ECON125: Macroeconomics Principles, Unit 1 Introduction and Review

This assignment, prepared for ECON125 at the College of Science, Technology and Applied Arts of Trinidad and Tobago, provides a comprehensive introduction to macroeconomics. It covers fundamental concepts such as economics as a social science, distinguishing between micro and macroeconomics, and the significance of microeconomics as a foundation for macroeconomics. The assignment outlines major macroeconomic issues and objectives, including controlling inflation and unemployment, stimulating economic growth and development, and maintaining positive balances on the balance of payments. It utilizes the circular flow model to explain aggregate demand, aggregate supply, and aggregate output, and it discusses the linkages between the key components of the economy, including firms, households, governments, and the rest of the world. Key definitions such as production, consumption, and factors of production are explained, along with the concepts of scarcity, demand, and supply, which are central to understanding macroeconomic principles. The document also explores microeconomic concepts and the choices societies must make due to scarcity and the concepts of marginal costs and benefits, opportunity cost, and rational choice in economic decision-making. The assignment draws from Chapters 1 and 13 of John Sloman's 2006 text.

Aliyah Amisha Ali
Principles of Macroeconomic- ECON125- Co2 Mr. Wayne Bissoo
College of Science, Technology and Applied Arts of Trinidad and Tobago
UNIT 1 - INTRODUCTION/REVIEW LEARNIN OUTCOMES
Upon successful completion of this unit, the participant will be able to:
- Explain economics as a social science and distinguish between the sub-disciplines between
micro and macro economics.
- Discuss the importance of microeconomics as the foundation of macroeconomics.
- Identify and outline the major macroeconomic issues/objectives (Controlling inflation &
unemployment, Stimulating growth & development and maintaining positive balances on the
balance of payments).
- Use the circular flow of model to explain and illustrate aggregate demand, aggregate supply,
& aggregate output
- Discuss the linkages between the major components of the economy (The firms, households,
government and the rest of the world)
Chapters 1 and 13, pgs 3 to 30 and pgs 367 to 394, in John Sloman, 2006
Chapter 1- Introducing Economics
Introduction Economics
Economics has a lot to do with money: with how much money are paid; how much they spend;
what it costs to buy various items; how much money firms earn; how much money there is in
total in the economy. But despite the large number of areas in which our lives are concerned
with money, economics is more than just the study of money.
It is concerned with the following:
 Production of goods and services: how much the economy produces, both in total and of
individual items; how much each firm or person produces; what techniques of
production; how many people are employed.
 Consumption of goods and services: how much the population as a whole spends ( and
how it saves); what the pattern of consumption is in the economy; how much people buy
of particular items; what particular individuals choose to buy; how people’s consumption
is affected by prices, advertising, fashions and other factors.

Aliyah Amisha Ali
Principles of Macroeconomic- ECON125- Co2 Mr. Wayne Bissoo
College of Science, Technology and Applied Arts of Trinidad and Tobago
The Problem of Scarcity
Scarcity is the excess of human wants over what can be produced. Because of scarcity, various
choices must be made between alternatives.
*The central economic problem mainly has to do with scarcity. Given that there is a limited
supply of factors of production (land, labor, and capital), it is impossible to provide everyone
with their wants. Potential demands exceed potential supplies.
At any one time the world can only produce a limited amount of goods and services. This is
because the world only has a limited number of resources. These resources, or factors of
production as they are often called, are of three broad types:
• Human resources: labor. The labor force is limited both in number and in skills.
• Natural resources: land and raw materials. The world’s land area is limited, as are its raw
materials.
• Manufactured resources: capital. Capital consists of all those inputs that have each had to be
produced in the first place. The world has a limited stock of capital: a limited supply of
factories, machines, transportation, and other equipment. The productivity of capital is limited
by the state of technology.
DEFINITIONS
Production- The transformation of inputs into outputs by firms in order to earn profit (or meet
some other objective).
Consumption- The act of using goods and services to satisfy wants. This will normally involve
purchasing the goods and services.
Factors of production (or resources) The inputs into the production of goods and services: labor,
land and raw materials, and capital.
Labor- All forms of human input, both physical and mental, into current production.
Land and raw materials- Inputs into production that are provided by nature: e.g. unimproved
land and mineral deposits in the ground.
Capital- All inputs into production that have themselves been produced: e.g. factories, machines
and tools.

