
both the goods/services market and the labor market, using markets to coordinate their economic
activities.
98. Why are smaller, more open economies like Belgium and Sweden likely to have higher export-to-GDP
ratios compared to larger, more self-sufficient economies like the United States? (p. 17)

Answer: Smaller economies need to rely more on trade and specialization across borders to take
advantage of economies of scale, so a larger share of their economic activity involves exports.

99. How does the chapter describe the relationship between microeconomics and macroeconomics in
terms of their complementary perspectives on the economy? (p. 12)

Answer: Microeconomics focuses on the actions of individual agents like households and firms, while
macroeconomics examines the economy as a whole, but the two perspectives complement each other in
understanding economic issues.

100. What is the key difference between theories and models in the way economists use them to analyze
economic problems? (p. 13)

Answer: Theories are more abstract representations, while models are more applied or empirical, but
the terms are often used interchangeably by economists as analytical tools.