Principles of Macreconomics

Lecture Notes: Basic Economic Concepts

Jae Hun Shim

Economics is the social science that studies how society allocates their limited
resources. Households, firms and governments make optimal decisions subject to
their scarce resources. For instance, Households decide what to buy and how
much they buy within their budget in a goods market, and they decide how many
hours they work within their limited workable time in a labor market. Thus,
economists study the decisions of each economic agencies. Also, economists
explore how the whole economy responses to changes in decisions of economic
agencies and economic conditions.

Market is a place where people engage in economic transactions. In goods

market, households buy goods such oranges and TVs from sellers, and in labor
market, firms hire workers and households provide the labor. Market can be
categorized in a small scale. For instance, in goods market, there are many
markets such as computer market, ice-cream market and furniture market.

The opportunity cost is the value that you give up getting alternative item. A
worker who earns $10 per hour may decide to take a rest for one hour instead of
working and lose $10. The lost value from choosing not to work, $10 is the
opportunity cost of the rest. The opportunity cost may change decisions of
economic agencies such as households, firms, and government because as the
cost raises, you lose more.

Microeconomics is the branch of economics and study decisions of individual

consumers, workers, firms and government. Macroeconomics on the other
hands, study the performance of economy as a whole and examines
macroeconomic variables such as output, the interest rates, inflation, the
busyness cycle, unemployment rates and economic growth. Two branches are
interrelated closely. Changes in behaviors of individual workers or firms also alter
the performance of the economy. For instance, with the higher unemployment
benefits, more people choose not to work and thus unemployment rates increase
and output falls.
Economic rational decision: economics assume that people are rational so that
they purposefully make a best decision among many alternatives to maximize
their utility (happiness or satisfaction gained from consuming goods or leisure).

Economic assumption: Economists use assumption to simply the economy. In

practice, individual consumers and firms are different. Each firms produce
different goods and services using different production factors. Each individual
households have different tendency towards economic outcomes. To simplify the
economy, economists assume that all households and firms are identical, called
generalizations. Also, to examine the impact of changes in one value, economists
use other things being equal assumption. For instance, what happen to
consumption choice of a representative consumer if hamburger price increases
while other prices of goods are constant (other things being equal).

Production factors (Economic resources): To produce goods or services, firms

employ three major production factors. Labor refers to physical and mental
actions to produce goods or services. Land refers to natural resources such as
water, oil, wood, and arable land. Capital refers to all manufactured aids including
machinery, factories, transportation, and tools. The term investment in
Economics refers to spending on capital goods. Because production factors or
economic resources are scare, society makes best allocation decisions.
The circular flow shows a simple model of the economy. In the economy, while in
reality, there are many economic agencies like households, firms, banks,
government and foreigners, this model represents the economy with two parties,
households and firms and they interactive in a goods & service market and
resource market.

In goods and service market, firms produce goods and services and sell them to
households. In return, households purchase those goods from firms and pay
money which are revenues for firms. In resource market, households provide or
sell production resources: labor, capital and land. Firms pay costs of using
resources with the revenues by selling goods. For instance, if you buy a computer
from firms or sellers then with this money, firms pay rents and wages to
households. The circular flow thus, shows how two agencies interact with each
other with a simple graphical model.