Aliyah Amisha Ali
Principles of Macroeconomic- ECON125- Co2 Mr. Wayne Bissoo
College of Science, Technology and Applied Arts of Trinidad and Tobago
Demand and Supply
Demand and supply and the relationship between them lie at the very center of economics.
Demand is related to wants. If good and services were free; people would simply demand
whatever they wanted.
Supply, on the other hand, is limited. It related to resources. The amount that firms can supply
demand on the resources and technology available.
Given the problem Scarcity, given the human wants exceed what can actually be produced,
potential demand with exceed potential supplies.
Dividing up the subject
Economics is traditionally divided into two main branches- microeconomics and
macroeconomics, where ‘macro’ means big, and ‘micro” means small
Macroeconomics is concerned with the economy as a whole. It is thus concerned with aggregate
demand and aggregate supply.
 Aggregate Demand- The total level of spending in the economy.
 Aggregate Supply- The total amount of output in the economy.
Microeconomics is concerned with the individual parts of the economy. It is concerned with the
demand and supply of particular goods and services and resources: cars, butter, clothes and
haircuts; electrician, secretaries, blast furnaces, computer and oil.
Macroeconomics
Definition- Macroeconomics
The branch of economics that examines the behavior of aggregates- income, employment,
output, and so on- on a national scale.
Because things are scare, societies, and concerned that their resources should be used fully as
possible, and that over time their national output should grow. Macroeconomics problems are
closely related to the balance between aggregate supply and aggregate demand. If aggregate
demand is too high relative to aggregate supply, inflation and trade deficits are likely to result.

Aliyah Amisha Ali
Principles of Macroeconomic- ECON125- Co2 Mr. Wayne Bissoo
College of Science, Technology and Applied Arts of Trinidad and Tobago
Rate of Inflation refers to a general rise in the level of prices throughout the economy. It is the
percentage increase in the level of prices over a 12-month period. If aggregate demand rises
substantially, firms are likely to respond by raising their prices.
Balance of Trade deficits are the excess of imports over exports. If aggregate demand rises,
people are likely to buy more imports.
Recession is where output in the economy decline: in other words, growth becomes negative. A
recession is associated with a low level of consumer spending.
Unemployment is likely to result from cutbacks in production. If firms are producing less, they
will need to employ fewer people. *Note that there is much debate as to who should officially be
counted as unemployed.
The major macroeconomic issues/objectives that governments attempt to address in the economy
are:
 Control inflation rates in the country
 Manage unemployment levels, especially of labor resources
 Stimulate economic growth & economic development in the country
 Maintain positive balances on the balance of payments and the balance of trade
The government uses various strategies that will be further discussed. In order to setup these
strategies governments need information about the performance of the economy in terms of
demand, supply and output.
Aggregate Demand, Supply and Output
Definition- Aggregate Demand (AD)
Measures the total demand for all goods and services in a country over a period of time (Daily,
Weekly, Monthly or Yearly)
Definition- Aggregate Supply (AS)
Measures the total amount of goods and services supplied in a country for a period of time
( Daily, Weekly, Monthly, Yearly)
Definition- Aggregate Output
Measures the total amount of goods that are produced in a country for a period of time ( Daily,
Weekly, Monthly or Yearly)

Aliyah Amisha Ali
Principles of Macroeconomic- ECON125- Co2 Mr. Wayne Bissoo
College of Science, Technology and Applied Arts of Trinidad and Tobago
These measures, and others that will be outlines in the next unit, are important for governments
and policy makers to assess the current position of the economy and help to determine what
should be done in the future.
Recall the two sector Circular flow model with firms and households.
Aggregate Demand (AD) consisted of all the goods and services demanded by the households.
Aggregate Supply (AS) consisted of all the goods & services supplied to the household by the
firms
Aggregate Output is all the goods & services produced by the firms.
This diagram adds the three other sectors of the an open economy with government.
Government, Financial Institutions and the rest of the world via Trade as depicted in the
diagram.

Aliyah Amisha Ali
Principles of Macroeconomic- ECON125- Co2 Mr. Wayne Bissoo
College of Science, Technology and Applied Arts of Trinidad and Tobago
Here you can see that the measurement of AD, AS & Output becomes more complicated as the
number of sectors and activities have increased.
These attempt to illustrate the real world activities of all the sectors of this economy.
The links between these sectors of the economy are relatively straight forward:
Households are units of consumption but are also owners of some of the factors of production
(Land ,Labour Capital & Enterprise)
Firms are units of production and they hire the factors of production from the households to
produce the goods and services. They also pay factor incomes (Rent, Wages & Salaries, Interest
and Profits) back to the households.
Governments play a varied role depending on the amount of government intervention into the
economy. Generally, they levy taxes on the other sectors and redirect those taxes to transfers and
expenditure on goods and services that may not be provided via the market system (e.g. State
Health Care, Education, Road and infrastructural development to name a few areas of
government expenditure).
Governments also borrow money via the Financial Institutions either locally or internationally
to finance some of their activity.
The Rest of the World illustrates the relationship between household, firms, government and
financial institutions with the rest of the world.
Firms will import some items, like machines and raw materials and export finished goods and
services while households will generally import goods and services from other countries.
Governments borrow money internationally to finance some of their activities and investments.
Financial Institutions are intermediaries between all the other sectors to facilitate the movement
of money in the form of capital between them.
This facilitates international and domestic trade, as well as domestic investments that facilitates
growth of firms and industries in the country.
Macroeconomic policy, therefore. Tends to focus on the balance of aggregate demand and
aggregate supply. It can be
 Demand- Side Policy- Which seeks to influence the level of spending in the economy.
This in turn will affect the level of production, prices and employment, OR it can be
 Supply-Side Policy- This is designed to influence the level of production directly.

Aliyah Amisha Ali
Principles of Macroeconomic- ECON125- Co2 Mr. Wayne Bissoo
College of Science, Technology and Applied Arts of Trinidad and Tobago
Microeconomics
Definition- Microeconomics
The branch of economics that examines the functions of individual industries and the behavior of
individual decision-making unit- that is, business firms and households.
Microeconomics and Choice
Three main categories of choice must be made in society because of resources are scarce. These
include:
 What, and how much, to produce.
 How to produce it.
 For whom to produce it.
Marginal Costs and Marginal Benefits.
Economists use the term marginal when referring to additional or incremental. Marginal costs
and marginal benefits are key concepts.
Marginal Costs of production is the change in total production cost that comes from making or
producing one additional unit. To calculate marginal cost, divide the change in production costs
by the change in quantity.
Marginal Benefits is the additional benefit above what you’ve already derived. A marginal
benefit is a maximum amount a consumer is willing to pay for an additional good or service. It is
also the additional satisfaction or utility that a consumer receives when the additional good or
service is purchased.
Choice and Opportunity Cost
Choice involves sacrifice. The more food you choose to buy, the less money you will have to
spend on other goods. The more food a nation produces the fewer resources will there be for
producing other goods.
*Opportunity cost of undertaking an activity is the benefit forgone by undertaking that activity,
in other words the opportunity cost of any activity is the sacrifice made to do it. It is the best
thing that could have been done as an alternative.
Rational Choice
Economists often refer to rational choices. This simply means the weighing-up of the costs and
benefits of any activity, whether it be firms choosing what and how much to produce, workers

Aliyah Amisha Ali
Principles of Macroeconomic- ECON125- Co2 Mr. Wayne Bissoo
College of Science, Technology and Applied Arts of Trinidad and Tobago
choosing whether to take a particular job or to work extra hours, or consumers choosing what to
buy, in other words Rational Choices involves weighing in up the benefit of any activity against
its opportunity.
Rational decision making
Involves weighing up the marginal benefit and marginal cost of any activity. If the marginal
benefit exceeds the marginal cost, it is rational to do the activity (or to do more of it). If the
marginal cost exceeds the marginal benefit, it is rational not to do it (or to do less of it).
Microeconomic objectives
Microeconomics is concerned with the allocation of scarce resources: with the answering of the
what, how and for whom questions. But how satisfactorily will these questions be answered?
Clearly this depends on society’s objectives. There are two major objectives that we can identify:
Economic Efficiency- A situation where each good is produced at the minimum cost and where
individual people and firms get the maximum benefit from their resource.
 Productive Efficiency is a situation where firms are producing the
maximum output for a given amount of input, or producing a given
output at the cost.
 Allocative Efficiency is a situation where the current combination of
goods produced and sold gives the maximus satisfaction for each
consumer at their current levels of income. Note that a redistribution of
income would lead to different combination of good that was
allocatively efficient.
Equity
Even though the current levels of production consumption night be efficient, they might be
regarded as unfair, if some people are rich while other are poor. Another microeconomic goal,
therefore, is that of equity. Income distribution is regarded as equitable if it is considered to fair
or just. The problem with this objective, however, is that people have different notions of
fairness.
Equity is where income is distributed in a way that is fair or just. Note that an equitable
distribution is not the same as an equal distribution and that different people have different
views on what is equitable.
Illustrating Economic Issues.
Illustrations on economics are very important and useful to show relationships between several
economic concepts. Ideas and arguments that might take a long time to explain in words can
often be expressed clearly and simply in a diagram.

Aliyah Amisha Ali
Principles of Macroeconomic- ECON125- Co2 Mr. Wayne Bissoo
College of Science, Technology and Applied Arts of Trinidad and Tobago
Two of the most common types of diagram used in economics are graphs and flow diagrams.
These are:
The Production Possibility Curve
Production Possibility Curve- A curve showing all the possible combinations of two goods that a
county produce within a specified time period with all its resources fully and efficiently
employed.
This diagram is a graph. Like many diagrams in economics it shows a simplified picture of
reality- a picture stripped of all details that are unnecessary to illustrate the points being made.
A production possibility cure is shown above, assuming that some imaginary nation devotes all
its resources-land, labor, capital- producing just goods food and clothing.
A production possibility curve illustrates of microeconomic issues of choice and opportunity
cost. If the country chose to produce more clothing, it would have to sacrifice the production of

Aliyah Amisha Ali
Principles of Macroeconomic- ECON125- Co2 Mr. Wayne Bissoo
College of Science, Technology and Applied Arts of Trinidad and Tobago
some food. This sacrifice of food is the opportunity cost of the extra clothing. The fact that to
produce more of one good involves producing less of the other is illustrated by the downward
sloping nature of the curve. For example, the country could move from point x to point y in
Figure 1.2. In doing so it would be producing an extra 1 million units of clothing, but 1 million
units less of food. Thus, the opportunity cost of the 1 million extra units of clothing would be the
1 million units of food forgone.
It also illustrates increasing opportunity costs. This simply means that as a country produces
more of one good it has to sacrifice every increasing amount of the other. The reason for this is
that different factors of production have different properties. People have different skills; land
differs in different parts of the country; raw materials differ from one another; and so on
*Thus as a nation concentrate more and more on the production on one good, it has to tart using
resources that are less and less suitable- resources that would have been better suited to
producing other goods.
Over time, the production possibilities of a nation are likely to increase. Investment in new plant
and machinery will increase the level of capital.
A Circular Flow Of Goods
The process of satisfying human wants involves produces and consumer. The relationship
between them is two-sided and can be in a flow diagram.
The consumers of goods and services are labelled ‘households’. Some members of households,
of course, are also workers, and in some cases are the owners of other factors of production too,
such as land. The producers of goods and services are labelled ‘firms’ Firms and households are
in a twin ‘demand and supply’ relationship with each other.

Aliyah Amisha Ali
Principles of Macroeconomic- ECON125- Co2 Mr. Wayne Bissoo
College of Science, Technology and Applied Arts of Trinidad and Tobago
Barter Economy- An economy where people exchange goods and services directly with one
another without any payments of money. Workers would be paid with bundles of goods.
Market-The interaction between buyers and sellers.
The circular flow diagram, like the production possibility curve, can help us to distinguish
between microeconomics and macroeconomics.
ECONOMIC SYSTEMS.
The classification of Economic Systems.
All societies are faced with the problem with scarcity. They differ considerable, however, in the
way they tackle the problem. One important difference between societies is in the degree of how
much the government is in control of the economy.
Types of Economic Systems
Centrally planned or command Economy is where all economic decision are taken by the central
authorities or the government of the country.
Free-Market Economy is when all the economic decisions are taken by individual households
and firms and with no government interventions.
Mixed Economy is one where all the economic decisions are made partly by the government and
partly through the market. The problem with mixed economies is that it is “unidimensional” ,
and thus rather simplistic.
*Unidimensional- having one dimension
Many countries fall under the category of having a mixed economy, where there is a mixture of
the government and the market
In many developing countries, much of the economic activity in poorer areas involves
subsistence production.
Subsistence Production is where people produce things for their own consumption.

Aliyah Amisha Ali
Principles of Macroeconomic- ECON125- Co2 Mr. Wayne Bissoo
College of Science, Technology and Applied Arts of Trinidad and Tobago
The Command Economy
The command economy is usually associated with a socialist or communist economic system,
where land and capital are collectively owned. The state plans the allocation of resources at three
important levels:
 It plans the allocation of resources between current consumption and investment for the
future. By sacrificing some present consumption and diverting resources into investment,
it could increase the economy’s growth rate.
 At microeconomic level, it plans the output of each industry of the firm, the techniques
that will be used, and the labor and other resources required by each industry. Industries
are required to perform an Input-Output Analysis.
*Input- Output Analysis- This involves dividing the economy into sectors where each
sector is a user of inputs from and a supplier of outputs to other sectors. The technique
examines how these inputs and outputs can be match to the total resources available in
the economy.
 In a command economy the distribution of output is planned between the consumers.
This will depend on the government’s aims.
Assessment of the Command Economy
High growth rates could be achieved if the government direct a large amount of resources into
the investment. Unemployment can be avoided if the government carefully plans the allocation
of resources and labor in accordance with the production requirements and labor skills.
*National Income could be distributed more equally or in accordance with needs. In practice of a
command economy could achieve these goals only at a social and economic cost. The reasons
are as follows:
 A cumbersome bureaucracy is involved when plans get larger and complicated. Heavier
and more complex economies acquire a greater task of compiling and analyzing data.
 If there is no system of prices, or if prices are set arbitrarily by the state, planning is likely
to involve the involve the inefficient use of resources. It is difficult to access the relative
efficiency of two alternative techniques that use different inputs, if there is no way in
which the value of those inputs can be ascertained.
 If production is planned but consumers are free to spend money incomes as they wish,
there will be a problem if the wishes of the consumers change, Shortages will occur if
they decide to buy less.
 The government might have to enforce plans even if they were unpopular.

Aliyah Amisha Ali
Principles of Macroeconomic- ECON125- Co2 Mr. Wayne Bissoo
College of Science, Technology and Applied Arts of Trinidad and Tobago
THE FREE MARKET ECONOMY
Free decision-making by individuals.
In a free market economy, individuals are free to make their own economic decisions.
Consumers and firms decide what to buy with their incomes. Demand and Supply decisions of
consumers and firms are transmitted to each other through price mechanisms.
The Price Mechanism.
The price mechanism performs as follows:
 Prices responds to shortages (results in prices rising) and surpluses(results in prices
falling).
*NB When demand equals supply, this is called equilibrium price. The graph below shows a
demand and supply where there is an excess supply in demand and supply, the equilibrium
price is present when the demand and supply intersect on the graph.
The effect of changes in demand and supply.
A change in demand- When demand rises, this signals a rise in prices of goods. This then acts as
an incentive for supply to rise. This causes an effect such that that high prices of these good
relative to these costs of production is signaling that consumers are willing to see resources
diverted from other uses. This is a mechanism that firms do. The divert resources from goods
with lower prices relative to costs (hence lower profits) to those goods that are more profitable.

Aliyah Amisha Ali
Principles of Macroeconomic- ECON125- Co2 Mr. Wayne Bissoo
College of Science, Technology and Applied Arts of Trinidad and Tobago
A fall in demand is signaled by a fall in price. This then acts as an incentive for supply to fall.
The good are now less profitable to produce.
A change in demand- A rise in supply is signaled by a fall in price. This acts as an incentive for
demand to rise. A fall in supply in signaled by a rise in price. This then act as an incentive for
incentive demand to fall.
The interdependence of markets
The interdependence of goods and factor markets-A rise in demand for a good will raise its price
and profitability. The suppliers of inputs will respond to this incentive by supplying more. This
can be summarized as follows:
1. GOODS MARKET
 Demand for the good rises
 This creates storage.
 This causes the price of the good to rise
 This eliminates the storages by choking off some of the demand and encouraging
firms to produce market
2. FACTOR MARKET
 The increased supply of the good causes an increase in the demand for factors of
production (i.e. inputs) used in making it
 This causes a shortage in those inputs
 This eliminates those storage by choking off some of the demand and encouraging
the suppliers of inputs to supply more.
Interdependence exists in the other direction too: factor markets affect goods market. The
interdependence of different goods markets. A rise in the price of one good will encourage
consumers to buy alternatives. This is drive up the price of alternatives. This in turn will
encourage produces to supply more of the alternatives.
Assessment of the free market
The fact that a free-market economy functions automatically is one of its major advantages.
There is no need for costly and complex bureaucracies to co-ordinate economic decisions. The
economy can respond quickly to changing demand and supply conditions
In practice, however, markets do not achieve maximum efficiency in the allocation of scarce
resources, and governments feel it necessary to intervene to rectify this and other problems of the
free market. The problems of a free market are as follows:

Aliyah Amisha Ali
Principles of Macroeconomic- ECON125- Co2 Mr. Wayne Bissoo
College of Science, Technology and Applied Arts of Trinidad and Tobago
• Competition between firms is often limited.
• Lack of competition and high profits may remove the incentive for firms to be efficient.
• Power and property may be unequally distributed
• The practices of some firms may be socially undesirable
• Some socially desirable goods would simply not be produced by a private enterprise.
• A free market may lead to macroeconomic instability,
• The is ethical objection, that a free-market economy, by rewarding self-interested
behavior, may encourage selfishness, greed, materialism and acquisition of power.
THE MIXED ECONOMY
Because of the problems of both free market and planned economies, all real-world economies
are a mixture of the two systems.
In a mixed economy, the government may control the following:
• Relative prices of all goods and inputs by taxing or subsidizing them or by direct price
controls.
• Relative incomes, using income taxes.
• The pattern of production and consumption, using legislation.
• The macroeconomic problems of unemployment, inflation lack of growth, balance of
trade deficits and exchange-rate fluctuations by the use of taxes and government
expenditure, the control of bank lending and interest rates, the direct control of prices and
the control of foreign exchange.
The nature of Economic Reasoning
The methodology employed by economists has a lot in common with that employed by natural
scientists. Both attempt to construct theories or models which are then used to explain and
predict.
Models in economics
Economic Models- A formal presentation of an economic theory.
Models are construction by making a general hypothesis about the causes of economic
phenomena. The process of making a general statements of a hypothesis or from a particular
observation is known as induction.
Prediction- This process of making assumptions and drawing conclusions from modes is known
as deduction. When making such deduction, it has to be assumed that nothing else that can
influence the outcome has changed.
Ceteris paribus Latin for ‘other things being equal’. This assumption has to be made when
making deductions from theories.

Aliyah Amisha Ali
Principles of Macroeconomic- ECON125- Co2 Mr. Wayne Bissoo
College of Science, Technology and Applied Arts of Trinidad and Tobago
Economics and Policy
Economists play a major role in helping governments to devise economic policy. In order to
understand this role, it is necessary to distinguish between positive and normative statements. 1
A positive statement is a statement of fact. It may be right or wrong, but its accuracy can be
tested by appealing to the facts. ‘Unemployment is rising.’ ‘Inflation will be over 6 per cent by
next year.’ ‘If the government cuts taxes, imports will rise.’ These are all examples of positive
statements.
A normative statement is a statement of value: a statement about what ought or ought not to be,
about whether something is good or bad, desirable or undesirable. ‘It is right to tax the rich more
than the poor.’ ‘The government ought to reduce inflation.’ ‘Old-age pensions ought to be
increased in line with inflation.’ These are all examples of normative statements. They cannot be
proved or disproved by a simple appeal to the facts.
Chapter 13- The National Economy